Teradata Corporation
Q2 2008 Earnings Call Transcript

Published: 25 Aug 2008

[Operator:]

Good morning and welcome to the Teradata second quarter 2008 earnings release conference call. At this time all participants are in a listen-only mode. (Operator Instructions) Today’s conference is being recorded. If you have any objections you may disconnect at this time. Now I’d like to the call over to Gregg Swearingen, VP of Investor Relations.

[Gregg Swearingen:]

Good morning and thanks for joining us for our second quarter earnings conference call. Mike Koehler, Teradata’s CEO will lead our discussion highlighting Teradata’s second quarter results. After Mike’s remarks, Steve Scheppmann, Teradata’s Chief Financial Officer, will provide more details relating to our Q2 performance. Darryl McDonald, who heads Teradata marketing and strategy, is also in the room and will participate in our Q&A session. Our discussion today includes forecasts and other information that are considered forward-looking statements. While these statements reflect our current outlook, they are subject to a number of risks and uncertainties that could cause actual results to vary materially. These risk factors are described in Teradata’s 10-K and other filings with the SEC. On today’s call we will also be discussing certain non-GAAP financial information, such as free cash flow and results excluding the impact of certain non-recurring items. Reconciliations of non-GAAP financial results to our operating results and forecasted GAAP results, and other information concerning these measures, are included in our earnings release and on the investor page of Teradata’s website, teradata.com. A replay of this conference call will also be available later today on teradata.com. And for those listening to the replay of the call, please keep in mind that the information discussed is as of August 7, 2008 and Teradata assumes no obligation to update or revise the information included in this conference call whether as a result of new information or future results. I’ll now turn the call over to Mike.

[Michael Koehler:]

Thanks, Gregg and good morning everyone. Teradata delivered a solid second quarter led by our international and services business. I was particularly pleased with our operational performance in the quarter with product gross margins improving 110 basis points over Q2 2007 and services margins up 260 basis points. Overall, our operating margins at 20.2% included $9 million of incremental new company costs worth 2 points of operating margin, which if excluded, would have resulted in the second highest operating margin of all quarters in Teradata history. Revenue growth of 6% was driven by a very strong performance in our EMEA region, where revenues were up 33% or 22% in constant currency and by our services business which grew 11% in the quarter. However, continued softness in the U.S. resulted in our overall revenue growth being slightly lower than what we had expected. In the financial services industry, we had excellent revenue growth in every region in Q2 and we continue have good activity and are adding new customers. In early July, after the close of Q2, we announced HSBC as a new customer, one of the largest and most influential financial services institutions in the world. During the past four quarters we have now added as new customers the number one or number two largest banks in five of the top 15 GDP countries in the world. On a global basis, 9 of the 10 largest banks are now using Teradata. We are building a broad-based foundation from which to grow from with the addition of leading customers such as these. Financial services institutions are investing to strengthen their business intelligence infrastructure to operate with better precision and with less risk and lower costs. We also generated good growth in the retail industry in Q2, particularly in EMEA where we had major upgrades including Metro and Otto in Germany, and upgrades at retailers here in the U.S. such as Best Buy, Big Lots and Myers. Retailers continue to look to Teradata to help drive more efficient operations across their enterprises, such as optimizing their supply chains and also to address new initiatives such as customer privacy. The travel and transportation industry also expands good growth. Facing challenges from oil price increases, companies in these sectors have become highly motivated to reduce costs and improve business models. Our solutions and business impact models help these organizations find ways to leverage their data to help meet these goals. In the second quarter we were pleased to see that BNSF Railway was awarded a 21st Century Achievement Award by Computerworld towards innovative fuel saving program utilizing Teradata. In the utility industry, we had a new account win with Xcel Energy, a company with over five million customers in the west and Midwestern U.S. Their new Teradata solution will allow Xcel to identify ways to maximize revenue recovery, reduce costs and improve customer satisfaction, and allows Xcel to manage the massive amounts of real time data being generated from their meters, billing and collection systems. Overall where markets are good, such as in EMEA and most of APJ we continue to see good growth. Conversely, in markets such as the U.S. where we continue to see softness, our revenue growth is challenged. Our win rates in the U.S. continue to remain the same and activity is high. But the scrutiny placed on new large CapEx and OpEx expenditures continues to lengthen our sales cycles. In these softer markets, we’re placing greater emphasis on helping companies reduce costs through data warehousing. Over the years Teradata has developed market leading business impact models to help companies model cost reductions from data mart consolidations as well as data center consolidation initiatives. Consolidating data centers enables strong costs savings with reduced operating and support costs, while providing the benefit of a fully integrated data warehouse for better decision making in these tight economies. In addition, we’ve launched industry-specific entry level data warehouse bundles to accelerate implementation in ROIs for customers. These solutions include industry-specific software tools and consulting along with the Teradata platform. In summary, our full year revenue and EPS guidance remains unchanged, but with the U.S. lower than what we had anticipated entering the year and with EMEA higher. Turning to the longer term picture for Teradata, our fundamentals and business model remain strong. Revenue is our number one priority, and along with that, growing market share. The recently released Gartner Dataquest report, which estimated 2007 market shares for relational database software companies, showed that Teradata grew share and achieved higher revenue growth in 2007 than the overall market. We continue to execute on our four key growth initiatives to position ourselves for higher growth in 2009 and beyond. We are well on our way to adding a minimum of 30 territories in 2008 to expand our market coverage. We continue to drive activity and investments with partners. We’re continuing to invest and grow our consulting services business and we are expanding our platform family. We’ve had a good initial market acceptance and several wins since the launch of our data mart and entry level data warehouse platforms last April. Customer names we can mention include Western Digital, Delta Community Credit Union, Timberland, MDC and the government of Egypt. Our growth initiatives combined with our strong balance sheet and cash flow generation position us well to continue growing our business and increasing shareholder value. Before I turn the call over to Steve, I’d like to remind everyone of the annual Teradata PARTNERS User Group Conference coming up October 12 through the 16 in Las Vegas. I hope to see some of you there. This event is the place to meet and hear from the world’s leading data warehouse practitioners and learn from them about their experiences and best practices. This year we have over 85 customer presentations as well as presentations from the thought leaders in Teradata. We expect have over 3,000 attendees again this year. I hope you can join us and if you are interested, please contact Gregg. Now I’ll turn the call over to Steve, who’ll provide more details about the quarter and for the year.

[Stephen Scheppmann:]

Thanks Mike, and thanks for joining us today. Turning to this family of products in our business model, recurring revenue dynamics and our investments in our growth markets continue to attract customer interest and our pipeline is very active. Our customers continue to focus on the solution that enhances their competitive advantage in the most cost effective manner and supports an accelerated payback. This is the Teradata solution. The following discussion will provide a detailed view of our financial reporting, beginning with our revenue and gross margins. Q2 2008 revenue of $455 million increased 6% on a year-over-year comparison which included a five percentage point benefit from currency translation. We experienced broad-based gross margin expansion throughout our business model. Gross margin improved nicely in Q2 2008; 54.7% compared to 53.5% in the second quarter of 2007, a 120 basis point improvement. The drivers include currency, stronger deal mix, and the continued strength of our maintenance services business. Detailing our performance geographically, Americas’ revenue of $236 million was down 6%, largely due to the continued lengthening of the sales cycles in the U.S. as macroeconomic pressures are causing customers to continually weigh their capital decisions. Revenues in the Americas was up significantly in financial services, in travel and transportation, but down significantly in manufacturing, and to a lesser extent, retail. Gross margin in the Americas regions improved 270 basis points to 58.9% compared to 56.2% in the second quarter of 2007. Gross margin in the Americas improved due to deal mix and the strength of our maintenance services. In EMEA, revenue growth accelerated at an increase of 33% to $128 million, which included 11 points of currency benefit. We saw revenue growth in several different industries, especially in financial, retail, travel and transportation. By country, we saw a good growth in Germany and in France, among others. Gross margin in EMEA region was 53.9%, a 700 basis point improvement from the 46.9% generated in the second quarter of 2007. Gross margin improved due to currency, product volume growth and favorable deal mix. In our Asia-Pacific/Japan region, we reported 10% revenue growth. However, there are a couple of things I would like to point out about APJ’s revenue growth. First of all, the reported growth rate benefit from the 11 points of currency. On the other hand, it was a very tough year-over-year comparison in the second quarter of 2007, our APJ region grew 24%. So the results were decent when considering the tough year-over-year comparison. Revenue in APJ was up in the financial services and manufacturing industries, but down in communications and retail. Gross margin in APJ was 50.5%, down from the 53% in Q2 2007. Within the numbers we generated good improvement in the services gross margins, but saw a decline in product gross margins due to the mix of transactions by country. From the revenue segmentation perspective, product revenue is basically unchanged as the strong growth in the product revenue in EMEA covered the product revenue decline in other regions, largely in the Americas, but also to a lesser extent in APJ. Product gross margin improved 110 basis points to 66.1%. Meaningful improvement in both Americas and in EMEA, while down in APJ due to geographical mix of transactions within the region. Services revenue, which once again provided more than 50% of our revenue, increased 11% to $234 million in the second quarter of 2008. This increase was driven by maintenance services, 20% increase our annuity driver and as a strong foundation for the consistency of our recurring revenue and cash flow model. In all three regions we generated good services revenue growth during the quarter. Services gross margin also improved meaningfully in all three regions, resulting in a 44% gross margin to Q2 2008 versus 41.4% in Q2 2007. The 260 basis point improvement was due to an increase in our maintenance services volume. Now I’ll turn to our expense structure. SG&A increased by $20 million or 18%, largely driven by incremental costs associated with Teradata operating as an independent public company. The $9 million of incremental costs in total with $6 million recorded in operating expenses. The impact of FX of $5 million contributed to the increase. R&D expenses on the income statement decreased $5 million. This decrease was a direct result of the timing of the capitalization of software R&D. Let me be clear however, we are not reducing our investment or spend in engineering. Our gross spend will increase $11 million over 2007. In 2009, you will see more of the expenses we see less capitalization and more expensing of software R&D. Operating income of $92 million of the second quarter improved from $88 million from the second quarter of 2007. Higher volume, a favorable deal mix and the good performance in our maintenance services business more than offset the $9 million of incremental costs associated with Teradata operating as an independent publicly traded company. Included in our results was $5 million of stock-based compensation expense, $1 million more than in Q2 2007. Below the operating income line, Teradata had other income $2 million in the quarter which compared favorably to Q2 2007 when Teradata operated as a part of NCR and did not have interest income. For Q2 2008, our effective tax rate was approximately 27% versus the previously guided 25% for the year. Approximately 1% of this increase in Q2 represents a true-up of the Q1 for a revision to our annual forecasted effective tax rate of 26% on a year-to-date basis. The effective tax rate recognized each quarter is based on the annual estimated effective tax rate calculated on a full year forecasted results and applied on a quarterly basis. Quarterly, the company refines the estimates used to build the effective tax rate. Based on the analysis to-date, the company has currently estimated that the forecasted annual effective tax rate for 2008 will approximate 26 to 27%. The company’s first U.S. tax return on a standalone basis for the post-spin period ending December 31, 2007 is not due until September 2008. Resulting adjustments, if any, from the prior year tax return are required to be reflected as a discrete item or a discrete rate item in Q3 2008. Accordingly, the potential impact of the adjustments, either positive or negative, has not been included in the above estimate of the annual effective tax rate for 2008. GAAP EPS in Q2 2008 was $0.38 compared to $0.27 in Q2 2007. In the second quarter of 2007, Teradata recorded a tax adjustment that lowered EPS by $0.04. Excluding the tax adjustment, non-GAAP EPS in the second quarter of 2007 would have been $0.31. During the second quarter we repurchased 1.4 million shares of stock for approximately $34 million. During the first half of the year, we bought 2.9 million shares for approximately $72 million. We have $182 million remaining on our board authorization for share repurchases. Going forward, we expect to be opportunistic regarding these share repurchases. Turning to the cash flow statement, in the second quarter, we generated cash from operating activities of $85 million, compared to $93 million in Q2 2007. Cash from operating activities was lower in the quarterly year-over-year comparison due to additions to working capital largely due to a higher receivables balance. This was caused by the timing of transactions in the quarter; the FX impact and a higher mix of international revenue where collections typically take longer. After using $25 million for capital expenditures, we generated $60 million of free cash flow, which compares to $66 million of free cash flow in Q2, 2007. Teradata defines free cash flow as cash flow from operating activities, less capital expenditures for property and equipment and additions to capitalized software. Turning to the balance sheet, as of June 30, 2008 we had $367 million of cash and short term investments, an increase of $28 million for the end of March, even after using $34 million for share repurchases in the quarter. Looking forward, we anticipate that in Q3, 2008 our quarterly year-over-year comparison will be tough. This is largely due to the favorable timing of transactions in Q3 2007 when we reported a strong 17% growth in revenues. In Q4, 2008 we should see the benefit of a smaller comparable based on Q4, 2007. With that being said, our current view of our full year guidance based on our 27% effective tax rate in the current exchange rate environment, we continue to anticipate full year revenue growth to be in the 5 to 8% range, consistent with our view at the end of last quarter, more of the growth is expected to come from outside the United States. In terms of our earnings per share, we continue to expect EPS at the higher end of our prior $1.35 to $1.45 guidance range. With that operator, we are ready to take some questions. Thank you.

[Operator:]

Our first question is from Nabil Elsheshai - Pacific Crest Securities.

[Nabil Elsheshai:]

I was just wondering about Americas. You’re a month into the quarter. You talked about delays from Q2. Have you seen those things close at the beginning of Q3? Or seen any change in the macro as you go into the Q3 quarter?

[Michael Koehler:]

We see things pretty much the same as we saw coming out of the first quarter and coming out of the second quarter. Not much change there. The one thing I want to clarify is when we talked about the Americas, it also includes Latin America, where we’ve had very strong growth going on.

[Nabil Elsheshai:]

Yes.

[Michael Koehler:]

My comments will be around the U.S.

[Nabil Elsheshai:]

Fair enough. Then in EMEA, do you break out products in EMEA? Just what growth are you seeing on the product side versus the services side in Europe?

[Stephen Scheppmann:]

It’s not broken out on there on the segment side. Generally speaking, we see strong growth across the product and the services side in EMEA. There is strong growth for both product and services.

[Nabil Elsheshai:]

Okay, so fair enough. Then what about products growth ex-currency? You gave us total revenue ex-currency which would be up above 1%. Products were flat with the currency benefit; what would they be without currency?

[Stephen Scheppmann:]

In EMEA?

[Nabil Elsheshai:]

No. Just overall products number.

[Stephen Scheppmann:]

For overall products number, you’d just assume that the exchange rate impacts it.

[Nabil Elsheshai:]

The same?

[Stephen Scheppmann:]

Relatively consistently.

[Nabil Elsheshai:]

Okay great. Then the last question. On the R&D if you could help me a little bit there. If I would add up in Q2 of last year capitalized and reported R&D, it’s I think $49 million. This quarter the sum is $43 million. I was just trying to figure out the GAAP if you aren’t cutting back in R&D.

[Stephen Scheppmann:]

There’s no cutback in R&D. As I mentioned, the total engineering spend will be $11 million greater in 2008 versus 2007. What you’re seeing is the impact of more costs being capitalized in 2008 compared to 2007. The gross spend is more but the costs under FAS 86, the capitalized amount and the capitalized R&D is greater. As a result, it’s contributing in my comment in 2009 where you’ll see more of that now coming through in 2009 from amortization.

[Nabil Elsheshai:]

Okay, all right. Thanks. I’ll come back in the queue if I have follow-ups.

[Operator:]

Our next question is from Matt Summerville - KeyBanc.

[Matt Summerville:]

With the new wins you’ve had on the newly launched products, has those customers migrated away from maybe originally considering the 5550 down to, say, the 2500? Or are these customers previously really hadn’t had a formal data warehouse strategy?

[Darryl McDonald:]

The customers that Mike mentioned are actually new customers that have bought the new platforms. However, we do have some existing customers that have bought the 2500 in addition to the 5550. An example of that is Safeway, was one of our original customers who bought a specific data warehouse appliance for our marketing application. That’s an example of existing customers buying the new platform. We do have other customers who are looking at older technology, that maybe four or five years old and they look to refresh. Given the technology performance of our new platforms, the 2500 is a good replacement for some of those technologies given the evolution and the performance it brings.

[Matt Summerville:]

How would you characterize the success you’ve had with these new products relative to your own expectations? Could these new products help shorten the duration of the overall sales cycle in the U.S., which again, you’ve described as being pretty consistent with what you’ve seen the last two quarters?

[Michael Koehler:]

The new platforms are more effective and more efficient, Matt, so you’re on a good point. It’ll help shorten the sales cycles. As far as meeting our expectations and the activity and the wins we’ve had so far, I would say it’s roughly on what our expectations were in the get-go. The opportunity here is there is some incremental revenue opportunity but also more efficiency and effectiveness at getting at some of these opportunities with the extended platform family.

[Matt Summerville:]

With respect to your sales force for your territory add plans looking out over the next couple of years, first, has that changed at all? Are you actually pulling more of that into 2008 than maybe you originally talked about? Are we still looking at $100 million in incremental sales in 2010, an additional $50 million on top of that in 2011? And then Steve, could you just remind me what the expense associated with this effort is in 2008 that’s embedded in your guidance please?

[Stephen Scheppmann:]

I believe the 2008 guidance we gave, Matt, and I’ll check, was the revenue and the operating income impact. The revenue I believe was the $100 million in 2010 and $150 million 2011 with 25% operating income and 30% operating income in 2011; those ranges.

[Michael Koehler:]

As far as the number of territories go, Matt, like I said, we’re well on our way to getting 30 plus. And as the opportunity presents itself, we’ll definitely go more. Just seeing how things go here throughout the rest of the year, but we’re well on our way to getting to 30 territories this year that was modeled and those revenue numbers that we gave you on 2010 and 2011.

[Matt Summerville:]

The deals in the U.S., Mike, that you’ve seen pushed in the fourth quarter first and the second quarter, what closure rates would you assign to those deals that have moved?

[Michael Koehler:]

The win rates overall in the U.S. remain the same, so there’s no change in the win rates; it’s this delay and a bubble. You have some revenue that could have been had in the quarter that moves out to the next quarter. Then you get to the next quarter, as the case in Q2, and you have similar movement out again. It’s not a change in win rate issue at all. It’s simply the delays and deferrals and the length of the sales cycles that we’re experiencing in getting closure in a lot of these opportunities.

[Matt Summerville:]

As we think about gross margins in the back half of the year, as you look at your funnel both from a product and service standpoint, how should we be thinking about where your gross margins come in in the back half of after the year? How is the mix of business you see in the funnel now relative to what you had in the second quarter?

[Michael Koehler:]

On the services side, we expect to see the sustained improvements that we’ve seen in the margins in the services business. On the product side, we’re always vulnerable to deal mix. We executed quite well in the second quarter and we ended up with a good product gross margin improvement. As we look at some of the things that are materializing, as we said here, well in the third quarter, we see some mixes of deals that could be lower. A little too early to tell in the game. But I’d say none of this is material, but the caveat is there’s always a deal mix question when it gets to the actual result on the product gross margins in a given quarter. But overall, the trend is extremely positive when you look at the product gross margins in the second quarter. I would also say on a year-to-date basis, because we’ve lost product volume in the first quarter and for the first half. As product volume picks up in the second half, that’s a good guide. That’s a very positive thing that’s going in our direction. The only caveat I got is the deal mix; more volume is upside when we look at the second half of the year.

[Matt Summerville:]

Steve, you mentioned in your prepared remarks growth and support services was about 20%. What was it on the PS side? And then with respect to the tax rate, help me understand why the effective rate for the year is moving up relative to the prior 25%? If the U.S. contribution isn’t as strong as what you originally thought?

[Stephen Scheppmann:]

First question on the PS side, about 5% growth in the quarter. Second, on the effective tax rate. Yes, there’s a lot of moving parts on the effective tax rate. One of it is what you described the allocation of the taxable income by taxing authority and you and I know the U.S. is probably the second highest on the statutory tax rate. But other pieces in there is as we look at allocations of costs and other items within transfer pricing and transfer cost and looking at our estimates for the year and where we see things coming through for the year have changed or have updated our estimates on a full year 2008 basis that drove this increase. We look at on a quarterly basis and adjust those estimates quarterly. But my visibility at this point in time, that’s my best estimate on that effective tax rate coming up from the 25 to the 27%.

[Matt Summerville:]

Okay great thank you.

[Operator:]

Our next question is from Jason Rodgers - Great Lakes Review.

[Jason Rodgers:]

Hello. I was wondering if you could provide the breakdown of revenue by industry as you did in the last quarter?

[Michael Koehler:]

What we said at the last quarter is we’re going to do it on a yearly basis. Quite frankly, in any given quarter the lumpiness at an industry level, it moves around quite a bit. It’s really only good to look at this on an annual basis. We’ll be talking about it at the end of the year.

[Jason Rodgers:]

Okay. And I was wondering if you could make any further commentary on the competitive environment, whether you’re seeing any further inroads by any particular competitor taking market share et cetera?

[Darryl McDonald:]

At this point in time, we’re not seeing any increased competition. There’s always competition out there from the major database providers. However, Teradata is growing its market share. I think as Mike mentioned in the opening comments, Teradata actually moved to the number four position in the database market share worldwide, ahead of Sybase and behind Microsoft. We’re not seeing any increased competition from any particular vendors in the market. It hasn’t been a challenge or an issue for us at this point in time.

[Jason Rodgers:]

Okay. And finally, I was just wondering why you wouldn’t be increasing your guidance at this point with the strong results in the second quarter? I don’t know if you’re seeing any further weakness in the Americas at this point or is it just a function of conservatism or the higher tax rate?

[Michael Koehler:]

As I mentioned, the strong third quarter comp in 2007, we have the higher tax rate coming through, so those are the primary drivers as I look out over the next six months.

[Jason Rodgers:]

Okay, thank you.

[Operator:]

Our next question is from Justin [Harrison] - Ramsey Asset Management.

[Justin [Harrison]:]

Hi, thanks for taking my call. I was wondering if you could break out the gross margins for products and services without the benefits of Forex?

[Michael Koehler:]

No we don’t. It’s included in those numbers and I don’t have it at those levels available publicly.

[Justin [Harrison]:]

Okay. And, probably this is for Darryl. I was just wondering if you had any either thoughts positive or negative from the acquisition of Microsoft’s DATAllegro. I know they were a small player, but targeted the high end. Does that help you; hurt you or what are your thoughts on that?

[Darryl McDonald:]

My initial comments are that, we are a strategic partner with Microsoft. As you know, we’re one of the partners that they go to market with with their business intelligence stack with a custom built adapter into Teradata. We’ll continue to go to market and support Microsoft from a business intelligence and analytical partnership. At the same time, we did compete with them when Microsoft Sequel Server would tried to compete with Teradata. I think with the acquisition of DATAllegro, that will continue. From our perspective, DATAllegro was not a big competitor in the market place. We hadn’t competed with them probably in the last two years in the market place. I think it’s probably a good acknowledgment that being able to scale into the 100s of terabytes in the enterprise data warehouse space is something that a lot of our competitors are aspiring to do. I think it’s something that Teradata does today. We’ll keep an eye on future announcements that Microsoft will make about DATAllegro. But as of now, we’ll support our strategic partnership on the business intelligence side and we’ll compete to head-on as it relates to Microsoft Sequel Server and DATAllegro.

[Justin [Harrison]:]

Okay. Thank you.

[Operator:]

Our last question comes from Matt Summerville - KeyBanc.

[Matt Summerville:]

Two quick follow-ups. First, over the last couple of quarters have you seen much in the way of change in terms of average deal size? Have there been any new trends with respect to pricing? Then the other question being if you could just comment on new customer wins year-to-date, if you can provide some number around how many new customers you’ve added thus far in 2008?

[Michael Koehler:]

Regarding pricing, I think the best indicator there is when you look at our product gross margins year-to-date, it would indicate we’re having good results in that area. We don’t report on new customer wins. I won’t provide that data point, other than we’ve had some pretty good wins; the names that we can mention, like HSBC. The quality in new account wins I’m very pleased with, as well as the quantity. On the deal size, not much change in deal size. The issue we have is what Teradata represents to companies for its non-services business is new, large CapEx decisions. It’s not something that’s part of a longer-term project. These are discrete new large CapEx decisions and that is basically the challenge we have in the U.S., Matt.

[Matt Summerville:]

Great, that’s all I have. Thank you.

[Michael Koehler:]

With that, I’d like to thank all of you for joining us. Once again we are very pleased with the results here in the second quarter. Operationally very strong; good business model that’s intact. Our number one priority is getting after the revenue, not only for the balance of 2008 but keeping the investments going in our strategic growth initiatives for the longer term. With that I’d like to thank everyone for joining the call.