Teradata Corp

NYSE:TDC

Earnings Call Transcript 2018-Q3

[Operator]

Good afternoon. My name is Kelly, and I will be your conference operator today. At this time, I would like to welcome everyone to the Teradata Q3 2018 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the prepared remarks, there will be a question-and-answer session Thank you.

I would now like to turn the call over to Gregg Swearingen. Please go ahead.

[Gregg Swearingen, Teradata Corp.]

Good afternoon. Thanks for joining us for our 2018 third quarter earnings call. Vic Lund, Teradata's President and CEO, will be on our call today. Oliver Ratzesberger, our Chief Operating Officer, will then provide an update on our strategy, product offerings, and customer use cases. Then CFO Mark Culhane, will discuss our financial results and guidance.

Our discussion today includes forecast 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 differ materially. These risk factors are described in Teradata's 10-K, 10-Q and other filings with the SEC.

On today's call, we will be discussing certain non-GAAP financial information, which excludes such items as stock-based compensation expense and other special items described in our earnings release, including acquisition, reorganization, and transformation-related costs, asset impairments, and capitalized software development costs.

We will also discuss other non-GAAP items such as free cash flow and constant currency revenue comparisons. A reconciliation of our GAAP results to our non-GAAP results and other information concerning these measures is included in our earnings release and on the Investor page at teradata.com. A replay of this conference call will be available later today on our website.

Teradata assumes no obligation to update or revise the information provided during this conference call, whether as a result of new information or future results.

And now, I will turn the call over to Vic.

[Victor L. Lund, Teradata Corp.]

Good afternoon, everyone, and welcome to our third quarter earnings call. The highlight of the quarter for me was our 82% subscription uptake. This number obviously exceeded the guidance we gave you as well as our plan. When you adjust for this number, our revenue performance exceeded the high end of our guidance. You also saw that our earnings per share exceeded the high end of our guidance range.

Our success is being driven by our strategy which is focused on our unique customer set, not the market broadly. Our market segment is the 500 largest analytically driven companies in the world and they account for over half of the total technology spend globally. They have characteristics which make them unique in the world of analytics.

First, they generate a large amount of data that is growing exponentially. Second, they have very large investments in their data ecosystem which consist of thousands of data instances, obviously driving complexity. Third, we view that their ecosystem is going to remain a hybrid environment for the foreseeable future. And finally, they're very smart and they require unique answers to the questions they have about their business. Obviously dealing in this environment requires the ability to perform at scale.

They understand that hope is not a strategy, that there isn't going to be a bright, shiny object that's going to appear on the horizon to deliver analytic solutions for them. This journey is filled with hard work, it requires a strategy that considers their existing investment, the risks they encounter and the difficulty associated with their complex environments.

It requires a partner who understands scale and has a history of delivering outcomes. Teradata is that partner. They know and trust us. And so, our involvement with them has been increasing and delivering our improved performance.

Either way, this assessment is not ours only. There is a body of independent research starting to appear that supports our assessment of our customer base and why they are unique, and why they require unique solutions. Gregg will be happy to share some of that research with you, if you are interested in it.

In closing, I'd like to thank our customers for giving us the opportunity to prove that Teradata is delivering answers to the unique questions they have. We are grateful that you took the time to listen and understand that we are in fact a unique and new company. I'd also like to thank our teams who through the change have managed to stay focused and delivered strong operating performance quarter-over-quarter.

With that, I'll turn it over to Oliver.

[Oliver Ratzesberger, Teradata Corp.]

Thanks, Vic, and good afternoon, everyone. Since we last spoke, we have made significant advancements in redefining and repositioning our business. I'm excited to talk about what we have achieved. We have been hard at work and it has been very productive.

Today, I will underscore three key takeaways. First, we set a new course to find a new strategy and we launched our bold new brand positioning. Second, we introduced Teradata Vantage, our powerful new analytics platform. And third, our commitment to customers remains at the center of everything we do, validated by a phenomenal response from our customers as they realize the value in having the answers they need.

Just 24 months ago, we began our business transformation journey and set a new course for Teradata to innovate and devise new solutions to address the challenges the digital world is creating, a world where the ability to rapidly turn information into actionable insights has become an absolute competitive necessity. We challenged the industry to think differently about analytics, resulting in creating a brand new category, we call it, pervasive data intelligence.

Pervasive data intelligence defines the value we deliver to our customers. The ability for companies to deliver answers to their toughest business problems. And at Teradata we do it at scale anywhere and anytime. This means we deliver real time intelligent answers leveraging 100% of our customers' relevant data, regardless of scale or volume all the time. We provide the answers across any infrastructure. Our industry leading technology offers choice and flexibility whether deployed as-a-service, across public clouds, on-premises or in a hybrid environment.

Earlier, Vic spoke about the challenges today's business leaders are up against. Every day, the team at Teradata is focused on overcoming these challenges by enabling the world's leading enterprises with the largest analytic opportunities to rise above the complexity, cost and inadequacy of today's analytics landscape and deliver answers that matter to their business.

Armed with a bold new strategic direction, we determined now was the time to reposition and amplify our brand. In October, we introduced a new Teradata brand and mission to transform how businesses work and people live through the power of data. Concurrent with our new positioning, we also formerly named San Diego as our new corporate headquarters.

We are confident that our bold and authentic brand firmly positions us to lead the new direction in analytics, and we enthusiastically embrace our role as the leading provider of hybrid cloud analytics software. During this reinvention, we remained focused on technology innovation and launched the new Teradata Vantage, our next-generation analytics platform.

Vantage empowers our customers to leverage all of their data, all of the time so that they can analyze anything, anywhere, and deliver analytics that matter. With this launch, we purposefully move beyond enterprise data warehousing as Teradata Vantage allows enterprises to uncover actionable answers to their toughest business questions. Vantage does this by tightly integrating the best analytic functions and engines to provide a scalable, agile platform that enables enterprises to drive business value at the scale they need.

Users are able to access and analyze all of their data without having to learn a new tool or language or worry about where the data is located. Vantage also provides access to a wide variety of descriptive, predictive and prescriptive analytics, autonomous decision-making, machine learning functions, visualization tools and more, and all deployed across public clouds, on-premises, or on optimized or commodity infrastructure or as-a-service. This streamlined access is also by Vantage's integration with popular third-party tools and analytic languages meeting users where they are and allowing them to work in the environment they already know best.

As automation increasingly drives business, artificial intelligence and machine learning have become essential to help enterprises scale to compete in the digital cloud-based data-driven world. But as that scale increases, so does the sheer volume of data. Only Teradata Vantage enables AI and machine learning to scale and deliver timely actionable answers faster across the organization. This, in turn, feeds a stronger return on investment for the business.

Together, these functions and capabilities make Vantage the most powerful and flexible tool available for uncovering reliable, rapid, actionable intelligence and bring pervasive data intelligence to reality for our customers. I mentioned earlier that we are committed to keeping our customers at the center of everything we do. And just two weeks ago, we held our Teradata Analytics Universe Customer Conference, and the response to our new brand and positioning in Teradata Vantage was nothing short of amazing.

Speaking of amazing, I'd like to share some recent customer wins and use cases that demonstrate our momentum. We added a large U.S. hospital and healthcare services company at a new customer replacing Netezza and other competitors as it realized the benefits of our healthcare industry expertise and focus on business outcomes.

A longstanding U.S. government customer migrated its Teradata environment to the public cloud and leveraged new analytics to drive improved performance. A Fortune 100 manufacturer increased its consumption of the Teradata software to improve the efficiency of its supply chain and increase uptime of its fleet.

One of the world's largest banks is now using Teradata to drive better customer service by consolidating customer inputs from numerous channels to get to real root causes. We displaced Oracle at one of the largest healthcare companies in the world helping the company modernize its analytics environment and thereby increase consumption of Teradata.

A multinational financial and credit card company added a new use case to its Teradata environment to support its new digital identity product for consumers. We significantly increased consumption of Teradata at a global technology company as it migrated to the public cloud.

I've just gone through a partial list but you can tell that what we are seeing is very positive customer traction across industries and geographies. I can confidently declare that we are all in as we challenge the status quo in analytics. Our Teradata team is proving every day that we are transforming how businesses work and people live through the power of data.

As I mentioned earlier, this has been a very productive time for us. We've defined our new strategy, launched our bold new brand, delivered one of the most significant offers in our history and increased customer uses, and we aren't going to stop anytime soon.

I would like to use this public opportunity to thank the entire Teradata team for rising above and delivering an incredible body of work. Being a part of this transformation is energizing and is extremely rewarding, and I look forward to sharing more during our upcoming Analyst Day. Thank you.

And now let's turn the call over to Mark.

[Mark A. Culhane, Teradata Corp.]

Thanks, Oliver, and good afternoon, everyone. We achieved another solid quarter. Our third quarter performance was highlighted by our continued accelerated movement to subscription transactions as we saw more transactions completed via subscription in Q3 than expected. Our strategy is clearly working, and the shift to subscription is happening even faster than expected just 90 days ago.

In Q3, 82% of our bookings were subscription based, which year-to-date puts us at 71%. The pace of our transition to subscription continues to exceed our internal expectations, and we now expect the subscription-based component of our bookings mix for full-year 2018 to be at the high end or slightly above our previously expected range of 65% to 70%.

Given more transactions shifted to subscription than expected, our reported revenue in Q3 was $526 million, flat with prior year and a 2% increase in constant currency. We had a large perpetual transaction on the last day of the quarter switch to subscription based, which resulted in our reported revenue being slightly below our guidance range. Had this transaction closed as we expected as a perpetual transaction, we would have exceeded the high end of our guidance range.

Just as we experienced in Q2 where a forecasted subscription based transaction went perpetual resulting in significant upside to our revenue expectation. This quarter, we experienced the opposite, with the customer deciding on the last day of the quarter to switch from a perpetual purchase of Teradata to a subscription purchase, which we will always favor over a perpetual transaction. As it ultimately benefits us in the long run as it will add future significant ARR and benefit recurring revenue going forward.

Recurring revenue which includes revenue from subscription based transaction and perpetual license related maintenance and upgrade rights was $312 million in Q3, a year-over-year increase of 7% or 9% in constant currency. As we mentioned on our Q2 earnings call, we incurred significant foreign currency headwinds which resulted in Q2 ARR growth, net of FX in low-single digits.

That impact coupled with approximately 1.5% of additional FX headwind in Q3 impacting revenue during the quarter and traditional back-end loaded subscription based bookings not significantly contributing to recurring revenue during the quarter, resulted in Q3 recurring revenue flat with Q2 2018.

Perpetual software license and hardware revenue, which is revenue from on-premise perpetual transactions was $77 million, a year-over-year decrease of 14%. We continue to expect that perpetual revenue will decline year-over-year as our bookings mix shifts more towards subscription-based transactions.

Since most customers are purchasing software on a subscription basis, but some purchased their hardware up front, the majority of our perpetual revenue is now hardware related. And consulting revenue which was $137 million in Q3 decreased 5% from Q3 2017. As a reminder, we have shifted our strategy to focus on the top 500 analytical opportunities.

Correspondingly, we are focusing our consulting group on engagements that lead to increased consumption of Teradata's software within the top 500. As a result, we expect our overall consulting revenue to decline as we reduce our focus on non-top 500, lower-value, lower margin-related services. However, we expect our consulting margins to improve as we focus more on higher-value and higher-margin business consulting.

ARR growth for Q3, prior to negative currency impacts, was $35 million, $29 million after inclusion of negative currency impact, which results in total ARR at the end of Q3 of $1.24 billion. Within total ARR, subscription-based ARR increased more than 150% year-over-year. As our bookings mix continues to shift more to subscription, we see our subscription-related ARR growing while ARR related to maintenance and upgrade rights from our prior perpetual business is declining as customers shift to subscription.

Our backlog was approximately $1.9 billion, an increase of 2% from June 30, 2018, 13% increase from yearend 2017 and 55% increase from the end of Q3 2017.

Before I continue to highlight our Q3 operating results, please note unless stated otherwise my comments today reflect Teradata's results on a non-GAAP basis, which excludes items such as stock-based compensation expense and other special items identified in our earnings release.

EPS in the third quarter was $0.36 higher than both our guidance range of $0.30 to $0.32 and higher than $0.29 reported in Q3 2017. The upside in EPS was driven by our continued focus on operational spending, which resulted in higher overall gross margin and operating expense performance.

Turning to gross margin. Gross margin of our recurring revenue was 72.4% versus 73.3% in Q3 2017. As expected, the mix of our current recurring revenue includes more subscription based revenue versus perpetual maintenance revenue than the prior year. We expect our recurring revenue margin to be approximately 70% in the fourth quarter of 2018 and low 70s for the year but to improve over the longer term as we gain efficiencies and leverage our subscription related investments.

Gross margin of our perpetual revenue was 50.6% as compared to 54.4% in Q3 of 2017. The lower margin as compared to prior year was due to the current year revenue mix being predominantly hardware related versus a higher portion of software in the prior year.

Given our current forecast and expectations for Q4 perpetual transactions, we expect perpetual revenue margins in Q4 to be mid-40s range and to be in the low 40s range for the full year. And gross margin of our consulting revenue improved to 9.5% compared to 4.9% in Q3 2017. We expect the margins to continue to improve significantly in Q4 as we continue our focus on making operational improvements and due to the seasonal profitability trend of this business.

We continue to expect our consulting margins to be approximately 10% for the full year and to continue to improve going forward as we better align our consulting business to the strategy of the company. Overall gross margin was 52.9% in the third quarter versus 51.3% in the third quarter of 2017. We expect gross margins in Q4 to be low 50s range and to be approximately 50% for the full year.

Turning to operating expenses, selling, general and administrative expenses were $144 million in Q3, decreasing $4 million or 3% from the third quarter of 2017. We expect SG&A expense to increase in the fourth quarter due to seasonally higher sales commissions as well as our increased marketing activities related to our rebranding of the company and our annual Teradata Analytics Customer Conference.

Research and development expense was $78 million versus $70 million in the third quarter of 2017. We expect R&D expense in Q4 to be slightly lower than the Q3 level.

Operating margin for the quarter was 10.6% versus 9.9% in Q3 2017. We expect operating margin in Q4 to improve slightly from Q3 and to improve longer term as we continue our focus on operational spend. Teradata's non-GAAP tax rate of 17.3% for the third quarter was lower than the 26.5% rate in Q3 2017 as expected largely due to the 2017 U.S. tax reform. We continue to expect our full year tax rate to be approximately 20% and expect a fourth quarter tax rate in the high-teens.

Turning to cash flow, net cash used in operating activities was $33 million in Q3 2018 compared to $8 million used in the third quarter of 2017. Capital expenditures were $35 million in Q3, an increase from $32 million in Q3 of 2017. The increase in CapEx was, as expected, primarily driven by capital improvements to our San Diego headquarters and the increased mix of transactions moving to subscription.

As a result, free cash flow for the third quarter was negative $68 million which was roughly what we expected. Based on our current view of subscription and perpetual transaction in Q4, we continue to expect full-year free cash flow in the $175 million to $200 million range.

As of September 30, 2018 cash was $768 million. During the third quarter, we bought $49 million of Teradata stock or approximately 1.2 million shares.

Through the end of the third quarter, we bought approximately 5.4 million shares for $206 million leaving us with $338 million of share repurchase authorization remaining at the end of the third quarter.

Turning to guidance, our outlook for Q4 and full year is based on our current expectations of forecasted Q4 transactions going perpetual versus subscription which as we have experienced the past two quarters can be very fluid.

Currently, we continue to expect total revenue in 2018 to be in the $2.13 billion to $2.15 billion range despite the business shifting faster to subscription as well as almost an additional percentage point increase in currency headwind versus 90 days ago. This translates to expected Q4 revenue of $555 million to $575 million, which is predicated on perpetual revenue in the $75 million to $95 million range, and consulting revenue lower than the prior year Q4 by approximately 2%.

In terms of EPS for the full year, we expect $1.22 to $1.26. This is based on full-year weighted average shares outstanding of approximately 122 million. And for the fourth quarter, EPS is expected to be in the $0.41 to $0.45 range, based on 120 million weighted average shares outstanding in Q4.

Now, I'd like to provide you with an update on our full-year expectations for the following key metrics. In terms of ARR, after adjustment for 1.5% of currency headwind, we expect approximately 10% growth in 2018 due to accelerating activity in Q4. Keep in mind, this currency impact is on a base of over $1.2 billion of ARR.

We expect recurring revenue to increase approximately 9%, as reported, and in constant currency. And we expect new bookings subscription mix to be at the high end of our previous guidance range of 65% to 70%, if not slightly higher.

As I close, I wanted to mention I attended the Teradata Analytics Universe Customer Conference a few weeks ago. At the conference, I spent a significant amount of time talking with our customers. It is very clear from those discussions that customer engagement is up and that our Teradata Everywhere strategy resonates with them. And most importantly, customer interest in our newly available Vantage analytics platform is very high, which significantly broadens our market opportunity.

I was pleased to hear customers speak favorably about our strategy and that they clearly believe it's now easier to work with and buy from Teradata. This is extremely positive for the future of the company and our financial results.

And with that, operator, we are ready to take questions.

[Operator]

Your first question comes from the line of Derrick Wood from Cowen & Company. Please go ahead.

[J. Derrick Wood, Cowen & Co. LLC]

Great. Thanks. And congrats, it sounds like you guys beat your Q3 bookings expectation. And I guess my first question is on Q4, and your guide for Q4 is now higher than what the implied Q4 guide was previously. I'm curious, is this generally due to the strong subscription bookings in Q3 coming fully recognized in Q4 or is there something else in your Q4 pipelines that are incremental versus what you saw a quarter ago?

[Mark A. Culhane, Teradata Corp.]

Yeah. Thanks, Derrick, this is Mark. So, yes, it's both. Clearly, we had a strong subscription bookings quarter in Q3 and that starts to flow through Q4. And secondly, yes, our pipeline of activity in Q4 is more robust than what we were expecting a quarter ago. So, it's a combination of both.

[J. Derrick Wood, Cowen & Co. LLC]

Okay. And then a question on Vantage. I mean, the product direction really shows you guys focus more on software than hardware, and I think that should help with your strategy to focus more on line of business versus IT. So – and as you roll out the focus on the Vantage architecture, do you see this as being a near-term catalyst in targeting new application use cases, new users and maybe a boost on growth or is this – you guys have long sales cycles, is this something that will take longer to play out? And maybe you could just share some feedback that you've gotten on Vantage. Thanks.

[Oliver Ratzesberger, Teradata Corp.]

Yeah, Derrick, this is Oliver. Yes, so, we absolutely see Vantage a driver for adoption by business and lines of business in our various customers. This is really the next generation of our strategy. We started with Teradata Everywhere, we've now elevated our offering with Vantage to a level above of that building on the strength of Teradata Everywhere. And for those of you that have been at the Teradata Analytics Universe user conference, you've actually heard customers talk about Vantage. We had speakers up on stage that talked about their experience of Vantage and how game changing Vantage is to their ability from ideation to production rollout of advanced models, machine learning.

We had one customer up on stage that said, we can now score and rollout against 200 million or 250 million customers and prospects in under 35 minutes from idea to production rollout, and that's powered by Vantage. So, this is clearly resonating with the customer base. And, yes, we absolutely see that this will be one of our big accelerators of our strategy going forward.

[J. Derrick Wood, Cowen & Co. LLC]

Great. Thanks for the color.

[Operator]

Your next question comes from the line of Wamsi Mohan from Merrill Lynch. Please go ahead.

[Param Singh, Merrill Lynch, Pierce, Fenner & Smith, Inc.]

Hi. Thank you. This is Param Singh on for Wamsi. Firstly, I just wanted to get a sense of what subscription mix is going hosted. Was this, say, on public cloud platforms like AWS? And with the higher amount of subscription, what does that mean for CapEx going into calendar 2019?

[Mark A. Culhane, Teradata Corp.]

So, this is Mark. We don't break out the cloud versus on-prem, but the vast majority still continues to be on-prem. This is going to be a hybrid environment for a long time in the top 500 market we serve and the enterprise-class workloads that we deal with. As it relates to 2019, we'll provide more commentary on 2019 both at our Analyst Day and ultimately on our Q4 call.

[Param Singh, Merrill Lynch, Pierce, Fenner & Smith, Inc.]

Got it. So, just one follow-up call, I guess on the cash flow, do you think that could be tempered into the following year given the higher subscription mix or do you expect it to stabilize there?

[Mark A. Culhane, Teradata Corp.]

No, I continue to say and I've said for the last couple of quarters now that it's possible that 2019 grows over 2018 depending on where we land on subscription mix. That has a big driver to that in terms of free cash flow. As that free cash flow – as the business moves to subscription that does have free cash flow impacts but we have ways to moderate and finance those kinds of impacts and we're doing some of that which you saw in the quarter.

[Param Singh, Merrill Lynch, Pierce, Fenner & Smith, Inc.]

Okay. I'll get back in queue. Thank you.

[Operator]

Your next question comes from Raimo Lenschow from Barclays. Please go ahead, your line is open.

[Raimo Lenschow, Barclays Capital, Inc.]

Hey. Thanks. Can I stay on that subject, Mark. So, if I look at the cash flow number this quarter, obviously it was a little bit lower than people have modeled. Is that kind of directly linked to the better subscription performance? So, going forward, if you have a strong subscription quarter that kind of often comes with a lower cash flow quarter, is that the right way to think about it for the next couple of quarters where you're still going for this?

[Mark A. Culhane, Teradata Corp.]

So, there's a few things here. Yes, higher subscription quarters can have impacts on free cash flow. But again, we will look to finance some of that free cash flow impact as well. And so, to help moderate that.

Two, we mentioned on the call, in my prepared remarks we shifted our headquarters to San Diego and we clearly spent money on our corporate headquarters. And the third thing we announced was as part of that is the relocation of folks out of Dayton to here and the impacts of moving out of Dayton which will have some impact as well. That's what drove the free cash flow results in Q3. Those were the three primary drivers. Going forward, it will be subscription versus perpetual and what does that ultimately look like.

[Raimo Lenschow, Barclays Capital, Inc.]

Okay. Perfect. And maybe one follow-up for Oliver. And so, obviously we have quite a bit of movement in the analytics industry. We saw the Cloudera-Hortonworks merger, etcetera. Can you just talk a little bit to what you see in terms of when you talk with customers obviously with Vantage you have a very unique offering. Like, in the past, people kind of (38:16) Hadoop but that thinking has changed. Like, how's the understanding of the customers evolving in terms of what Teradata stands for versus what other guys are doing in the industry?

[Oliver Ratzesberger, Teradata Corp.]

Yeah. I'd be happy too. So, the number one theme that we are seeing today with executives in the largest companies, which is as we keep reminding everyone, that is our go-to-market segment, right? In the largest companies, we have seen that companies have adopted almost endless technology in the last 10 years.

Many of them have hundreds, even thousands of data silos by now. They have almost every – any technology that they could get their hands on in one form or another. And a lot of these executives are now saying we can no longer sustain the complexity in our business model, the amount of head count required to run hundreds or thousands of data silos within these organizations. Again, this is a very typical scenario for very large-scale, high-end companies that we are focusing on.

And increasingly, they're – they are coming to us and saying, this has run out of control. We need to simplify that. We need to consolidate. We need to get rid of one off data silos. And this is where we feel and we know that Teradata is uniquely positioned.

Because a lot of the competitors out there in the market are – kind of the problems for some of these technology silos, because they only operate at a departmental level, they can only work at smaller scale, they can only work with lower users. And so, this is why our focus has been so important to us. It's really helping these customers simplify that. And with Vantage, that message that we started with Teradata Everywhere has gotten to a new level with these customers.

And so, when we talk right now to top executives with customers around the world, quite often the topic of complexity is front and center with them comes up and basically it helped us eliminate dozens, if not hundreds of data silos. We know Teradata can do it and that we know that the TCO is a lot lower than us spending so much money with so many point solutions.

[Raimo Lenschow, Barclays Capital, Inc.]

Perfect. Thank you. Well done.

[Operator]

Your next question comes from the line of Phil Winslow from Wells Fargo. Please go ahead, your line is open.

[Philip Winslow, Wells Fargo Securities LLC]

Hey, thanks, guys, for taking my question. And appreciate all the color on the quarter in terms of FX impact. Just a couple of follow-ups to that. First, in the recurring guidance thank you for that for Q4, I wonder if you can kind of delineate what the currency impact there is for Q4? And then as you sort of start to look into next year and as we model forward, just trying to get a sense of what impact the currency impact will linger into next year? And just one quick follow-up to that.

[Mark A. Culhane, Teradata Corp.]

Yeah. So, we've said we expect another point of currency headwind coming into Q4. So, it'll be 2 points, we expected 1 point of headwind walking into the quarter now it's 2. So, it's up 1 point from what we thought a year ago. What it would be in 2019, we don't know till we get to the end of the year and start to see – I mean we can't, we can't try to forecast what we think foreign currency is going to do or not going to do. But it's clearly been a headwind for us and everyone else over the course of the last few quarters.

[Philip Winslow, Wells Fargo Securities LLC]

Got it. And then just a follow-up on the competitive front here. You mentioned Oracle. And obviously in your last question, you just talked about the couple – the core Hadoop players. What has the feedback been? Obviously, Vantage, you just talked about that a couple of weeks of ago, unleashed that vision on the marketplace. Just what was the early feedback? And then in terms of the competitive displacements you saw this quarter, what were the drivers behind those?

[Oliver Ratzesberger, Teradata Corp.]

Yes. So, on the feedback, we've got – first of all, we've got several customers lined up very earlier this year as alpha/beta customers because the interest was already very high beginning of the year, even before we publicly announced the availability. As we announced that, just to give you a little stat from our Analytics Universe conference that we just had a couple of weeks ago, we have planned 450 seats of hands-on share Vantage experience. We were oversubscribed by about 600 people just at the conference just wanting to get their hands on this.

Coming out of the conference, we have a lot of quotes and a lot of statements from customers saying that this is really hitting the mark. This is really what they are interested in. They want to move from departmental point solutions from technology to focusing on answers and outcomes. And as such, the brand and the offering that we launched with Vantage is resonating very well with the customer base. So, early indications are very promising and the funnel is very interesting for us.

[Philip Winslow, Wells Fargo Securities LLC]

Got it. And the next question, the second quarter. Yeah.

[Victor L. Lund, Teradata Corp.]

So listen Vic. I'll get that. The other thing I would say about Vantage, that is really striking a chord with the customers is the ability to think about analytics on an enterprise scale. And that is opposed to biting off different solutions that you end up just compounding problems. The ability to attack your analytics future from an enterprise scale is playing very, very well with our customers.

In fact, that gets more interest early on with business people when I talk about it because it allows them to have a predictable timeframe where they can gauge their investment, their returns and their ability to drive analytics as they're ready for it. And that's a really important difference, the enterprise versus the point solution here.

[Philip Winslow, Wells Fargo Securities LLC]

Got it. Thanks, guys.

[Operator]

Your next question comes from line of Dane Crane from Bernstein Research (44:38). Please go ahead. Your line is open.

[Unknown Speaker]

Hi. Thanks for fitting me in. A question for Mark on the subscription or the recurring revenue growth. It looks like ratable bookings mix is increasing a lot faster than you expected, yet there's not really an increase in your constant currency guidance for recurring revenue growth.

I'm wondering why recurring revenue is expected to grow even faster for the full year given the higher subscription bookings mix. Is that due to you selling less perpetual license than you're expecting or than you previously expected to? Or is it because of increase in duration for the subscriptions bookings? Thank you.

[Mark A. Culhane, Teradata Corp.]

So, yeah, Dane (42:59). So, yes, recurring revenue growth is totally being driven by subscription and ARR growth. Keep in mind that whatever we book in Q3 is backend loaded in Q3. So, at best, it's one quarter's worth of expression and not every subscription deal we do starts the following day, right? There can be a period of time before it starts expressing itself to revenue. And so, we're at that point like all subscription businesses where the Q3 Q4 bookings don't really express themselves in the current year recurring revenue growth, but it sets you up for what it's going to be the following year and we're no different on that front, and that's the biggest driver. Perpetual doesn't have anything to do with recurring revenue.

[Unknown Speaker]

Okay. So, no change in terms of your expectations for unit volume or key core growth?

[Mark A. Culhane, Teradata Corp.]

No, not from what it was 90 days ago.

[Unknown Speaker]

Got it. That's helpful. Okay. Great. Thanks very much and congrats on the nice quarter.

[Mark A. Culhane, Teradata Corp.]

Great. Thank you.

[Operator]

Your next question comes from the line of Brad Reback from Stifel. Please go ahead. Your line is open.

[Brad Robert Reback, Stifel, Nicolaus & Co., Inc.]

Great. Thanks. Mark, quick question. Deferred revenue was a big use of cash this quarter. Given the commentary on bookings strength, I would have thought it would have been a little more or a little less negative than it was. Is that just a function of linearity in the quarter and that should reverse itself in 4Q to some extent? Thanks.

[Mark A. Culhane, Teradata Corp.]

Yes. Two things there, Brad. So, one is the historical perpetual license-related maintenance is huge in Q4. And then that revenue starts to get recognized across the year and comes out of deferred revenue and gets expressed into the revenue line. That is a big downward push to deferred revenue. And then it's offset by the deferred revenue you're adding and, yes, we're adding, but that's still of the $1.24 billion in ARR the biggest portion of that balance today is still that maintenance related, although the subscription portion as we said in our prepared comments is growing in excess of 150%. So, that's really the phenomenon, is the seasonality of the maintenance and when that gets built. So, yes, seasonally, we'll see, we believe it'll uptick in Q4 and it really grows in Q1 when we actually bill out all of the big Q4 maintenance renewals.

[Brad Robert Reback, Stifel, Nicolaus & Co., Inc.]

And then maybe one quick follow-up on the services gross margin. Obviously, there's seasonal benefits that you see in the back half of the year. How should we think about the progression in 2019 broadly? Is the second half the new starting point or should we think about the overall 2018 result as the starting point? Thanks.

[Mark A. Culhane, Teradata Corp.]

Yes. So, great question. So, there is seasonality to this business. Historically, Q4 has always been a large consulting margin quarter, just given the way certain projects that are done on milestones that ultimately tend to get accepted in Q4, which causes the revenue to be recognized and that improves the margin. So, it's the end of the year where we end up on a full year's kind of the starting point of what we see going forward into 2019. But overall, we will improve our margins in 2019 over 2018. But Q1 has always been low and then it sort of builds from there across Q2, Q3, Q4.

[Brad Robert Reback, Stifel, Nicolaus & Co., Inc.]

Perfect. Thanks very much.

[Operator]

Your next question comes from the line of Tyler Radke from Citi. Please go ahead. Your line is open.

[Tyler Radke, Citigroup Global Markets, Inc.]

Hi. Thank you very much. Question for Oliver. So, you mentioned some competitive displacements of Netezza and Oracle on the call. And it's not something I feel like you've historically talked a lot about. I'm just curious if you think that that's seen an uptick, or you're seeing an acceleration in kind of legacy re-platforming and what you think might be driving that, if that's the case.

[Oliver Ratzesberger, Teradata Corp.]

Yeah. Great question. Yes. My answer is, yes, absolutely. This, simplification of these complex infrastructures at the enterprise level is what is exactly driving, replacing other technologies in the existing top 500 customer base, and that is something that we believe will drive our share-of-wallet within these customers.

It's really consolidating these data silos, and these data silos are often made from third-party technologies, even brand-new technologies that just came out in the recent years. We have first customers that come to us and say that they have now 10 or 12 instances of that, and all of a sudden they realize, a single Teradata instance will serve them much better. And these are the conversations that we are seeing increasingly in our customer base.

[Tyler Radke, Citigroup Global Markets, Inc.]

Great. And a follow-up for Mark. I just wanted to understand the ARR target for the full year. I think you said that it's – you continue to expect it to be 10% growth, but with 2% in terms of currency. But I'm curious since that's more of a bookings-based metric, which presumably if you're seeing a higher subscription bookings mix. And in the subscription deals, you've talked about uplift. Like, why wouldn't that number go higher than what we saw in 2Q just because you are seeing higher subscription bookings mix? Thank you.

[Mark A. Culhane, Teradata Corp.]

Yeah. So, yes, it's 10% as reported. It's up a couple of points from that in constant currency. So, we continue to expect that. It will depend on the mix of what Q4 turns out. We have a pretty broad range on perpetual expectations for Q4 because several of those transactions that are forecasted as perpetual, there's also conversations with customers about them potentially taking it down on subscription. So clearly, it could be higher, right? And as you said, it is a bookings metric and you can get healthy on a bookings metric in one day. And so, we'll see how it plays out. I think we're trying to be cautious and conservative at the 10%, but it certainly could be higher.

[Tyler Radke, Citigroup Global Markets, Inc.]

Okay. Thank you.

[Operator]

We have time for one more question. Our last question will come from Keith Bachman from BMO Capital Markets. Please go ahead, your line is open.

[Jung Pak, BMO Capital Markets]

Hi. Thanks. It's Jung Pak for Keith Bachman. I had a question on your recurring gross margin guide of 70% for Q4. Is that due to the higher mix of subscription revenue relative to maintenance? And how should we think about the recurring gross margins going forward as subscription mix continues to increase?

[Mark A. Culhane, Teradata Corp.]

So, yes, it's a function of the mix of the type of recurring revenue, which more of it is becoming subscription related versus the traditional perpetual maintenance related, and that has some impacts. I would expect – we said approximately 70%, I would expect us to be better than that in Q4. But for full year we'll be in the low-70s. Longer term as we leverage some of the subscription-related investments we've made, we expect that that could tick back higher to the mid-70s, best in class in the subscription world is 80%, the minimum threshold you need to be is 70%.

We're 72-ish today on a full-year basis and change. And we sort of expect us to be in the low-70s. But over time, we think that ticks up as we leverage and get scale across the significant subscription investments we've made.

[Jung Pak, BMO Capital Markets]

Great. And I have a follow-up. Americas was down 4% in constant currency. Can you help us understand what happened there and if the deal shift to subscription had any impact. Thanks.

[Mark A. Culhane, Teradata Corp.]

Yes, so, Americas, clearly they're moving to subscription way faster than international. So, that's clearly been an impact year-over-year. And then on a reported revenue basis, the one large perpetual transaction I referenced was an Americas' transaction. And so, that clearly puts – from a total revenue perspective it being down year-over-year but they're moving to subscription much, much faster. So, I'm actually pleased that year-to-date it's flat with last year given the vast amount of business they've moved to subscription across 2018 versus a year ago.

[Jung Pak, BMO Capital Markets]

Great. Thank you very much.

[Operator]

That does conclude our Q&A session. I will now turn the call over to Vic Lund for closing comments.

[Victor L. Lund, Teradata Corp.]

Perfect. Thank you, all so much for joining us here today. We will give you more color around our strategy positioning and our long term expectations on our Analyst Day on December 12. And we're hopeful that you can all be there to hear it. We can give you some more detail around where we're going and what 2019 and how beyond that looks like. And as Mark said, if not, we will update our guidance at the end of Q4. Again, thank you, all for taking the time to listen and we look forward to seeing most of you here in Rancho Bernardo.

[Operator]

That concludes today's conference call. You may now disconnect.