Teradata Corp (TDC) 2016 Q2 法說會逐字稿

(Operator Instructions)

At this time, I would like to welcome everyone to the Q2 2016 Teradata earnings conference call.

(Operator Instructions)

Gregg Swearingen, Vice President of Investor Relations, you may begin your conference.

Good morning. Thanks for joining us for our 2016 second-quarter earnings call. Victor Lund, Teradata's CEO, will provide some thoughts on his first 90 days, as well as Teradata's transformational initiatives. Steve Scheppmann, Teradata's CFO, will then discuss our Q2 financial performance as well as our guidance. Also joining our call today is Oliver Ratzesberger, President of Teradata Labs, who will be available during 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, 10-Q and other filings with the SEC.

On today's call, we will also be discussing certain non-GAAP financial information, which excludes such items as stock-based compensation expense, asset impairments, acquisition and reorganization costs, the marketing applications business, which was sold on July 1 of this year and other special items, as well as other non-GAAP items such as free cash flow and constant currency revenue comparisons. A reconciliation of our non-GAAP results to our reported GAAP results and other information concerning these measures is included in our earnings release and on the Investor page of Teradata's website.

We will host an Analyst's Day on November 17 at our R&D facility, which is located near San Diego. We will be providing more information regarding this meeting in the next few weeks. A replay of this conference call will be available later today on our website. Teradata assumes no obligation to update or revise the information included in this call, whether as a result of new information or future results. I'll now turn the call over to Vic.

Good morning. I'm going to give you some perspective that I have over the first 90 days of Teradata. But I guess in short, I would say that I'm enthusiastic about what I found. I've spent a great deal of time analyzing the data around our business and the transformation. I've been on the road meeting with Teradata employees at town halls, with sales team and with every functional organization within Teradata. I've met with customers in the Americas and internationally. I've also met with more than 50 industry analysts, who firmly believe that Teradata still has the most sophisticated and powerful analytic capabilities in the market.

They also believe that we are on the right path with our cloud deployment options to assist our customers that want to leverage the cloud. I have reviewed our strategic direction with the Board, and they concur with our strategy. We are now moving forward to execute our plan. I'll come back with a little more of the, so what, after Steve covers the financial results. As you can understand, I've only been at this 90 days. It would be presumptive of me to go too deep right now. But as we said last quarter, we will have a full presentation ready for our analyst meeting. We are on track to do that. Steve?

Thanks, Vic. Teradata generated results better than our guided expectations in the second quarter. Excluding the marketing applications business, which we sold on July 1, 2016, Q2 revenue was $564 million, which was down 3% in constant currency on a comparable basis from Q2 2015. Non-GAAP EPS of $0.71, a meaningful increase from the $0.53 in Q2 2015, due to the higher than expected revenue and the benefit of our cost management initiatives.

My comments today reflects Teradata's going forward business on a non-GAAP basis, which excludes the marketing applications business in 2016, stock-based comp and other special items as identified in our earnings release. Just as we did last quarter on our website, we have provided a 2016 non-GAAP view of our results without the marketing applications business.

Turning to revenue by region, excluding the marketing applications business in both 2015 and 2016, revenues in the Americas region decreased 6% in constant currency. We continue to see headwinds in regard to large capital expenditures being approved, particularly in the US. Although, we are working hard on our transformation, particularly on our hybrid cloud offerings and how we interface with and provide value to business users, we expect this headwind related to large IT capital expenditure projects to continue.

Our international region increased 2% in constant currency. Within international, EMEA revenue was down 3% in constant currency, while APJ revenue increased 10% in constant currency. There's been a lot of attention on the impact of Brexit. I will provide a few specifics about our UK business. Revenue in the UK was up 3% in constant currency in the second quarter. We had good performance in the UK in Q2; however, we expect headwind in the second half of the year in the UK due to the devaluation of the British pound. To provide context, in 2015, UK contributed less than 5% of Teradata's total revenue.

Turning to gross margins. Product gross margin in the second quarter was 60%, in line with our expectations but down from the 65.6% in Q2 2015, due to deal miss. Services gross margin in the quarter was 48.5%, up from 46.3% in Q2 2015. Services margin improved due to better consulting margins, as well as the exit of the marketing applications business. Overall, gross margin was 53% in the second quarter compared to 54.3% in Q2 2015.

Turning to operating expenses. SG&A expense of $132 million was down 26% from Q2 last year. The decrease was primarily due to our cost management actions, as well as the exit of the marketing applications business. Research and development expense of $36 million in the quarter was down 31% from the prior period. The decrease was largely due to the cost management actions we commenced in Teradata Labs last year, as well as the exit of the marketing apps business this year.

We continue to expect R&D expense for the full year to be down 10% to 15% as reported. However, due to the investments associated with our strategic growth initiatives, we expect R&D expense will increase on a comparative basis, excluding marketing apps, as we move into the second half of the year, as well as into 2017. As a result of all of these items, operating margin for the quarter was 23.2%, a strong increase from the 17.2% in Q2 2015. The improvement in operating margin was due to our cost management actions and higher services gross margin, as well as the exit of the marketing applications business.

Our non-GAAP effective tax rate for the second quarter was 27.1%, comparable with the 27.6% in Q2 2015. Looking forward, we expect our full-year non-GAAP effective tax rate to be approximately 27%, with the actual tax rate being primarily dependent upon the ultimate earnings mix. GAAP EPS was $0.49 in Q2. This compared to a GAAP EPS loss of $1.87 in Q2 2015, which was driven by the good will impairment charge related to the marketing applications business. Our non-GAAP EPS was $0.71 compared to $0.53 in Q2 2015.

Turning to cash flow. Net cash provided by operating activities was $99 million in Q2 2016 versus $80 million in the second quarter of 2015, due to a net favorable year-over-year change in working capital. In the second quarter, we had $27 million of capital expenditures in addition to capitalized software, the same as in the second quarter of 2015 resulting in free cash flow of $72 million versus $53 million in Q2 2015. We continue to expect full-year free cash flow to be equal to GAAP net income, excluding the impairment charges or up to $50 million higher, which at the high end of our range would approximate $270 million.

Moving on to the balance sheet. We had $909 million of cash as of June 30, 2016 of which more than 98% is held outside the US. This is down -- slightly down from the $917 million as of March 31, 2016, as we used $80 million of cash in Q2 to completely pay off our revolving credit facility. We moderated our repurchase activity in the second quarter as we had been quite active in Q1, as well as in 2015, which enabled us to get to the shares repurchased that we had planned for. During the first half of the year, we bought approximately 2.6 million shares for a total cost of approximately $62 million. As of June 30, we had approximately $528 million of share repurchase authorization available.

Before I turn to guidance, I want to provide a little color commentary on what we see in the market. Our revenue has been impacted by our customer's focus on less capital intensive options like cloud and other alternatives, including other purchasing options such as subscriptions, rental and other usage-based models. Many customers have delayed or reduced on-premise purchases in order to evaluate Teradata's cloud, public cloud and other consumption options.

Our current outlook for Q3 and the remainder of the year includes new cloud opportunities with the vast majority with current Teradata users, as they desire to start building out their hybrid cloud environments. This is a good start to our initiatives associated with different solutions and usage-based subscription offerings that make it easier for our customers to consume Teradata. To provide more color, we are seeing an interest in our term rental or usage-based utility offers.

For example, in Q2, we signed an $11 million contract with a well-known airline utilizing our rental term offering, that resulted in revenue being recognized ratably. In July, we closed a significant transaction with a large known -- well known healthcare company using a utility-based model, in which revenue will be recognized based on usage. In addition, we have many other customers evaluating these usage-based pricing alternatives. This is not unexpected and is aligned with our transformation.

But as you likely understand, this will begin to impact our year-over-year revenue comparisons, as some of the revenue we would have normally recognized in a given quarter will now be spread over a number of periods. That said, we are pleased with our Q2 results and expect Q3 revenue in the $550 million to $560 million range. We expect non-GAAP EPS to approximate $0.60 in Q3, as the benefits of our cost reduction continue. But we will see the increased investment for our new initiatives reflected in our operating results beginning in the third quarter. We expect product gross margin in Q3 to be approximately 60% and services margin in the mid 40%s.

We expect, as reported total operating expenses to decrease approximately $20 million year-over-year in Q3, with reported R&D expense being up slightly year-over-year and up sequentially from Q2. For the full year, we continue to expect revenue, excluding the marketing applications business, to be in the $2.25 billion to $2.32 billion range. Although, we had a good first half in the terms of EPS improvement, our full-year expectation for non-GAAP EPS remains in the same at $2.35 to $2.50, since we will begin to see the impact of our increased investments in our operating results in the second half of the year.

We have made good progress in our cost reduction initiatives, as you can see from our results and are now shifting from a cost reduction phase to a more responsive cost management phase, as we properly invest with Teradata's future to better align with the changing marketplace. Our future investments, which we will provide greater details on during our Analyst's Day in November, will support our cloud offerings, our analytical solutions, and improve the effectiveness and efficiency of our infrastructure and support functions. Although, these planned investments will begin to impact our results in the second half of 2016, they will become more meaningful in 2017.

In closing, market changes have disrupted business as usual for many companies. The companies, such as Teradata, that have flourished in the past must adapt. The good news is Teradata has best-in-class technology, smart and talented and customer respected people and outstanding customers to tell us they're going to continue expanding their on-premise data environments while also leveraging the cloud. They are looking for us to deliver smarter, more flexible and easier to use options to consume Teradata. We are on it, and fully intend to deliver both for our customers and our shareholders. Now, I'll turn it back over to Vic.

Thank you, Steve. I would now like to provide an overview of our business at a level I am comfortable sharing at this point in time. First, our technology is strong and our customers want and need it. Our customers are among some of the largest and most aggressive users of analytics in the world. They believe our offerings are a key part of their long-term strategy. They see us as a trusted adviser to help them sort out the best ways to deal with the explosion of data. They trust us because we bring scalable solutions that work.

Second, I have seen firsthand that Teradata has very talented people who are the best at what they do, and they are hungry for change. They are passionate about our new direction, our technology, and what we can do for our customers. They know they are the best at bringing analytics and data together for the customer's advantage. This isn't just my view, but the view of the customers I've had face-to-face meetings with. So if this is true, why has our revenue been challenged?

Our product has remained product centric and our sales approach too IT focused. This is inconsistent with where the market is going. Some of our customers believe that we are unreceptive to the new ways they want to buy, consume and deploy technology. This is absolutely not true, and we are going to change this misconception. We have made dealing with us harder than it should be. We need to update our infrastructure so that we can be more efficient and more responsive in serving our customers. So the question is, what are we doing differently?

We have refined our strategy to be even more customer centric giving customers what they want and how they want it. We will become more focused on business outcomes and be more consultative in our approach. We will be riveted on helping business users solve their challenges, rather than leading with technology. This approach has been very well received by my initial customer visits, and will position us as a trusted advisor with both the business and technical leaders in our customer's organizations.

Our strategy is based around a core belief, that analytics and data unleash the potential of great companies. To empower companies to achieve higher impact business outcomes, we will be providing differentiated business solutions and analytical architecture expertise that pull through our technology solutions. Our core database technology remains the key element of our strategy, and we will continue to deliver our best-in-class data analytics at scale.

Since business users are now a key buyer of analytics, we are shifting our emphasis towards delivering high impact business solutions for our customers. In doing so, we will leverage a more consultative solution selling approach to identify and deliver value to business buyers supported by our business and industry consulting. In the Americas, we have restructured our business and industry consulting practice into a more centralized organization, so we can leverage these resources across industries and deliver a consistent message to our customers.

We see growing demand from business buyers for one stop shop, for analytics that can create high-value business outcomes and many of our customers look to Teradata for this. We will focus our analytic consulting on solving customer challenges where we have expertise and assets. By capturing the IP from these engagements, we will be able to leverage these use cases with other companies. Our opportunity lies in our ability to scale and monetize these solutions.

As more companies begin to explore various open-source, cloud and deployment alternatives, they need a partner that can help navigate and optimize their analytical architectures. Our years of implementation experience in enterprise class analytic infrastructures and data integration, along with open-source experience brought by Think Big, enable us to help customers achieve their analytical business objectives. We will provide broad technology architectural consulting and migration services to guide their data strategies.

By objectively discussing the benefits of open-source, cloud and on-premise deployment options, along with the optimal placement of data across the ecosystem, we can make their architecture easier to use and deliver solid benefits, thus giving them higher returns on their investments in technology and related solutions. While having a flexible analytical ecosystem is increasingly important, our customers tell us they want to continue to rely on Teradata for sophisticated workloads and our solutions, including on-prem systems will continue to be a major component of their ecosystem.

In addition, the continuing to improve the performance and value of our market-leading database, we are aggressively extending our portfolio of technology solutions to deliver an end-to-end analytical ecosystem across the hybrid cloud architecture to accommodate our customer shifts in buying preferences towards the cloud. Our cloud strategy is focused on delivering three types of offers. First, we have the Teradata software only available in the public cloud for the do-it-yourself segments that want to purchase Teradata software and deploy it on the public cloud.

We have further accelerated our release of the Teradata data warehouse on AWS running MPP and expect it to be available on AWS later this quarter. This is not a scaled-down version of Teradata, it has the same performance benefits of our Teradata MPP on-prem system rooted in our superior processing engine, shared nothing architecture and best-in-class performance optimizer. In tests of real world consumer queries, it proves much more powerful than any other major competing cloud database today. Additionally, we are planning to release Teradata database on Microsoft Azure running MPP in Q4. We will soon have Aster available on AWS.

Second, we have our hybrid cloud solution, which meets the needs of companies who have hybrid on-premise and cloud environments either as an in-state goal or as an interim path towards 100% cloud deployment. Third, we are offering Teradata managed cloud solutions for the do-it-for-me segment of the market. This is the most strategic opportunity for Teradata in the cloud, where we are not just selling our technology, but rather providing a full managed solution. We will leverage not only our own data centers as hosting options, but also the public clouds to provide infrastructure as a service capabilities to achieve broader reach and align with customer cloud preferences.

We will extend our managed cloud business with new entry-level and higher performance/service level options. We are also on track to launch Teradata managed cloud in Europe later this quarter, thus expanding our reach globally. To accelerate our cloud strategy, we have fundamentally changed our development and engineering process to provide our customers with the rapid releases of functionality required to meet their business growth. Additionally, we have recruited top cloud talent to augment our team.

As we are creating more flexible options to better align with how customers want to buy and deploy Teradata, we are also realigning our direct salesforce with the biggest revenue opportunities and highest probabilities of success. These efforts will give our teams more time with our customers, support better coordination and improve productivity. Further, we are going to see that our sales teams are properly supported with the tools they need to properly explain our strategy to their customers.

The largest companies in the world remain the best revenue opportunity for us, as they have the most complex analytical requirements and the need to scale. Further, they drive the vast majority of global IT spending. This is Teradata's sweet spot, where we can provide differential capabilities to solve a broad range of problems and where our value proposition is most compelling. But we haven't done a great job of capitalizing on the revenue opportunities here. For example, we have less than 40% of the global 500 as our customers. Our share of wallet in these customers is smaller than it should be.

Concentrating on these larger revenue opportunities with a solution-oriented focus will require a very different sales approach in how we build account plans and how we market through our customers. Evolving our go-to-market approach will better position Teradata with both business buyers and IT buyers and increase wallet share with our existing customers as well as add new ones. Business buyers will look to Teradata for analytic solutions tailored to their industry and business problems.

Our new hybrid cloud will allow IT buyers to have the highest performance possible, deployed the most agile way and at the lowest cost of total ownership. As we execute our strategy and ramp our business solutions in hybrid cloud offerings, we intend to make it easier customers to procure and deploy Teradata by offering multiple and flexible consumption and pricing options. This is an area where we have more work to do to ensure that we deliver fair value to our customers, while at the same time seeing that Teradata is properly rewarded for the value we deliver.

We will provide more information in this area on our Analyst's Day. During the presentation, we will be able to demonstrate that our initiatives have both near-term and long-term returns. While it is true that our complete strategy implementation will take time, it will not take long before you start to see the results of these implementations. Steve pointed out that we have made good progress on our cost reduction efforts and are now shifting to a responsive cost management process.

We need to make sure our initiatives get the funding they require to better align with the changing marketplace. However, these investments will only be made if they accelerate the return of our revenue growth or reduce our cost footprint going forward. To support our successful transformation, we're also making organizational changes to ensure that we have the right talent in the right positions. We will continue to provide you with more information on these changes, as well as our go-to-market approach.

I am well aware that simply creating plans does not make them happen. Rest assured, we have identified tasks with clear owners and are defining measurable objectives to drive our long-term success, while still focusing on short-term results. In order to provide more transparency to our transformation roadmap and success, we will provide actions, metrics and a multi-year financial model at our Analyst's Day.

Last quarter, I told you I would take the first 90 days to evaluate the business. As you've heard today, that's well under way. Our top priority now is driving our business forward, executing on our transformation and returning greater shareholder value. Given this focus, the Board and I have determined that it is premature to initiate a CEO search at this time. We will let you know when we begin that process. When we do, the Board will be deliberate in its actions. In closing, the Teradata will empower companies to achieve high-impact business outcomes through analytics at scale on agile data foundations. We will be business outcome focused and consultative in our approach, serving as trusted advisers throughout the organization.

As we look forward, we will: develop world-class cloud capabilities and services to make Teradata available no matter where or how our customers want; refine and execute our go-to-market strategy to optimize our revenue opportunity; provide analytical business solutions that deliver high-impact business outcomes; create an environment and culture that supports our nimble and effective organization driving innovation; finally, and very importantly, ensure our strategy delivers long-term revenue and earnings growth. I can assure you that we are advancing on all fronts and are under way executing against our transformation. With that, operator, we are ready to take any questions.

(Operator Instructions)

Katy Huberty, Morgan Stanley.

As you shift focus to investing in cloud and realigning go-to-market, how should we think about overall operating expenses over the long run? I know you commented on R&D up in the back half in 2017. But should we also expect that OpEx grows particularly next year?

Yes, Katy. Yes, as we see the investments in cloud, analytical solutions, the infrastructure side, yes, the pure OpEx number will be increasing in 2017. Our opportunity and our goal is also drive that revenue number be it in a subscription model or be it on an on-premise model. But to provide you the metrics to demonstrate to Vic's words that those operating expense increases are going to generate future revenue growth or on the other side enhance our efficiency from an operating expense perspective. But from a pure OpEx perspective in 2017, they will go up.

Okay. As part of your transformation, I assume you're looking at many options. In that context, are you free to repurchase shares? If so, why are you spending so little, particularly in the June quarter on the buyback? Thanks.

Yes, Katy, there's no restriction on the repurchase of shares. We still have over $500 million of authorization. As we are going through our strategic transformation, strategic objectives and initiatives, we are looking at and evaluating make or buy situations in order to enhance -- or to get to the market faster with some of our initiatives. Now, remember, the majority of our cash, over 90%, is international and we use US cash on that. But we do have the revolver. So, at this point in time, we're maintaining our flexibility from a capital structure perspective to make sure that we have the dry powder available to us for these strategic initiatives. As we lay this out in the Analyst's Day, you will see both an operational and a capital structure strategic plan going forward.

Okay. Thank you. Congrats on the quarter.

Derrick Wood, Cowen and Company.

Steve, you mentioned that some customers are delaying deals in front of your cloud offering. I know you guys have a full MPP version coming out in the cloud soon. How are you expecting the uptick from this new service? Do you have customers in beta? Are they ready for some sizeable moves? Or do you think this will be more of a toe-dipping exercise with a backup workload and it will gradually move into the cloud?

Yes, Derek, I'll have Oliver comment on the technology side of that. Then I'll close on some of the financial implication side.

So, on the technology side, we are releasing Teradata MPP on AWS this quarter. We actually have been testing for the last several quarters. We have several customers that we have also in beta tests going on, a lot of positive feedback. A lot of -- a lot of customers that are really looking to leverage this deployment option in addition to on-premise. It's really a core component of our hybrid cloud storage. So it is something that we're actively working on that is coming out very rapidly that we have tested for several quarters and are very confident that customers will indeed move to that very rapidly.

Yes. Derek, what I'm seeing in the funnel is I'm seeing exactly what Oliver just described is that the customers are looking to build out. The new opportunities on this cloud is really on our hybrid cloud offering. So these are a majority of our existing customers looking at, as you said, toe tipping in that. But, again, we're not seeing it as cannibalization of that on-premise. We're seeing it as an addition additive to that hybrid cloud solution. So we're very optimistic with the funnel activity and early stages is quite positive with respect to the reception of this hybrid cloud offering.

Great. Maybe a follow-up for Vic. Just a little bit more color on the changes in the salesforce would be helpful. Are you building any kind of new inside sales that could drive more volume business in the cloud? Or is it really still a focus on strategic accounts and maybe Lauren and people that can go after business? Maybe a little more color on the salesforce changes would be helpful.

Great. Sure. So our go-to-market, we got in and I -- how do I say this? I don't have the whole half an hour to go through this. But I guess our go-to-market, one of the biggest eye opening things I found was that we basically didn't support our field from a corporate perspective in terms of education, about where we were going and strategy. Our go-to-market approach, we didn't have any central approach or anything like that.

So the initial thing of what we're doing is just simply getting back to real basic blocking and tackling from a go-to-market perspective, looking at our accounts and how we align where we are and going at it. So near term it's that, longer term obviously we have to build out these capabilities. This is one of the investments we have to make going forward is to get a back-end support for all of that.

I think the second part of your question revolved around what is our targeted market? I think I said in my opening comments, so just to be clear, we believe that in the top 400 or 500 accounts worldwide is our sweet spot. That's driven because of two reasons. One they account for a huge percentage of the relevant technology spend for us. They also appreciate and want to help in very complicated analytic solutions, and we're capable of delivering that. Our share of wallet in those accounts, it's not just the number. But in the accounts we have, because we have been so resistant to change, they haven't looked for us to expand our presence in them.

I've got to tell you, from my visits with early customers, just simply the fact that we admit that open-source exists and Hadoop's there and where they are and the cloud is coming, has made them much more receptive to doing business with Teradata. So on all fronts, I think we're at it. It's a little what I said, some of it will come earlier, some of it will take a little longer. But I really am quite enthused about what I found about our people, our technology and our customer's reception to it.

So I hope that answers -- we obviously owe you some more detail around this, and at the analyst meeting we'll do that. By nature, I only want to tell you what I know to be true, but I tell you that I know to be true that our customers like us, that we have the capabilities, and I really am quite thrilled. I told a lot of the folks around here, the worst thing that could happen from my perspective is that I would have walked in and found everything perfect because then it would've been hard to figure out where we're going to go. But we have a lot of near and long-term opportunities to return Teradata to where it should be. Our people are enthusiastic about it as well.

Great. Thank you.

Keith Bachman, Bank of Montreal.

I had two questions as well. I wanted to return to an earlier question. Does the cloud -- the advent of the cloud delivery that you're focusing on, mitigate some of the challenges, at least that we hear of deploying the technology. That is to say, I agree with you, you're targeting some of the largest fortune companies. You're at 40% penetration rate. But some of the dynamics are that getting Teradata systems up and running is difficult, to load it and whatnot and it's also expensive. So if you're trying to win new workloads, I understand the message surrounding hybrid cloud, but if you're trying to new workloads with new customers, is the cloud going to help you get there?

This is Oliver. I'm going to take that question, absolutely. In fact, when you look at how we look at cloud and our cloud first strategy of how we develop technology and happening so for the last couple of quarters, it is not just that we run Tera technology in the cloud, it's really about the deployment options, dep ops, the agility that comes with that. We are now able to instantiate an entire ecosystem of multiple Teradata system, Hadoop, Aster, QueryGrid, other technologies in as little as 25 minutes in a cloud.

What that allows us to do is, if a business has an idea, wants to try something out, they can stand up and enter our ecosystem within minutes in less than an hour. That previously would have taken them months or longer to go through capital requests to install the systems, to load the data, to set everything up, right? So cloud brings a lot of opportunities to our technology. We're very excited. We're using it even internally.

We have gone to a quarterly hack-a-thon setup where we instantiate these technologies on a moments notice, no data from customers and then interact with that data within a matter of hours and days what would previously have taken a much longer time. So that is a big enabler for us to take our technology into new use cases that previously we weren't agile enough to deploy that.

Okay. Great. Thank you for that answer. I'd like to ask my follow-up question and just talk a little bit about product gross margins. I understand this quarter you indicated mix went against you. But as you think about the strategy that you're laying out over the next number of quarters, how would you anticipate product gross margins, the puts and takes, including the advent of the subscription model?

Yes, Keith. With the qualifier, you'll see a lot of that detail on November 17 meeting. But for the remainder of 2016 here, we're looking at product gross margins with the mix that we see and even with some of those subscription models or usage models in play in Q3 and Q4, that product gross margin for the second half of the year should be around 60%, consistent with our expectations coming into the year.

So I'm not seeing anything at this point in time that's going to change that significantly. It really comes down to the options for the different type of scenarios that customers may elect. We'll have more clarity, more transparency on that product gross margin going into the future as we give you that multi-year financial roadmap. So, again, for 2016, I'm still seeing it right where our expectations are, about 60%.

Okay. Fair enough. Thank you for taking my questions. Cheers.

Wamsi Mohan, Bank of America, Merrill Lynch.

So with your upcoming release of the MPP solutions on AWS and Azure, how do you view the need to maintain the entire Portfolio longer term? How much overlap in investment between the on-prem and cloud base offerings or can you give us some split of how you're thinking about the investments on those? Then do you see any deferrals in the quarter that you were expecting to see? If you could comment on those rolling deferrals that you commented on last time? I have one more follow-up.

Yes, Wamsi, before Oliver jumps in on the investments on the cloud -- or the platforms, rolling deferral is nothing unusual in the quarter. We still keep seeing them. But the gives and takes makes Q2 pretty consistent with the prior quarter.

Yes. On the R&D investment side, hybrid cloud is really the big story for us. We see a lot of use cases where customers want to maintain a presence in a data center for specific workloads. They want to leverage cloud or various cloud platforms for new types of workloads, new types of data. The beautiful story for us is that we have been in this transition or transformation to go to a software-only platform really over the last several quarters in that the software that we actually run Teradata MPP on the AWS and soon on Azure is actually the exact same software that we run on our, for example, IntelliFlex platform in the data center.

That really allows us to have a single development stream that has a cloud-first focus. We even treat now our on-premises systems as if they were cloud systems. So that allows us to really focus investment dollars into this and not having to deal with multiple different deployment options.

Thanks. So, Vic, last quarter you mentioned you viewed your role as being completely engaged but not a long-term one. So is it just the sense of urgency in your transformation that you view the CEO search as disruptive? What milestones should we be looking at or tracking or you are looking at and tracking to determine if and when there will be a CEO search? Thanks.

Wamsi, thank you. So, yes, focus is a very important thing. My role -- I'm not going to be here for ten years or however long. I think the change from last quarter is simply that when I got into the details, you never know exactly when you come in what you're going to find. I have a great sense of urgency. The organization is rallying around what that is. I have promised the people at Teradata that I'm not going to come in and start something and leave when it's half done, so I'm going at it.

We need to work down this, figure out where it is and then figure out exactly when it's the right time to start that CEO search and when -- and when we should do. I will reiterate that when we do that, there are internal candidates and then the Board will be deliberate in what they do. Obviously, they have what they have to go through. But I guess just, we have a lot going on right now. It's making progress. We're getting traction.

The Board asked, and I agreed, that we will think about that when the time is right. But we don't want to lose focus on the traction we've got going and the progress we're making. I still remain enthused about this and excited to go forward. So when the time comes, we'll make that announcement and go forward. But for right now, that is where we are. When the time is right, we'll do it. But we're going to do it when it's right for the business, and that obviously means for the shareholders.

Congrats on the margin then, on the progress made.

Thank you.

Bhavan Suri, William Blair.

Just one product specific question and then one partner related question. On the product side, when you look at the cloud offering, just some sense of performance, meaning does it scale linearly? Does it deliver the same sort of per compute processing power that the core solution has? Or would you need things like Amazon to upgrade the interconnect to get that performance? I suspect this one is for Oliver, but I'd love to get some thoughts on sort of as you're testing it, what sort of scale and performance are you seeing from the cloud solution?

Bhavan, yes, a great question. It's something that we focus a lot on, in fact, for the last several quarters we have been testing very heavily MPP on the various cloud platforms. We are actually quite happy with the performance that we're seeing in the cloud. In fact, we have done bench marks where we compare against other leading offerings in the cloud. We see that we consistently outperform the other offerings by orders of magnitudes. We are seeing that the advantage that we have with the Teradata software, especially with the optimizer, scales extremely well in the cloud.

We have seen that linear scale that we have in our on-premises solutions. It's just that the units in the cloud are usually smaller. You add more smaller units together to get to the same performance footprint that you have in a data center. But when we compare it note for note compared to other technologies that run in the cloud, we see phenomenal performance. In fact, we just took some of the industry analysts through it two months ago.

The feedback from them was just -- they were in awe, what kind of performance Teradata can produce in something like the AWS cloud. We're seeing very similar performance on Azure. Yes, there's differences between AWS and Azure in terms of what their back-end is. That is reflected in the performance in there But whatever the performance is that we see in the cloud, we can leverage it to its maximum.

That's helpful. Thank you. Then my follow-up, just maybe this is for Vic. Your services model historically has been a couple of select partners like maybe IBM Global Services, but typically Teradata has performed a lot of the services for implementing Teradata systems. You've now acquired or recently acquired another services company in the big data space. But as you deploy and think about going a little lower market and deploy this across multiple clouds and try and approach a customer base with multiple use cases, are you guys thinking about changing the partner strategy? Would you guys be willing to not partner more with some of the global SIs and folks like that for Teradata implementations? Or do you still plan to keep the services component largely in house?

Well, I -- so let me step back just a little and kind of answer that from a little broader perspective. So, yes, we have done broad -- most of our service implementation ourself and we've used others. The answer to the question -- I'm not trying to be cute about this, is that we have to look at it business case by business case and figure out what we do, we'll do whatever makes sense, but remembering that we are a trusted advisor.

One of the key things we have to do when we engage with a large company is that we have to make sure that we deliver what we say we will deliver and be able to deliver it at scale. So we will do nothing that will compromise that. It is one of the key tenants we are going after. The most recent acquisition we did in big data is an adjunct to our Think Big. Both of these companies -- they are -- ours are open-source focused. We are doing that to expand our footprint.

As you all know, that these very bright people are hard to find in the world and we've had the good luck of being able to acquire some of them through acquisitions. They're smaller companies, very smart, aggressive entrepreneurial people. It also helps us increase -- the last one was to increase our footprint internationally. So we are open to whatever from our partner -- what partners we work with. But we are -- we want partners and we want them that are consistent with our strategy.

I get back to that -- the key tenant for us is simply that we have to be able to deliver what we say we can at scale without any hiccups. So we'll do whatever makes sense, but right now that's where we are. Then -- it's just because we're dealing with big customers, and that's what they all like about us. When I'm out talking to them, they all say, well, you guys do what you say you're going to do and it's scalable.

I think a lot of our customers are starting to find out that open-source and Hadoop are great, but that it requires smart people on top of them to make them work. In some cases, there are people promising things that when they get in, they just simply aren't scalable. They can do them on a small scale. But When you have to get them up, they just don't work. So this is one of our key differentiating points in the market. So we are not going to sacrifice that.

Got it. That's helpful. Thanks for taking my questions, guys. Nice job there.

(Operator Instructions)

Jesse Hulsing, Goldman Sachs.

This is probably for Steve. With product gross margins coming in low for Q2 and down, I think, 500 basis points year-over-year, did you have any big floor sweeps or anything unusual that would have pulled that down?

No, Jesse, no big floor sweeps that pulled it down. We had one transaction that was more related to an ELA customer. It was more hardware centric, large transaction. It was what we had anticipated, what we had expected as we looked out into this year. So nothing unusual that would indicate that I'm not comfortable with that product mix in the second half of the year being around 60%.

Got you. A quick follow-up for Vic. I know it's early and you have only talked to customers for a few months. But in your conversations, do you get the sense that the addressable wallet in your large customers is stable? Or do you think that cloud and open-source are reducing the spend on analytic platforms in aggregate in these big global 2000 type organizations?

So I guess -- so not an easy answer, right? But I actually think quite the opposite. I think that we have a lot of opportunity in these big accounts because we have to be flexible. We're going at it. We're going to solve through analytic solutions what they want. They have more data, not less, that they need help. In a consultative nature, that means that you're going to drive revenues a different way. Our customers are trying to understand how to get into the cloud, all of that.

So I think there is a lot of opportunity coming down the road in that regard. I know it seems hard at times to believe. It was hard for me a little bit at first when I got out, but the two key issues I heard from customers when it came down was, one, so you guys are going to go to the cloud. You understand that there's new things coming. You're going to help us work with that. I said, yes, we're going to. The amount of uncertainty there was about that in the marketplace surprised me. I think a lot of our customers actually were worried about that.

I think the second issue that came down, and they were thrilled to hear, and that is that we are committed to driving this business forward. Teradata is going to be around for a long time. We are going to be their partner and be there to help them. I think just hearing that has made them more receptive and it's been easier for our folks to get in. So when I say I'm enthusiastic about it, I really am. I mean, it's not that we have got to perform. We have got to do what we say we can do. We have got to do all of this stuff we're talking about, right?

But we have the capability and the people already inside the business to execute this strategy. Now are we going to need more of them going forward? Sure. But that more will be when we leverage and grow revenues. We're just going to have to have them in the field. So I'm really enthusiastic. Our guys, we get in with open-source from Think Big are great, they're smart, they're fast, people love them. So people are viewing us because we are coming with real offerings that demonstrate a different Teradata. So I think that's helped us a lot.

Thanks, Vic. I appreciate it.

Brent Thill, UBS.

This is Fatima Boolani on for Brent. A question for Vic. Vic, you mentioned you spent the better part of your first 90 days talking to customers and partners worldwide. In that context, the international performance of the business has continued to be strong. So I'm wondering if you can shed light on what type of buying behavior that you're seeing that is different from domestic trends? Or perhaps there is an execution playbook that is different domestically? Any color there would be helpful. A follow-up question for Oliver, if I may.

So, yes, I talked a little about that. This is real -- I think real simple. Yes is the answer to international. They have led a more consultative practice over there over the last couple of years. They've led the way we are here in early stages of that, I would say. But so, yes, we did have a little different strategy over there. We did have more of a back-end support in Europe. Actually the guy that was leading that locale is coming to the US to do that for us worldwide. So, yes, saw it -- 100% supportive of our strategy. So absolutely you saw it. It was very encouraging.

That's very helpful. A question for Oliver. Regarding the IntelliFlex architecture, now that fundamentally sort of decoupled the storage from the compute and I would imagine necessarily be disruptive to your overall hardware business, since it sort of deemphasizes the product families underneath. I was hoping you could help us appreciate the headwinds and the tailwinds as more customers adopt IntelliFlex? What the economic realization is from the adoption of IntelliFlex? Perhaps a lack of adoption in on-premise appliances.

So we are actually very excited about IntelliFlex and so are our customers. We have just released it this quarter. They're talking to a lot of accounts around the world. It is really reducing friction in installing Teradata systems. It is very much bringing cloud-based practices into the data center, growing storage and compute independently. It also helps us internally simplify our development roadmaps and collapse various different product lines into IntelliFlex, which makes us more nimble, faster time to market.

It allows our customers to more precisely implement what they need and do that much, much faster. So the hardware business for Teradata, by the way, is not going away, right? The hybrid cloud is strong back-end is the on-premises solution. We have enough indications from our large customers that they have no intention of moving everything into the cloud, right?

As such, they appreciate what we're doing with IntelliFlex. What we will be showing with IntelliFlex over the upcoming quarters is new technologies that we can implement with that. We can bring those to market in a much, much faster way than we have done before. So a lot of excitement in the Company around IntelliFlex. It allows us also with our managed cloud to bring IntelliFlex into there and have the same performance footprint that we have in on-premises solution. That really opens up a lot of possibilities for us as a Company.

Thank you.

Karl Keirstead, Deutsche Bank.

A question for Steve, a couple cash flow questions. I think you mentioned in your comments the upper end of your free cash flow guide is still $270 million, if I heard you correctly. I think you did $297 million through the first six months, implying that your second-half free cash flow might be down. Could you just explain why that would be?

Second and related, I think Teradata did $40 million of special acquisition, integration and reorder costs in the first half of 2016. Are you anticipating more of these quote, one-time costs, in the second half? Then maybe, lastly, you mentioned on a couple of occasions the need to update your infrastructure. Could you elaborate on what that means? Will that have any CapEx implications for second half and 2017? Sorry for all of those questions.

No, let me get the middle one on the special charges. Yes, we expect those to be declining in the second half of the year. So, yes, the first part was the ramp of the six months. Again, as you heard Vic say, we're now in the execution mode and so expecting that to be declining. On the free cash flow side, yes, it's really a function -- again, sitting at around $300 million, high end of the range, on our guidance range $270 million.

It really comes down to the function of that working capital, the timing of that working capital in our models. So at the end of the year, primarily driven by that AR side and potentially some of the equipment investments on some of these other usage-base models in the second half. I'm being cautious on that working capital number -- or that free cash flow number in the second half. So, again, you'll see more details at the Analyst's Day.

On the back-office infrastructure side, it's really getting back to those comments Vic made on the sales support side. We need to become more efficient on having our account execs address the business solutions at a customer, not spending time configuring hardware-type sales or product sales and getting that through the system. Again, this is getting more infrastructure support on the sales side to make them more efficient out in the field. Also, it's upfront making that support investment for the cloud business. So, again, that revenue will be ramping up on predominantly the subscription model. The upfront, we call it scaffolding, or the infrastructure around that cloud will be growing in front of that revenue, so that we're not mitigating that or adversely impacting that revenue growth trajectory.

Good stuff. Thank you, Steve.

Last quarter, I told you I believed in Teradata and its people. My first quarter here has only made me more excited about that, as you've heard. Our customers, as I said, they value our technology, our people and the solutions we deliver for them. The team is charged up. We're fully engaged and we're ready for change. I look forward to updating you on our progress next quarter and then at the analyst meeting. Thank you all so much for joining our call today.

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