Teradata Corporation (TDC) Earnings Call Transcript & Summary

Welcome, everyone. I'm Katy Huberty, Morgan Stanley IT hardware analyst. And I'm really excited to be joined by Steve McMillan, CEO of Teradata. Steve joined the company in June of last year and is really catalyzing the company's shift to cloud. Previously, Steve was responsible for worldwide operations at F5 and was Senior Vice President of Customer Success in Managed Cloud Services at Oracle. Before we begin the discussion, let me just point you to Morgan Stanley Research Disclosure website at www.morganstanley.com/research disclosures. If you have any questions, please don't hesitate to reach out to your Morgan Stanley sales representative. So with that, Steve, thank you so much for being here today.

It's a pleasure to be here, Katy. Great to spend time with you.

So as I said, you're relatively new in the role. 9 months ago, you joined the company. You've already made significant changes. Talk to us about where you have focused your first 9 months and some of the more impactful changes that you've made around product engineering, go-to-market and marketing to drive future growth for the company.

Yes, great. And thanks for the question. I think I'd just like to start out by saying I'm really proud of how Teradata has really embraced that appetite for transformation and execution over the last 9 months. I've asked a lot of the team, and I think they've really stepped up to that, especially demonstrating resiliency in the current environment, I think it's -- I think the company has just solidly been executing over the last 9 months. In terms of changes, I think people are incredibly important, and we've -- I've been really focused on getting the right team in place. We appointed a new Chief Product Officer, a new Chief Strategy Officer. We've just recently got a new Chief Revenue Officer as well as key recruits in places like cloud ops, a new CIO for the company and key finance recruits. And we've just appointed a new Senior Vice President and General Manager of Cloud. So I think the people and getting the right team in place is really important. And then driving a real culture of transformation, the principles that we're really looking at there, make sure we're market- and customer-driven, having agility in all that we do and that we're accountable to one another. And it's really that accountability to one another and driving that through the transformational change, including that focus on diversity, equity and inclusion as well as ESG activities, it's really a rallying cry around the company. But to your point, Katy, we also did some very strategic things around our investment profile. We switched the investment profile. We used to spend 70% of our research and development dollars on on-prem, and we switched that so that we're spending 70% of our development dollars in cloud. And that really enabled us to accelerate our rate and pace of delivery of cloud-native integrations and cloud capabilities in the product, modernizing that customer experience and so really generating a true modern experience for Teradata and the cloud. That's been incredibly important. And then the continuing focus in terms of modernizing our GTM sales, go-to-market sales motions, things like building out that customer succession during the renewals engine, continuing that transformation of our consulting business to focus on utilization of the product and then building up a partner ecosystem. And then as you pointed out, that marketing focus to really make sure that we're positioning ourselves in the market around our cloud message and cloud capabilities.

You've also reduced friction for customers to try your cloud product.

Yes, that's right. So part of that investment was then creating a demo and trial environment that you can sign up through our website. And removing that friction has been a common theme across the entire customer journey, not just demonstrating and showing the Teradata Vantage in the cloud to customers, but also thinking about that entire process. What we've seen is as we've progressed our cloud vision for the product, we're continuously removing friction. If you think about an on-prem environment, there's no more difficult friction to increase capacity and the capability of pure data warehouse and analytic system. You have to add in new hardware to be able to do that. In the cloud, we're finding that elasticity of environment and having less friction enables a lot of expansion of the Teradata environments. We see our customers only use about 20% of the features of the product. When they land in cloud, they start using new features, and they start expanding the system into new use cases, which has been really exciting to see our customers do that.

So what's your vision for what Teradata looks like in 3 years? And how should we expect that to translate into a financial model?

Yes. I think from a -- we believe that CTOs and CIOs and CDOs are going to want a connected multi-cloud platform, so they've got optionality of choice across the public cloud environments for their data warehousing and analytics platform. They want a modern data fabric that spans all of the places where they have data gravity, no matter where that is. And we are going to continuously make sure that we're building out that architecture to deliver against that. We've got proven proof points now that we can win in the market based both on our capabilities inside the product and also our price performance at scale. So we believe that in 3 years, a good portion of our existing customers, they'll still have on-prem investments, but they're going to be looking at how to extend it into the cloud. They're going to be looking at that overall data fabric. We also believe that we're going to migrate it and won new customers in the cloud over that period of time. We're very bullish on our cloud business just now and the guidance that we gave in terms of we expect to at least double our cloud ARR again this year. That doesn't assume a lot of new business from new customers. So that is upside for us as a company as we drive that change in product and removing that friction, to your point, and really build on that capability that we see our customers want in terms of that multi-cloud data warehouse and analytics capability. So I think we've got the opportunity to win significant cloud business, and we'll continue to see our on-prem business continuing to grow the market data sets that on-prem is still going to grow. But the cloud is clearly, with 30%-plus growth rates, is the place we'll focus from our profitable revenue growth strategy. Yes. So I think you'll continue to see us increasing our revenues, increasing our free cash flows, and that's pretty much what we guided to for this year.

Last quarter, it was sort of an awakening moment for investors when you released the cloud ARR figure for the first time, which was $106 million, growing well in excess of 100%. And as you just said, you expect it to at least double again this year. How much of that cloud ARR to date is from existing workloads that are moving from on-prem to cloud or -- and existing customers versus new customers or new workloads? And how would you expect that mix to change as you move through the next couple of years?

Yes. I think as we said on the earnings call, about half of our cloud ARR growth was from new and expanded workloads from customers that were already in the cloud with us and the other half came from existing customers migrating from on-prem to the cloud. But to your point, like they've taken the friction out of our customers' ability to expand their Teradata ecosystems once they land in the cloud has really given a platform for expansion, yes. So -- and especially when you compare that to what happens on-prem. And we see that throughout the entire customer base. During COVID, we gave incremental on-prem technology to customers to help them respond to COVID. As soon as that technology landed, they immediately started to use it. And so that expansion motion that we saw on-prem with -- given that capacity on demand, we see that every single day in the cloud. So we are expecting continued growth in our cloud business. We said at least 100% growth year-over-year in this year and expect to grow 165% year-over-year for Q1. So we do expect a significant number of our existing customers to utilize that hybrid approach as we go forward, and we're making technology investments to ensure that our customers can get the most out of that. And our high-end enterprise customers have told us that they want to see Teradata has a path to the cloud for them, which I think would now more than ready to demonstrate. And they are thinking about migrating that over time. So as Mark, our CFO, pointed out on the Q4 earnings call, we expect that on-prem subscription business to continue to grow and also capitalize on that cloud growth. So we're really bullish about the opportunity ahead of us.

As you gather more data and the cloud business scale, should we expect to get more transparency into what those net expansion rates look like in the cloud versus in the on-prem business?

Yes, I think just now, we're capturing these patterns in terms of what's happening from an expansion perspective, and we clearly have a set of operational metrics around that modern go-to-market motion that looks at how are we expanding, what's our net retention rate looks like, what's our net expansion rate looks like. And I'm really pleased with how the sales teams have responded to the incentives that we've put in place for this year, which really encourages the team to prospect for new logos. And encouraged the team to protect the base, and then they get a really good multiplier for growing the ARR in the cloud. So I think we're really excited about that modern motion and as we start to get those patterns, we want to make sure that we issue guidance and issue future-looking statements around those metrics and that we're very solid in terms of the guidance that we've issued. I think you've seen over the -- my tenure in the last 9 months, I'm very much focused on issuing guidance that our shareholders can believe in and that we believe in and that we're going to deliver against.

That's right. And with your cloud ARR metric, many other companies include other things, hybrid or maintenance in those ARR figures. Your cloud ARR is pure Teradata software running at the public cloud vendors.

That's absolutely right. And we were very careful to -- we do have a Teradata private cloud solution. We've taken that as not in these public cloud ARR numbers. This is Teradata running on AWS, Azure and Google Cloud. In most of those cases, we are provisioning the infrastructure as well as the software and running that as-a-service for the customer. And so all of that is included in the ARR. We also have a differentiating capability in terms of we can run Teradata and our customers' tenant so that we can utilize their infrastructure investments or commitments to the public cloud vendors and deploy Teradata on top of that. That's not the business that we've had to date, but it's certainly something that's really interesting to our customers who have made these large long-term commitments to the public cloud providers.

Now investors fear that as customers migrate to the cloud, they may give preference to cloud-native solutions. Have you had many customers migrate their workloads to a competitor's platform? And how have those migrations trended over the last few quarters? And then alternatively, I think you've seen some customers return to Teradata after trying some of those competitors. Just talk about the gives and takes on the competitive side of the cloud business in particular.

Yes. We have seen customers try those cloud-native solutions in the public cloud with varying degrees of success. What I would say is when I talk to a CI, they're worried about lock-in. They're worried. And if you think about where they are spending their money now with these public cloud providers, they want to have optionality of choice between an AWS and Azure or Google. Having Teradata available on all of those 3 platforms that our customers can really choose which cloud they're going to invest in, and that, I think our perspective is we are tracking the code on being able to federate data across these public cloud environments. And just as many companies have worked out in federate compute across these cloud environments, we're really looking at it in terms of we can federate the data and insights that we've got. So to your point, I think our customers are really buying into that multi-cloud vision. They're seeing that from a cost-performance perspective. Teradata is actually better than some of these cloud-native solutions. Just because of our technology, we're -- because we were born on-prem, that's probably not a term that you hear very much. But being born on-prem, we're used to optimizing the capacity and squeezing every single element of usage out of the processing and storage capability, so we can give a much more predictable cost performance for our customers in the cloud. And so I think at scale, we are seeing our -- the customers really, if they've kicked the tires on a native-cloud solution, they're really looking at the Teradata solution now has been a true cloud capability that delevers the enterprise scale that they need. And we were really delighted recently getting -- we were put in the leader quadrant from a Gartner perspective. And then from a performance perspective, getting 3 -- being the top performer in 3 out of the 4 use cases that they've put forward from an enterprise data warehousing perspective. It just proves out that we've got that technology capability in the cloud.

Now one of the ways to reduce the risk of customer loss to some of the cloud-native competitors is to focus on growing your own customer base, which before your tenure, wasn't emphasized as much as in the past. So talk about what incentives you're putting in place to focus on new customer acquisition? And does Vantage running in the cloud just make it easier for new customers to try the Teradata platform?

Yes, absolutely something we're really excited about. Having that modern and cloud product available and having our sales team is really confident in how we can utilize that cloud product to delever with the trust and confidence that our customers have had in us for years and years and years. Having the cloud products so that we can utilize native object stores, and we think of the product really is a platform that we're opening up. The Teradata have all wanted to get all the data and put an inside our ecosystem so really opening up to have a modern cloud product that natively integrates with these Cloud-First party services gives us the ability for our sales teams to go out and hunt those new logos. We see most of the growth that we're going to get from a new logo perspective will be in the cloud, perhaps wouldn't come as a surprise to you. However, we do think there's lots of opportunity for us to present this cloud vision to current customers of both IBM and Oracle that want to have a capability that looks to the future, gives them the ability to play in a multi-cloud environment and move -- consolidate their on-prem, that might be in an IBM environment or an Oracle environment, onto Teradata and then be able to move that to the cloud in the future. So we're really bullish about all of these different sales motions that we think will propel our company's -- our target market segment to move to the cloud in the future.

Teradata -- you mentioned earlier that Teradata consulting revenue is declining, but that's a purposeful shift toward opening up your partner ecosystem. Talk about what type of partners you're looking to bring on to the Teradata platform and what benefit does that bring in terms of solution selling and go-to-market?

Yes, thanks. The -- it's great that you pointed that out because if you look under the covers of what's happened to Teradata revenue, you do see that decline in the consulting business. And that has been very much a strategic decline in consulting to make space to -- for us to work with, especially SIs and developing a partnering approach. So as I've been talking on our earnings calls from the very first earnings call I presented on, I have at least one of the customer situations and mentioned one of the SIs that we're working with because these SIs, they're advising customers on the best way to move forward, how to modernize that fabric. And so we're getting a great partnering our approach with the SIs. The other partners that we think about, there's 3 other segments of partners. One is the cloud service providers, where we see that value exchange in terms of when they deploy -- when we deploy Teradata, that they see increased use of their first-party services. And so there's a great value exchange for our cloud service providers. ISVs, we've seen some great use cases deployed. GE Digital actually recently talked about a solution built on Teradata for the airline industry. And then from a VAR perspective, looking to extend that sales capability across geographies. So I think -- and those -- all of these -- the VARS, the ISVs, SIs, they clearly want to make their money and get from a consulting perspective. And to the friction point, we're just removing that friction in terms of not competing head-to-head from a consulting perspective. We want to win the technology platform dollars and enable that technology platform with our consulting team and have the SIs do the SI work. So really excited about that.

And where are cloud margins today compared to the on-prem subscription business? And what's the right revenue scale for the cloud margins to converge with the rest of subscription revenue?

Yes. Currently, our margins in the cloud business are lower than our overall recurring gross margin. And we take some restructuring steps to continue to make sure that we have that profitable revenue growth engine even as the cloud mix continues to increase inside the business. But I just -- like any "born in the cloud" capability, we expect our cloud margins to improve as we scale the business and give again more and more leverage in our cost structure. As well as that, we're increasing levels of automation and capability to run these workloads in the cloud, got lots of operational investment that we're doing in terms of growing our cloud ops capability. And I think what we're seeing overall is it's going to be interesting to watch how many of our customers choose to deploy the Teradata software as a service in the cloud because, clearly, we don't make money when we resell that -- when we include that AWS or Google Cloud or Azure cloud infrastructure inside our ARR. But if our customers start to deploy Teradata and use the advantage of Teradata in terms of its software capabilities on their infrastructure, clearly, the profitability of that is incredibly high. The ARR is a little bit lower, but the profitability is high. So I think we'll start to see lots of things come into the cloud margin mix that will enable us to improve it over time.

And is there an opportunity to improve margins as you scale the business and then go back to the cloud providers and negotiate lower infrastructure costs?

Yes. And I think the cloud providers are -- the hyperscalers are really seeing the fact that Teradata can be a great tool and a great partnership to really grow their revenue as well as Teradata growing their revenues as we combine our capabilities. And I said, as we invested in the cloud, one of the things that we did was really improve our cloud-native integrations with those cloud providers. So if you want to utilize the AI stack from Google and combine it with Teradata, you can do that in the right kind of way. And I think as those hyperscalers start to recognize just how much data Teradata can bring to their environments, they are going to be really motivated to work more with us. And we've just appointed a new SVP and GM of Cloud, and one has key responsibilities is creating those strategic agreements with the cloud providers as we move forward, which will obviously help to positively impact our cloud margin as we move forward.

Now if we look at other software businesses that have gone through a transition from a licensing model to a subscription model, typically, when that transition is done, free cash flow is higher than when they started. Where do you see normalized free cash flow for Teradata once you get through the subscription and the cloud transitions?

Yes. We're largely through that transition from perpetual to subscription, and we do expect to begin seeing those tailwinds from that transition with respect to free cash flow as we collect cash from prior year deals and it starts to add up as well as cash from deals in the current year. We reported $216 million of free cash flow in 2020, which was nearly $89 million increase from 2019. And for this year, we're saying at least $250 million of free cash flow in 2021, and we're pretty confident in the guidance that we gave there. We do plan on having an Analyst Day, and we'll talk about our longer-term targets and longer-term vision. But look, we're really proud to have a hypergrowth cloud business that is generating positive free cash flow at the company level overall. And that continued profitable revenue growth is going to be the focus for the company as we move forward.

One of the questions that has come in over the webcast, and it's a topic that most of your infrastructure peers have touched on, is just sort of the demand recovery that we might see in 2021 as businesses reopen and people return to the office and companies are willing to spend more cash and take a little bit more risk in terms of trying new technology. What are you seeing on the demand environment? And what's your view as to what sort of a CapEx recovery we might see this year?

Well, again, I think what we are really reassured about in terms of our results last year was just how solid and reliable the Teradata business is overall. We're really looking forward as that risk appetite changes and organizations become a little bit more willing to invest cash in digital transformation projects. I think we saw some acceleration of digital transformation to respond to the pandemic, and I quoted an airline. Clearly, the airline industry is a distressed industry. But they're investing in data and analytics to improve their operational effectiveness and efficiency. I think what we'll see as we move through 2021, and those digital transformation budgets start to open up again, that they'll use those investments to start growing top line. And that will, I think, really expand that level of IT spending. So we're pretty bullish on capturing that and especially capturing the growth in the cloud.

Now we spend a lot of this conversation on the cloud strategy. Teradata share price has reacted favorably to your cloud focus as you bring new leadership into the company, and that cloud ARR figure that you released about a month ago. But if you look at the share price, it still trades at a meaningful discount to your cloud-native peers. And you could argue that Teradata should be, at some point, a double-digit market cap. How are you thinking about the strategic path that you have to potentially unlock more of that potential value and trade more on par with your cloud-native peers?

Look, I think from our perspective, this is about proving Teradata in the cloud. And we're clearly seeing those proof points in the industry today. We talked about -- a little bit about it earlier in terms of customers that have kicked and cut tires in cloud-native, and they've come back to Teradata either because they can get the solution to work or it's too expensive to run. I think as we continuously demonstrate the fact that we have an incredibly positive story around our cloud technology, and that's translating into really excellent growth. Again, predicting that we're going to double our cloud business again this year, that's going to prove out the -- our thesis in terms of Teradata is a modern and relevant cloud data platform that can address the needs of our kind of customers, both today and tomorrow. So super excited about it. We would totally agree with that assessment, Katy.

So just -- we have 2 minutes left. We started the conversation focused on where you spent your first 9 months. Tell investors where you plan to focus over the next 9 months of your tenure?

Look, I think it's cloud, cloud, cloud is building those capabilities and those muscles to give that vision to our customers about where we can take them from a data perspective, open their eyes to the fact that Teradata is a market leader, both from a cost-performance perspective, but also from a capability perspective. We've got the industry analysts on-site in terms of Gartner and so forth saying that now. So I think as we put more wood behind that arrow, we draw out our cloud product and cloud platform. Our sales teams are removing that friction to take that message to new customers. We're really confident that we're going to at least double our ARR this year. We're going to increase free cash flow year-on-year. That continued profitable growth is something that we believe that can be set for the long term. And Teradata is going to be looking out front rather than being a rearview mirror technology as we move forward.

That's great. We look forward to watching the progress, and it sounds like hearing more at an Analyst Day later this year. Thank you, Steve, so much for joining us today. Have a great day, everyone.

It was a pleasure. Thank you so much.