Good afternoon. My name is Chantelle, I will be your conference operator today. At this time, I would like to welcome everyone to the Teradata Q1 2018 earnings call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star, then 1 on your telephone keypad. If you would like to withdraw your question, press the pound key. In order to allow time for everyone to ask a question today, please limit yourself to one question. Thank you. Gregg Swearingen, VP of Investor Relations, you may begin your conference.
Good afternoon, thanks for joining us for our 2018 first quarter earnings call. Victor Lund, Teradata CEO, will lead our call today. Oliver Ratzesberger, our COO, will discuss our technology advancements, differentiation, and customer activity. CFO Mark Culhane will discuss our financial results and guidance. 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 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 also 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 may also discuss other non-GAAP items such as free cash flow. 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 of teradata.com. A replay of this conference call will be available later today on that website. Teradata assumes no obligation to update or revise the information provided during this call, whether as a result of new information or future results. Now I'll turn the call over to Vic.
Good afternoon, everyone. I'm very pleased with our strong start to 2018. Our first quarter reported revenue and our non-GAAP EPS were better than expected. Not only were our reported revenues up versus Q1 2017, on the old perpetual basis, our revenues in Q1 of 2018 exceeded those of Q1 2016, a clear indication that consumption is growing. In addition, more of our bookings mix was subscription-based than we had originally expected, therefore, our Q1 performance was even better than it appears on the surface. Our strategy is clearly working. Customers are moving to our subscription-based options faster than we expected. This trend is being driven by Teradata Everywhere, our flexible and scalable offering that reduces the risk of our customers' analytic investments. The net result is that our pipeline, ARR, deferred revenue, and backlog are all growing.
I want to spend a few minutes on what we are doing to drive these positive results. Fundamentally, today's Teradata is a very different organization than it was two years ago. We have added subscription-based purchasing options, have developed Teradata Everywhere, and are deploying new capabilities of our Teradata Analytics Platform throughout 2018. We are developing cloud offerings that run on AWS and Azure in private cloud and on-prem. We have transformed our go-to-market strategy and built a field team that is able to engage with customers and address their needs, not only on the technology front, but also, importantly, to help them solve their most pressing business problems with market-led analytics. Further, we have changed our compensation structure and now incentivize our teams to sell subscriptions. Also, we have built a sales operation organization to assist in the global deployment of best practices.
We introduced and instilled new rigor in a formal account planning process. Our sales teams now have modern tools like salesforce.com to help them develop, track, and monitor customers. We have changed the skill set at Teradata by combining the people who develop the software that makes Teradata uniquely positioned to drive analytic performance at scale with new talent in areas like cloud and AI. We recently brought all of our consulting teams into one global organization to drive revenue and support our customers, with the goal of bringing us in line with industry benchmarks for sales and profitability. We have also strengthened our leadership team, bringing in an experienced CFO, CRO, CHRO, and in the last quarter, we added a CMO who will enhance our brand and help us develop a more disciplined approach in delivering our message to the market.
As I mentioned last quarter, we promoted Oliver to the position of COO to sharpen our focus on all the aspects that touch our customers. The new leadership team is seasoned, driven, and committed to successfully completing our transformation. While we have been adjusting all these levers, we are continuing investments in our infrastructure to enable us to become more efficient as we move forward. Finally, while driving revenue and customer engagement remain key, there are still multiple areas where we can continue to improve the effectiveness of our cost structure, and we will exploit all of those opportunities. Looking back, we have accomplished a great deal, yet as a team, we know we are still in the early stages of this exciting journey. I would like to thank the entire Teradata team for all their efforts to drive these results.
Many folks said we were crazy to take something like this on in a public forum, but the team has validated my belief in them and their commitment to succeed. With that, I'll turn it over to Oliver.
Good afternoon. Today, I will share why I'm so confident in our future. I'll talk about some of our innovations around our hybrid cloud-based data and analytics that are helping customers drive business outcomes and be on the fastest path to analytics in the cloud. We at Teradata are very excited because of the enthusiasm and support we are seeing from our customers. This was very visible at our recent Teradata Universe event in EMEA, where we saw a 24% increase in customers and prospects, and where I had many engaging conversations with executives. I have three key takeaways for you. First, Teradata is well-positioned to take advantage of digital transformation. Second, we are seeing increasing adoption of our hybrid cloud-based analytics. Through our Teradata Everywhere strategy, we offer customers the best path to the cloud.
Third, with the power and scale of our advanced analytics, we are seeing companies add new use cases, increase consumption, and grow TCORs. Today, I'll walk through how we have aligned our business to maintain our market-leading position. As the momentum towards digital transformation increases, redefining the way companies build new business models, create operational efficiencies, and ultimately generate growth, we believe data analytics is the foundation for this digital transformation. Teradata is well-positioned to take advantage of this revolution. We are executing to help the world's leading companies achieve high-impact business outcomes from analytics at scale. Companies are recognizing that our production quality advanced analytics, along with our flexible licensing and deployment options, are the best for their needs. As a reminder, our Teradata Everywhere strategy has four key tenets. Analyze anything, deploy anywhere, buy any way, and move any time. Let's take a look at our advantages.
Customers can analyze anything through our new Teradata Analytics Platform, which integrates with their preferred engines, tools, and languages. They can deploy anywhere. With our hybrid cloud offerings, customers can run the same Teradata software on AWS, Azure, Teradata Cloud, and on-premises cloud. Through our flexible pricing options and our IntelliCloud as a service offering, we enable customers to buy any way. We help customers move any time. An industry first that allows them to move their software across deployment options whenever they need on their timeline. Through their TCORs and converting to our buy any way subscription licenses. During their analysis, they also looked at cloud-native vendors and found them to be cost-prohibitive and unable to scale to meet their needs.
A few other examples of customers leveraging Teradata Everywhere through IntelliCloud include, a global CPG company is running Teradata on AWS to optimize their consumer promotions, improve sales planning, and enhance supplier contract negotiations. A very large telco chose Teradata's new on-premises cloud to provide more elastic expansion capabilities to meet unpredictable workloads, improve service levels, and reduce data center costs. A leading U.S. healthcare organization adopted Teradata to help ensure that its data remains highly reliable and available as the company moves into predictive analytics and machine learning. This last example illustrates how we are driving new advanced analytics capabilities that help companies increase their return on investment in IoT. As part of our Teradata Analytics Platform, we recently announced 4D Analytics. This advanced functionality is especially relevant in edge computing applications with constantly changing time and location variables.
We integrate analytics for where and when, primarily geospatial, temporal, and time series data, and combine them with operational and customer data, enabling our customers to operationalize IoT. This new functionality will help lead the IoT revolution and is the foundation of digital transformation. It enables new use cases like making smart cities smarter by analyzing patterns of trains, taxis and cars, traffic lights, restaurant traffic, and general citizen movement to provide insights for improving traffic flow. Another use case like optimizing fleet management by studying sensor data from a vehicle fleet, predicting the probability of a breakdown, then proactively addressing and minimizing the business impact. With the power and scale of our advanced analytics, we are seeing companies increase consumption and TCORs as they add new use cases, including a major manufacturer is running factory analytics on Teradata. A leading energy company added supply chain analytics.
One of our world's leading interactive entertainment companies is enabling GDPR compliance analytics. A global machinery manufacturer is running predictive maintenance. A large U.S. healthcare company is improving clinical outcomes. A multinational agrochemical company is improving yield management. It is also important to note that Teradata continues to garner excellent recognition from industry analysts for both our customer dedication and our technology innovations. We started out the year by being acknowledged as the number one for customer satisfaction in the Forbes JUST 100 rankings. We additionally were named a visionary leader in Gartner's Data Management Solutions for Analytics, and further attained the highest scores in their Critical Capabilities for Data Management Solutions for Analytics report. As I turn the call over to Mark, know that we remain fully committed to continue leading the market and helping our customers drive differentiated value from their data and analytics solutions.
We are operating with fierce urgency to help the world's leading companies get on the fastest path to the cloud for analytics at scale. Are excited to earn the ongoing validation from our customers. The entire Teradata team is bullish on our new growth strategy. We are in it to win. Mark.
Thanks, Oliver, and good afternoon, everyone. We've had a great start to the year, and I'm very happy to report better than expected Q1 results, not only in terms of total revenue and non-GAAP EPS, even more importantly, we had 62% of our new and add-on bookings shift to subscription, significantly higher than anticipated. Although Q1 is seasonally a smaller quarter, this provides us the confidence that our full year 2018 subscription bookings mix will exceed our earlier projection of 40%-50%. We now expect full year subscription-based bookings to comprise 50%-60% of our new and add-on bookings mix. Obviously, a higher mix of subscription also impacts our reported revenue, EPS, and free cash flow for the year.
customers purchasing Teradata on a subscription basis is clearly a positive trend, evidenced by the 11% increase in recurring revenue in the first quarter, which seasonally is our lowest bookings quarter of the year. As you have seen in our earnings release, we have changed our financial statement disclosure to better align with our new strategy and how we are managing the business. We are now reporting our revenue in the following classifications. Recurring revenue, which includes revenue from subscription-based transactions and services, as well as perpetual license related software upgrade rights and maintenance. Recurring revenue was $302 million in Q1, which increased 11% from Q1 2017. Perpetual software license and hardware revenue, which is revenue from on-premise perpetual transactions. In Q1, revenue from perpetual software license and hardware was $69 million.
This revenue will likely continue to decline year-over-year as our bookings mix shifts more towards subscription. It is also likely that this revenue will be a greater mix of hardware revenue going forward as a result of the adoption of 606. Finally, consulting revenue, which was $135 million in Q1 and increased 5% from Q1 2017. At March 31, 2018, our ARR was approximately $1.2 billion, an increase of 11% from the end of Q1 2017. Our backlog was approximately $1.7 billion, an increase of approximately 5% from year-end 2017. Before I highlight our Q1 results, I want to make it clear that 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.
Total Q1 revenue was $506 million, above our guidance range of $490 million-$500 million. EPS in the first quarter was $0.19, higher than our guidance range of $0.13-$0.16, and as expected, lower than Q1 2017 due to the shift to subscription-based transactions and investments related to the company's transformation since Q1 2017. Turning to gross margins, recurring revenue gross margin was 73.2% versus 78% in Q1 2017. As expected, the lower margin year-over-year was due to Q1 2018 recurring revenue mix being more subscription-based revenue, which carries lower margins than legacy maintenance upgrade rights revenue. We expect our recurring revenue margins to be in the low 70s range for the remaining of 2018. Perpetual software license and hardware revenue gross margin was 40.6% as compared to Q1 2017's 48.9%.
As expected, the lower margins are due to the revenue mix being predominantly hardware related, which carries lower margins as compared to software. We expect going forward, this revenue will be largely hardware related, and therefore margins will fluctuate on a quarterly basis depending on the type of hardware deals done. Q2's margin will likely decline from the margin seen in Q1 2018. In consulting revenue gross margin, it improved 170 basis points to a negative 3% compared to negative 4.7% in Q1 2017. Seasonally, the first quarter is typically the lowest revenue quarter and a heavy consultant training quarter, resulting in the weakest consulting margins during the year. We have invested in our consulting business to drive our business outcome-led strategy.
This is an area of focus for the company, and we expect our consulting margins to exceed comparable 2017 levels, improve from Q1 2018 levels, and for the full year, be in positive single digits. Overall gross margin was 48.4% in the first quarter versus 51.1% in the first quarter of 2017. We expect Q2 gross margin to slightly decline from our Q1 2018 level. Turning to operating expenses, selling general and administrative expense was $142 million in Q1, increasing as expected, $15 million or 12% from the first quarter of 2017, largely driven by our strategic transformation investments, including higher selling expense. Research and development expense was $68 million, up $3 million or 5% from the first quarter of 2017, driven by continued investment in our cloud offerings as well as our new Teradata Analytics Platform.
Total expenses increased $18 million or 9% in Q1 versus the prior year period. As a reminder, during our fourth quarter earnings call, we mentioned that we expected operating expenses to increase by up to $20 million year-over-year in Q1 2018 due to the strategic investments that we have previously discussed. Operating margin for the quarter was 6.9%, better than expected, versus 12% in Q1 2017. We expect operating margin to improve from Q1 2018 levels on a full year basis. Teradata's non-GAAP tax rate of 25.8% for the first quarter was lower than the 35.1% rate in Q1 2017. As [inaudible] expected due to the recently enacted U.S. tax reform in Q1 2018 compared to $248 million in the first quarter of 2017.
As expected, the decrease in cash provided by operating activities was due to higher expense run rate from our prior year strategic transformation investments that began subsequent to Q1 2017, the company's ongoing transition to subscription-based purchasing options, which result in the company collecting cash over time versus all upfront, and the overall timing of cash collection. Our capital expenditures increased $10 million year-over-year, largely due to customers shifting to subscription-based transactions. As a result, free cash flow for the first quarter was $156 million versus the $230 million in Q1 of 2017. Turning to our balance sheet, we had $939 million of cash as of March 31, 2018. Regarding cash repatriation, during Q1, we brought back $300 million, mostly to pay down our revolving credit facility and buy back shares. We expect to bring back an additional $500 million across the balance of the year.
We plan to use a portion of these funds to buy back shares and keep the remainder for general corporate purposes. During the first quarter, we bought $76 million of Teradata stock, or approximately 2.1 million shares. We continued to buy shares during the first part of the second quarter. Year-to-date, we have used $105 million of cash to buy back approximately 2.8 million shares. We currently have $425 million of share repurchase authorization remaining and will be opportunistic in repurchasing shares during the remainder of 2018. Total deferred revenue was $604 million at March 31, 2018, which was $105 million higher than on December 31, 2017, due to increasing subscription-based transactions and the seasonality of our maintenance billings. I would also like to point out that the adoption of 606 on January 1, 2018, reduced deferred revenue by $19 million.
In terms of the 606 impact on our Q1 reported results, there was no significant revenue impact. As expected and included in our guidance assumptions, operating expense was benefited by $5 million as a result of capitalizing sales commissions, which were previously expensed in prior periods. Turning to guidance. As I previously mentioned, we are experiencing increased movement to subscription-based contracts, which we now expect to be 50%-60% of our new and add-on bookings mix Up from our previous assumption of 40%-50%. As a result, our 2018 full year and second quarter reported revenue margins, operating profit, EPS, and free cash flow are impacted by the anticipated increased subscription-based bookings. We now expect total revenue in 2018 to be approximately $2.15 billion-$2.18 billion, and total revenue in Q2 to be approximately $520 million-$530 million.
We expect to continue our strategic investments throughout 2018. We now expect full-year operating expenses to increase by approximately $20 million-$30 million from 2017, $18 million of which was incurred in Q1. We continue to expect our 2018 full year non-GAAP effective tax rate to be approximately 20%. We expect our Q2 effective tax rate to be lower than our Q1 rate, but higher than the anticipated full-year rate due to the seasonality of pre-tax earnings and the timing of the tax impact related to discrete items and non-GAAP adjustments. As a result of these assumptions, including our bookings mix shifting to subscription-based transactions faster than previously expected, we are now estimating our 2018 full year non-GAAP EPS to be approximately $1.40-$1.46. This is based upon full year weighted average shares outstanding of approximately 123 million.
Q2 non-GAAP EPS is expected to be in the $0.17-$0.19 range based on 122 million weighted average shares outstanding in Q2. In addition, EPS in Q2 will be impacted by lower perpetual revenue margins driven by some large customers purchasing hardware but subscribing to software. We now expect our 2018 free cash flow to be approximately $175 million ± $25 million, as we see an increasing mix of our transactions shifting to subscription. This accelerating mix shift to subscription results in more customers paying us over time versus all up front, thus reducing our previous assumptions of cash collections, which lowers our free cash flow assumptions in the short term. I would like to provide you with an update on our full-year expectations for the following key metrics.
In terms of ARR, we now expect ARR to grow a little more than our original 10% estimate to approximately 11% in 2018. Recurring revenue, we continue to expect 12% growth in 2018. Bookings mix, we expect approximately 50%-60% of 2018 new and add-on bookings to be structured as subscription-based transactions. To the extent this mix percentage increases beyond this range, our financial operating results will be negatively impacted. We continue to expect high teens TCOR growth in 2018 as we continue to see increased consumption of Teradata from new use cases at existing customers and the addition of new customers. In closing, it's clear our strategy is working as our customers are shifting to our subscription options faster than anticipated. This is extremely positive news for the future of the company, despite the short-term impacts to our financial operating results.
With that, operator, we are ready to take questions.
At this time, I would like to remind everyone, in order to ask a question, press star, then 1 on your telephone keypad. In order to allow time for everyone to ask a question today, please limit yourself to one question. We will pause for just a moment to compile the Q&A roster. Your first question comes from Katy Huberty with Morgan Stanley. Your line is open.
Thank you. Good afternoon. Quick question on the quarter, then I have a big picture question. Why was the international gross margin so weak this quarter?
Hi, Katy. This is Mark. The mix of revenue and international, they probably have over 60% of our total consulting overseas than it is in the U.S., obviously, consulting margins are much, much lower than the overall margin profile.
Okay. Oliver walked through a number of good examples where you're getting pulled into AI, IoT, automation use cases, and I wonder if you can just spend a couple of minutes explaining what products that's pulling from Teradata, whether you think you have a full portfolio to address and to gain the largest wallet within those type of projects, because that seems like it's a big opportunity going forward.
Thanks, Katy. Completely concur. We believe this is a very large opportunity for us going forward, there's a couple of things coming together from our product portfolio. The first thing is the Teradata Everywhere foundation. The fact that we can deploy in multiple deployment forms, the various product offerings that we have. On top of that is really the Teradata Analytics Platform that is bringing together the different engines, the different languages, the different tools. This is where we hear from C-level executives around the world from our customer base that they have been struggling with complexity. They have been struggling with silos. They have been struggling with one-off technology that is very hard to operationalize, maintain, keep up and running, and operate. The Teradata Analytics Platform is what is resonating extremely well with the customer base.
I talked a little bit about our recent release about 4D Analytics, which is one step towards that, or the next step towards it, which really brings together this location-based, time-based, version-based view of data that allows customers to prepare the data for the algorithms. AI is only as good as the feature extraction, the data pipelines, the data science pipelines that you can build for the infrastructure. This is where we feel that we have a very strong product offering, customers, again, as I said, just came back from Universe in EMEA, with 24% more customers out there. Every single one of their executives talked about how these capabilities are game-changing for their digital transformations that they're going after.
Thank you very much.
Your next question comes from the line of Wamsi Mohan with Bank of America. Your line is open.
Yes, thank you. Good afternoon. Can you talk a little bit about the linearity this year? You have just under 50% of revenues in the first half, but only 26% of EPS. Sounds like you have some larger hardware transactions in Q2, which could put some pressure on margins that might reverse. What else changes in the back half of this year for profitability?
Hi, Wamsi. This is Mark. You're right. Q1 has always been our lowest revenue quarter. Q4 has been our highest revenue quarter. Q4 is our highest revenue consulting quarter. We see nice margin profile on the consulting in Q4. If you look at what it's been historically, even across 2017, it was in the low double digits in Q4 of 2017. Yes, we have some transactions that are largely hardware related in Q2 that are putting pressure on there. From an EPS perspective, the back half, particularly Q4, has always been the largest EPS quarter. Certainly was across 2017, and we expect that again in 2018. We see the back half moving on the EPS side much more dramatically than the first half.
Okay. Thanks, Mark. Your revenue guide for recurring revenue is still at 12%, you're moving faster to subscription, as you alluded to. Can you talk about what is happening with your customers from a maintenance perspective, which is probably the offset? Just, if I could, a little surprised to see the growth margin profile on the consulting business. Is there anything that is changing for you as a company in a particular fashion? Maybe it's incremental training or whatever it might be that is not allowing you to benchmark appropriately, even for the full year at that mid-single digit or high single-digit margins.
On the recurring revenue guide, first, we're only in through one quarter, and we had a great quarter and a great shift to subscription, and I continue to expect that to happen, which is why I haven't moved that off the 12% at this point in time. Yes, we are seeing shifts from maintenance and upgrade rights to subscriptions. We're seeing uplifts when that happens and so forth. Obviously as that, we take a look at that across the balance of the year. We'll determine whether or not how that impacts overall recurring revenue growth. Clearly, within recurring revenue, our subscription-based revenue is growing in excess of 100% and more than doubling year-over-year, which is what we expected, and we continue to see that happen. That's happening sort of on that front. What was the second part of that question?
Just on the consulting gross margin profile.
Yeah. Well, if you look across what happened in '17, they were negative in Q1. They became slightly positive in Q2, a bit more positive in Q3, low double digits in Q4. I said in my prepared remarks, we expect that same phenomenon to happen. I expect quarter-over-quarter across the balance of the year, we will see our consulting margins exceed '17 levels, both on a quarter basis and a full-year basis. The change has been we've now had our consulting organization. It's one organization, where in the past it wasn't. It's all managed and organized. We brought that together. That's creating some efficiencies. As I said on the call, this is a big area of focus for us going forward because historically, we've seen those margins be much, much higher in the past.
We're going to, over the transformation over the next couple of years, get them back to that level. Big area of opportunity for us, we believe.
Thank you.
Your next question comes from the line of Raimo Lenschow with Barclays. Your line is open.
Thank you. My question for Oliver. Oliver, can you talk a little bit about the competitive environment? If you go and sell Teradata now in the new fashion as a subscription model that is more looking at the cloud as well and deployment anywhere, is that predominantly the old guys? Is it the new guys like a Snowflake? Are you competing with the Redshift of this world? Just help us understand this a little bit better. Thank you.
Yeah. Raimo, thanks for the question. Of course, there is competition in our market, right? We have seen competition over the years. As you said, it was Redshift a few years ago that was predicted to be the big competitor. There's other names like Snowflake that are going around today making a lot of noise. Here's something really interesting. Our strategy is really to focus on the largest analytical opportunities out there, the top 500 as we talk about, right? In theory, that Everywhere is resonating extremely well with them. Why is that the case? Well, those are customers that operate at the largest end of the scale, right? They have petabytes of information. They have thousands of users and applications. They expect from their analytics platforms to do it all at the largest scale with the biggest amount of complexity and so forth.
The competitors that we see out there, while they are very noisy, they are good at small silos deployments. Yes, they can bring out the data mart for a small department, but they really struggle to scale beyond that. That is now becoming visible yet again, in our customer base. Those customers that have tested and tried some of these new capabilities are validating that at scale, they are not working. I told you about a large fintech company that doubled down on Teradata investment in Q1, doubled their TCORs with us, went completely to subscription. They have tested both Redshift and Snowflake, they told us it became cost prohibitive and impossible to scale to go onto these platforms. Yes, we see this. Yes, we hear that. This is where we believe we are differentiated the most.
For those customers in the top 500, hybrid cloud is a big deal. They need to be able to say, "I move some workloads into the public cloud. I use some workloads into the private cloud," they're also moving some workloads into their private data centers. You need a solution that runs unchanged in all of these environments. That's the other side of some of these competitors. They are either cloud only or one cloud only, that really limits the applicability for most of the use cases that we're seeing in our customer base.
Perfect. A quick follow-up for Mark. Just can you define how you define ARR, Mark? Thank you.
ARR is annual recurring revenues, combination of our subscription business and the historical perpetual license maintenance upgrade business is what's ARR.
How do you calculate it? Do you take last quarters and then multiply it by four? Is it including forward-looking numbers?
No, no, it's in forward-looking. That's the next 12 months. That's an annual recurring revenue run rate. It's not a backwards 12 months. It's a forward 12 months.
Okay, perfect. Thank you.
Your next question comes from Derrick Wood with Cowen and Company. Your line is open.
Great. Thanks. Mark, thanks for all those numbers and color. It's nice to get some more granularity. Real quick, on the last quarter, you talked about pipeline up 2x. I don't know if you'll be updating that regularly, but any commentary on how it looks today versus three months ago and any other color on the pipeline, especially since you've had a lot of new field executives you brought in?
Yeah. This is Vic. Pipeline's up again from where it was before. Continues to grow. We feel good about it. New opportunities coming in, we feel just as strong about our pipeline now as we did last quarter.
Okay. Kind of a higher level question. One thing we're hearing, I know you guys have talked about this in the past, customers have wanted cloud optionality in the database world, even if they're not really ready to move their database infrastructure to the cloud. I guess first, is there a way to measure quantitatively or qualitatively how having that option for cloud has improved your ability to get budget approval or budget approval cycles? Second, is public cloud seeing a whole lot of adoption at this point, or can you give us a sense for, in that subscription line, what the mix looks like between term hosted and public cloud?
Yeah. What you're talking about is the core of Teradata Everywhere. It first started off last year when we first shared that really with customers, where they were very positive about the fact that, "Oh, I have optionality. I have choice." As you say, they might not be ready to move everything into one particular cloud, they want to know that wherever they go, they can move anytime to any other deployment form. It helps executives and companies around the world to de-risk their buying decisions.
It has become very obvious as more and more customers are adopting that and the success stories are coming out, how easy it was for them to shift from on-premise to managed cloud in public cloud, and to be able to do that in 70 days as we have one example that we shared with you, for very large scale deployments without rewriting a single line of code for the applications that were originally written for the on-premise world. That is giving us a lot of momentum with executives in the conversations that we're having with them, and it's really helping us together with the new bundled pricing and subscription pricing, with the choice of where you can deploy, but also the ability to move at any time without having to re-license. That all comes together.
Again, if you apply that to the top 500 and if you apply that to our core customer segments, that is what-
What is driving the positive customer momentum that we're seeing, the feedback has been absolutely great from the customer base on that.
Okay. All right. Thanks.
Your next question comes from Karl Keirstead with Deutsche Bank. Your line is open.
Thanks. Question for you, Mark. Mark, it looks like you reclassified a fair amount of consulting revenues into your recurring bucket. I've got two questions there. First, just from a definition standpoint, what were the consulting services that sort of moved over and that were, in your definition, more recurring? Because most people think of consulting as frankly being non-recurring. Secondly, the piece that moved over into the recurring bucket, did it have any different growth or margin profile than the segment that is currently retained in the consulting bucket? Thanks so much.
Yeah. What got moved over is our managed services. Those are all sold on subscription predominantly, that's all under subscription contracts that renew. That's a recurring item, and that's why it's sitting in the recurring bucket. The growth profile of that has been largely pretty small. It's been pretty flat, that's not what's helping drive any recurring revenue growth at all. It's all the subscription that's driving the recurring revenue growth. That's pretty flat. It does have some differentiated margin profile. Obviously, the managed services margins on that, given their subscription and largely fixed fee, have a higher profile than standalone consulting margins.
Got it. Okay. That's very helpful. Thank you. If I could ask one follow-up, just on the pure subscription revenues. I know you haven't disclosed it in the past, but if I remember correctly, I think you suggested on the last call that you think the subscription revenue growth could be north of 100% in 2018. I just wanted to just recheck on that guidance. Do you still feel comfortable with that, assuming I had that number correct?
Yes, we do.
Okay.
Grow in excess of 100% and more than double in 2018 over 2017.
Got it. Thank you.
Your next question comes from Jesse Hulsing with Goldman Sachs. Your line is open.
Thank you. On the recurring margins or gross margins, I should say, they tick down year-over-year. I'm just wondering where you think those can go, as you go through this transition and, I guess, scale up that revenue base. I'm curious, your thoughts on the full year 2018, also, I guess, over the medium term and long term, where do you think those margins can go?
Yeah. The recurring revenue down year-over-year is a mix. It's obviously more subscription-based revenue versus the perpetual license legacy maintenance upgrade, those have different margin profiles. That's what you're seeing, you'll see across 2017 that they declined across 2017 as more of that subscription revenue came into the recurring revenue line. Over time, we expect these to grow from the low 70s that we expect across the balance of 2018 and approach closer to 80%, which we think is best in class, in the subscription world. They're very good, candidly, in the low 70s compared to a lot of the other SaaS companies out there and so forth. Yeah, we expect to drive them even higher than from the low 70s going forward.
Gotcha. Mark, just so I am looking at the right numbers and doing the right math. When you say recurring revenue growth of 12%, which is also what you guided to on the fourth quarter call, is that on last year's reported 605 numbers or on the 606 numbers? I'm not totally sure.
Well, the 2018 numbers are 606. We did not recast the comparable 2017 numbers to go back to 605. The 12% on that basis, the 606 adoption was a headwind to our recurring revenue growth across the year as compared to the prior year.
The guidance is on your 606.
Yeah. All our guidance is on a 606 basis.
Okay. Got you. Thank you.
Your next question comes from Phil Winslow with Wells Fargo. Your line is open.
Hey, great. Thanks, guys, for taking my question. As Vic mentioned earlier, when I do the back of the envelope math to sort of, with your recurring portion versus last year, it did seem that I see a pretty solid uptick in just product growth as adjusted for that ratable mix year-over-year. I remember Q1 being a particularly good quarter last year. You talked about it and essentially like a tough comp here in Q1 because of a large deal. Can you tell me what drove that year-over-year strength here in Q1, particularly in the context of that tough comp? Was it big deals again? Was it just sort of just volume of business across customers? Just sort of what's driving that off that tough comp?
A little bit of everything, I guess the big thing, we saw versus last year an uptick in international. We were surprised at how quickly international jumped on board this year. We quite honestly expected for that to be a little slower. That's what happened last year, and it accelerated significantly in Q1. That would be the number one factor that caused that percentage to increase and be better than last year.
Great. Just one quick follow-up to that, just the pricing environment that you're seeing in Q1 and kind of how you're thinking about that in Q2 and beyond relative to sort of what you were seeing last year.
We're putting discipline. We've talked about discipline in the field and where we are at, and we are not giving product away or anything like that. We are holding our price line. When you go through the deals with the big customers we got, sometimes they're very complicated, how you get it all done and get it into a subscription base, and that can create some issues. In terms of pure pricing, we're holding strong with where we are. We believe in what we've got. I've told our team they got to have swagger, they got to believe in what they sell, and it's worth what we're offering. We're holding where we're at. We aren't feeling any pressure. In fact, we continue to not try to close deals at quarter end to get a deal done.
First of all, it doesn't matter that much under a subscription basis. Secondly, we don't need to do that. We have a product and it's fairly priced, and we think we're treating our customers fair, and we expect a fair return. Pricing pressure is not anything that I'm overly worried about.
Great. Thanks, [Jesse].
Yep.
We have time for one more question. Your next question comes from the line of Abhey Lamba with Mizuho Securities. Your line is open.
Yeah, thank you. Mark, this is the first time we're getting the revenue breakdown the way it is. Can you talk a little bit about what's in the recurring bucket, different relative size of each of them, and how should we think about their respective growth rates? Is it also safe to assume that incremental gross margin on some of those recurring buckets is going to be pretty high, in the high 90s?
Yeah, we've shifted to a recurring revenue presentation, perpetual hardware presentation, and consulting presentation. Within the recurring revenue bucket, yes, we expect those margins over time to improve, based on the comments I made to Jesse's question, that we expect those to improve from the low 70s going forward. Clearly, maintenance software upgrade rights have a blended margin profile that's higher. Clearly, you got software and hardware in those numbers, but software's high 90s and hardware is lower than that. Over time, as this shifts and moves to subscription, we see margin improvement moving higher. We fully expect to see that a bit across 2018, but clearly more as we get into 2019 and 2020 as we complete the movement away from perpetual.
Got it. Oliver, if I can ask one last one. Can you talk about the competitive landscape in terms of adoption of Hadoop for ETL workloads? At some point in the past, you had quantified a potential range of your workloads that could be at risk of migration away to Hadoop. Any color on that in terms of what you're seeing currently in the market would be helpful.
Yeah, absolutely. I've been quite outspoken that we have used Hadoop as a tool for the right use cases before. What we're seeing, particularly over the last year, and I think the whole industry is seeing that, is that Hadoop use cases are actually shifting quite a bit to cloud-based architectures. This is really intersecting very well with what we're doing with Teradata Everywhere and our focus on cloud deployments. We're seeing very few Hadoop installations move into the cloud. The vast majorities of adoption in the cloud is on cloud-native architectures, S3 and EC2 and all the technologies that the cloud vendors offer that. This is what we really have focused over the last couple of years with Teradata Everywhere as we're rolling out. There's a very nice intersection that we're seeing there that's coming together. We expect Hadoop to be a tool out there.
We expect it to be used in customers around the world, we certainly don't see a lot of workloads moving off of Teradata to it.
Thank you.
You're very welcome.
There are no further questions at this time. I will now turn the call back over to Mr. Lund.
Thank you everyone for joining us today. I think you've all sensed the enthusiasm that we have about where we are today and our future and where we're going. I'm personally enthused by not only we have all the areas that we still have opportunity to improve our operation in. I've talked about some of them, consulting and driving to a better-operated company, and those are what our infrastructure investments around. All in all, very, very positive about where we're going. Good trends, confident for the year. We are going to be hosting an analyst day here in San Diego sometime in Q4 and updating you on our outlook as we are getting some more clarity around conversion rates and where we are headed as a company. We will be able to provide you a little longer view at that time, and we will get those dates to you.
Again, thank you very much for joining us today, and we look forward to our call at the end of Q2.
This concludes today's conference call. You may now disconnect.