Earnings Call Transcript - TDC Q2 2022

Operator, Operator

Good afternoon. My name is Lisa, and I will be your conference operator today. I would like to welcome everyone to the Teradata Second Quarter 2022 Earnings Call. All lines have been muted to prevent background noise. After the speakers' remarks, there will be a question and answer session. I will now hand the conference over to your host today, Christopher Lee, Senior Vice President of Investor Relations and Corporate Development. You may begin your conference.

Christopher Lee, SVP of Investor Relations and Corporate Development

Good afternoon, and welcome to Teradata's 2022 second quarter earnings call. Steve McMillan, Teradata's President and Chief Executive Officer, will lead our call today, followed by Claire Bramley, Teradata's Chief Financial Officer, who will discuss our financial results and our outlook. 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 today's earnings release and in our SEC filings, including our most recent Form 10-K and in the Form 10-Q for the quarter ended June 30, 2022. The that is expected to be filed with the SEC within the next few days. These forward-looking statements are made as of today, and we undertake no duty or obligation to update our forward-looking statements. On today's call, we will be discussing certain non-GAAP financial measures, which exclude such items as stock-based compensation expense and other special items described in our earnings release. We will also discuss other non-GAAP items, such as free cash flow and constant currency revenue comparisons. Unless stated otherwise, all numbers and results discussed on today's call are on a non-GAAP basis. A reconciliation of non-GAAP to GAAP measures is included in our earnings release, which is accessible on the Investor Relations page of our website at Investor teradata.com. A replay of this conference call will be available later today on our website. And now I will turn the call over to Steve.

Steve McMillan, President and CEO

Thank you, Chris, and good afternoon everyone. Thank you for joining us today. Teradata’s momentum continued during the second quarter of 2022. Our results demonstrate our business resilience during volatile economic trends and these results are driven by our solid business model, critically important what we do for customers, and our cloud momentum. Our strategy is right, and our business fundamentals are solid. In the second quarter, we delivered public cloud ARR of $234 million, growing 75% year-over-year in constant currency. Our cloud ARR growth accelerated as more customers connected to Teradata in the cloud both year-over-year and sequentially, and they committed more substantially as well. Recurring revenue is now 80% of our total revenue, which not only demonstrates the mission-critical value we provide to our enterprise customer base, but also underpins the healthy generation of durable free cash flows. We also generated more than $100 million of free cash flow in the quarter, and we exceeded the high end of our quarterly outlook for non-GAAP earnings per share. On both metrics, we have passed 60% of our annual outlook. Our ongoing execution reflects our clear focus on our strategy as a profitable multi-cloud data and analytics platform leader and gives us conviction that we are reaffirming our annual outlook, including an expanded outlook range for total ARR. Claire will share more in her remarks. We are intent on keeping our momentum doing what we said we would do, even in the current challenging macro environment. Our strategic customer focus is in leading global enterprises diversified across many industries. Our customers are strong, stable businesses that require the best data and analytics to succeed. And when they place their trust in Teradata, they make multiyear commitments. As a result, our business model is resilient with predictable revenue. We all know that every day, the amount of data grows, and right along with it grows the need to capitalize on that data, extract the greatest value from it, and make the best business decisions faster. Our platform is designed to deliver a unique advantage that enables cost-effective growth. With Teradata, companies can access and use the data without duplication or data movement. We take the analytics engine to the data. There is no need to copy and move it to get value. As a result, the Teradata platform provides efficiencies over others; competitors' costs increased disproportionately higher and faster than the growth in analytics. Using data where it resides allows businesses to create advanced analytics with the entire universe of available data and not waste money moving and duplicating it. Our Vantage platform, the foundation for game-changing analytics, is already in place. It is a simple and very efficient effort to add data elements to bring better insights and greater value. Just one example, as a company is doing a forecast model for inventory needs during the holidays and might need a subset of weather data to build a more accurate model and make more informed decisions. With competitors' platforms, the company would have to copy all that data and move it into their system. Doing the series forecasting would require additional data movement, which always leaves more time and more cost to the customer. But with Teradata, all of that can be done without moving the data—a much smarter and more efficient solution that only we deliver and one that drives more consumption for Teradata. Particularly now, companies need the insights provided by the powerful data and analytics Teradata provides. Studies indicate that C-suite leaders, notably CIOs, are planning for technology-enabled growth and efficiency during unpredictable periods of challenge and uncertainty. Companies need data at enterprise scale to review, rethink, and rapidly adjust to changing market conditions. We have seen these secular drivers play out during the uncertainties of the pandemic, and the need for data and analytics is likely to remain a C-suite imperative. High-priority areas are directly in our sweet spot, including cloud, data, and analytics. Each quarter, we provide updates on our technology, demonstrating our continued growth as a cloud leader. I'm very excited about our announcement that is just around the corner as we take the next step with our cloud data and analytics platform. Later this month, we will introduce our most significant cloud capabilities yet, bringing our industry-leading enterprise data and analytics platform, best-in-class workload management, and patented analytics capabilities into the next generation so that companies can scale smarter, innovate faster, and grow stronger in the cloud. Organizations will be able to support their largest and most complex workloads with outstanding cost efficiencies and enterprise price performance with Teradata today, and we are taking our capabilities even further. They will be prepared to accelerate their highest value opportunities, unlock data through our flexible and scalable platform, and activate their analytics through more data-driven decision making. Ultimately, we help solve mission-critical challenges and generate returns. We will share more at the time of our launch, but rest assured, we will do it better than anyone else. Following our announcement, we will be taking our message on the road, coming to all of our regions around the globe with our event series entitled "Possible." Our marketing team is accelerating to drive greater awareness of Teradata's differentiated capabilities. Throughout this global series, we will showcase proven approaches to create value from data and analytics and accelerate results even in dynamic business environments—exactly what our customers need now. To help customers address their analytics needs, we are ensuring they are aware of our capabilities. We have driven ongoing expansion in our pipeline of opportunities in the cloud through the first half of 2022. We have actively worked on expanding the pipeline with several drivers, including greater awareness of the differentiated capabilities of our platform and brand as the connected multi-cloud data platform for enterprise analytics, greater experience in selling cloud-first, and in selling with partners. Our results clearly show the strength of our efforts to grow through migrations to the cloud by continuing to expand hybrid environments as customers maintain their on-prem environment while adding new incremental workloads in the cloud with Teradata and winning new clients, both in the cloud and on-prem. We expect customer successes to continue as we look ahead to the second half of the year. Let's walk through a few examples. A Fortune-500 insurance company is migrating its entire Vantage on-prem environment—development, production, and disaster recovery systems—to Vantage on AWS. The customer chose Teradata because of the ease of migration we offer, our proven scalability to manage increasing analytical workloads, and our roadmap that aligns perfectly with their long-term strategy for data and analytics. PetroRio, the largest independent oil and gas company in Brazil, has chosen Vantage on AWS as an enterprise data and analytics platform. As a new Teradata customer, PetroRio relies on Teradata to build a logical and flexible environment it can leverage for business analytics. One of the largest boutique healthcare labs in the U.S. has chosen Vantage as the foundation for its data and analytics strategy. This new Teradata customer is integrating disparate data from several legacy databases and homegrown systems into a hybrid Vantage environment. Workloads will initially be deployed on-prem to start and then ultimately migrate to Vantage on AWS. Another customer will leverage Vantage to improve its personalized services and develop unique therapies to treat cancer. American Airlines, one of our long-standing customers, migrated to the cloud with Vantage and Microsoft. Vantage on Azure provides the flexibility, elasticity, and industry-leading price performance this airline titan needs for its business-critical operations. I encourage you to watch the videos on our website that outline the successful migration and the results achieved from data and analytics running on Vantage. I am very proud of how our team performed and drove wins in the quarter. We did not see anything unexpected as we executed our strategy in a competitive market and challenging macro environment. There were no surprises or deal delays in the quarter. I am really enthusiastic about the strength of our pipeline as we enter the second half of the year. I mentioned wins and pipeline growth with partners. As a data platform leader, we are steadily enabling partners to extend our reach and drive adoption and consumption of Teradata. We have recently made some great partnership announcements that address important and emerging needs. We recently announced the integration of our Vantage platform with Amazon SageMaker. With the enterprise scale advantage, we empower even the largest organizations to execute complex analytics on massive data sets while using their favorite data science tools and languages. Projects around AI and ML are able to move to wide-scale production in weeks rather than months, allowing our joint customers to accelerate their projects and achieve faster value. Additionally, we just announced a new collaboration between GE Digital, Microsoft, and Teradata. We are working together to support the imperative of addressing the devastating effects of climate change. Together, we will develop an offering designed to help aircraft operators achieve fuel efficiency and reduce carbon emissions. Teradata Vantage will be the underlying data and analytics platform to support these environmental sustainability initiatives. Operating sustainably is a core element of ESG, and ESG is a core component of all aspects of our business. Our annual ESG report has just been released, which outlines the depth of our increased attention and focus, as well as the actions taken and the progress made as a responsible corporate citizen. I invite you to read through it on our website. Another significant element of ESG is governance, and we have just added new strength to our Board of Directors. I'm incredibly pleased that Tod Matalan joined our Board in the second quarter, and I'm excited that Teradata will benefit from his deep financial experience and proven track record of successful transformations to the cloud. Teradata continues to be recognized as an ESG leader and has been named in the 50-50 women on Boards Gender Diversity Directory. Diversity, equity, and inclusion are cornerstones of our company, and I am proud that we are walking the walk. As I turn the call over to Claire, I remain confident in our future. We are growing in the cloud, and we have powerful technology that continues to improve. All this increases our total addressable market, a market that is large and organically growing due to the never-ending need for data and analytics. I'm enthusiastic about accelerating in the second half of the year, driving profitability, generating free cash flows, and returning shareholder value. Now I'll turn the call to Claire.

Claire Bramley, CFO

Thank you, Steve, and good afternoon, everyone. In the second quarter, we reported $25 million of sequential cloud ARR growth or $30 million in constant currency. We also delivered earnings per share of $0.03 above the high end of the previously provided range and generated another quarter of very healthy free cash flow. This quarter was in line and consistent with the forecast that underpins our fiscal 2022 outlook. Our forecast is driven by our cloud-first profitable growth strategy and our solid financial fundamentals. Despite the current challenging economic environment and persistent currency headwinds, we are doing what we said we would do, and we remain on track to achieve our fiscal 2022 outlook. Let's get into the quarterly results, starting with ARR. Total ARR decreased by approximately 3% year-over-year as reported and grew 1% year-over-year in constant currency. On a year-over-year basis, there was approximately a 4% negative impact on the reported growth rates associated with exiting Russia, as was shared with you last quarter. On a sequential basis, total ARR declined by approximately $37 million, with approximately $32 million related to currency headwinds. Cloud ARR grew 68% year-over-year as reported and 75% year-over-year in constant currency. Cloud ARR grew in all three geographic regions, both year-over-year and sequentially, continuing the momentum we have seen throughout the year. Cloud ARR growth in the second quarter was driven primarily by migrations, including a number of seven-figure deals. This migration activity came from a healthy number of existing on-prem customers new to the cloud with Teradata. Total new logos for the quarter were in the low double digits. This amount grew sequentially and year-over-year, better than historical seasonality. Total new logos included both on-prem and cloud customers, representing the financial services, government, and transportation industries, to name a few. This new logo momentum is a proof point of executing our strategy. Regarding cloud expansions, our net expansion rate was approximately 120%. This is below our planned rate, but we are still on track to deliver our outlook of approximately 80% growth year-over-year in cloud ARR as reported and in constant currency. In the quarter, we had more customers expanding compared to the same period last year. These enterprises are starting their expansion on the Vantage cloud platform with smaller test and development workloads, but the potential for even greater growth ahead. In addition, we see two other trends that are not included in the net expansion rate calculation that point to future growth. First, customers are expanding more than one-for-one at the point of migration than we originally modeled. Second, we are seeing new incremental cloud workloads from existing on-premise customers who are expanding their hybrid environments. These trends, along with our seasonally stronger second half and excellent cloud pipeline, give us confidence in our ability to achieve this year's cloud ARR growth target. With regards to non-cloud components of total ARR, subscription ARR decreased 3% year-over-year as reported, and maintenance and software upgrade rights ARR decreased 24% year-over-year as reported. Both were driven primarily by customers shifting their Teradata spend to term or cloud subscriptions and were also impacted by currency headwinds and the ceasing of Russia operations, which was reflected in last year's numbers. Moving to revenue. Total revenue was $430 million, a 12% decrease year-over-year as reported and an 8% decrease in constant currency. Recurring revenue was $345 million, an 8% decrease year-over-year as reported and a 5% decrease in constant currency. As a percentage of total revenue, recurring revenue was 80% in the second quarter—a new high for Teradata. There was a negative year-over-year impact in the reported growth rate of approximately 15% of total revenue and approximately 14% for recurring revenue. Both were affected by the cessation of operations in Russia, the impact of upfront recurring revenue, and currency headwinds. We have provided a slide in this quarter's earnings presentation that shows the impact by quarter to ARR and revenue. It also clearly demonstrates that the underlying business is growing as expected. To add additional color on this quarter's recurring revenue, there was approximately $12 million of recurring revenue that remained from our results due to exiting Russia. There was also less year-over-year benefit from upfront recurring revenue engagement. The impact of a negative $6 million is a small net positive amount we had expected in the quarter. For reference, this compares to a positive $22 million impact in the second quarter of 2021. Looking ahead, we see a change in the quarterly shape and net upfront recurring revenue in the second half of 2022. We continue to expect a net negative amount in the third quarter but now anticipate a net positive amount in the fourth quarter. As a result, we now anticipate a net $0.20 benefit to earnings per share related to upfront recurring revenue, similar to last year. Regarding perpetual and consulting revenue, we continue to execute against our strategy, moving to a higher-margin subscription revenue model and collaborating more with partners to drive higher adoption and greater consumption of Teradata. Moving to profitability. Teradata's second quarter gross margin rate was 61.2%, and gross margin dollars were $263 million. The year-over-year decline in gross margin dollars is primarily due to negative currency impacts, ceasing our business operations in Russia, and the negative impact from upfront revenue abatement in the quarter. Cloud gross margin dollars are improving as we continue to scale our cloud revenue. The operating profit margin was 12.8% in the quarter, and the year-over-year decline in operating profit margin was primarily attributable to lower revenue. We continue to invest in cloud, go-to-market, and research and development to drive greater adoption and consumption of our platform while maintaining solid cost discipline. Second quarter earnings per diluted share of $0.33 exceeded the high end of the previously provided outlook range of $0.30, even after accounting for a $0.02 benefit from the more favorable tax rate. Turning to free cash flow and capital allocation. Free cash flow generated in the quarter was $102 million, driven primarily by efficient cash conversion sustaining our positive operational trends of cash collections over the last five quarters. In the second quarter, we repurchased approximately 2.1 million shares or $67 million in total. Of this dollar amount, $50 million related to the completion of the ASR transaction we entered into in February, and $17 million related to incremental share repurchase during the quarter as we believe our shares are undervalued. We will continue to be opportunistic during the second half of the year. For the first half of 2022, we have returned 126% of our year-to-date free cash flow to shareholders. As a reminder from our Investor Day, we committed to an annual 50% return target. We remain committed to capital allocation that drives shareholder returns. That includes share repurchases but also continued investment in the company that supports our strategy, the cloud acceleration, and profitable growth. On our capital structure, we upsized and extended the maturities of our debt facilities this past June, securing better pricing and increased flexibility for the company. In conjunction, we also entered into new interest rate and cross-currency swaps to reduce interest expense and minimize risk. With regards to the 2022 outlook, I would like to provide some context on the third quarter and the rest of the year. We continue to have confidence that cloud ARR dollar growth will accelerate sequentially throughout the year. We know that our fourth quarter is seasonally our highest quarter from a sales perspective, and we expect a similar pattern from total ARR and cloud ARR growth in 2022. The strength of our weighted pipeline continues to improve. As Steve mentioned, customers continue to commit more substantially to Teradata in the cloud. We see that in our increasing win rates. Despite the current economic environment, we still have strong conviction in our cloud ARR. We are building in conservatism and widening the outlook range for total ARR to account for on-prem deal timing given the macroeconomic environment. We have reviewed our 2022 financial forecast against the end of July currency exchange rates. Despite the continued strengthening of the U.S. dollar since April 2022, we are pleased to reaffirm our outlook for all other elements in constant currency and on a reported basis, though we could be towards the lower end of our ranges if currency headwinds continue to worsen. We will continue to focus on the fundamentals that drive healthy profitability and durable free cash flow generation. With that, we reaffirm our 2022 financial outlook. This includes approximately 80% growth year-over-year in cloud ARR as reported and in constant currency. Free cash flow of approximately $400 million and non-GAAP earnings per diluted share to be in the range of $1.55 to $1.65. For total ARR, we are widening the outlook range to decline in the low single-digit to mid-single-digit percentage range year-over-year as reported and grow in the low single digit to decline in the low single-digit percentage range year-over-year in constant currency. Our complete 2022 outlook can be found in our second quarter earnings press release and presentation. For the third quarter of 2022, we anticipate non-GAAP earnings per diluted share to be in the range of $0.27 to $0.31. We project the non-GAAP tax rate to be approximately 21% in the third quarter and approximately 25% for the full year. We also forecast the weighted average diluted shares outstanding to be approximately 106 million shares in the third quarter and approximately 107 million shares for the full year. Thank you very much for your time today. Let's please open the call for questions.

Operator, Operator

Your first question comes from the line of Chad Bennett with Craig-Hallum.

Chad Bennett, Analyst

So regarding the cloud, what was the public cloud ARR in the quarter? Last quarter, even though we experienced FX impacts on the overall business, revenues, and ARR, we did not mention any FX impact on public cloud ARR. What has changed this quarter? I was under the impression that most of our public cloud business was priced in U.S. dollars.

Claire Bramley, CFO

Yes, this is Claire. Thanks for your question. So yes, we did see an impact, as you say, between the 68% year-over-year and 75% year-over-year between reported and constant currency. You may have noticed we did keep our full year guide of approximately 80% in reported and constant currency. So it's just a mix that we're seeing in the current quarter for Q2 that has a bigger impact on the currency impact. But for the full year, the mix is unchanged and in line with what we laid out a few months ago.

Chad Bennett, Analyst

So do we expect a headwind in the second half of the year from FX to public cloud? I know you reiterated reported in constant currency, but is the delta we've seen in the quarter something we should expect?

Claire Bramley, CFO

No, I think as you move towards, there may be a small impact in Q3, but as you look to how we're going to finish that in Q4, the mix is more weighted to your contracts in U.S. dollars. So the second half will not see a significant headwind regarding currency.

Chad Bennett, Analyst

I have a quick follow-up regarding net expansion. Claire or Steve, can you provide some insight into the 120 plus figure? I understand the initial development and test use cases, but since it's a trailing 12-month metric, how should we approach this from a cohort perspective? While we might not have extensive cohorts to analyze, could you share any details on how expansion has played out over the past 24 months or within a 12-month cohort?

Steve McMillan, President and CEO

Yes, Chad, I'll start off. Thanks very much for the question. It's really interesting when we look at the cohorts. I think what's actually playing out with the migration of our customer base to the cloud is that the sales team is executing exactly on strategy and is incentivized to maximize their cloud ARR at the start of the migration. So we are seeing incremental cloud ARR compared to on-prem ARR at that first point of migration. Therefore, they are actually capturing more expansion at that first point of migration, and for those cohorts, it's then impacting the subsequent net expansion rate. But overall, it means that we are still very solid in terms of the models that we have to achieve our cloud ARR, both for the guidance for the fiscal year and also for the goals that we've set out for 2025. So simply put, we're seeing more expansion on migration, which is subsequently reducing the expansion through the life of that cohort, and we expect to see that continue to improve as we progress through time.

Operator, Operator

Your next question comes from the line of Tyler Radke with Citi.

Tyler Radke, Analyst

Claire, could you just help us understand some of the assumptions that are going into the wider range on total ARR? I guess first on the macro side, are you embedding any more conservatism in terms of close rate, deal timing? And then secondly, just because you are seeing more cloud expansions, and it does feel like you feel pretty good about the cloud ARR number. I guess if you see more cloud conversions, does that help or hurt total ARR just in terms of the economics between on-prem and cloud? Just help us understand those moving pieces as we think about the wider range.

Claire Bramley, CFO

Yes, thanks for your two questions. First of all, with regard to the extended range on total ARR. Absolutely, we are adding in some conservatism there as we look towards the end of the year. That expansion is really to take into account potential on-prem deal timing impact that we may see in Q4 given the current macro volatility and also knowing that Q4 is really our highest quarter of total ARR growth. Regarding your second question in terms of it's actually good economics for us. What we see is that as they convert more at the point of migration, we may then see a little bit less expansion, but the expansion over time remains very strong and continues to be strong. So that's what gives us that confidence, not just in the full year 2022 guide of approximately 80%, but we are, thanks to what we're doing today, on track also for the long-term estimate of approximately $1 billion in 2025. So we are very optimistic about where we are today based on what we see, including the coverage and customer wins that we're currently experiencing, and the benefits that we expect to continue to realize in the second half of this year as we move toward achieving $1 billion by 2025.

Tyler Radke, Analyst

And Claire, just on free cash flow. So obviously, maintaining the guide for the full year despite some currency headwinds is impressive. It does look like if we look at the second half implied free cash flow, the seasonality or mix of free cash flow is a bit higher than we saw last year. Maybe just help us understand kind of the levers at your disposal, how you're able to offset those currency headwinds, and why seasonality might be a little bit different than last year.

Claire Bramley, CFO

Yes, absolutely. So as you said, very happy with the guide of approximately $400 million of free cash flow. And the fact, actually, that in the current macroeconomic environment, we are maintaining this quarter our full year guide on earnings per share compared to our guide last quarter suggests that we continue to navigate well through the current challenges. With regards to the cash flow generation, our biggest opportunity is in working capital. We've seen some great trends in our cash collections, for example, and a generation of working capital. And we've done that again in Q2, as you've seen with $100 million of free cash flow generation. So we're confident that we can maintain that healthy balance sheet and strong working capital and cash conversion cycle as we progress through the year.

Operator, Operator

Your next question comes from the line of Wamsi Mohan with Bank of America.

Wamsi Mohan, Analyst

If we look at your total ARR at constant currency, your initial outlook at the beginning of the year was high single-digit growth. And today, at the midpoint, it's flat. And I know 4 points of that is Russia, which you couldn't have anticipated. But given your more mission-critical enterprise workloads, it would seem that you should be relatively more resilient to a macro downturn. And Steve, you noted some of that resiliency in your prepared comments, and you also noted a strong pipeline. So can you just help square the change in your constant currency total ARR from sort of the beginning of the year through now—through that lens, if possible? And I have a follow up.

Steve McMillan, President and CEO

So the biggest lags in our total ARR are clearly due to Russia and currency impacts. Yes, what we see in the business is that our workloads run within our customers are absolutely mission-critical. Unlike many of our competitors, we don't run discretionary workloads around marketing campaigns or sales campaigns. We are helping these organizations operate, close their books, run their supply chains, and manage the critical operations of the business. Therefore, our ARR is very sticky and solid in our customer base. Our cloud pipeline for the second half of the year continues to strengthen in both quantity and quality as we progress those opportunities. So I guess, the biggest delta is from a Russia and FX perspective.

Wamsi Mohan, Analyst

And Claire, your gross margins on recurring revenues were at the lowest level in a while. Can you just talk about the moving pieces here? How much of that is relative to changes in upfront payments? How much of that might be due to FX? And on the upfront side, I think you called out sort of a delta versus expectations in the second quarter and now maybe more upfront in the fourth quarter. Can you discuss the underlying cause that's actually driving that change?

Claire Bramley, CFO

Absolutely. To your point regarding recurring revenue margins, there are two factors we see both quarter-over-quarter and year-over-year. First of all, we have a full quarter in recurring revenue of the impact of Russia; that has had an effect. We also, of course, see the currency impact and the upfront impact. Just to remind everyone, on Page 8 of our earnings presentation, we have laid out the impact across ARR, total revenue, and recurring revenue by quarter from those three headwinds that we're seeing. So upfront revenue, FX, and Russia. As I mentioned earlier, Russia was an accretive business for us, so we did have a drop at the bottom line from FX and the upfront revenue year-over-year decline that we saw in Q2. So again, I mentioned that we saw a negative impact of $6 million in the current quarter compared to a positive $22 million impact in the second quarter of 2021. To your point about timing, this is purely driven by the renewal and expansion of our on-premise customers; it has always been difficult to predict, which is why we provide high-level estimates. Thus, we did experience a slight difference from what we had expected in Q2, as you said, slight negative versus a small net positive. The same applies as we look out to the second half of the year.

Operator, Operator

Your next question comes from the line of Erik Woodring with Morgan Stanley.

Unidentified Analyst, Analyst

This is Sabrina on for Erik Woodring. I guess our first question is you beat 2Q EPS out your outlook by the midpoint but kept the full year EPS guide unchanged, which implies the second half is coming down slightly. Can you talk about why that is, given your revenue outlook hasn't changed? And then I have a follow-up.

Claire Bramley, CFO

Yes, absolutely. So actually, the $0.02 of the $0.03 above the top end of the range was actually due to favorable taxes. So that's not a knock-on benefit. Our overall tax rate for the year is unchanged. It is just the seasonality of our tax rate, Sabrina. Regarding currency headwinds, we have noted a slight deterioration in the currency rate by approximately 25 basis points, so we're factoring that into our full year EPS as well. So those are the main drivers affecting our EPS outlook. I missed your follow-up question, sorry.

Unidentified Analyst, Analyst

Yes. And just a follow-up: can you talk about how your customer conversations have evolved since the end of the quarter? Have there been any changes by geography, deal size, or the pace of customer decision-making given the macro environment?

Steve McMillan, President and CEO

Sabrina, no—this is Steve. Thanks for the question. We're not seeing any changes from that perspective. Again, we're very solid in our existing customer base. We understand what those customers are doing. We have long-term relationships with our existing customer organizations. We haven't seen any demand signal weakness for our offerings or what the customers are buying either in this past quarter or for the rest of the year. As I mentioned earlier, we're actually seeing our cloud pipeline continue to increase. That gives us a good demand signal from a cloud perspective. The mission-critical nature of our established customer base means that committed ARR and those multiyear agreements contribute stability around our business model and financial results.

Operator, Operator

Your next question comes from the line of Matt Hedberg with RBC Capital Markets.

Anushtha Mittal, Analyst

This is Anushtha from Hedberg. To start with, could you talk about how you're thinking about the pace of hiring in the remainder of 2022, given the inflationary environment? And what will be the key areas of development?

Steve McMillan, President and CEO

Thank you for the question. Yes, we are going to continue hiring critical talent, especially cloud talent. Even in the past quarter, we've recruited a new head of our EMEA organization. We are being very prudent with all of our investments. Our focus is to ensure that we maintain profitable growth. We will continue to invest in the business in key areas where we believe that growth will be driven, especially from a cloud perspective, cloud skills, and capabilities, and continue to advance our strategy. We haven't encountered challenges in recruitment; one of Teradata's real strengths is the culture of the company. People love coming to work for Teradata as they can bring their genuine selves. This culture and the environment we create make it a positive place for people who want to stay with us and demonstrate great results, while also enabling us to attract the right kind of talent. Again, from an investment perspective, we will be prudent in our investments to ensure that we achieve that profitable growth.

Anushtha Mittal, Analyst

And then in the current environment, as enterprises increasingly prioritize ROI investments, could you talk about the durability of Teradata's platform in a recessionary scenario? In addition to the functionality, does a better price performance than competitors serve as a benefit in landing new logos?

Steve McMillan, President and CEO

Yes, absolutely. Price performance is a key factor in how we win new logos, and it also enhances the stickiness of our platform. The workloads we run for our customers are indeed mission-critical. I view this from an AI, ML, and analytics perspective—our customers only utilize about 20% of the capabilities of the platform. Thus, we perceive it as an opportunity for us and our customers to harness those capabilities, potentially reduce spending on other platforms they have in their technology stack, and leverage the Teradata capabilities they are already paying for and are already inside the Teradata platform. That also provides us opportunities and maintains stability in the customer environment.

Operator, Operator

Your next question comes from the line of Raimo Lenschow with Barclays.

Unidentified Analyst, Analyst

This is Sheldon on for Raimo. We are certainly hearing different perspectives on the challenging macro environment by region. In the quarter, it looks like the Americas segment for revenue declined 8% in constant currency versus strong double-digit growth last quarter. This is a little surprising given the insulation from Russia and FX and the mission-critical nature. Was that a surprise to you? And is there any moving parts there to consider? Would it be the less upfront recognition in the quarter?

Claire Bramley, CFO

Yes, absolutely. You hit the nail on the head. We're actually growing in constant currency in the Americas for the first half, but specifically in Q2, as you said, we are declining. The big impact there in constant currency is from the upfront revenue recognition, which reflects a seasonal impact between Q2 of this year versus Q2 of last year. However, overall, for the half, we see constant currency growth in the Americas.

Unidentified Analyst, Analyst

And then a quick follow-up, if I may. How has the reception been from customers on the blended pricing with both the capacity-based piece and the consumption element, and how did that consumption element specifically perform versus your expectations in the quarter?

Steve McMillan, President and CEO

Yes. We're seeing some of our customers take advantage of that blended pricing model, but by far the bulk of our revenue comes from fixed capacity agreements, which provides financial certainty around our business model and results for the year. We're starting to see our customers utilize those consumption agreements for their initial workloads. I believe this is also a great way to win new logos, as customers can start small with us and then expand. Even in those agreements, we observe that customers want the best of a blended model because they can contract with us at a reduced rate for fixed capacity and then pay for what they need, which gives us real insight into the financials of our cloud business as we move forward. So it's an appealing model that our customers are embracing, but it still constitutes a minor portion of our current recurring revenue streams.

Operator, Operator

Your next question comes from the line of Derrick Wood with Cowen.

Derrick Wood, Analyst

I jumped on late. From what I've heard so far, it sounds like you're not seeing a material impact from the macro; you remain confident in demand and pipeline around cloud, but perhaps there was some delay in on-prem renewals, and I wanted to touch on that if I look at the on-prem ARR, I come up with about a 6% decline in constant currency, which was down versus a 3% decline last quarter or maybe flat in Q4. Was that an area that was a little weaker? And with respect to your guidance for total ARR, are you expecting that to make up in terms of stronger renewal of that business in the second half? Or do you presume that some of those renewals might slip?

Claire Bramley, CFO

Yes, let me start on the impacts that we're seeing on total ARR. You may have missed that we have added a new disclosure on Page 8 of our earnings presentation, which breaks down the impacts across total ARR, revenue, and recurring revenue. What you will see is that across currency and Russia year-over-year, we're seeing an 8% impact year-over-year. So a combination of currency and Russia are significant headwinds. This increases to approximately 14% impact on recurring revenue year-over-year. So when you view that and analyze that additional disclosure, hopefully, it clarifies that indeed, the underlying business is growing as expected. I'll pass it to Steve to talk about the macro.

Steve McMillan, President and CEO

Yes. From a macro perspective, Derrick, as you know, we are rock-solid in our customers, executing mission-critical workloads which provides stability to our revenue platform. Furthermore, our business model now being 80% recurring revenue enhances revenue stability as we progress through the year. The multiyear commitments around fixed capacity that we maintain for our customers also instill confidence in our second-half financial performance. Thus, while macro impacts are present, our financial model remains very robust.

Derrick Wood, Analyst

And then back on the clarity around free cash flow. I mean you guys have done a great job in light of the FX headwinds, Russia, and really maintained the health of free cash flow this year. Are there— I know you don't guide beyond this, but were there onetime impacts this year that you were able to pull levers on that could be tough to replicate going into next year? Or is that just like cash conversion focus something that can be durable?

Claire Bramley, CFO

I believe the cash conversion focus is durable, Derrick, absolutely with great, consistent performance. So absolutely, the cash conversion cycle is sustainable. We experienced a tax refund benefit, which I mentioned in Q1; that was a benefit this quarter. However, I maintain absolute confidence in our potential to generate sustainable free cash flows in the long run. As highlighted at our Investor Day last year, we still have good visibility towards approximately $550 million by 2025.

Operator, Operator

There are no further questions at this time. I will now turn the call back over to Steve McMillan for his final remarks.

Steve McMillan, President and CEO

Thank you, Lisa. As we sign off, I've got great confidence in our future. Our strategy in the company is absolutely right. We are growing in the cloud, and we're driving a strong pipeline for the second half of the year to accelerate that momentum. Our Vantage data and analytics platform remains mission-critical for enterprises all over the world, and I'm incredibly excited about our upcoming announcement that takes our industry-leading capabilities into the next generation so that companies can scale smarter, innovate faster, and grow stronger in the cloud. We remain very focused on delivering shareholder value. Thanks for joining us today.

Operator, Operator

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