Earnings Call Transcript - TDC Q3 2024

Operator, Operator

Good afternoon. My name is Cameron, and I will be your conference operator today. At this time, I would like to welcome everyone to the Teradata Third Quarter 2024 Earnings Call. I would now like to hand the conference over to your host today, Chad Bennett, Senior Vice President of Investor Relations and Corporate Development. You may begin your conference.

Chad Bennett, Senior VP of Investor Relations and Corporate Development

Good afternoon and welcome to Teradata’s 2024 third 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 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 September 30, 2024, which 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 them. 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, constant currency comparisons and 2024 revenue and ARR growth outlook in constant currency. 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 our 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

Thanks, Chad, and thanks, everyone, for joining us today. In Q3, Teradata grew our cloud business, delivered enhanced technology innovations that strengthen our hybrid trusted AI position and added to our partner ecosystem, all core elements of our strategic plan. Cloud ARR grew 26% year-over-year as reported in Q3, with a solid cloud net expansion rate of 120%, and we have already closed an 8-figure cloud deal in the fourth quarter. Despite strong growth in cloud ARR, we have recently seen a change in our large transformational deals. Customers are planning to migrate workloads to the cloud in a more staged process. The total customer spend with Teradata is unchanged, and there is no impact on our total ARR. However, this shift results in a reduction to our cloud ARR, and we are therefore lowering our 2024 outlook to 18% to 22% for the full year. We see ongoing healthy growth in our quote business and continued migrations, which we anticipate will help us increase the mix of cloud in the future and drive total ARR growth in 2025. The strength in the fundamentals of our business is clear, serving customers’ needs across both our cloud and on-prem businesses. We are increasingly seeing customers leverage our hybrid capabilities as they look to transform and commit to Teradata technology for the long term. As we have shared, we see that Teradata is increasingly becoming more strategic. The very large organizations we work with have both data in the cloud and on-prem, and we believe we are uniquely positioned to address their needs with our differentiated hybrid platform. We remain comfortable in closing deals over time, as evidenced by the 8-figure deal I mentioned. We’re seeing signs of greater engagement with both customers and prospects, as well as improvement in renewal rates. These are primarily the result of our go-to-market restructuring. We’re in the early stages of our go-to-market reorganization and expect to see improving execution as we move into 2025. Our teams are taking AI to our customers, and more than 20% of our pipeline includes an active AI sales engagement. In the third quarter, we continued to add new logos and grow our new logo pipeline. Teams are actively working on closing the large deals in the pipeline. Teradata remains true to being customer and market-driven, and we have adjusted the timing of deals to align with our customers’ extended decision-making on these strategic opportunities. Teradata remained highly profitable in the third quarter. Profitability increased with non-GAAP earnings per share of $0.69 versus $0.42 in Q3 of 2023 and free cash flow of $69 million compared to $36 million in Q3 of 2023. We will uphold our commitment to maintain margins, protect and grow free cash flow, and return capital to shareholders. When we look ahead, we see opportunity as companies embrace AI; they need data at scale. Data at scale is the foundation of GenAI applications, and data at scale has always been at the core of Teradata. We’ve made great strides advancing our perception and our innovations, as I will now explain. I’ll start with recognition received for our market position in trusted AI: Ventana Research rated Teradata as an overall leader in a top-rated analytic data platform company and is one of the best in meeting product and customer experience requirements. Ventana also ranked Teradata as exemplary in Ventana’s AI and ML Ops platform games. We’re also very pleased with the response from our recent events in London and Los Angeles, where we received positive feedback from customers, prospects, partners, and analysts. We heard consistent comments on our clear strategy, differentiation, and trusted AI, as well as partnerships that strengthen our open and connected ecosystem approach that customers want. Across the board, we heard from attendees that they were impressed with the breadth of customers who shared their insights into the value Teradata brings to their organizations. One analyst noted that customers and partners alike continue to view Teradata as their strategic vendor around analytics and called out the potential we bring to help them with GenAI workloads. Another noted our strong pace of innovation, our differentiated hybrid capabilities, and our superior pricing economics for customers. It was from these customer events that we announced a sweeping set of innovations that support and advance our differentiated position in trusted AI. Starting with enhancements to ClearScape Analytics, our analytics engine for AI innovation, these enhancements are designed to enable organizations to maximize the return on investment of their AI and ML investments. They are also intended to boost data science productivity to achieve business outcomes faster and more efficiently. We have brought Spark to ClearScape Analytics. Data scientists are now able to easily convert Apache Spark code to Teradata machine learning, eliminating the need for reengineering or data movement that significantly reduces complexity and costs. Customers can leverage Vantage Cloud’s enterprise-grade workload management, security, and data integration that is designed to operationalize trusted AI at scale. One example is a large Latin American bank that recently trialed a migration of some data workloads to VantageCloud using this capability. The workloads were to perform daily analytics for 16 million credit card records and 75 million consumer transaction records. The results were dramatic: 56% faster processing with VantageCloud and 47% cost savings with VantageCloud compared to Databricks, all without moving data in and out of their data warehouse. In October, we announced our new bring-your-own (BYO) LLM capability designed to enable customers to simply and cost-effectively deploy GenAI use cases at scale. Organizations are recognizing that larger language models aren’t best suited for every use case and can be cost prohibitive. Bring-your-own language model allows companies to choose the best model for their specific business needs, including small or medium domain-specific language models from open-source providers like Hugging Face. Many models are free to use but expensive to run and can be tailored to industry and horizontal use cases for real-world value. For customers with more complex generative AI needs, including training or fine-tuning, ClearScape now also provides them with the flexibility to strategically leverage either GPUs or CPUs, depending on the complexity and size of the large language model. Teradata’s ability to leverage GPUs allows customers to develop and operate LLMs for purpose-built GenAI business applications, without being constrained to siloed AI tools that require complex workflows or large amounts of data movement. In addition to these models being easier to deploy and more cost-effective overall, we bring the language models to the data so organizations can also minimize the expense of data movement and maximize security, privacy, and trust. With these ClearScape announcements, we are continuing to deliver what we see as the most powerful open and connected AI and ML capabilities in the market today. All VantageCloud customers have access to ClearScape Analytics with these new features. Our focus on driving innovation has never been stronger, and I’m pleased to report that we have appointed Louis Landry as our Chief Technology Officer. I’m excited that Louis will bring his expertise in advanced engineering and emerging technologies to help accelerate the pace of innovation at Teradata. Louis has led our technology and innovation office, and his knowledge of Teradata technologies, deep engineering, and years of experience leading technology innovations at larger enterprises make him an excellent CTO for Teradata. Hillary Ashton, our Chief Product Officer, will be leaving Teradata at the end of the year and will facilitate a smooth transition out of her role. As we build on our innovations and strengthen our open and connected ecosystem, our focus on partnerships remains front and center. We recently announced integration of NVIDIA’s AI accelerated computing platform with our Vantage platform for the development and deployment of GenAI applications to accelerate trusted AI workloads, both large and small. VantageCloud Lake integration with NVIDIA’s platform is designed to enable our customers to more affordably deploy everyday GenAI use cases faster and in their environment of choice for immediate return on investment. We also announced that the Teradata platform is now integrated with dbt Cloud. We bring our ability to manage complex large-scale data sets with enterprise-grade reliability, robust security, and governance and combine that with dbt’s transformation tools to turn raw data into actionable insights. Together, we believe that we can enable unparalleled data management and agile analytics, empowering engineering teams to transform data at scale with less manual effort, all to help organizations accelerate their AI and ML initiatives. Finally, we introduced a generative AI-driven customer complaint analyzer solution built on VantageCloud Lake in concert with edge solutions and consulting. The customer complaint analyzer is designed to continuously capture data signals to identify, address, and prevent customer complaints. This powerful solution is designed to help companies improve their customers’ experience and reduce churn, and we already have a healthy opportunity pipeline for this new AI use case. We’ve had great customer reactions to our announcements. For example, our team demonstrated how we can help companies more effectively integrate signals from customers into their workflows and quickly act on them. We use Hugging Face models, leveraging the bring-your-own model feature in ClearScape analytics to help analyze and summarize customer calls for classifying the output and automating treatment of the next best action, all in a single integrated analytic workflow without moving data. This AI-driven solution provides faster responses to customers, and we demonstrated how an entity could analyze and address 300,000 calls a day, up from 30,000 calls a day with our manual process. We are seeing great interest as the benefits can be far-reaching, including cost savings, improving customer satisfaction, and increasing the lifetime value of the customer. These announcements and our customer engagement events are executed with one goal: to help our customers achieve massive value for trusted data. I’ll wrap up with a sampling of some of our recent wins that should illustrate this goal in action. A U.S. insurance company and member of the S&P 500 migrated to the cloud with VantageCloud Lake on AWS. Their account had implemented a cloud strategy and migrated its Hadoop data lake to Snowflake years ago before we had a quote offering. Our team introduced VantageCloud Lake and demonstrated that Teradata was the best and most cost-effective solution for the company’s complex workloads, and we won this business back. Our lake offering on AWS will support the customers’ business insurance division, and we’re collaborating with Cognizant on the migration. We also had a significant win with one of the largest banks in Asia-Pacific. In this competitive win, the bank chose Teradata on AWS to achieve robust performance and reliability needs. It runs risk, compliance, and regulatory reporting on Teradata. We will also integrate VantageCloud Lake as an innovation platform so that the bank can develop AI/ML use cases with further constraints of working with production data. This move marks a significant evolution to enhance their agility and innovation capabilities. Finally, a Fortune 500 insurance giant added VantageCloud Lake on AWS to run additional analytic workloads for its finance department. As I close, I’ll reiterate that we remain committed to accelerating growth and innovation. We see strong market opportunities that align with our strengths, and we are delivering AI innovations and value for customers. We have proven that Teradata can and does evolve with changing market dynamics, as we’ve grown our cloud ARR business to more than $0.5 billion in under 4 years while aggressively returning capital to shareholders. We believe that we are well-positioned with a hybrid trusted AI platform as enterprises begin to commercialize AI uses. We have been and will continue to take actions to improve growth. We have made meaningful leadership changes in products and go-to-market, with Rich now in the CRO role for two quarters. We have made material changes in our go-to-market organization designed to improve execution. We believe we are taking the right actions to return us to growth, and while it’s still early in seeing the results from those changes, we firmly believe in our differentiated technology, our people, and in our future. Now I’ll pass the call to Claire.

Claire Bramley, Chief Financial Officer

Thank you, Steve, and good afternoon, everyone. In the third quarter, cloud ARR grew to 38% of our total ARR, up from 30% at this time last year. We continue to demonstrate strong improvement in operating margin, profitability, and free cash flow generation. Year-over-year free cash flow nearly doubled, and our operating margin increased over 800 basis points. As Steve mentioned, we anticipate a different migration product within our large transformational cloud deals. The durable nature of our business model remains intact with over 80% of our revenue being recurring, delivering a gross margin of over 70% and a total operating margin of 20%. With the reiteration of our total ARR outlook, we continue to expect improvement in our overall retention rates going forward. Let me now share more details on our quarterly financial results, starting with revenue. Third-quarter recurring revenue was $372 million, up 3% year-over-year as reported, and 5% year-over-year in constant currency. Recurring revenue was driven by strong growth in cloud revenue. We saw a small net benefit from upfront revenue in the quarter. Recurring revenue as a percentage of total revenue was 85%, up from 82% from the prior year period. Third-quarter total revenue was $440 million, flat year-over-year as reported, and up 2% in constant currency. The year-over-year constant currency growth in recurring revenue was partially offset by lower consulting revenue. Moving to profitability and free cash flow. Total gross margin was 61.6%, up 130 basis points year-over-year, driven by our strategic focus on recurring revenue. Operating margin was 22.5%, up over 800 basis points year-over-year. Non-GAAP diluted earnings per share was $0.69, exceeding the top end of our guidance range. The primary drivers for the EPS outperformance were currency and upfront revenue. We generated $69 million of free cash flow in the quarter, which is a $30 million increase sequentially and nearly doubled on a year-over-year basis. In the third quarter, we repurchased approximately $15 million or 0.5 million shares. Year-to-date, we have returned 144% of free cash flow in the form of share repurchases, and we remain committed to returning at least 75% on a full-year basis. Moving to our full-year 2024 outlook. As a reminder, our outlook ranges are in constant currency for the ARR and revenue metrics. We reaffirm our previous outlook for total ARR, total revenue, recurring revenue, and free cash flow. Although total ARR is unchanged, we are seeing a different mix between cloud and on-prem. For cloud ARR, we now expect more staged migrations for the large transformational deals and anticipate growth of 18% to 22%. We are increasing the non-GAAP earnings per share outlook. It is now $2.30 to $2.34. Additional full-year outlook assumptions include weighted average shares outstanding of approximately 98 million, other expense of approximately $48 million, and we project a non-GAAP tax rate of approximately 25%. Our net expansion rate we anticipate a slight deceleration, but to still be in line with historical levels. Regarding our outlook for the fourth quarter of 2024. We anticipate non-GAAP diluted earnings per share to be in the range of $0.40 to $0.44. We project the non-GAAP tax rate to be approximately 22.1% and the weighted average shares outstanding of 97.5 million. Previously announced cost reduction actions remain on track to ensure the durability of our margin profile as we return to total ARR growth next year. Free cash flow growth remains our focus, and we are committed to returning 75% of free cash flow to shareholders in the form of buybacks. We will provide an update to our fiscal 2025 outlook during our Q4 earnings call in February. 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 Matt Hedberg with RBC. You may proceed.

Matt Hedberg, Analyst

Great. Thanks for taking my questions. Maybe one for Steve and then one for Claire; you noted sort of at the top of your remark, there was a change in how customers are thinking about cloud migration. I’m curious if you could just maybe double-click on that a bit more. Is this an industry-wide thing? Do you think it’s something that’s sort of unique maybe to your base? And I’m just sort of curious, has it changed sort of the medium-term outlook on cloud mix and kind of overall growth when obviously that cloud mix is part of a big part of sort of the total company acceleration?

Steve McMillan, President and CEO

Thanks, Matt, for that question, and I’ll let you come back to ask a clearer question afterwards. Fundamentally, we are seeing strength in our business, both from a cloud perspective and from an on-prem perspective. But as I said in my prepared remarks, we have seen recently a material change in the buying behavior in a handful of our large conversion deals. The way these customers are approaching their cloud strategy is in a more staged nature. They’re breaking down that cloud migration into smaller deals. And as they’re doing that, they’re actually leveraging the hybrid nature of our platform where they can run both in the cloud and on-prem. So to your point, we are seeing a mix change of committing in the cloud and on-prem. And so while initially, we’re less than the cloud, we don’t see a change to the total commitment or opportunity, and that’s why we reiterated our full-year ‘24 total ARR gain. And in ‘25, we talked about returning to growth from a total ARR perspective. So we saw a handful of 8-figure deals essentially, in some cases, convert into a set of 7-figure deals.

Matt Hedberg, Analyst

Got it. That’s super helpful, Steve. And then maybe sort of a related question for Claire; to me, it feels like there’s a bit more higher priority on Q4 on-premise spending within your base. And I guess I’m wondering, I think a lot of us are wondering, do we see maybe a bit more of a December budget flush this year? And I’m wondering, did your guidance contemplate maybe a bit more of that given that historically budget flush, I think, tends to impact more on-prem than cloud. And then when you think about sort of cloud growth and maybe even reacceleration, what are the building blocks of that essentially?

Claire Bramley, Chief Financial Officer

Hi, Matt, yes. So just on your first part of your question with regards to budget flush, we haven’t factored any uplift from a budget for us. We’ve done a customer-by-customer pipeline analysis. And as Steve said, look at what we expect to close in ‘24 and factor that into our updated assumptions for both total ARR and cloud ARR. So no budget flush assumed for on-prem at the end of 2024 in December. With regards to as you look forward into the future, so I think just generally on 2025, I would say we’re still driving towards the metrics that we talked about last quarter. As Steve just mentioned, that means total ARR growth in 2025 and also growth in our free cash flow year-over-year in 2025, and we continue to anticipate robust growth in cloud ARR in 2025 as well. So naturally, we’re not providing detailed guidance. And this quarter, we’ll provide it at our Q4 earnings, which is in line with when we would normally provide it, which is in February of next year.

Matt Hedberg, Analyst

I appreciate the answer from both of you. Thanks a lot.

Steve McMillan, President and CEO

Thanks, Matt.

Claire Bramley, Chief Financial Officer

Thanks, Matt.

Operator, Operator

Your next question comes from the line of Chirag Ved with Evercore ISI. The line is open.

Chirag Ved, Analyst

Thank you so much for taking my question. Steve, if you think about the business over the next couple of quarters, given the mix change and customer approach to cloud, does this change how much you’re indexing on cloud versus on-prem in terms of your approach to innovation, contracts, renewals at this point? And what are you seeing to support and guide that decision-making process?

Steve McMillan, President and CEO

Thanks, Chirag, for the question. So I just want to reiterate, we are completely committed to our cloud-first strategy. We believe it continues to reposition Teradata in the marketplace as modern and relevant for our customers. We believe that the innovations we develop from a cloud perspective actually enable additional capabilities on-prem. So as an example, I was talking about being able to bring your own language model. We are actually able to leverage our technologies and technology development to deliver that capability, both in the cloud and on-prem. So the focus from a strategic perspective is very much to keep on that cloud-first mission; cloud first but not cloud only is absolutely our strategy. I would say as well that as we look forward, the strength of our cloud pipeline still remains intact. We expect these customers to continue a migration path to the cloud with Teradata, and we have continuously demonstrated that we are the best path to the cloud for some of the largest organizations in the world to move their complex, large workloads to the cloud and utilize the Teradata technology set in the cloud. So because we’re not seeing a deterioration overall in the pipeline, we’re just seeing that timeline of migration pushing out into the future, we remain committed to that cloud strategy and execution, and we believe it will still remain a fundamental part of our growth strategy as we move forward.

Chirag Ved, Analyst

Great. And then, Claire, maybe one for you. Recurring revenue came in ahead of where the street was at for Q3, and you maintain the full-year guide. Can you talk through what happened in Q3 and what you’re expecting in Q4 from the recurring revenue point of view?

Claire Bramley, Chief Financial Officer

Yes. So I think it’s just more of a linearity in the modeling, Chirag, so not a big difference in terms of what we’re expecting internally. We did see a slight benefit from more upfront revenue which hits both total revenue and recurring revenue, but that was more of a linearity change. So no overall change to what we’re expecting, just a slight shift between Q3 and Q4, which is why the full-year guide remained unchanged.

Chirag Ved, Analyst

Perfect. Thank you both.

Claire Bramley, Chief Financial Officer

Thank you.

Steve McMillan, President and CEO

Thanks.

Operator, Operator

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

Tyler Radke, Analyst

Thanks for the question. Steve, I wanted to go back to the commentary you made around the staged migrations that you’re seeing with customers in terms of moving to the cloud. I guess why do you think this is happening and why now? I mean, is this a macro budgetary-driven decision? I mean it would seem like budgets have been tight for a while. So what’s kind of your theory on why this is happening and why now? And just to clarify, is this only customers that you saw in Q3, what makes you think that this was just a function of the sample size versus a broader trend that extends into next year?

Steve McMillan, President and CEO

Yes, Tyler, thanks for the question. So over the past couple of months, we’ve branded our customer marketing events, both in London and L.A., which gave us the opportunity to talk in depth with several of our customers regarding what their plans are and how they plan to move forward. Now we’re seeing an impact in a handful of our really very large deals. So, looking at those 8-figure deals and where we’ve had appetite for customers to make a migration path and migrate their entire real estate to the cloud in one program, just like the deal that we signed early in the fourth quarter, the 8-figure deal that we signed. But we are seeing a handful of customers that are choosing to essentially take a less risky approach to these major transformational programs that they are executing. They’re still committing to Teradata, and in many cases, they’re committing incremental spend with Teradata across both on-prem and the cloud. But for the cloud deals, we expect those to close in a more staged process. So instead of one 8-figure deal, we’ll close multiple 7-figure deals over a longer time period.

Tyler Radke, Analyst

Very helpful. And a follow-up on that for Claire. Last quarter, you talked about seeing similar cloud growth as your prior guide in 2025 as 2024, which I think was around 30% and $1 billion in cloud in 2026. Do you still expect $1 billion in 2026 or does this sort of change the trajectory of that cloud business ramping to $1 billion?

Claire Bramley, Chief Financial Officer

I guess, Tyler, just on that, I would say we still see a path to the $1 billion for cloud ARR in 2026. Naturally, we’re working with these customers on the detailed timing of their stage processes. So we will obviously update the cloud ARR for 2025 in February. We don’t anticipate to recover all of this in 2025, but definitely, we anticipate, as Steve mentioned, some of these additional stages to close in 2025. So we’ll come back on the 2025 cloud ARR, but we still see that path to the $1 billion because, as Steve said, they’re still committing to migrate with us over time.

Tyler Radke, Analyst

Great. Thank you.

Steve McMillan, President and CEO

Thank you. Thanks a lot.

Operator, Operator

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

Erik Woodring, Analyst

Great. Thanks so much for taking my question, guys. Steve, maybe I’ll start with you just it feels like Teradata has faced a bit of a perfect storm of headwinds this year between some on-prem erosion, some deal elongation, and now staged migration timing dynamics. And I’m just wondering how can you be sure that the headwinds you have encountered this year have nothing to do with competitive pressures? For example, elongation of sales cycles taking longer to migrate to the cloud. Is there a sign that those are – is there a risk that those customers are potentially evaluating maybe other cloud-native platforms? Just help us gain some comfort that this isn’t competitive risk and this is more just related to timing and maybe company-specific issues? And then I have a quick follow-up. Thank you so much.

Steve McMillan, President and CEO

Yes. Thanks, Erik. Look, we absolutely expect to convert these opportunities over time that are in the pipeline. And I want to refer to the fact that those customers are actually making commitments to us from both an on-prem and a cloud perspective. So they are – we expect them to start those cloud journeys with us. So we’re just seeing essentially a more staged approach to the execution. From a competitive perspective, I’m very proud of how we’re doing from a competitive perspective. I mentioned in my prepared remarks, one customer that had migrated to Snowflake that has recently made the decision to come back to utilizing the Teradata platform in the cloud. But I’m also really happy with how we’re doing from a competitive perspective against the newer players like Databricks. I made the reference to a Latin American bank that had migrated workloads from Databricks, and actually, they are utilizing Teradata, and they’re doing it twice as fast in terms of process and speed and for half the cost. We are continuously building up that catalog of competitive execution and competitive win-backs. We are absolutely convinced of our lowest cost per query in comparison to the competition. I think what we see as we look at these very large deals and some of the largest organizations in the world, it’s really all about risk appetite, and for these customers, Teradata is the least risky way of actually migrating to the cloud and getting the benefits of cloud technology. So, I think the way that they are using and deploying our technology set in terms of our hybrid capabilities is something that none of the other competitors can actually deliver against. And so leveraging that hybrid capability as they execute through and a migration serves a differentiated position, so that’s how we can be more assured that we are doing well from a competitive perspective.

Erik Woodring, Analyst

Okay. Thank you. So, that’s really helpful. And then maybe my follow-up is for you, Claire, which is, can you maybe just talk a little bit more about the change in gross margin profile of your recurring revenue base, given some of these mix-shifting dynamics and what – and really when you expect that recurring revenue gross margin to kind of bottom and stabilize and start to expand? Has that timeline changed as you have now kind of thought about the different underlying mix between on-prem and cloud in your business? Thanks so much.

Claire Bramley, Chief Financial Officer

Thanks Erik. Yes. So, just with regards to gross margin, we have actually been very stable with our total gross margin and our recurring gross margin over the last couple of quarters. And I am pleased that even though we have been increasing the mix of cloud ARR, we have been able to offset the negative impact that has by an improvement in our cloud margin rate. So, we are seeing a continued improvement in the cloud margin rate year-over-year and quarter-over-quarter, and we expect that to continue, and we are seeing that offset the negative impact from the mix change. As we look out into the future and we continue to increase the mix of cloud ARR, we will continue to maintain that stability.

Erik Woodring, Analyst

Great. Thanks so much for that, guys.

Claire Bramley, Chief Financial Officer

Thank you.

Operator, Operator

Your next question comes from the line of Howard Ma with Guggenheim. Your line is open.

Howard Ma, Analyst

Thanks. Steve, I want to – I understand you already gave a pretty thorough explanation of the stage migrations. But what can you point to further? I mean maybe – so I just – I was just brainstorming. I was thinking maybe it’s verbal customer commits around the timing of migration expansions, even if it’s not contractual, right, maybe you can share some data on conversations or maybe it’s telemetry data that support the stickiness on Teradata, or maybe you have a pronounced on-premise renewal base next year? So, really anything more concrete that could instill confidence that, that slower cloud migrations or what you are calling steady migrations won’t translate into future competitive losses?

Steve McMillan, President and CEO

Yes. Thanks for the question. Look, I would start off by saying we are strategically positioned in all of these accounts that we’re talking about, and overall, our pipeline remains strong. Our deal opportunity hasn’t really changed at the aggregate level; it has just changed shape in terms of timing of execution. And also to the point we were just talking about, we have not lost any cloud opportunities from that large deal set. In fact, our total ARR remains unchanged. The total customer commitment and spend commitment with Teradata has remained unchanged. If I look specifically in the second half in terms of our execution, we have actually got better renewal and retention rates in the second half of 2024. That’s going to help power some of our total ARR growth as we move into 2025.

Howard Ma, Analyst

Got it. And for Claire, speaking of 2025, I respect that you are not giving any discrete guidance so far, but you are making some pretty big initiatives. I mean there are product initiatives at your recent customer conference, your go-to-market re-org is underway. Can you help – can you just paint a picture for us and help us understand when these initiatives will kick in? I mean we are in November already, right? So, as we look around the quarter to next year, how would they kick in into the numbers? And on the back of that, why should we not expect significant acceleration next year?

Claire Bramley, Chief Financial Officer

Yes. So, we are committing to total ARR growth in 2025, Howard. We are committing to an increase, an improvement compared to 2024. The three main drivers of that that support that total ARR growth in 2025 include a higher percentage of cloud, so that obviously drives more growth. We are anticipating robust growth in 2025, and that will increase the percentage of cloud. The other things as well that we are expecting is a meaningful improvement in our retention rates for the full year in 2025. Finally, we expect on-prem expansion improvement year-over-year as well. So, there are multiple things, including robust cloud growth that will be helping us to move back to total ARR growth next year, which obviously I would say is a meaningful improvement compared to where we are in 2024.

Nehal Chokshi, Analyst

Yes. Thank you. Help us understand what it means in terms of change in year-end total workloads on Teradata given takedown cloud ARR, but no change in total ARR.

Steve McMillan, President and CEO

Hi Nehal. Thanks very much for the question. It’s as we have been executing these customer events recently, I had the opportunity to talk to a lot of our customers. What we see is that they still have the requirement to operate data at an enormous scale and do that in the most effective and efficient way. Teradata is definitely the platform that can enable them to do that. When we talk to them about the most recent capability developments we have had, both from an analytics perspective and database or in platform, or utilizing the analytic capabilities of the environment in which they are working. These are all ways that our customers want to utilize the Teradata technologies. The thing that really resonated with our customers is the fact that we meet our customers where they want to be. So, if they want to leverage the Teradata platform in the cloud, they can do that. If they want to leverage on-prem, they can do that. If they want to do that in a hybrid environment, that’s something that Teradata can deliver uniquely in the marketplace in terms of giving that one platform across those environments. We still see real demand in terms of utilizing the Teradata platform for these modern workloads and in modern environments.

Nehal Chokshi, Analyst

So, the reason why I asked that question is because I thought that on an on-premise customer converts or in their on-premise estate to cloud, there is an expansion associated with that. So, if we have a slowdown in the cloud migrations, you would actually have less total ARR. Is that not correct?

Claire Bramley, Chief Financial Officer

Yes. So, Nehal, it’s a good point. We do normally and on average see an uplift at the point of migration. In the grand scheme of things, in terms of our total ARR range that we guided, we were able to build that in that range. So, yes, there is an impact linked to the reduction of the cloud ARR, but we have been able to absorb that in our total ARR previous numbers.

Nehal Chokshi, Analyst

I see. Understood. Okay. And then of the $50 million takedown for cloud ARR for 2024, is there a significant concentration within that $50 million to like just a couple of customers?

Steve McMillan, President and CEO

I mentioned in the prior questions that there are a handful of customers where the deals have moved from eight figures to seven figures. Clearly, you just need a few of those, and you can rapidly build up that cloud ARR number. What I would say is, and it goes to that question about whether it’s something systemic inside the marketplace. We are still seeing our customers committed to us; the message to execute on that cloud migration with us, and we will capture the expansion that we have been talking about. But we are also seeing those customers actually looking to expand their overall spend with Teradata and the combination of both on-prem and cloud in many cases.

Nehal Chokshi, Analyst

Got it. And then if I can sneak one more in. Steve, you cited a few customers within the quarter that are coming back to Teradata from Snowflake. What’s the frequency of this type of customer case? And any change in that frequency that you are seeing relative to a quarter or a year ago?

Steve McMillan, President and CEO

Yes. We are definitely seeing that our platform becomes more and more performant, and also the capabilities in our platform from an analytics perspective enable us to compete for those data science workloads. For example, as we continue the development of our cloud-first strategy, it’s enabling us to go back with a win-back message and the ability to address customer requirements and customer needs that we haven’t been able to in the past. I believe our competitive position will continue to improve over time.

Operator, Operator

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

Wamsi Mohan, Analyst

Hi. Yes, thank you. Steve, can you perhaps just address the broader macro trends as well, where are you seeing maybe just in terms of expectations of spend going into ‘25? And large deal cadence, are you seeing any changes in the way those are progressing, not just in these cloud migrations that you have spoken about, but just in the base business as well? And I have a follow-up.

Steve McMillan, President and CEO

Yes, Wamsi, I will just reiterate that I think the fundamentals of our business remain very strong. We don’t see increased competitive pressures. I talked in my prepared remarks about winning a bank in the Asia Pacific region against a highly competitive environment. But we see the customer spend at Teradata remaining strong, both now and into the future. And clearly, you know our business very well; we deal with some of the largest organizations in the world, so that commitment has given us the confidence to say that we are going to return to total ARR growth next year. From a spend perspective, we are working to increase our addressable market with the capabilities that we are developing from an AI perspective. We are working with some large banks in the U.S. where we are actually deploying generative AI use cases in the Teradata platform, using Hugging Face language models as an example. We are starting to expand not only to maximize our presence in enterprise data warehousing, data lakes, and data lake houses, but also in terms of the analytical workloads that we can operate against. I am confident in terms of the opportunity that we will have as we move into the future.

Wamsi Mohan, Analyst

Okay, thanks Steve. And I guess just to follow-up on your point around AI also. You said 20% of your pipeline includes active AI sales engagement. How would you think about the rate and pace of this business? Is this something that has got pretty long proof-of-life, proof-of-concept timing, or do you think that you have something that will translate much faster and this 20% pipeline will significantly grow a quarter from now?

Steve McMillan, President and CEO

Yes. I think as we look at the AI and GenAI, those data science projects, a number of them are failing. A recent study noted that more than 50% to 60% of AI and GenAI workloads are not moving out of proof-of-concept into production. One of the reasons for that is operating at scale, and what we are able to demonstrate for our customers is that we can actually take them from that idea and concept and then operationalize that at scale with all of their trusted data inside their ecosystem. I think as we look at our pipeline of opportunities and we can prove that out to our customers, we can help them go not just to leverage on a proof-of-concept but actually deploy these solutions at scale in the production environment; that’s really going to add to the tailwind for us as we move into the future.

Operator, Operator

Your next question is from the line of Derrick Wood with TD Cowen. Your line is open.

Derrick Wood, Analyst

Great. Thanks. My first question, Steve, there is a lot of talk about growing adoption of Iceberg in the broader data analytics ecosystem. What are you guys seeing from your customers, and do you think this changing cloud migration behavior has anything to do with companies contemplating data storage movements to Iceberg?

Steve McMillan, President and CEO

Yes. I think we talk to nearly every single one of our customers about how they plan to leverage an open table format on native object store. We see that as a great opportunity for us. Our Cloud Lake platform supports open table formats, and we don’t lock our customers into one particular open table format. We have a strategy that we want to support both Iceberg and Delta Lake as open table formats. Now, if we look at that from a Teradata perspective, we see that again as looking to increase our TAM, as we look at the amount of data that is in native object stores and putting structure around that data in native object stores. That’s something that the Teradata ecosystem only touches in a light way just now. As we look to the future, we look at that as an opportunity to, again, expand our addressable marketplace; the opportunities that we have in terms of unstructured data is often an order of magnitude larger than the structured data inside an organization.

Operator, Operator

Your next question comes from the line of Patrick Walravens with Citizens JMP. Your line is open.

Patrick Walravens, Analyst

Great. Thank you. So, Steve, I think you mentioned in your remarks that Hillary is going to be moving on, and you are looking for a new Chief Product Officer. What are the top characteristics that you are looking for in that individual?

Steve McMillan, President and CEO

Hi Pat. Thanks for your question. Just to be clear, Hillary is going to move on, but we are taking this opportunity to leverage the bench strength that we have inside the organization from both a product management, a product engineering, and Chief Technology Officer perspective. So, I announced that Louis Landry is going to be appointed as our Chief Technology Officer. As we move into the future, I am nicely elevating the product management focus we have and inside the company and the product engineering focus that we have inside the company to have those roles report directly to me.

Operator, Operator

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

Raimo Lenschow, Analyst

Perfect. Thanks for squeezing me in. Two quick questions, Claire, on the cash flow side, you outperformed this quarter, but yes, the full year unchanged, and anything around timing of things that came in, in Q3, etcetera, that you want to point out? And then I have one follow-up for Steve.

Claire Bramley, Chief Financial Officer

Yes. To your point, Raimo, we were pleased with the performance of free cash flow. We anticipate there to be a slight linearity impact with regards to our working capital. So, slightly overperformed on DSO and BPO compared to our previous expectations. That would just be a linearity impact between Q3 and Q4, but we feel good about the meeting being in the range of our free cash flow guide for the full year, and it will be a similar increase in cash flow that we saw this time last year.

Operator, Operator

Your next question comes from the line of Austin Dietz with UBS. Your line is open.

Austin Dietz, Analyst

Great. Hey Steve. Hey Claire. I know we have spent a lot of time on migrations and their more staged nature on the call so far. But the cloud net expansion rate this quarter seemed to slow several percentage points. I believe it’s a trailing 12-month metric; therefore, the in-quarter piece would have slowed by more than that. So, do you mind just unpacking what you saw from a net expansion perspective this quarter? And then how should we think about that cloud net expansion rate over the near to medium term?

Claire Bramley, Chief Financial Officer

Yes. Thank you, Austin, for the question. So, as you mentioned, our net expansion rate was 120% in Q3 and is a trailing 12-month metric, so that’s a deceleration. That was mainly driven by our healthcare vertical and also some of our European business. We do expect further deceleration into Q4, given the mix of migrations versus expansions. As we look forward, we will obviously continue to monitor with the stage migrations that we see, what the impact will be in 2025. As a reminder, expansion at the point of conversion for the first 12 months is not included in our net expansion rate. So, we are also impacted by that as we update the migration timing of our customers’ migrations.

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, and thanks, everybody, for the questions. The fundamentals of our business are strong, and we firmly believe in Teradata’s differentiated technology and future growth. We all remain focused on improving execution and accelerating that growth, and we remain committed to protecting and growing our free cash flow and returning that capital to our shareholders. Thank you all.

Operator, Operator

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