Earnings Call Transcript - TDC Q2 2024

Operator, Operator

Good afternoon. My name is Matt, and I will be your conference operator today. At this time, I would like to welcome everyone to Teradata's Second Quarter 2024 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. I would 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 Vice President of Investor Relations and Corporate Development

Good afternoon, and welcome to Teradata's 2024 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 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 our SEC filings, including our most recent Form 10-K, and in the Form 10-Q for the quarter ended June 30, 2024, 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 them. On today's call, we will be discussing certain non-GAAP financial measures which exclude such items as stock-based compensation expense, 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 in 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 Relation 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 Chief Executive Officer

Thanks everyone for joining us today. As we get started, I'd like to welcome Chad Bennett to the Teradata team. Chad joins us after years of covering software and SaaS companies at Craig-Hallum Capital. We're excited to have Chad adding his expertise to Teradata, and keeping you up to date on our company. Our Q2 results demonstrate our ongoing strong performance in cloud, with cloud ARR growth of 32% in constant currency. This reflects the increasing interest in our differentiated hybrid cloud capabilities. Also, when customers choose Teradata in the cloud, they are expanding with us as they see the value. Our cloud net expansion rate remains strong at 123%, and we have doubled the number of eight-figure cloud ARR customers year-over-year. Despite the cloud ARR growth, total ARR declined by 3% year-over-year. Additionally, we generated non-GAAP earnings per share of $0.64, and delivered $39 million of free cash flow. Looking at our results overall, our performance continues to be challenged by the industry macro environment and longer customer decision cycles. We fully recognize we need to improve our execution. We have undergone a comprehensive review and are taking actions to improve our results, including bringing an increased focus on cost reduction. This has led to a reset of our financial outlook for the rest of this year and into 2025. Let's start with actions in our go-to-market organization. Last quarter, I introduced Rich Petley, our new Chief Revenue Officer. Rich has worked with speed and has brought new management discipline to the global team, building upon the results he generated from EMEA, which meaningfully outperformed the other regions during his tenure. The sales function has been realigned to drive increased effectiveness, leverage best practices that resonate globally, while also creating structural and cost efficiencies. In the pipeline review, we are encouraged about the large deal opportunities for the second half of 2024. Our pipeline of large eight-figure ARR deals has also increased to three times what it was in Q2 of last year. In our new logo pipeline, we continue to see momentum. In the second half, we anticipate ARR from new logos doubling over the prior year. However, we continue to see longer decision-making cycles, and we believe this is consistent with what others are experiencing in the industry. As I've noted in prior calls, with the strategic nature of our analytics, we are seeing more decision makers involved in deals, and from across multiple business units. This compound decision environment moves Teradata beyond IT and affords us the opportunity to help more departments understand what is possible with our hybrid cloud platform and best-in-class analytics. Yet it does lengthen deal cycles. We expect deal elongation to continue, and just one example, in Q2, we closed the eight-figure transaction that slipped out of Q4 2023. Following our thorough review of the business, with the additional discipline and rigor applied from the realigned go-to-market organization, we have decided to reduce our outlook. Our revised outlook reflects the uncertain macro environment, our additional scrutiny of the pipeline, and as well it accounts for the risks we see with longer deal cycles and less on-prem expansions. As we move ahead, we are addressing vectors that we believe will accelerate growth and deliver increased value for customers. We are taking proactive measures to reduce operating expenses across all aspects of the business. We're focusing on reducing expenses in non-revenue generating areas, including a reduction in headcount of approximately 9% to 10%. We remain committed to protecting earnings and free cash flow, and we will continue to invest in areas where we can accelerate revenue growth. Claire will cover the revised outlook and our financial results in more detail. As we look ahead, we remain confident in our opportunity. With AI and generative AI as catalysts for innovation in all industries, Teradata has been trusted by leading companies for years to provide secure, trusted, and well-governed data. The enterprise of the future will be built on trusted data and trusted AI, ensuring that accountability, transparency, and oversight every business needs to empower faster decision making, improve their customers' experience, and continuously create value. Our expertise and technology are what the market needs now. We've surveyed a broad range of C-suite executives and AI decision makers, and an area where they are looking for support is in successfully navigating new AI initiatives. We're confident that our hybrid cloud platform is ideal to help companies align their AI goals to their business strategy and help them lead in their industries with trusted data and trusted AI. In Q2, we advanced our open and connected approach that is designed to allow enterprises to employ modern data strategies and deliver value from trusted AI at scale. Furthering our innovations, we unveiled Teradata VantageCloud Lake on Google Cloud. Together, we are combining the advanced data and analytics capabilities of VantageCloud Lake with the scalability and flexibility of Google Cloud. This launch is expected to enable enterprises that rely on Google Cloud to efficiently scale their AI initiatives and power new generative AI use cases. One of our first customers for this Lake offering is Oi S.A., a leading Brazilian telephone operator. It will leverage VantageCloud Lake on Google Cloud for Revenue Assurance. With this release, our powerful data lake solution is now on all three major CSP platforms: Amazon Web Services, Google Cloud, and Microsoft Azure. Teradata will continue to innovate on our open and connected ecosystem by embracing Open Table Formats, with first-party support for Apache Iceberg and Delta Lake, driving new analytic workloads, and enabling broader AI access to data. Our Open Table Format support is designed to enable customers to both access and store data in an open and standard way that's easily shared across different analytic engines and tools. This allows us to capture more compute power and provide more comprehensive analytic solutions to our customers, solidifying our position as a leader in data and analytics. In the quarter, we also announced that Teradata AI Unlimited, our first on-demand AI/ML engine in the cloud, is integrated into Microsoft Fabric, and OneLake, Fabric's unified, multi-cloud data lake. Teradata AI Unlimited in Microsoft Fabric can extend user freedom to innovate with frictionless, on-demand access to ClearScape Analytics. It is designed to enable developers, data scientists and engineers to maximize their performance by providing access to vast amounts of data and unlimited flexibility to explore, create, and experiment. They can seamlessly explore data, conduct experiments, and operationalize AI use cases without risk to mission-critical production environments. For example, a data scientist might use AI Unlimited to experiment with advanced geospatial functions to address route delivery and improve the supply chain. Alternatively, an analyst might explore innovative churn models, using AI Unlimited's advanced analysis capabilities, coupled with Fabric-native data and business intelligence tools. Multiple life science companies could even collaborate together on disease research, leveraging gradient boosting capabilities of AI Unlimited against data sets in Fabric OneLake. The opportunities are exciting, both for our customers and for us. AI Unlimited is now in public preview in both AWS and Microsoft marketplaces. Now, I will share a few more examples of wins from the quarter. A US-based multinational healthcare company is expanding its Teradata hybrid ecosystem to include VantageCloud Lake on AWS. This is expected to accelerate the development of healthcare innovation and new services to improve customer health outcomes and healthcare affordability. As this long-standing cloud customer is expanding, it becomes one of our top five cloud accounts. We are also pleased that Teradata is now the official cloud analytics partner of the LA Clippers and the Intuit Dome, the Clippers new home. In this new logo win, the team and arena will leverage VantageCloud Lake, with its AI technologies among the suite of services provided. In addition, Joyo Bank in Japan will leverage VantageCloud on Azure as its Analytics & Data Platform for digital transformation, integrating customer and marketing data and using advanced analytics such as AI to maximize its value to customers. As customers select Teradata, we were recognized by Gartner as a customers' choice for Cloud DBMS in its Peer Insights Voice of the Customer report. Teradata was one of only five vendors leading the way as a Customers' Choice. This 'Voice of the Customer' report evaluations companies based on verified users' experiences in implementing and operating cloud solutions. Along with our advances in our technology and with customers, we made strides with partnerships in the quarter. We announced that we are bringing open-source support for trusted AI innovation in partnership with Anaconda. The integration of ClearScape Analytics and Anaconda's Python and R packages is expected to help enterprises deploy large scale data science, AI/ML, and generative AI use cases. We also recently announced new integration of DataRobot's AI platform with ClearScape Analytics and VantageCloud. This integration provides enterprises the ability to import and operationalize DataRobot's AI models, at scale, inside our platform. This functionality is available through ClearScape Analytics' Bring Your Own Model capability and is designed to enable customers to unlock data and results faster and accelerate AI innovation. Also, in the quarter, we expanded our Strategic Collaboration Agreement with AWS to help customers accelerate modernizing their data analytic ecosystems, further support them as they migrate to the cloud, and maximize the value of AI opportunities with improved data-driven insights. As I hand the call to Claire, we are taking actions and are committed to executing. We remain confident in delivering solid cloud growth and in maintaining our enduring commitment as a trusted partner to our customers. With trusted data and trusted AI rapidly becoming table stakes, our technology is in the sweet spot of opportunity. Our attention will remain on delivering innovations that keep Teradata at the forefront of data and analytics. We are equally dedicated to maintaining our momentum on strong partnerships that drive value for customers, and we remain steadfast in protecting profitability and free cash flow. Now, let's pass the call to Claire.

Claire Bramley, Chief Financial Officer

Thank you, Steve, and good afternoon, everyone. In the second quarter, cloud ARR growth remained healthy at 32% year-over-year in constant currency, supported by a cloud net expansion rate of 123%. Q2 cloud ARR grew $19 million sequentially in constant currency, and we closed the eight-figure deal that had slipped from 2023. Total ARR declined year-over-year driven by previously disclosed large on-prem erosions and lower expansion activity. We believe this will be the last quarter of impact from these erosions and we continue to view the first half of 2024 as an outlier when compared to our forward-looking retention rates. While our pipeline and large deal activity remains strong, we continue to experience elongated deal cycles driven by higher levels of strategic engagement with our customers. We are seeing expansion activity being pushed out which leads to an even more pronounced back-end weighting in 2024. To reflect a more prudent stance on timing of large deal closures and conversion of our pipeline, we are lowering the outlook. As Steve mentioned, we are taking pro-active measures to reduce non-revenue generating costs and improve go-to-market productivity and efficiency. I will quantify these measures later in my remarks. Let me now share more details on our quarterly financial results, starting with revenue. Second quarter recurring revenue was $368 million, down 1% year-over-year as reported and 2% growth year-over-year in constant currency. We saw strong growth in cloud revenue, and a small positive impact from upfront revenue, offset by the anticipated on-prem erosions and currency. Net upfront revenue was a positive $5 million. Recurring revenue, as a percentage of total revenue, was 84%, up from 80% from the prior-year period. Second quarter total revenue was $436 million, down 6% year-over-year as reported, and down 3% in constant currency. The year-over-year change is primarily due to lower perpetual and consulting revenues. Moving to profitability and free cash flow. We continue to be pleased with our profitability. Total gross margin was 62.2%, up 160 basis points year-over-year, driven by a strong expansion in cloud gross margins, and lower perpetual and consulting revenues. Operating margin was 22%, up 640 basis points year-over-year. Non-GAAP diluted earnings per share was $0.64, exceeding the top-end of our guidance range. In addition to gross margin strength, we benefited in the quarter from lower operating expenses due to reduced headcount and variable compensation. We generated $39 million of free cash flow in the quarter, which is an $18 million increase sequentially. The year-over-year decline is driven by the linearity of ARR. In the second quarter, we repurchased approximately $47 million, or 1.2 million shares. We remain committed to returning at least 75% of free cash flow to shareholders in the form of share repurchases. Before turning to the outlook, let me cover the cost reduction actions that we are implementing over the next six to 12 months. In total, we anticipate reducing operating expenses by approximately $75 million to $80 million, on an annualized run rate basis. While some of the savings will drop to the bottom line, we also plan to invest a portion of this amount back into revenue-generating growth areas. The total cash impact from associated severance payments is anticipated to be $45 million to $50 million, of which approximately $30 million to $35 million is expected to be paid in 2024. We estimate $15 million to $20 million of non-GAAP operating profit benefit in 2024 from these cost reductions. Moving to our full year 2024 outlook. As a reminder, our outlook ranges are in constant currency for the ARR and revenue metrics. Our revised full year 2024 outlook is as follows: total ARR to decline 2% to 4%; Cloud ARR growth of 28% to 32%; total revenue to decline 2% to 4%; recurring revenue to be flat to down 2%; free cash flow of $270 million to $290 million; non-GAAP earnings per share of $2.20 to $2.26. A breakdown of the 700 basis point change to total ARR is as follows: approximately 100 basis points from churn or erosion activity; approximately 350 basis points largely from lower expected on-prem expansions; approximately 250 basis points impact, due to deal timing. Regarding the free cash flow revision, the primary drivers are lower billings due to ARR reduction, second half severance payments, which are partially offset by lower operating expenses. Additional full-year outlook assumptions include: for currency, using the end of June currency rates, we anticipate year-over-year headwinds of approximately 210 basis points on revenue, 125 basis points on total ARR, and 170 basis points on cloud ARR; weighted average shares outstanding of approximately 98.4 million; other expense of approximately $50 million; we project a non-GAAP tax rate of approximately 24.5%. Regarding our outlook for the third quarter of 2024, we anticipate non-GAAP diluted earnings per share to be in the range of $0.54 to $0.58. We project the non-GAAP tax rate to be approximately 23% and the weighted average shares outstanding of 97.8 million. We expect total ARR to be flat sequentially in Q3. We anticipate sequential acceleration of cloud ARR dollar growth in Q3. We expect the fourth quarter to be the strongest quarter of the year, and deliver 60% or more of the annual cloud growth, supported by the strength of our large deal pipeline which is three times larger than this time last year. With regards to 2025, while we remain confident in the opportunity we have in front of us, given the changes to our 2024 cloud ARR outlook, our 2025 target of $1 billion will push into 2026. We continue to anticipate our cloud ARR growth rate in 2025 will be similar to 2024. The pro-active measures we have taken should result in low- to mid-single-digit year-over-year growth in total ARR, operating margin in the low 20% range, and free cash flow of approximately $320 million to $370 million. In closing, we continue to see strong growth in our cloud business, both in migrations and expansions. The adjustments to our outlook reflect deals taking longer to close, and a more prudent stance on the conversion of our pipeline which remains strong, and no change in our competitive position. Thank you very much for your time today. Let's please open the call for questions.

Operator, Operator

First question comes from Erik Woodring with Morgan Stanley. Your line is now open.

Erik Woodring, Analyst

Great, guys. Thank you so much for taking my question. Steve, maybe I'll start with you. I know your cloud ARR growth forecasts are within that you model 120% net expansion rate. You're obviously outperforming that at, call it, 123%, 124% the last handful of quarters, but you are falling short on cloud ARR, which means either net migrations, expansions at the point of migrations or new logos are underperforming. So last quarter, you did talk about strong on-prem to cloud migrations, but can you maybe just help us understand across each of those three kind of categories, what's happening under the hood? What's the biggest headwind as we think about outside of net expansion where you might be falling short on cloud ARR and how deal elongation is impacting those three categories? And then, I have a follow-up, please. Thank you.

Steve McMillan, President and Chief Executive Officer

Thank you for the question, Erik. You're correct that our cloud annual recurring revenue grew by $19 million in constant currency in Q2, but we did have some deals that were delayed until the second half, which was below our expectations. We're not losing anything in the pipeline; it remains strong, but we're noticing a shift in customer buying behavior, as they're postponing decisions to migrate to the cloud. Consequently, we see some deals being pushed back, and deal elongation is prevalent. Our observation is that this issue worsened during the second quarter, prompting us to be more cautious with our cloud ARR guidance for the year. From an expansion standpoint, we're performing well. Our cohort of customers from last year expanded by 123%. Looking ahead, we anticipate maintaining at least a 120% expansion rate. Regarding new logos, I mentioned our strong new logo pipeline in the last earnings call. We secured new logos in both on-prem and cloud during the second quarter, achieving some significant wins. As we head into the second half of the year, we expect our new logo activity to double compared to the same period last year. Overall, the deal elongation is impacting our cloud ARR, which is why we've adjusted our full-year guidance accordingly.

Erik Woodring, Analyst

Thank you for that detail, Steve. I'd like to clarify something. It’s been a very volatile year, and the macro environment is challenging and uneven. As you think about your guidance for 2024 and the commentary you've provided for 2025, based on this year's unforeseen performance, what gives you the confidence to share those metrics for 2025 with assurance? Where does that confidence come from, considering the volatility in performance and deal elongation? Thanks so much.

Claire Bramley, Chief Financial Officer

Thanks, Erik. Let me begin with our outlook for 2024. We are confident in our projections because we have meticulously assessed all the large deals individually, applying significant discounts to our closed assumptions related to those deals. For the non-large deals, we are relying on the lower end of our historical conversion rate for the pipeline. Additionally, we are assigning senior leadership and executive sponsorship to all our large deals. Several actions have been implemented for 2024. As Steve pointed out, we have noticed a shift in customer behavior during Q2, which we have incorporated into our outlook by utilizing heavily discounted claim assumptions and conservative conversion projections. This is what supports our confidence for 2024. Looking ahead to 2025, we see some positive trends. The cloud business is continuing to grow robustly, and even with our updated forecast, we expect a 30% growth in cloud ARR for the year. As we sustain our cloud growth and maintain around a 120% net expansion rate, this favorable mix will benefit us in 2025. We do face a headwind from our retention rate, which decreased in the first half of 2024 due to significant on-premise erosion. However, we are anticipating improvements as we move through the year and expect retention to enhance further into 2025. Lastly, as mentioned in our prepared remarks, we are implementing various cost reduction initiatives, and we plan to reinvest some of the savings to accelerate growth in targeted areas.

Operator, Operator

Thank you for your question. The next question is from the line of Tyler Radke with Citi. Your line is now open.

Tyler Radke, Analyst

Yeah. Hey, Steve. Hey, Claire. Thanks for taking the question. So, we've been talking about the tough macro environment for Teradata for a few quarters now. And I guess, with this latest push out of some of the targets, I'm curious, like, what is different now about the deal elongation conversations that you are having now versus three to six months ago? And how much is sort of the conversation involving kind of future architecture shifts as it relates to Iceberg tables? If you could just comment on that piece? Obviously, that's been very thoughtful in the space to whether that's holding up decisions here at all. Thank you.

Steve McMillan, President and Chief Executive Officer

Thank you, Tyler, for your question. We are certainly noticing a significant change in customer purchasing behavior as they are reviewing their budgets and ensuring their spending decisions are sound. However, we are not experiencing a major shift in the competitive landscape, nor are we facing significant losses in our opportunities. In fact, we have a robust pipeline of eight-figure deals, which is three times larger than what we had in the second quarter of last year. Nevertheless, these substantial deals are undergoing increased scrutiny from large corporations, which is affecting our closure rates. As for open table formats, we have been actively working to support them. Our platform accommodates various open table formats, and we do not see this as a concluded area of competition. Our technology strategy at Teradata focuses on enabling multiple open table formats on a native object store, providing our customers with a flexible and dynamic data and analytics solution. We are applying similar technology principles to large language models and AI models, allowing our customers to integrate their own models into the Teradata ecosystem to utilize reliable data from their enterprises. Trusted AI is a significant trend in the industry, and we believe we are exceptionally positioned to excel in this domain with our open and connected data and analytics platform.

Tyler Radke, Analyst

Great. Thanks for the color. And then maybe a follow-up for Claire just on the restructuring here. Pretty significant, I think about 10% of the workforce. If I just take 10% of your operating expenses, that gets you to about $70 million of savings. I guess, is that the right way to think about the savings from this, and is that sort of the right way to bridge the difference between this year's free cash flow guide and next year? Just help us understand the moving pieces there on the cash flow as it relates to restructuring? Thank you.

Claire Bramley, Chief Financial Officer

Yeah, of course, Tyler. So, absolutely. So, our total annualized run rate savings expected from the headcount reductions is $75 million to $80 million, of which $15 million to $20 million is expected in 2024. As I mentioned, some of this is going to happen over the next six to 12 months, and not all of these actions will take place in '24. So, I would assume of that $75 million to $80 million of annualized run rate savings prior to reinvestment, 75% of that will flow into fiscal 2025. With regards to the cash impact, we are anticipating a $30 million to $35 million cash impact from severance payments in fiscal 2024. In total, we're anticipating cash payments of $45 million to $50 million, which means approximately $15 million to $20 million will be cash paid in fiscal 2025.

Operator, Operator

Thank you for your question. Next question is from the line of Howard Ma with Guggenheim. Your line is now open.

Howard Ma, Analyst

Thanks. Maybe to dovetail off of Tyler's question on restructuring, so one for Steve, and I have a follow-up for Claire. So, Steve, what is the impacts of the restructuring efforts on account coverage? And just given the more pronounced back-end weighting, what gives you the confidence that you've taken the appropriate measures to close the deal that you need to close in Q4 to achieve guidance?

Steve McMillan, President and Chief Executive Officer

Yeah. Thanks for the question. From a go-to-market perspective, our new Chief Revenue Officer has taken the time to review the overall organization. We actually took the opportunity to reduce a layer of management, and I think that has enabled us all to be closer to the customer. We've also streamlined that global go-to-market organization, taking out a regional structure and having a more industry and geographical basis around that. We've taken the opportunity as well to promote some top talent into those key leadership positions in the company. And Rich's new team is, I said, a proven leaders inside Teradata who have got a great track record of delivering on their commitments. We continue to see that traction and momentum in our largest customers. I mentioned the eight-figure deals in the pipeline. Those deals are more difficult to close, but we've got the right team and the right talent focused on that. In terms of the restructuring activity, all of that restructuring from a go-to-market perspective and putting that new structure in place has been executed already. The deal ownership is incredibly clear from an execution perspective. As we look further and inside the company, we're going to focus on our non-revenue-generating areas, but whilst maintaining a balance to make sure that we are continuing to invest in the growth areas of the business.

Howard Ma, Analyst

Thank you, Steve. Claire, it seems there might have been unexpected large customer churn in the second quarter. Was that included in the 100 basis points you mentioned for the guidance reduction, or should we expect similar large customer churn as experienced in the first quarter for the rest of the year? Thank you.

Claire Bramley, Chief Financial Officer

We did not experience any unexpected customer churn in Q2. We continued to see the effects of the significant on-premises erosions we discussed at the end of 2023, which impacted Q2 as anticipated. In response to your question, we have revised our churn expectations for the entire year, anticipating an increase of 100 basis points in fiscal '24. This stems from a customer we identified previously as at risk, along with a couple of other high-risk customers, and the timing of these developments has accelerated into 2024. So, there were no surprises in Q2, but as you pointed out, we have updated our full-year assumptions by 100 basis points.

Operator, Operator

Thank you for your question. Next question is from the line of Chirag Ved with Evercore ISI. Your line is now open.

Chirag Ved, Analyst

Hi. Thank you for taking my question. So, just on the erosion front, what are some of the steps that you're taking to mitigate potential future erosion and incentivize existing customers to leverage VantageCloud as opposed to potentially migrating, credits, incentives, partner support? I mean, how are you thinking about this opportunity? And are you seeing incremental success in customer retention quarter-over-quarter? Thank you.

Steve McMillan, President and Chief Executive Officer

Thanks, Chirag. Thanks for the question. Yeah, you're absolutely right, we've got a whole host of activities undergoing in terms of our customer success motion. Just taking a little step back, we did know and have known that 2024 was going to be an outlier from an erosion perspective in terms of us having more on-prem erosion than other years. And we are expecting that, as Claire said earlier, to normalize as we move back into 2025 to a more normalized erosion rate. And just reflecting back, if you think about the erosion pattern that we have from a Teradata perspective, it's usually customers that have made the decision to migrate off Teradata many years ago, so four-plus years ago when we did not have the cloud offering that we have in place today. So, the key strategy for us in terms of ensuring that we are remaining relevant inside our customer base is to execute our cloud-first strategy, that's to get our cloud platform deployed and save these customers, and we've had some great success at that. Our cloud business getting up to being 37% of our total ARR at the end of Q2, a significant indication that many, many of our customers are committing to us and committing to their future from a Teradata perspective. Over the last couple of years, we've grown a very successful customer success management function with some great leadership around the company to ensure that we understand what's going on inside our customers, that we have proactive safe plans in place, that we are continuously demonstrating the value of the new technology developments that we're deploying. And in some cases, that would also include some commercial motivation for our customers to move to the cloud with us. We see, however, that our cloud business has been super successful. Most of our customers, when they move to the cloud with us, also grow with us. And that's a great testimony to taking the customer from that on-prem base into the cloud. So, a number of different actions in place around the organization, and we're confident in terms of the customer base that we have and the visibility that we've got into that base as we move forward.

Chirag Ved, Analyst

Maybe just one more quick one on my end. Have you seen any changes in the competitive environment, or has it remained pretty consistent over the course of the last few quarters?

Steve McMillan, President and Chief Executive Officer

Yeah. We've seen the competitive environment to be fairly consistent. We are super delighted from a Teradata perspective now that we've got our new VantageCloud Lake launched on the Google platform. That's going to enable us to start addressing with our most modern technologies all of our customers that utilize the GCP platform as their cloud provider. Also, from a new product release, our Teradata AI Unlimited product integrated into Microsoft Fabric, enables us to partner a very close level with Microsoft in terms of their most advanced technologies and their new technology announcements. So, at the macro level, we don't see any major changes in the competitive environment, but certainly, from a Teradata perspective, we're putting new technologies out there, which enable us to compete more and more effectively as we move forward.

Operator, Operator

Thank you for your question. Next question is from the line of Nehal Chokshi with Northland Capital Markets. Your line is now open.

Nehal Chokshi, Analyst

All right. Thank you. Two questions for Claire. First question, calendar '24 free cash flow, looks like about $40 million of the $80 million free cash flow reduction is due to reduced billings, and that would equate to about 2% reduction in your billing expectations. Is that correct?

Claire Bramley, Chief Financial Officer

Yeah, that's right. And now you need to take, to your point, lower billings assumption from lower ARR and revenue in the year. Also remember, we guided to the low end. So, the reduction is from $340 million down to midpoint of $280 million. So, one of the main drivers is lower ARR and revenue, which impacts both '24 and '25. The other impact, obviously, is the higher cash payments that we're making on severance, partially offset by cost reduction.

Nehal Chokshi, Analyst

Okay. And then, you're also providing some initial thoughts on calendar '25 on the free cash flow and you're projecting it to increase $65 million year-over-year. So, $40 million is due to no additional restructuring payments presumably, and then, the other $25 million would be basically from the projected overall ARR and billings growth that you're projecting?

Claire Bramley, Chief Financial Officer

Yes. So, actually there will be $15 million to $20 million expected of severance payments in 2025. So, we do see a benefit from lower severance payments, but those severance payments of $45 million to $50 million are split with $30 million to $35 million being in fiscal 2024 and $15 million to $20 million in '25. So, we see a benefit, but we do still have some severance payments being paid in 2025. To your point, we are anticipating to also see a benefit from cost reductions, and we also anticipate improvement in ARR gross billings, which is what you mentioned.

Operator, Operator

Thank you for your question. Next question is from the line of Matt Hedberg with RBC. Your line is now open.

Matt Hedberg, Analyst

Great. Thanks for taking my questions. Steve, can you talk about the linearity in the quarter? I'm curious, did things deteriorate as the quarter went on, or was it kind of consistent throughout Q2?

Steve McMillan, President and Chief Executive Officer

Yeah, Matt, thanks for the question. We tend, as many enterprise software companies are, to be kind of back-end loaded towards the end of a particular quarter. And so, as we look at execution, a lot of our linearity always skews to the back end of the quarter. So, it doesn't give us a lot of visibility as we go through the quarter of what's actually happening. And we clearly, we're getting messages from our customer base about the decisions we were making around the spend patterns, and we saw that impact in terms of our overall results from a Q2 perspective.

Matt Hedberg, Analyst

Thank you for that. Claire, regarding the 9% to 10% reduction in headcount, you mentioned in your prepared remarks that there will be expense reductions across all areas of the business, and there seems to be a focus on some non-revenue-generating areas. Could you provide more details on where these reductions will occur? Additionally, it appears you plan to reinvest some of the savings. Can you clarify what the total targeted headcount will be after accounting for both the reductions and any rehiring?

Claire Bramley, Chief Financial Officer

Yeah. So to your point, we made some changes and done a reorganization in the go-to-market teams, as Steve said. So, taking out additional layers of management, focusing more on geographic and industry verticals rather than the regional setup we have previously. So, there have been a number of changes in the go-to-market organization. We have tried to prioritize non-revenue-generating activities, but we are looking across the board to ensure that we have prioritized our investments across everywhere, so including products, including marketing, go-to-market and non-revenue-generating. But obviously, we are trying to maximize the savings in the non-revenue-generating areas. When it comes to reinvestments, we are still finalizing our plans with regards to the exact number of reinvestments because this will be over the next six to 12 months. So, we'll give further details on that as we give a guide on 2025 at the end of the year. But what we do anticipate is where we see areas that can help us accelerate our growth in 2025 and beyond, we do see the opportunity to be able to reinvest some of those savings that we're taking out over the next six to 12 months.

Operator, Operator

Thank you for your question. Next question is from the line of Patrick Walravens with Citizens GMP. Your line is now open.

Patrick Walravens, Analyst

Oh, great. Thank you. I guess what I would start with is, do you see that Fortune 500 companies, in general, as they're determining their data strategy are anchoring that on selecting a primary or single data warehouse vendor?

Steve McMillan, President and Chief Executive Officer

Hi, Pat. Thank you for the question. We see that there is ample opportunity for various players in the market. From our standpoint, we believe we provide the best route to the cloud for the world's largest organizations that manage complex mixed workloads at scale, and we can offer that solution in the most cost-effective manner. Additionally, we are introducing new capabilities to our platform, which will not only support enterprise data warehouses but also enable us to compete in areas like Lake or Lakehouse deployments and high-performance analytics that align well with AI and GenAI solutions. Many of our customers are exploring multiple solutions within this broad range. At Teradata, our goal is to provide the most effective engine to meet the diverse workloads and needs of our customers.

Patrick Walravens, Analyst

Okay. I mean, everyone on this call and you guys as well have heard that example of the bank in Asia Pac that decided to go Databricks and listed everyone else that they're replacing in the process. You were one of several other vendors, other data warehouse vendors. So, I'm just wondering how common is that, Steve? Is that something that most large organizations are designed to do, pick one and replace the others, or is it not that common?

Steve McMillan, President and Chief Executive Officer

Vendor lock-in is not beneficial for customers. From Teradata's standpoint, we understand our customers' needs and maintain strong relationships with them. In cases where customers are using outdated versions of our on-premise ecosystem and made prior decisions before our advanced cloud technologies were available, they may choose to transition away from Teradata. Currently, we believe we play a crucial role in our customers' ecosystems by addressing their most critical workloads, particularly at an enterprise level. Our long-standing massively parallel computing architecture excels at processing AI and Gen AI workloads efficiently. We are well-positioned to compete for the appropriate workloads within our customers' operations. Moving forward, customers will likely evaluate which solutions best meet their workload needs, including their storage requirements. They may seek high-performance block storage or consider more cost-effective options like open table formats or native object stores. Teradata's goal is to accommodate all of these needs.

Operator, Operator

Thank you for your question. Next question is from the line of Wamsi Mohan with Bank of America. Your line is now open.

Wamsi Mohan, Analyst

Yes. Thank you so much. So, Blair, on the restructuring benefit of $15 million to $20 million net benefit in 2024 on EBIT, is there incremental EBIT benefit that flows into 2025?

Claire Bramley, Chief Financial Officer

Yes, Wamsi. We are expecting a total annualized run rate of $75 million to $80 million. Before reinvestment, about 75% of that is projected to impact fiscal 2025. Therefore, we anticipate an incremental benefit. As previously mentioned, we are assessing our reinvestment strategy and exploring opportunities that will ultimately foster long-term growth. Consequently, there should be a benefit in fiscal 2025, but we are still finalizing the modeling regarding the amount we will invest, keeping in mind our strong emphasis on return on investment.

Wamsi Mohan, Analyst

So, Claire, I guess, like the question is really that, is there going to be an organic EBIT increase going into next year? Because if you are looking at sort of your preliminary thoughts on 2025 with low single-digit top-line and 20% EBIT margin, it's about 50 basis points of margin expansion. Is that contemplating a net level of investment that supersedes some of this cost savings or is the organic EBIT actually declining? And how would you bridge that with cash flow then if organic EBIT is declining for the north of $50 million improvement year-on-year?

Claire Bramley, Chief Financial Officer

Thank you for the question, Wamsi. As we consider our low 20% range and look at it from a dollar perspective, we continue to expand our cloud gross margin and implement proactive cost reductions. We expect to see dollar growth year-over-year from 2024 to 2025, which is included in our fiscal 2025 cash flow assumptions. This growth will come from an increase in billings and a benefit from lower severance, contributing to the year-over-year cash impact. We believe this is how we will achieve the low 20% operating margin while also seeing dollar growth as we transition into 2025.

Operator, Operator

Thank you for your question. Next question is from the line of Derrick Wood with TD Cowen. Your line is now open.

Derrick Wood, Analyst

Great. Thanks. I guess for Steve or Claire, just in terms of the reduction in the ARR outlook, can you couch how much of this is coming from what you're seeing in your pipeline and sales cycles today versus how much of this is from anticipated disruption from the restructuring? Just wondering whether you're anticipating much disruption from go-to-market motions due to the reorg?

Steve McMillan, President and Chief Executive Officer

No, thank you for the question, Derrick. We don't expect any disruption in our go-to-market execution. As you mentioned, we have a strong pipeline with substantial deals, and we have some of our best salespeople working on them. I have complete confidence in the leadership team we've established in the go-to-market organization. They have maintained their momentum consistently. However, we do notice a continued lengthening of the deal cycle, which has been more pronounced in the second quarter due to customer decision-making processes, particularly for these very large deals.

Derrick Wood, Analyst

Got it. Understood. In your prepared remarks, you mentioned that you're seeing less on-prem expansions. Previously, you had been anticipating flat to slightly positive growth in on-prem excluding migrations. How does this outlook change considering your updated guidance and what you're observing regarding expansion activity?

Steve McMillan, President and Chief Executive Officer

I’ll address the first part of your question, and then Claire can add her insights. What we are observing is that as customers review their budgets and consider their transition to the cloud, they are postponing on-premises expansions. It doesn’t make sense for them to increase their on-premises presence if they will eventually migrate to the cloud. Therefore, as they evaluate these cloud migrations, some are being delayed, which affects our overall Annual Recurring Revenue. This includes the typical expansions we expect during the migration from on-prem to cloud and the postponement of on-premises expansions as customers think about their future cloud strategy with us. It’s important to emphasize that we are not losing these opportunities to competitors; rather, we are experiencing delays in decision-making and these deals are being pushed into later quarters.

Claire Bramley, Chief Financial Officer

Yeah. And I'll just jump in to your point. Because of the reduction in on-prem expansions, we now would not anticipate to grow, to be flat or slightly up excluding migration. We'd actually expect that to decline. But we do believe that that's an opportunity, as Steve mentioned, over time as we move these large accounts to the cloud and then we tend to see larger expansion with us once they migrate to the cloud.

Operator, Operator

Thank you for your question. Next question is from the line of Raimo Lenschow with Barclays. Your line is now open.

Raimo Lenschow, Analyst

Hey, thanks for squeezing me in. Steve, the pipeline that you talked about like the double new logo pipeline versus the second half of 2023 and then the three times the pipeline of the eight-figure deal, where are these especially on the new logo side, where are they coming in like, they're obviously, they clearly must be kind of participating more in the market again. Like, what are the people looking for? What's the size or what's the typical profile of the customer there? Thank you.

Steve McMillan, President and Chief Executive Officer

Yes. Thanks, Raimo. I think we're seeing a very balanced view in terms of we're seeing new logos across all of the geographies and across all industries. So, most of the new logos are buying a use case. I mentioned that bank in Japan as an example who are using VantageCloud Lake for revenue assurance. So, it's really interesting because we've got that whole history of industry experience and say Teradata and how the biggest enterprises in the world use data and advanced analytics for business value, we can actually take those use cases on our new technology, and take those to new customers. The other thing I would point out, Raimo, is, the strength of our hybrid platform. So, we're seeing new logos both from an on-prem perspective and in the cloud. So, it's very balanced across different deployment models, different use cases, different industries and different geographies. And I think that gives us breadth of operation to actually execute and generate that new logo success, which we think in the second half is going to be double what we did in the second half last year from a new logo results perspective.

Raimo Lenschow, Analyst

Perfect. Okay, looking forward to that. Thank you.

Operator, Operator

Thank you for your question. Next question is from the line of Austin Dietz with UBS. Your line is now open.

Austin Dietz, Analyst

Hey, Steve. Nice to connect. I love to hear your views on where the data analytics industry is headed over the next few years. From your response earlier to Tyler's question, change in architectures don't appear to be impacting deal cycles yet, but there seems to be just real adoption around open table formats like Iceberg and shifting towards a more open architecture in the industry. So, yeah, I guess, how do you see the data analytics market evolving over the next few years? How do you think open table format changes the competitive landscape in the data analytics market? Does it become about query performance on iceberg tables at some point? I would just love your thoughts on where the data analytics is headed over the next few years.

Steve McMillan, President and Chief Executive Officer

Thank you for the question. We discussed several points earlier. Regarding open table formats, I believe the competition is still ongoing. Our strategy is to create an open and connected ecosystem that accommodates various open table formats. As technology progresses, we empower our customers to leverage both current and emerging open table formats. Looking ahead, our customers will likely want to implement workloads based on the most suitable storage tier. This could involve using cloud services with high-performance storage for complex, critical real-time applications, while opting for less robust storage for less essential workloads. The competition will center around whose query engine performs best. We're pleased to have launched Teradata AI Unlimited, which includes our analytics capabilities directly within the database. We have a high-performance query engine deployed in VantageCloud Lake that caters to a wide range of use cases. Our commitment is to maintain an open and connected approach that allows our customers to utilize the most advanced analytics capabilities, including Generative AI and analytic models.

Operator, Operator

Thank you for your question. There are no further questions at the time. I'll now turn the call back over to Steve McMillan for his final remarks.

Steve McMillan, President and Chief Executive Officer

Thank you, everybody, for joining us today. Look, as we end the call, I'd like to emphasize that we are confident that we've got a fantastic market opportunity in front of us. We've got a great technology and we've got the team to win. We've got our plans in place for execution and we are absolutely committed to moving forward successfully.

Operator, Operator

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