You should read the following discussion in conjunction with the Condensed Consolidated Financial Statements and the notes to those statements included elsewhere in this Quarterly Report on Form 10-Q. This Quarterly Report on Form 10-Q contains certain statements that are forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995. Certain statements contained in the MD&A are forward-looking statements that involve risks and uncertainties. The forward-looking statements are not historical facts, but rather are based on current expectations, estimates, assumptions and projections about our industry, business and future financial results. Our actual results could differ materially from the results contemplated by these forward-looking statements due to a number of factors, including those discussed in other sections of this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for the fiscal year endedDecember 31, 2019 (the "2019 Annual Report"). The Company does not undertake any obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. OverviewTeradata Corporation ("we," "us," "Teradata," or the "Company") is a leading hybrid cloud data and analytics software platform provider focused on helping companies leverage all of their data across an enterprise to uncover real-time intelligence, at scale. In doing so, we enable them to find answers to their toughest challenges. Our solutions enable customers to integrate and simplify their analytics ecosystem, access and manage data, and use analytics to extract answers and derive business value from data. Our solutions are composed of software, hardware, and related business consulting and support services to deliver analytics across a company's entire analytic ecosystem. Teradata's strategy is based on our mission of transforming how businesses work and people live through the power of data. Our target market is made up of companies that we believe are the world's most demanding, large-scale users of data. These companies face significant challenges including siloed data and conflicting and duplicative solutions that typically result in considerable expense to maintain and difficulty to manage the complexity. Our strategy is to provide a differentiated set of offerings to our target market through an extensible data and analytic platform. Teradata Vantage™ is an extremely scalable, secure, highly concurrent and resilient analytics platform that solves the most complex data challenges at scale faced by our targeted customer set. By offering customers full integration of their datasets, tools, analytics languages, functions, and engines in one analytical platform, Vantage reduces customers' complexity, risk, and costs. Our Vantage platform embraces leading commercial and open source analytics technologies and is available in the cloud and on-premises. All subscription-based Teradata software licenses enable portability of the software license between cloud and on-premises deployment options; this flexibility is designed to reduce risk associated with customers' buying decisions. Customer buying behavior has shifted from predominantly capital-intensive purchases to subscription-based purchasing options. In the near term, the movement to subscription-based transactions is negatively impacting the timing of our reported revenue and our cash flows because revenue and cash related to subscription-based transactions are recognized and received over time versus upfront as was the case with the capital purchase model. The transition to a subscription-based model is expected to increase our recurring revenue, create more predictable operating results and improve cash flow generation over time. Near-term impacts, however, can fluctuate based on the pace of customer adoption, which can be difficult to predict. In the longer term, we expect our reported operating results and cash flow to normalize and increase as customers increasingly transition to these subscription-based offerings. We are continuing to execute on our key priorities, including development and expansion of our cloud-based offerings, enhancements to our market-leading Vantage platform, consulting, partner solutions and operational excellence. To allow for greater transparency regarding the progress we are making toward achieving our strategic objectives, we utilize the following financial and performance metrics: 19 -------------------------------------------------------------------------------- Table of Contents •Annual Recurring Revenue ("ARR") - annual contract value for all active and contractually binding term-based contracts at the end of a period. ARR includes maintenance, software upgrade rights, subscription-based transactions and managed services. •Backlog - the price of firm orders for which work has not been performed or goods have not been delivered and the Company is contractually required to perform. COVID-19 During the six months endedJune 30, 2020 , the effects of the coronavirus disease 2019 ("COVID-19") pandemic and the related actions by governments around the world to attempt to contain the spread of the virus have impacted our business globally, and we expect our business will continue to be impacted for the foreseeable future. In particular, the outbreak and related preventive measures taken to contain COVID-19 beginning late in the first quarter of 2020 negatively impacted our ability to close transactions with customers and timely collect receivables in certain instances. We experienced a more favorable trend in the second quarter with meaningful ARR growth, strong cash flows and recurring revenue growth generated in the quarter, although we continued to see COVID-19 negatively impact our consulting business as described below. We also took the necessary actions to manage expenses and costs appropriately in light of the uncertainty COVID-19 created, which helped improve second quarter operating performance. We are keeping a watchful eye on COVID-19 impacts and have undertaken additional second half expense management and cost initiatives to further drive our operating performance and provide agility in the event of an unforeseen reduction in demand should it occur. During the first six months of 2020, we also experienced increased volatility in foreign currency exchange rates, in part related to the uncertainty from COVID-19, as well as actions taken by governments and central banks in response to COVID-19. Certain foreign currency rates have depreciated significantly against theU.S. dollar during the period. We expect continued volatility in foreign currency exchange rates during the remainder of 2020, though we cannot reasonably estimate the duration or extent of that volatility. As of the date of this filing, our supply chain has been relatively stable with respect to manufacturing and distribution capabilities; however, our supply chain is susceptible to volatility due to ongoing uncertainty as a result of ongoing international and domestic pandemic response and recovery efforts. Operationally, we have been able to run our business without significant interruptions, with the vast majority of employees having shifted quickly as ofmid-March 2020 to a work-from-home model, which remains in effect. However, our consulting business has been negatively impacted during the transition to work from home and shelter-in-place orders, and customers' efforts to reduce discretionary spending in light of COVID-19 uncertainties and impacts, with consulting projects being delayed or suspended by our customers. The Company also developed and continues to refine numerous engagement and communication programs to support employees both from a health and well-being perspective as well as to enhance their productivity during the pandemic. In general, our priorities in formulating and implementing our response to the COVID-19 pandemic and business disruption include the following: •People - protecting the health and well-being of our employees, •Customers - proactively connecting with our customers to support their needs and meet our service level commitments, •Supply Chain - proactively working to monitor existing inventory, supplier availability and securing inventory for future quarters, •Financial - responsibly managing expenses and costs to provide financial agility during the extended period of global economic uncertainty, •Global Community - making our technology available to customers, partners and communities, particularly in healthcare and government, where collectively we can positively impact efforts in combating COVID-19, and •Future of Work - planning to best position the Company to emerge as strong as possible when this crisis ends. 20 -------------------------------------------------------------------------------- Table of Contents As of the date of this Quarterly Report on Form 10-Q, we are continuing to execute our pandemic response plan and theTeradata Pandemic Response Team is refining and executing return-to-office plans with "safety first" considerations. Customer-facing teams are also proactively working to identify ways to assist customers, meet service level commitments, and engage with customers via virtual events. Despite these efforts, there remains a fair degree of uncertainty regarding the potential impact of the pandemic on our business, from both a financial and operational perspective, and the scope and costs associated with additional measures that may be necessary in response to the pandemic going forward. We will continue our diligent efforts to monitor and respond as appropriate to the impacts of the pandemic on our business, including the status of our workforce, supply chain, customers, suppliers, and vendors, based on the priorities described above. Our actions will continue to be informed by the requirements and recommendations of the federal, state or local authorities. We will remain agile and have contingency plans in place to appropriately respond to conditions as they unfold. For more information, see "Risk Factors" under Part II, Item 1A of this Quarterly Report on Form 10-Q.
Second Quarter Financial Overview
As more fully discussed in later sections of this MD&A, the following were significant financial items for the second quarter of 2020: •Total revenue was$457 million for the second quarter of 2020, a 4% decrease compared to the second quarter of 2019, with an underlying 6% increase in recurring revenue. The Company's business has shifted to subscription-based transactions driving increased recurring revenue, which was offset by a 41% decrease in perpetual software licenses and hardware revenue as transactions move to subscription and a 26% decrease in consulting services revenue in alignment with our strategy as well as the impact of COVID-19 as discussed above. Foreign currency fluctuations had a 1% negative impact on total revenue for the quarter compared to the prior year. •Gross margin increased to 56.0% in the second quarter of 2020 from 49.4% in the second quarter of 2019, primarily due to a higher recurring revenue mix as compared to the prior period. •Operating expenses for the second quarter of 2020 increased by 10% compared to the second quarter of 2019, primarily due to an increase in equity compensation expense. •Operating income was$8 million in the second quarter of 2020, compared to$10 million in the second quarter 2019. •Net loss in the second quarter of 2020 was$43 million , compared to a net loss of$1 million in the second quarter of 2019. The increase in net loss was primarily due to the higher operating expenses and discrete tax items during the quarter. 21 -------------------------------------------------------------------------------- Table of Contents Results of Operations for the Three Months EndedJune 30, 2020 Compared to the Three Months EndedJune 30, 2019 Revenue % of % of In millions 2020 Revenue 2019 Revenue Recurring$ 358 78.4 %$ 338 70.7 % Perpetual software licenses and hardware 17 3.7 % 29 6.1 % Consulting services 82 17.9 % 111 23.2 % Total revenue$ 457 100.0 %$ 478 100.0 % Total revenue decreased$21 million , or 4%, in second quarter of 2020 and included a 1% negative impact from foreign currency fluctuations. Recurring revenue grew 6%, which included a 2% negative impact from foreign currency fluctuations. This increase in recurring revenue was driven by our movement to subscription-based transactions from perpetual software licenses and hardware transactions, which is consistent with our strategy. Under subscription models, we recognize revenue over time as opposed to the upfront recognition under the perpetual model. For 2020, we expect ARR growth and recurring revenue growth. Taking into consideration the growth in recurring revenue offset by reduced perpetual software licenses and hardware revenue and reduced consulting services revenue, we expect that total revenues will decrease in 2020, although the amount of decline is difficult to predict due to the uncertain global environment caused by COVID-19. Revenues from perpetual software licenses and hardware decreased 41%, including a 1% negative impact from foreign currency fluctuations. We expect perpetual revenues to continue to decline as customers switch to our subscription-based offerings. However, some customers continue to purchase on a perpetual basis, and COVID-19 impacts might result in some additional customers preferring this option. Perpetual revenue is primarily hardware-related, as software is generally being sold on subscription. We expect that perpetual revenue will continue to decline in 2020 and will continue to be predominantly hardware-related. Consulting services revenue decreased 26%, including a 2% negative impact from foreign currency fluctuations, as we are realigning and focusing our consulting resources on higher-margin engagements that drive increased software consumption within our targeted customer base. Consulting revenue was also impacted by the transition to work from home and shelter-in-place orders that went in effect late in the first quarter in response to COVID-19. In the second quarter, we made progress towards our strategy of refocusing our consulting organization on Vantage-oriented offerings and de-emphasizing non-core consulting engagements. We expect consulting revenue to decline longer term as we build a deepening partner ecosystem and our product simplification efforts reduce our customers' need for consulting services while creating greater total value for our customers. We also expect consulting revenue to continue to be impacted by COVID-19, as we anticipate delays and/or cancellation of new projects. As a portion of the Company's operations and revenue occur outsidethe United States , and in currencies other than theU.S. dollar, the Company is exposed to fluctuations in foreign currency exchange rates. Based on currency rates as ofJuly 31, 2020 , Teradata is expecting less than one percentage point of negative impact from currency translation on our 2020 full-year projected revenue growth rate. Included below are financial and performance growth metrics for 2020: •At the end of the second quarter of 2020, ARR was$1.454 billion , an 8% increase from the second quarter of 2019, including a 1% negative impact from foreign currency translation, as compared to the second quarter of 2019. •Total backlog was$2.595 billion at the end of the second quarter of 2020, up 3% from the prior year. 22 --------------------------------------------------------------------------------
Table of Contents Gross Profit % of % of In millions 2020 Revenue 2019 Revenue Recurring$ 242 67.6 %$ 231 68.3 % Perpetual software licenses and hardware 6 35.3 % 3 10.3 % Consulting services 8 9.8 % 2 1.8 % Total gross profit$ 256 56.0 %$ 236 49.4 % The decrease in recurring revenue gross profit as a percentage of revenue was driven by a higher mix of subscription-based revenue that includes hardware and lower margin cloud, as compared to the prior-year period. Subscription-based transactions carry lower margins than revenue from perpetual-related maintenance and software upgrade rights as a result of embedded hardware rentals and cloud offerings in our subscription business. The increase in perpetual software licenses and hardware gross profit as a percentage of revenue was driven by deal mix compared to the same period a year ago. Consulting services gross profit as a percentage of revenue increased as compared to the prior-year period, due to improved utilization as well as increased price realization and our continued strategic focus to improve consulting margins. As indicated above, the consulting business was negatively impacted due to the COVID-19 pandemic; however, performance is expected to normalize in the second half of the year. We expect consulting gross margins to be in the low double digits for the year. Operating Expenses % of % of In millions 2020 Revenue 2019 Revenue Selling, general and administrative expenses$ 165 36.1 %$ 145 30.3 % Research and development expenses 83 18.3 % 81 16.8 % Total operating expenses$ 248 54.3 %$ 226 47.3 % The selling, general and administrative ("SG&A") expense increase was primarily driven by an increase in equity compensation expense, amortization of capitalized sales compensation, as well as additional investments in our go-to-market and customer success teams. The Company took several actions to manage operating expenses, including limiting travel and other discretionary spend. For the full year, we will continue to look for areas to optimize our cost structure while investing in our key strategic initiatives in cloud and transforming our go-to-market organization to support our recurring revenue model and expand our opportunities in the market. As a result of the actions we have taken in the first half, we now expect full year operating expenses to be flat year over year. Research and development ("R&D") expenses increased due to spending focused on accelerating our cloud initiatives. For the full year, we expect R&D expense to be flat to slightly up as we reallocate spending to accelerate our cloud initiatives. Other Expense, net In millions 2020 2019 Interest income$ 1 $ 6 Interest expense (7) (8) Other (5) (3) Other expense, net$ (11) $ (5) Other expense, net in the second quarter of 2020 and 2019 is comprised primarily of interest expense on long-term debt and finance leases, partially offset by interest income earned on our cash and cash equivalents. Other expense, net increased compared to the prior year primarily due to lower interest income on lower cash and cash equivalents. 23 -------------------------------------------------------------------------------- Table of Contents Provision for Income Taxes Income tax provisions for interim periods are based on estimated annual income tax rates, adjusted to reflect the effects of any significant infrequent or unusual items which are required to be discretely recognized within the current interim period. As a result of the 2017 Tax Act, the Company changed its indefinite reversal assertion related to its foreign subsidiary undistributed earnings and no longer considers a majority of its foreign earnings permanently reinvested outside of theU.S. The effective tax rates in the periods presented are largely based upon the forecasted pre-tax earnings mix between theU.S. and other foreign taxing jurisdictions where the Company conducts its business. The Company estimates its full-year effective tax rate for 2020 to be approximately 1,000.0%, which takes into consideration, among other things, the forecasted earnings mix by jurisdiction and the estimated discrete items to be recognized in 2020, which includes a$157 million one-time discrete tax benefit recognized in the first quarter of 2020 related to an intra-entity asset transfer of certain of the Company's intellectual property ("IP") to one of its Irish subsidiaries, which occurred onJanuary 1, 2020 . The forecasted tax rate is based on the overseas profits being taxed at an overall effective tax rate of approximately 47%, as compared to theU.S. federal statutory tax rate of 21%. OnMarch 27, 2020 , the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") was enacted in response to the COVID-19 pandemic. The CARES Act, among other things, permits net operating loss ("NOL") carryovers and carry backs to offset 100% of taxable income for taxable years beginning before 2021. In addition, the CARES Act allows NOL's incurred in 2018, 2019, and 2020 to be carried back to each of the five preceding taxable years to generate a refund of previously paid income taxes. It also allows deferral of certain payroll tax payments to 2021 and 2022. We are currently evaluating the impact of the CARES Act, but at present do not expect that the NOL carry back provision of the CARES Act would result in a cash benefit to us. Deferred payroll taxes as ofJune 30, 2020 were approximately$6 million . The effective tax rate for the three months endedJune 30, 2020 and 2019 were as follows: 2020 2019 Effective tax rate (1,333.3) % 120.0 % For the three months endedJune 30, 2020 , the Company recorded$39 million of discrete tax expense, a majority of which related to the true-up of the marginal tax rate from the first quarter based on revised full-year forecasted earnings. As a result, the Company recorded income tax expense of$40 million on a pre-tax net loss of$3 million for the three months endedJune 30, 2020 , resulting in an effective income tax rate of (1,333.3)%. For the three months endedJune 30, 2019 , the Company recorded$5 million of discrete tax expense, of which$4 million related to an uncertain tax position resulting from the reversal of the United States Tax Court's decision in theAltera Corp. v. Commissioner case (the "Altera Case") by theNinth Circuit Court of Appeals inJune 2019 . The Altera Case focused on whether currentU.S. Treasury Regulations requiring the inclusion of stock-based compensation expense in a taxpayer's cost-sharing calculations are valid. As a result, the Company recorded income tax expense of$6 million on a pre-tax income of$5 million for the three months endedJune 30, 2019 , resulting in an effective income tax rate of 120.0%. Revenue and Gross Profit by Operating Segment Teradata manages its business under three geographic regions, which are also the Company's operating segments: (1)Americas region (North America andLatin America ); (2) EMEA region (Europe ,Middle East , andAfrica ) and (3) APJ region (Asia Pacific andJapan ). For purposes of discussing results by segment, management excludes the impact of certain items, consistent with the manner by which management evaluates the performance of each segment. This format is useful to investors because it allows analysis and comparability of operating trends. It also includes the same information that is used by Teradata management to make decisions regarding the segments and to assess financial performance. The chief operating decision maker, who is our President and Chief Executive Officer, evaluates the performance of the segments based on revenue and multiple profit measures, including segment gross profit. For management reporting purposes, assets are not allocated to the segments. Our segment 24 -------------------------------------------------------------------------------- Table of Contents results are reconciled to total company results reported under GAAP in Note 12 of Notes to Condensed Consolidated Financial Statements (Unaudited). The following table presents segment revenue and segment gross profit for the Company for the three months endedJune 30 : % of % of In millions 2020 Revenue 2019 Revenue Segment revenue Americas$ 259 56.7 %$ 269 56.3 % EMEA 118 25.8 % 122 25.5 % APJ 80 17.5 % 87 18.2 % Total segment revenue$ 457 100 %$ 478 100 % Segment gross profit Americas$ 161 62.2 %$ 158 58.7 % EMEA 67 56.8 % 57 46.7 % APJ 41 51.3 % 37 42.5 %
Total segment gross profit
Americas revenue decreased 4%, which included a decrease in perpetual software licenses and hardware revenue of 17% and a 30% decrease in consulting revenue. Segment gross profit as a percentage of revenues was higher primarily due to an overall higher mix of recurring revenue. EMEA EMEA revenue decreased 3%, which included a 2% unfavorable impact from foreign currency fluctuations. An increase of 16% in recurring revenue was offset by a decrease of 60% in perpetual software licenses and hardware revenue and a decrease in consulting revenue of 27%. Segment gross profit as a percentage of revenues was higher primarily due to a higher mix of recurring revenue. APJ APJ revenue decreased 8%, which included a 1% unfavorable impact from foreign currency fluctuations. An increase in recurring revenue of 9% was offset by a decrease of 57% in perpetual software licenses and hardware revenue and a decrease in consulting revenue of 21%. Segment gross profit as a percentage of revenues was higher primarily due to a higher mix of recurring revenue. Results of Operations for the Six Months EndedJune 30, 2020 Compared to the Six Months EndedJune 30, 2019 Revenue % of % of In millions 2020 Revenue 2019 Revenue Recurring$ 703 78 %$ 669 71 % Perpetual software licenses and hardware 31 4 % 60 6 % Consulting services 157 18 % 217 23 % Total revenue$ 891 100 %$ 946 100 % Total revenue decreased$55 million , or 6%, for the six months endedJune 30, 2020 compared to the prior period and included a 2% negative impact from foreign currency fluctuations. Recurring revenue increased 5%, which included a 2% negative impact from foreign currency fluctuations. This increase in recurring revenue was driven by our movement to subscription-based transactions from perpetual software licenses and hardware transactions, which is consistent with our strategy. 25 -------------------------------------------------------------------------------- Table of Contents Revenues from perpetual software licenses and hardware decreased 48% as customers continue to switch to subscription-based offerings. Consulting services revenue decreased 28%, including a 2% negative impact from foreign currency fluctuations, as we are realigning and focusing our consulting resources on higher-margin engagements that drive increased software consumption within our targeted customer base. Consulting revenue was also impacted by the transition to work from home and shelter-in-place orders that went in effect late in the first quarter in response to COVID-19. Gross Profit % of % of In millions 2020 Revenue 2019 Revenue Recurring$ 467 66.4 %$ 456 68.2 % Perpetual software licenses and hardware 11 35.5 % 9 15.0 % Consulting services 3 1.9 % (5) (2.3) % Total gross profit$ 481 54.0 %$ 460 48.6 % The decrease in recurring revenue gross profit as a percentage of revenue was driven by a higher mix of subscription-based revenue as compared to the prior-year period. Subscription-based transactions are typically lower margin as compared to the recurring revenue from legacy software maintenance and software upgrade rights, due to the higher mix of rental hardware included in subscription-based transactions. The increase in perpetual software licenses and hardware gross profit as a percentage of revenue was driven by deal mix compared to the same period a year ago. Consulting services gross profit as a percentage of revenue increased as compared to the prior-year period due to improved utilization as well as increased price realization and our continued strategic focus to improve consulting margins. The Company continues to refocus our consulting organization on Vantage-oriented offerings and reduce our footprint in non-core consulting engagements. Operating Expenses % of % of In millions 2020 Revenue 2019 Revenue Operating expenses Selling, general and administrative expenses$ 323 36.3 %$ 296 30.3 % Research and development expenses 156 17.5 % 159 16.8 % Total operating expenses$ 479 53.8 %$ 455 47.3 % The SG&A expense increase was primarily driven by an increase in equity compensation expense, amortization of capitalized sales compensation, as well as additional investments in our go-to-market and customer success teams. R&D expenses decreased due to a re-prioritization of our R&D organization on strategic initiatives and reduced spending on de-prioritized initiatives. Other Expense, net In millions 2020 2019 Interest income$ 3 $ 12 Interest expense (14) (17) Other (8) (5) Other expense, net$ (19) $ (10)
Other expense, net in the first six months of 2020 and 2019 is comprised primarily of interest expense on long-term debt and finance leases, partially offset by interest income earned on our cash and cash equivalents. Other expense, net increased compared to the prior year primarily due to lower interest income on lower cash and cash equivalents.
26 -------------------------------------------------------------------------------- Table of Contents Provision for Income Taxes The effective tax rate for the six months endedJune 30, 2020 and 2019 were as follows: 2020 2019 Effective tax rate 835.3 % (120.0) % For the six months endedJune 30, 2020 , the Company recorded$113 million of discrete tax benefit. The discrete tax expense of$39 million recorded in the second quarter described above was offset by$152 million of discrete tax benefit recorded in the first quarter, a majority of which related to the intra-entity IP transfer described above. As a result, the Company recorded income tax benefit of$142 million on a pre-tax loss of$17 million for the six months endedJune 30, 2020 , resulting in an effective income tax rate of 835.3%. For the six months endedJune 30, 2019 , the Company recorded$7 million of discrete tax expense, a majority of which related to the uncertain tax position resulting from the reversal of the Tax Court's decision in the Altera Case. As a result, the Company recorded income tax expense of$6 million on a pre-tax net loss of$5 million for the six months endedJune 30, 2019 , resulting in an effective income tax rate of (120.0)%. Revenue and Gross Profit by Operating Segment The following table presents segment revenue and segment gross profit for the Company for the six months endedJune 30 : % of % of In millions 2020 Revenue 2019 Revenue Segment revenue Americas$ 503 56.5 %$ 538 56.9 % EMEA 236 26.5 % 235 24.8 % APJ 152 17.1 % 173 18.3 % Total segment revenue$ 891 100 %$ 946 100 % Segment gross profit Americas$ 305 60.6 %$ 315 58.6 % EMEA 128 54.2 % 107 45.5 % APJ 71 46.7 % 71 41.0 % Total segment gross profit$ 504 56.6 %$ 493 52.1 % AmericasAmericas revenue decreased 7%, which included a 2% unfavorable impact from foreign currency fluctuations. An increase of 1% in recurring revenue was offset by a decrease in perpetual software licenses and hardware revenue of 55% and a 30% decrease in consulting revenue. Segment gross profit as a percentage of revenues was higher primarily due to an overall higher mix of recurring revenue. EMEA EMEA revenue was flat and included a 3% unfavorable impact from foreign currency fluctuations. An increase of 16% in recurring revenue was offset by a decrease of 24% in perpetual software licenses and hardware revenue as well as a decrease in consulting revenue of 26%. Segment gross profit as a percentage of revenues was higher primarily due to a higher mix of recurring revenue. APJ APJ revenue decreased 12%, which included a 2% unfavorable impact from foreign currency fluctuations. An increase in recurring revenue of 7% was offset by a decrease of 67% in perpetual software licenses and hardware revenue and a decrease in consulting revenue of 27%. Segment gross profit as a percentage of revenues was higher primarily due to a higher mix of recurring revenue. 27 -------------------------------------------------------------------------------- Table of Contents Financial Condition, Liquidity and Capital Resources Cash provided by operating activities increased by$36 million in the six months endedJune 30, 2020 compared to the six months endedJune 30, 2019 . Teradata used approximately$21 million of cash in the first six months of 2020 for reorganizing and restructuring its operations and go-to-market functions to align to its strategy, as compared to$46 million in the first six months of 2019. The increase in cash provided by operating activities was primarily due to improved management of working capital. Although the COVID-19 pandemic did not have a significant adverse impact on our financial results for the second quarter of 2020, we have reviewed our capital projects to ensure that we are only spending on projects that are deemed to be essential in the current environment. We have taken steps to manage spending on travel, third-party services and other operating expenses, and we continue to focus on cash flow generation. Terms of payments have been extended for certain customers in impacted industries; however, the majority of these extensions do not go beyond the end of the fiscal year. We do not expect the pandemic to have a significant adverse effect on our liquidity, as we believe that operating cash flows and available liquidity are sufficient to support operational needs for at least the next 12 months. Teradata's management uses a non-GAAP measure called "free cash flow," which is not a measure defined under GAAP. We use free cash flow (which we define as net cash provided by operating activities less capital expenditures for property and equipment and additions to capitalized software) as one measure of assessing the financial performance of the Company, and this may differ from the definitions used by other companies. The components that are used to calculate free cash flow are GAAP measures taken directly from the Condensed Consolidated Statements of Cash Flows (Unaudited). We believe that free cash flow information is useful for investors because it relates the operating cash flow of the Company to the capital that is spent to continue and improve business operations. In particular, free cash flow indicates the amount of cash available after capital expenditures, for among other things, investments in the Company's existing businesses, strategic acquisitions and repurchases of Teradata common stock. Free cash flow does not represent the residual cash flow available for discretionary expenditures since there may be other non-discretionary expenditures that are not deducted from the measure. This non-GAAP measure should not be considered a substitute for, or superior to, cash flows from operating activities under GAAP. The table below shows net cash provided by operating activities and capital expenditures, along with free cash flow, for the following periods: Six Months Ended June 30, 2020 In millions 2020 2019 Net cash provided by operating activities $ 140$ 104
Less:
Expenditures for property and equipment (23) (27) Additions to capitalized software (4) (2) Free cash flow $ 113$ 75 Financing activities and certain other investing activities are not included in our calculation of free cash flow. There were no other investing activities for the six months endedJune 30, 2020 and 2019. 28 -------------------------------------------------------------------------------- Table of Contents Teradata's financing activities for the six months endedJune 30, 2020 and 2019 primarily consisted of cash outflows for share repurchases and payments on the Company's finance leases, and long-term debt. AtJune 30, 2020 , the Company had no outstanding borrowings on its$400 million revolving credit facility entered into inJune 2018 (the "Credit Facility"). The Company purchased approximately 3.7 million shares of its common stock at an average price per share of$20.52 in the six months endedJune 30, 2020 , and 4.3 million shares at an average price per share of$40.52 in the six months endedJune 30, 2019 under the two share repurchase programs that were authorized by our Board of Directors. The first program (the "dilution offset program") allows the Company to repurchase Teradata common stock to the extent of cash received from the exercise of stock options and the Teradata Employee Stock Purchase Plan ("ESPP") to offset dilution from shares issued pursuant to these plans. OnJuly 28, 2019 , Teradata's Board of Directors authorized an additional$500 million to be utilized to repurchase Teradata common stock under the Company's second share repurchase program (the "general share repurchase program"). As ofJune 30, 2020 , the Company had$432 million of authorization remaining under this program to repurchase outstanding shares of Teradata common stock. Share repurchases made by the Company are reported on a trade date basis. Our share repurchase activity depends on factors such as our working capital needs, our cash requirements for capital investments, our stock price, and economic and market conditions. As a precautionary measure, due to the uncertainty of the impact of COVID-19 on our business, in the second quarter of 2020, the Company suspended repurchases under its share repurchase programs and currently does not anticipate any share repurchases for the remainder of 2020. Proceeds from the ESPP and the exercise of stock options, net of tax, were$6 million for the six months endedJune 30, 2020 and$37 million for the six months endedJune 30, 2019 . These proceeds are included in other financing activities, net in the Condensed Consolidated Statements of Cash Flows (Unaudited). Our total cash and cash equivalents held outsidethe United States in various foreign subsidiaries was$339 million as ofJune 30, 2020 and$344 million as ofDecember 31, 2019 . The remaining balance held inthe United States was$156 million as ofJune 30, 2020 and$150 million as ofDecember 31, 2019 . Prior to the enactment of the 2017 Tax Act, the Company either reinvested or intended to reinvest its earnings outside ofthe United States . As a result of the 2017 Tax Act, the Company has changed its indefinite reinvestment assertion related to foreign earnings that have been taxed inthe United States and now considers a majority of these earnings no longer indefinitely reinvested. EffectiveJanuary 1, 2018 ,the United States moved to a territorial system of international taxation, and as such will generally not subject future foreign earnings toUnited States taxation upon repatriation in future years. Management believes current cash, cash generated from operations and the$400 million available under the Credit Facility will be sufficient to satisfy future working capital, research and development activities, capital expenditures, pension contributions, and other financing requirements for at least the next twelve months. The Company principally holds its cash and cash equivalents in bank deposits and highly-rated money market funds. The Company's ability to generate positive cash flows from operations is dependent on general economic conditions, competitive pressures, and other business and risk factors described in the 2019 Annual Report and elsewhere in this Quarterly Report on Form 10-Q. If the Company is unable to generate sufficient cash flows from operations, or otherwise comply with the terms of the Credit Facility or its term loan agreement, the Company may be required to seek additional financing alternatives. Long-term Debt. There has been no significant change in our long-term debt as described in the 2019 Annual Report. Our long-term debt is discussed in Note 10 of Notes to Condensed Consolidated Financial Statements (Unaudited). Contractual and Other Commercial Commitments. There has been no significant change in our contractual and other commercial commitments as described in the 2019 Annual Report. Our guarantees and product warranties are discussed in Note 8 of Notes to Condensed Consolidated Financial Statements (Unaudited). Critical Accounting Policies and Estimates Our financial statements are prepared in accordance with GAAP. In connection with the preparation of these financial statements, we are required to make assumptions, estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses and the related disclosure of contingent liabilities. These assumptions, estimates and judgments are based on historical experience and assumptions that are believed to be reasonable at the time. However, because future events and their effects cannot be determined with certainty, the determination of 29 -------------------------------------------------------------------------------- Table of Contents estimates requires the exercise of judgment. Our critical accounting policies are those that require assumptions to be made about matters that are highly uncertain. Different estimates could have a material impact on our financial results. Judgments and uncertainties affecting the application of these policies and estimates may result in materially different amounts being reported under different conditions or circumstances. Our management periodically reviews these estimates and assumptions to ensure that our financial statements are presented fairly and are materially correct. We assessed certain accounting matters that generally require consideration of forecasted financial information in context with the information reasonably available to us and the unknown future impacts of COVID-19 as ofJune 30, 2020 and through the date of this report. The accounting matters assessed included, but were not limited to, our allowance for doubtful accounts, stock-based compensation, the carrying value of our goodwill and other long-lived assets, financial assets, valuation allowances for tax assets and revenue recognition. While there was not a material impact to our consolidated financial statements as of and for the six months endedJune 30, 2020 , resulting from our assessments, our future assessment of our current expectations at that time of the magnitude and duration of COVID-19, as well as other factors, could result in material impacts to our consolidated financial statements in future reporting periods. In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP and does not require significant management judgment in its application. There are also areas in which management's judgment in selecting among available alternatives would not produce a materially different result. The significant accounting policies and estimates that we believe are the most critical to aid in fully understanding and evaluating our reported financial results are discussed in the 2019 Annual Report. Teradata's senior management has reviewed these critical accounting policies and related disclosures and determined that there were no significant changes in our critical accounting policies in the six months endedJune 30, 2020 . New Accounting Pronouncements See discussion in Note 2 of Notes to Condensed Consolidated Financial Statements (Unaudited) for new accounting pronouncements. Item 3. Quantitative and Qualitative Disclosures About Market Risk. There have not been any material changes to the market risk factors previously disclosed in Part II, Item 7A of the 2019 Annual Report. Item 4. Controls and Procedures. Evaluation of Disclosure Controls and Procedures Teradata maintains a system of disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934 (the "Exchange Act")) that are designed to provide reasonable assurance that information required to be disclosed in its reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in theSEC's rules and forms, and that such information is accumulated and communicated to management, including, as appropriate, the Chief Executive Officer and the Chief Financial Officer, to allow timely decisions regarding required disclosures. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. Based on their evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as ofJune 30, 2020 , our disclosure controls and procedures were effective to provide reasonable assurance that the information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified inSEC rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. 30
--------------------------------------------------------------------------------
Table of Contents Changes in Internal Control over Financial Reporting There have been no changes in our internal control over financial reporting that occurred during the fiscal quarter endedJune 30, 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. We have not experienced any material adverse impact to our internal controls over financial reporting as a result of most of our employees working remotely due to the COVID-19 pandemic. We are continually monitoring and assessing the COVID-19 situation on our internal controls to minimize the impact on their design and operating effectiveness.
© Edgar Online, source