ShoreTel's (SHOR) CEO Don Joos on Q3 2016 Results - Earnings Call Transcript

| About: ShoreTel, Inc. (SHOR)

ShoreTel, Inc. (NASDAQ:SHOR)

Q3 2016 Results Earnings Conference Call

April 28, 2016, 05:00 PM ET


Barry Hutton - Director, IR

Don Joos - President and CEO

Mike Healy - SVP and CFO


Greg Burns - Sidoti & Company

Barry McCarver - Stephens Inc.

Dmitry Netis - William Blair

Mike Latimore - Northland Capital Markets

Eric Martinuzzi - Lake Street Capital Markets


Good afternoon and welcome to the ShoreTel Third Quarter Fiscal Year 2016 Conference Call.

All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please also note that today’s event is being recorded. May I also add that we at Chorus Call use ShoreTel telephones. In fact. I am speaking to you right now on a ShoreTel telephone.

I would now like to turn the conference over to Barry Hutton, ShoreTel’s Director of Investor Relations. Please go ahead sir.

Barry Hutton

Hello and thanks for joining us today as we report the financial results for our fiscal third quarter of 2016. Joining me on the call today are ShoreTel's President and Chief Executive Officer, Don Joos, and ShoreTel's Chief Financial Officer, Mike Healy.

Before we begin, I will remind you that during today's call, management will make forward-looking statements within the meaning of the Safe Harbor provision of federal securities laws regarding the company's anticipated future revenue, gross margins, operating expenses and other financial and business-related information. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected.

Additional information concerning the risk factors that could cause actual results to differ materially from those in the forward-looking statements can be found in the company's most recent Form 10-K and 10-Q and the current report on Form 8-K furnished today. The information in this conference call related to projections or other forward-looking statements is based on management's current expectations. The company does not intend to update its forward-looking statements should circumstances change.

As a matter of policy, ShoreTel does not comment on financial guidance during the quarter, unless it is done in a public forum. Additionally, ShoreTel maintains a presence on Facebook, Twitter and Google Circles that it uses from time to time to republish company news.

We will be discussing both GAAP and non-GAAP results throughout this call and I ask that you refer to our press release issued today for the reconciliation between these amounts. Our non-GAAP numbers exclude stock-based compensation charges, amortization of acquisition-related intangibles acquisition relating cost other adjustments and their related tax impacts. We ask that you please keep your questions to the operational and financial results announced today.

And now, I'll turn the call over to Don.

Don Joos

Thanks Barry. I had previously outlined a strategic plan to transform ShoreTel into a cloud-based company. We are at an important inflection point within this transformation, where the hosted and product revenue are almost at parity with each other for the fiscal third quarter.

For the March quarter, we were short of our overall revenue guidance range by $800,000 due solely to a greater product revenue decline, which can be attributed to three primary factors. First, is the broader market decline of the premises-based solutions.

Second, by successfully executing our strategic plan, our actions are also impacting the product revenue decline and the third factor is a larger year-over-year decline in our service provider product revenue.

As we progressed throughout fiscal 2017, I expect the hosted revenue to exceed the product revenue. There are seasonal fluctuations with the product revenue, but overall we are now beginning to cross the inflection point in our strategic transformation. Over the past two years we have executed a range of actions to dramatically improve our financial position and flexibility, which allows us to make this transition.

During our November Analyst Day, we communicated five catalysts for growth, which are designed to leverage and to accelerate the industry shift towards cloud offerings. We've continued to execute this strategy and in the fiscal third quarter our success is evident in three key areas. First, our cloud bookings grew 31% year-over-year and reflected continued success with mid-market and enterprise customers.

Second, the integration of our recent acquisitions progressed well with the M5 Australia integration work predominantly complete. In the first 90 days after closing the Corvisa acquisition, the standalone contracts in our offering was rebranded as ShoreTel Flex and drove customer wins with customer size and ARPU metrics well above our historical cloud averages.

And third, we launched our premises to cloud migration program to monetize our install base and accelerate cloud growth. We saw several early cases of premise customers creating a combined premise in cloud hybrid solution and others choosing to make a full premise to cloud migration. This creates a very exciting opportunity for us and I will provide more program details in early results in a few minutes. All three of these development show the growing momentum across our business and give very strong support to the hosted revenue acceleration that we are starting to see and expect to continue into fiscal 2017.

Before I give an update on our strategic initiatives, I’ll briefly recap the third quarter financial results, which reflect our strategic focus on cloud services and the short term effects of our two recent acquisitions.

Total revenue in third quarter was $85.2 million. At the same time our hosted revenue grew 22% year-over-year, which reflects the acceleration in the second half of the fiscal year that we expected when we gave our annual guidance last August.

We had a non-GAAP operating loss of $3.9 million and a per share loss of $0.06 reflecting the financial impact from our January acquisition of Corvisa and the product revenue decline. We generated $2.1 million in cash flow from operations and at a cash balance of $100 million at quarter end.

The financial impact of the acquisitions on our overall business will continue to improve over the next few quarters as the integration in business ramp continues. As such I note that the midpoint of our Q4 financial guidance indicates a small non-GAAP operating profits which is consistent with our previously communicated expectation for the June quarter.

From a strategic point of view it’s clear that the market acceptance of ShoreTel Connect our successful go-to-market effort and our recent acquisitions provide us a solid foundation for continued hosted growth. To underscore our confidence I will share with you a range of proof points that are a result of our execution against the five catalysts for growth.

As a quick reminder, the catalysts are one, the rollout of the ShoreTel Connect offerings. Two, our global expansion of our cloud offering. Three, the scale of our channel partner community. Four, our success with mid-market and enterprise costumers and the fifth catalysts for growth is the ability for leverage our premises install base to drive cloud services.

Our first catalyst for growth is the rollout of ShoreTel Connect our solution built upon a single software code, feature set and user experience as Connect can be deployed across cloud premises in hybrid environment our customers now have increased operating flexibility and protection for their investments.

During the quarter, we enhanced our integration with Skype for Business. Now customers can leverage ShoreTel solution with the Skype for Business client.

In April, Internet Telephony Magazine recognized ShoreTel Connect as winner of the 2016 Unified Communications Product of the Year Award based on Connect’s innovation, ingenuity and excellence. The market acceptance of the Connect offering continues to grow and in the third quarter that Connect Solution was the majority of our new cloud deals.

Our second catalyst for growth is the global expansion of our cloud offering. In November, we acquired a cloud provider on Australia. At this point we have substantially completed the technical and functional integration. The offering has been formally launched and includes the use of our sip-based phones for a true end to end solution and can only be sold by 100 ShoreTel partners in Australia.

In March, we expanded our Canadian offerings to now include ShoreTel Connect Cloud and Hybrid Solutions. We are currently leveraging our existing channel partners and brand recognition in Canada to target mid-market and enterprise customers with a complete portfolio of Connect Solutions in the region.

Our third catalyst for growth is the scale in our channel partner network. Our partners continue to contribute and represent a large percent of our cloud bookings as they align with the market trends towards cloud services.

Our channel partners were involved in over 90% of the new client bookings and the breadth of partner engagement continues to expand as the number of partners that closed the cloud deal has increased in each quarter since Connect was introduced.

Let me share an example of the power of our channel partner network. In January, our partner won a connect cloud deal with a leading OEM distributor for their eight locations and will generate nearly $25,000 in monthly hosted revenue when fully implement.

Our fourth catalyst for growth is to maximize the mid-market and enterprise adoption of cloud services. We have always served the mid-market and enterprise customers with our channel partner network and our integrated end to end solution.

As a result today 90% of our hosted revenue comes from our hosted install base customers that pay above $1,000 per month. Furthermore, these customers are appreciate our high touch customer service model, which results in our industry low revenue churn rate. In Q3 our churn rate was just 4.7% on an annualized basis.

From mid-market and enterprise customers the contact centre offerings has proven to be a key component of their solutions. As a reminder, we've had a contact centre offering for many years. Our contact centre application is integrated with ShoreTel Connect and is designed for the scenario where our customer has a contact centre that is just a function within their business and receives great value from the tightly integrated solution.

Let me provide an example of the power of having our connect cloud offering with ShoreTel enterprise contract centre. A win in the March quarter included a third party logistics company, which previously used a competing cloud provider and was now considering a contact centre from a different vendor.

The customer decided on ShoreTel to provide its employees with a single tightly integrated solution consisting of ShoreTel Connect cloud and ShoreTel hosted enterprise contact centre. This customer signed a multiyear contract with over $30,000 in monthly hosted revenue resulting in a seven figure total contract value.

Another scenario is for customers whose business model is heavily dependent on the contact centre and desire a more robust offering. Our recent acquisition of Corvisa and specifically the ShoreTel Flex hosted contact centre offering, further aligns us with these larger customers.

With ShoreTel Flex they receive great value from the flexible, customizable and modular capabilities of the solution. With this offering we have expanded our ability to solve customer business problem and thus expand our market presence.

Let me provide a second example, which shows that having a flexible robust standalone contact centre can pull through other services a new prospect in the healthcare sector was looking for a cloud-based solution with the contact centre offering that could scale and integrate with its CRM software tool.

Following our acquisition of Corvisa we were able to offer the customer a single solution that combined ShoreTel’s Connect cloud along with the recently acquired contact centre solution ShoreTel Flex.

As a result, we secured the customer's full communication spend for their multiple locations. For our combined offering the customer pays over $6,500 in monthly hosted revenue with an ARPU of $71, significantly above our hosted installed base average. This was only possible by combining our existing hosted Connect solutions in our recently acquired ShoreTel Flex solution.

Our fifth catalyst for growth is to leverage our premises' install base to accelerate cloud bookings in hosted revenue growth. Today we have approximately four million seats in our premises' install base. We are well positioned to leverage these customers to drive hosted revenue from multiple reasons.

First we only know the customer's technical environment and system age. Second, our channel partners have existing relationships with these customers. Third, we anticipate the cost of acquisition for these customers to be 20% to 40% less than acquiring a new customer.

And fourth, since ShoreTel Connect gives employees a consistent user experience across all deployment environments it maximizes employee productivity as they do not need to learn a new system.

In the March quarter, we launched our Premises to Cloud Migration program that was ShoreTel designed and channel partner approved. Along with our channel partners we built the systems, tools and processes to simplify the effort.

We jointly developed the marketing programs and we created the incentives to reward partners and customers for adding cloud-based solutions. This program consists of three initiatives, the first initiative utilizes our Connect hybrid apps, so that existing premise customers can add cloud based applications via monthly subscription.

For example a major league baseball team is using Connect onsite, connect enterprise contact centre and more recently added a cloud-based hybrid approximately, which will generate over 2,100 in monthly hosted revenue. The second initiative utilizes Connect hybrid sites allowing customers to have multiple locations with a fully integrated but mixed cloud and premise environment.

For example our recent win involved a new customer in the education vertical who uses Connect onsite at its New York offices. In the March quarter they signed a three-year contract to add two additional locations to the ShoreTel solution, creating an integrated environment with the Connect onsite and Hybrid site solution thereby generating additional monthly hosted revenue.

It's important to note we're keeping our existing premises revenue while adding new hosted revenue and thereby increasing the total value and relationship with each customer.

The third initiative for our premise to cloud migration program is a customer’s full migration from our premise to cloud environment. For example in the March quarter one of our existing onsite customers are provider of retail clothing decided to migrate its existing onsite solution to Connect cloud with a three-year contract generating $3,200 in monthly hosted revenue.

The potential of an integrated cloud and premise environment became a reality when we started rolling out ShoreTel Connect. Some customers started their migration right away but with a formal program now launched we've already seen early positive indicators for this growth opportunity.

In conclusion over the past quarter we have made considerable progress against our catalyst for growth driving momentum across our business. Specifically, our third quarter included a few key successes.

First was our cloud bookings acceleration. As expected we had a strong go-to-market results in the quarter driving cloud bookings growth rate of 31% year-over-year. Second, was the integration in early ramp of recent acquisitions. We've made good progress on the integration of both Corvisa and M5 Australia and we've seen the new contract centre offering via driver for larger customer opportunities.

And third we're launching the program to monetize the premise's installed base to drive cloud growth. In the first month of the program, we’ve already had numerous customers migrate to a hybrid environment or fully migrate to our cloud offering. Both scenarios generate a new source of cloud bookings and revenue growth for the future.

We're continuing to see good momentum and proof points with our cloud business and as we continue to successfully execute our strategic plan, we do expect an ongoing decline in our product revenue, partially due to the broader market decline as well as our actions related the execution of our strategic plans, but I want to reiterate that we are committed and focused on driving profitability.

At this point, Mike will review the financial and business outlook.

Mike Healy

Thanks Don. Good afternoon, everyone. As Don mentioned, the industry has clearly seen an increase in cloud adoption. In addition, ShoreTel has taken strategic actions to further stimulate a premise-to-cloud transition and this inflection is evident in our Q3 results.

I would like to remind you that Q3 is the first quarter that reflects our acquisition of Corvisa, which closed on January 6.

On our last call we indicted this acquisition would impact our profitability along and along with the reduction in product revenue led to the non-GAAP $3.9 million net loss for the quarter. However, our acquisitions and five catalysts for growth are driving the hosted revenue acceleration that we saw in Q3 and expect to continue into Q4 in fiscal 2017.

Now I will provide some details for our financial results, which include the consolidated results of the two recent acquisitions, which are all rolled into our cloud business metric. Our total revenue in Q3 was $85.2 million, up 1% from a year ago and $800,000 below our guided range for the quarter. The variance from our prior guidance range was all due to a shortfall in product revenue that I'll touch on in a minute.

In Q3 our cloud bookings grew 31% year-over-year with a number of noteworthy bid market and enterprise wins. The majority of our new bookings came on the Connect platform and a majority of cloud bookings were sourced through our partner channel.

Hosted revenue was $32.8 million up 22% year-over-year; including very small revenue contributions from our recent M5 Australia and Corvisa acquisitions. Hosted revenue now represents 39% of our total revenue.

We ended the March quarter with 5,128 cloud customers, totaling 218,000 seats, year-over-year increases of 31% and 27% respectively.

Our total cloud installed base metrics continue to show our strong position with mid-market and enterprise customers as evidenced by our cloud installed base as an average seat size of 43, our average revenue per seat or ARPU is $52. Our average monthly cloud customer billing is $2209 and in Q3 we had an annualized cloud revenue churn of 4.7%.

Our product revenue in Q3 was $33.9 million down 14% year-over-year and 17% sequentially. The decline was driven by three primary reasons expected seasonality, our strategic focus on hosted revenue growth, and a $2.5 million year-over-year decline from our service providers, which had greater variability compared to previous quarters.

In Q3, we shipped 103,000 licenses from our premise business. Our support and service revenue in Q3 was $18.5 million up 1% year-over-year. This amount includes support revenue of $16.7 million, which grew 5% year-over-year and reflects our continued higher tax rates to support contracts. The remaining $1.8 million of services revenue declined $500,000 year-over-year as that revenue line tends to follow the product revenue trend.

Our recurring revenue comprised of hosted revenue plus support revenue total $49.5 million in the quarter of 58% of our total revenue, an all time high in company history. This represents an annualized recurring revenue run rate of $198 million.

In Q3, our international revenue was $6.8 million which was down 2% compared to the prior year and down 12% sequentially. Those trends are in line with our overall product revenue results. International represented 8% of our total revenues in Q3.

Now, as I turn the discussion to gross margins, operating expenses, and operating margins I will refer to non-GAAP amounts unless otherwise noted. In the third quarter, our total gross margins were 63.2%, up 60 basis points over last year, and down 220 basis points from last quarter.

Our hosted gross margins were 53.3% up 3.5 percentage points from a year ago reflecting our continued business scale and operational efficiencies. As I communicated during our January call, our hosted gross margins declined from the December, 2015 quarter as we observed the Corvisa acquisition into COGS and we did not have a recurrence of the three point benefit from telecom taxes like we did in the prior two quarters.

Product gross margins in the quarter were particularly strong at 67.1% up 190 basis points from the year ago and up 40 basis points sequentially reflecting improvements in our phone and switch margin. The support and service gross margins were 73.5% in the period down 230 basis points sequentially and year-over-year, mostly due to a small increase and labor cost.

The Q3 operating expenses were $57.8 million up $7.8 million from the year ago driven largely by our full quarter of employee related expenses from both of our acquisitions which have added approximately 110 employees since mid-November. We also had increases in other labor related spending and partner commission associated with higher hosted revenue.

When we announced the Corvisa acquisition in December, we communicated that this was primarily a technology acquisition and in the near term it would have a meaningful impact against our ongoing profitability since the cloud business is in an early ramp up stage with very little revenue in over 90 employees acquired.

Therefore in Q3 we had a non-GAAP net loss of $3.9 million or $0.06 per share mostly due to impact of Corvisa acquisition, as well as the reduction in product revenue.

Looking at the results on a GAAP basis, we had a net loss of $8.7 million or $0.13 per share which includes 822, 000 for one time acquisition fee and the normal charges for stock compensation of $1.9 million and also $1.9 million to amortization of acquisition related intangibles.

We recognize that our execution of our five catalyst for growth have led to an expected decline in our product revenue. Yet we firmly committed to our strategic actions which will capture the higher cloud opportunity.

Importantly, we have significantly improved our balance sheet and financial flexibility over the last few years. We continue to have the financial capabilities to simultaneously target cloud opportunities, make internal investments to drive further innovation and to consider strategic acquisition.

As of March 31, we had $100 million in cash and short term investments along with no debt outstanding and our $100 million line of credit remains in place. Our cash flow from operations in the quarter were $2.1 million bringing the fiscal year-to-date total to $25.3 million, which is allowed us to make two cash acquisitions in the last five months, while maintaining cash levels of $100 million.

Our capital expenditures during the quarter were $2.4 million similar to recent quarters as we continue to invest in our cloud business and technology innovation. Meanwhile our total Q3 depreciation and amortization $5.3 million.

Accounts receivable decreased by $3.5 million to end the quarter at $25.3 million and our day-sales-outstanding remains strong at 29 days. Inventory of $15.5 million was up $1.1 million sequentially as product shipments during the quarter were slightly below anticipated level.

On the liability side of the balance sheet, our deferred revenue increased slightly to $74.2 million the bulk of this deferred revenues for support agreement that we have build and collected up front. Over 70% of this deferred revenue will be recognized in the next 12 months.

And we finish Q3 with 1188 employees, a net increase of 102 employees over last quarter primarily due to the Corvisa acquisition. Our hosted revenue growth for fiscal 2016 will include a small contribution from our recent acquisitions as the business momentum is just starting to build. Given our Q3 results and our current outlook we continue to expect in modest revenue acceleration in the second half of fiscal year. For an entire fiscal 2016 we expect hosted revenue growth to be at or around 20%.

Now I’ll turn my comments towards the financial expectations. For our fourth fiscal quarter which reflect our continued shift to the cloud and the ramp of our recent acquisitions. As we look into fiscal Q4 there are few factors influence in our outlook. First, the macroeconomic environment specially for premise base sales continues to be challenging as customers are focusing more towards unified communications in the cloud.

Second, the execution of our strategic plan towards driving hosted revenue growth is well dealt in the decline in product revenue. Given our Q3 results on product and related services revenue, we expect those two revenue areas to continue to decline year-over-year in Q4, while our hosted revenue continues to accelerate all of which is implied in our Q4 revenue outlook.

Given that back drop in the fourth quarter of fiscal 2016, we expect total revenues to be in the range of $88 million to $94 million. We expect Q4 non-GAAP gross margins to be in the range of 62.5% to 63.5% while the GAAP gross margins will be roughly 1.5 points lower due to charges for stock based compensation and amortization of acquired intangibles.

Our expectation for Q4 non-GAAP operating expenses is in the range of $56.5 million to $57.5 million. In Q4 GAAP operating expenses will be approximately $2.5 million higher. The mid-point of this guidance implies a small non-GAAP operating profit for Q4.

Looking back at Q3 we recognized that our product revenue achievement and therefore overall profits were below expectations. But our cloud financial metrics including bookings and revenue showed continued positive momentum.

We expect -- we executed multiple operational objectives including the integration of two acquisitions, introducing Connect Cloud into Canada and further future rollout of ShoreTel Connect. Relative to our strategic growth plans, we launched the premise to cloud migration plan to target an important catalyst for growth, monetizing our premise installed base to accelerate our hosted revenue.

As usual, I will close with a few comments related to a few ShoreTel’s sports customers. As Zambia play-off are underway, we want to wish good luck to the Boston Celtics, Portland Trail Blazers and the defending champion Golden State Warriors who set a new record with 73 wins in a regular season.

In the national league, hockey playoffs we're alluding for our customer the Washington Capital and now with one month into the major league baseball season, we want to welcome the Milwaukee Brewers, our newest MLP customer into the ShoreTel family.

Now we are ready to take your questions.

Question-and-Answer Session


Thank you. We will now begin the question-and-answer session. [Operator Instructions] The first question comes today from Greg Burns with Sidoti & Company. Please go ahead.

Greg Burns

Good afternoon. Just wanted to dig in a little bit on the product business, how much was the variance in the quarter was market related versus maybe what you are doing promoting the cloud having a more negative impact than you would have expected going forward, just give us a little insight into what's driving the product declines?

Don Joos

Hi Greg its Don. A couple of things I would say, one is just that from a customer perspective, customers in my view are not asking if it should be premier cloud. They're really asking is how to best deploy a cloud solution.

So there is definitely a market trend occurring in there, but I would also say it's coupled with the fact that we are executing our strategic plan and so we are causing some of this product decline to occur.

It's hard for me to separate the two but I would say it's a combination of those two that is driving and that's why both Mike and I have prepared comments, we said as we look forward we do expect that continue to decline because that is part of our successful execution of our strategic plan.

I would say, I don’t see that as indicative of any operational weakness within the business when you aggregate topline revenue. There is no indication of operational issues or weakness. It's just about successfully executing our plan.

Greg Burns

Okay. And in terms of accelerating the cloud revenue growth do we still expect to get to the mid to high 20s at some point in 2017? Is that still kind of the midterm target?

Don Joos

No Greg for next year in terms of guidance and discussions we're going to handle that when we announce our Q4 results in August most likely so for now we're going to give you insights on all that when we do that in August.

Greg Burns

Okay. Thank you.


The next question is from Barry McCarver with Stephens Inc. Please go ahead.

Barry McCarver

Hey good afternoon guys and thanks for taking my questions. I guess a couple of questions, first off last six months, you guys have been real active in M&A, other companies as well.

We saw a competitor launch some -- several competitors launch new, hosted solutions, I am just wondering are you having any comments or chatter from channel partners. Are you seeing any purchasing habits of some of your customers as there is a lot going on in the industry particularly with on premise and moving towards hosted solutions?

Don Joos

Yes again I would say probably yes I think there is a customer buying behavior that is definitely changing in that whereas I said before like there are no longer asking should it be premier cloud we're seeing more and more and more customers are asking how to best deploy a cloud solution.

And I think that's where ShoreTel is uniquely positioned. I think we're uniquely positioned because we have -- they could go to cloud via hybrid as a two step, where they could go straight to that cloud offering.

So definitely Barry seeing the market move there, I think that's why the launch of our premise to cloud migration program is a key catalyst for growth because we're starting to see that activity.

It's interesting we saw that activity before we launched Connect some of our installed base had started to move and in the six months since we had launched Connect, we had basically done the same amount of migration as it was the prior two years. So we saw the pace start to accelerate and in the first 30 days of formally launching our program we're on pace to quickly eclipse that six month numbers.

So overall I’m just seeing a pace quickening from that perspective and I think that's why we're A, uniquely positioned and I think that's why our installed base is a strategic asset.

Mike Healy

Just Barry one other sorry one other indication I would give you of the cloud base in the bookings and how things are moving just one bit of information for in the bookings this quarter for seat sizes over 200 seats, we saw almost a 60% increase in dollar volume for those seat size above 200 seats. So again we’re getting bigger customers all the time and it’s accelerating.

Barry McCarver

That's helpful and then just one more if I can, when we think about your fiscal 4Q, that's always a little bit tricky for product revenues because usually there is little bit of a rebound after a pullback in 3Q, based on the guidance for total revenue in your comments on hosted growth it seems like there is probably a little bit of a change built in there for product. Can you give us just a little direction on how to think about that?

Don Joos

Maybe I will start and Mike you want to chime in. I think Barry just to take the point head on in regards to our guidance versus if I was to compare to where consensus was, our guidance midpoint is lower than where our consensus was and it's really driven by the product revenue for the reasons Mike had said whether it was market, whether it's our own actions and looking at our Q3 results.

But I would say that topline again is not indicative of an operational issue or weakness. It's more a reflection of where we're successfully executing our strategic plan because we're seeing the momentum and as we have previously indicated, we would see the momentum and acceleration of our hosted revenue in the second half and that is happening.

The product is most for the reasons that we had described and that's the only reason that the midpoint of that guidance has changed. It is just a reflection of where we are in the execution of our plan. Mike?

Mike Healy

Yes since it's the end of our fiscal year, we do typically have seen seasonality pick up in the product revenue from Q3 to Q4, so there is some of that built into our guidance, but certainly given the results this quarter and you were down 14% I think year-over-year we're not expecting to see much improvement in the year-over-year decline on the product revenue line.

Barry McCarver

Okay. That's helpful. Thanks guys.

Mike Healy

Thanks Barry.


The next question is from Dmitry Netis with William Blair. Please go ahead.

Dmitry Netis

Thanks guys. I want to also dive in into the cloud bookings number there and I know you've said 20% revenue growth for the year is doable on the hosted side. You did 32 A to get to 20 you probably need to do $35 million in the June quarter, that's roughly 23% growth year-over-year in the fourth quarter.

To get there, what do the cloud bookings, where would the cloud bookings need to be? I’m trying to reconcile the 31% with some of it may have been due to catch up from the December quarter, but to get to that number and to get the comfort around that number, where would the bookings number need to be, if you can provide some range or tell us like you did last quarter that your bookings are going to be in the range that would give us a lot more comfort?

Don Joos

Hey Dmitry, it's Don. So we're not actually giving guidance as it relates to the bookings. I kind of did that last quarter just to set an expectation based upon the December results, but let me answer your question with the couple of things.

One is when I look at the March quarter's bookings results, the majority of that is just coming from our five catalysts for growth that we've been executing against. For the deals that I had previously said had pushed from the December quarter, we did get fields that we were expecting in there. But the majority of that growth was coming from our five catalysts for growth.

As we look into the funnel from a Q4 perspective, we continue to see the momentum building from that perspective. When I look at -- so right now we have that momentum I would say that is building and I think that momentum builds into the 2017.

So, we had said the second half would accelerate in revenue and we haven’t guided, but we do see that momentum carrying into the '17 and it continues to build from there.

But I would say bookings is just one piece that drives hosted revenue. How we manage our churn, how we do add-ons and installations, installations cycle time and all those things are all contributing factors to what drives that hosted revenue number Mike?

Mike Healy

Yeah, I mean I would say Barry -- Dmitry sorry, as you know this quarter's bookings has very little impact on this quarter's revenue. Aprils booking will help and get installed by the end of the quarter, but that’s about it and then there only a month at a time.

So, really this quarter's bookings could be 5% growth and we still have no impact on revenue. It could be 50% and not very much impact on revenue, it's really impacts revenue into next year in terms of what happens on booking growth in this quarter.

So, as Don mentioned, a lot of things impact the revenue achievements for cloud or hosted this quarter, booking being one of them, but not a lot of influence certainly Q3's booking of 31% will have more of an impact on Q4's revenue number.

Dmitry Netis

Okay. That's very helpful detail and as far as the installation average times to installed what are those times. Were falling in that three months category or beyond that and just give us a little bit of a sense.

Don Joos

We're averaging right now, there has been a lot of operational work on that. We’re under a two month timeframe right now and so last couple of months here. but I would say some of your question is that as we look at the first half of this fiscal year to the second half of this fiscal year, we had said and it is showing that the hosted revenues accelerating.

That momentum as I said will continue in so my expectation is that '17 is going to be, '17 is going to be better than where we are today. So it's going to continue to build from that perspective into '17?

Dmitry Netis

Alright very good and one more question if I may.

Don Joos


Dmitry Netis

On the service provider side Mike or Don you had a little bit of a shortfall there, can you give us the total revenue that the service provider channel brought in the quarter and may be your last quarter as well?

I think the number I have here for September was 7.3 I’m just curious what the trajectory there is I know you said it was $2.5 million lower, but I wasn’t sure if it's a year-over-year number or quarter-over-quarter number. So any indication you can provide on that front.

As well as maybe tell us how those guys are transitioning over to the cloud. You had one big customer, one big service provider customer that signed up to sell cloud but you can update us on the progress and may be signing other service providers success of signing other service providers that would be great too. So it's about two-fold question there.

Mike Healy

Yeah, I will take the first part and I'll let Don comment on the second part, so all three service providers were down quarter-over-quarter and year-over-year. Q3 billings for all three of them were about $4.2 million down from $6.3 million in the quarter before. So that’s a sequential decline of about $2 million in year-over-year about $2.5 million.

Don Joos

So I think Dmitry and the other one is around looking at the -- I think the service providers are going through the same go-to-market changes as it relates to the shift that’s happening in the market place. So they're in transition.

One of our service providers is reselling our hosted offering and that continues to progress along. Another one has a managed IT offering that we are a part of and so that continues along.

And I indicated previously that we were working with another service provider. So we’re working with Verizon right now. We’re working from a product perspective with them as well as looking at the hosted offering. So we’re working with them on that.


The next question comes from Mike Latimore with Northland Capital Markets. Please go ahead.

Mike Latimore

Hi, thanks. I guess just on the last comment Don, so just to be clear, with Verizon you're in discussion, Is that the comment you're making around the cloud?

Don Joos

Its two parts with Verizon. So we do have a contract with them from just selling just selling a product perspective and we're working on it right from hosted perspective.

Mike Latimore

Okay. And then, I know you're lending a lot of bigger deals, the seats current metrics flattish or down a little bit this quarter why wouldn’t the number of seats per customers be going up.

Don Joos

Well so I guess a couple things, one is yes we're getting larger deals and I gave some proved points within the script and I would say a couple things to one is just that the installed base is it’s a lot of installed base.

So, it takes time for the overall install base to move with detail that we're closing right now, they're going through the implementation phase. So they're not in that installed base yet, but I would also say part of our focus is not just seats, but it's also looking at the ARPU, as I have given that example of that customer with $71 ARPU, so for us it's partly seats, partly from an ARPU perspective.

Mike Latimore

Got it. And then on the -- what's the general view on the cloud or hosted gross margins, do you see some leverage here over the next while as you its kind grow the revenue base?

Don Joos

Yeah, so a couple things on hosted gross margin this quarter 53 and soon going forward we expect then we move up until the right if we get leverage and scale in that business in the Corvisa business ramps up in terms of revenue.

So, I think in general it should be up into the right. We may have certain quarters where you have a step function in that when we get into some other new geographies and have a launch a data centre that you have to start paying rents and the equipment on that may have a step function and it's timely that progression but in general we do expect hosted gross margins on an non-GAAP basis be up into the right.

Mike Latimore

And I guess just last question on the cloud growth itself. How much of cloud growth in a quarter comes from booking either in that quarter, booking getting deployed versus just the current customers adding more seats and add on that sort of thing.

Don Joos

It’s both, it’s probably almost 50-50 between customers adding on seats and services as well as the bookings mostly from the previous quarter getting installed in that quarter and then the other pieces are obviously churn cancellations and price changes.

So all four of those but in general we call them add-ons or sometimes as big or the same amount as the new bookings are getting installed from the previous quarter.

Mike Latimore

Got it. Thanks.


The next question is from Eric Martinuzzi with Lake Street Capital Markets. Please go ahead.

Eric Martinuzzi

Thanks. I wanted to go a little bit deeper on the Corvisa serve how the pipeline has been changing since the acquisition if you could comment just was there and I know was admittedly a technology purchase, but now in ShorTel’s hands and with the new brand ShorTel Flex has there been an invigoration of that pipeline that you can comment or give color on and then I've a follow-up.

Don Joos

Yeah, and so as part of the integration what we've done is we had integrated very quickly a lot of the function straight into our business. So that includes our sales organization. So, our contact centre teams are now one team selling a ShorTel Solution whether that’s are Enterprise Connect or the ShorTel flex.

There are definitely more opportunities coming into our pipeline right now. We're rolling out from a channel program perspective. We had started initially with just a handful of partners just to get the ball in motion while we were working through our integration plans and now we're starting to expanding on the partners.

So one is yes, there are more opportunities coming and I would it also attracts more larger opportunities with that on services.

Q - Eric Martinuzzi

Okay. And then you talked in your prepared remarks on about a particular customer, I think it was a healthcare solution provider that had deployed ShorTel Flex and Connect Cloud integrated with their CRM, was that something that was already in pipeline, were you working on that with Corvisa prior to the market or is that something that happened post and what is the germination of the timeline of those types of deals happening?

Don Joos

Yeah, for that particular deal actually we were -- it was in our pipeline as they connect all the way and so what was great about this was that we were able to get the full spend because now under the ShoreTel umbrella we have the Connect and we have the Contact Center solution that they were looking for.

So if we hadn’t done the acquisition, we would have maybe seem a piece of that transaction versus getting the full strength from that customer. So it was in our pipeline, it just allowed us once we had closed to represent ourselves as a single solution and that’s get the full center from that customer all their locations.

Q - Eric Martinuzzi

But the normal, the length of a typical like when something enters the pipeline now as a contact center, could you just oppose that type of sale versus a classic kind of SMP?

Don Joos

Yeah a traditional more of a traditional just a voice sale a UC sale that doesn’t within our contact center. A contact center deal typically have a little bit longer of a cycle time just because you're dealing with a lot of work flows, you could be dealing with a the lot of third party proprietary or market applications that integrated in.

You really have to given to the work flow of the organization as it relates. So it does take a bit longer. There is definitely more implementation of professional services associated with those kinds of deals. So they do take a little bit longer, but they are also a little bit larger.

Q - Eric Martinuzzi

Thank you.


The next question is a follow up question from Barry McCarver with Stephens Inc. Please go ahead.

Barry McCarver

Yes, thanks guys. Just following up on the previous Corvisa acquisition, I know it's still very early stage, but just your thoughts on that impact to profitability in the ramp there over the course of the next year any color there?

Don Joos

I would say it's going as expected right. It's very small revenue that we got from Corvisa and is ramping up with nine year so 97 employees. So there a burn right now and it was close to what we had estimated in Q3. As revenue ramps up that burn will diminish over time.

Now again this was not an acquisition based on dilution, accretion. It was more a technology and talent acquisition of Corvisa and we did get great staff in Milwaukee mostly and the good contact center offering and sip trunking all as part of that acquisition.

Mike Healy

So the key for us on that one is really the scale on the top line.

Barry McCarver

I can’t recall if you provided any timeline in number of quarters until that’s breakeven?

Mike Healy

What we've done is we're not really breaking that out as a separate business. We quickly integrated sales. We integrated the support. We’ve integrated the engineering organization. So it's integrated in and that’s part of us getting some of the scale and leverage from an operating expense, So it's not separated out.

Barry McCarver

Okay. And then just secondly you said international revenue was about 8% of total. Do you expect that to move over the course of next couple of years?

Mike Healy

Yes international we’re just starting Australia with the cloud business at international numbers both cloud and premise combined together. So on the cloud side definitely it will ramp up as we get into other locations Canada, Australia and eventually U.K.

And then the bigger part of the number is the product number, naturally that one will decline as the rest of our product revenue declines, but overall I think net, net once we get the cloud business ramped up internationally, it will grow as a percentage of revenue.

Don Joos

Yes, it is one of our catalyst for growth as the global scale. I will just one comment Mike had made is so we have the U.K. it's really about expanding outside of the U.K. from a Western Europe perspective.

Barry McCarver

Very good, thanks guys.

Mike Healy

Thanks Barry.


Next question is also a follow-up from Mike Latimore with Northland Capital Markets. Please go ahead.

Mike Latimore

Thanks, Don just to be clear did you have a seven figure win in the quarter is that right?

Don Joos

Yes total contracts -- from a total contract value is a seven figure deal.

Mike Latimore

Okay. Is that ACV or multiyear?

Don Joos

Well it's a multiyear.

Mike Latimore

Okay. And then I think back on the Corvisa press release you talked about getting the 30% cloud growth I believe in fiscal '17 is that -- I think you touched on this already but how should we think about that economy?

Don Joos

We're not giving specific guidance as it relates to '17, but I will say is that we do see '17 growing at a faster pace than '16, we do see '17 growing at a faster pace than the second half of our '16. We're going to give overall guidance associated with our multiyear August call, but we are expecting '17 to be accelerating in comparison to our second half.

Mike Latimore

And then you talked a little bit about some customers migrating from Prem to cloud. Do you have just a rough number of how many have migrated off of the maintenance to cloud at this point?

Don Joos

Right now I would say it has not had a -- it's not a majority, it is not a material part of our existing bookings. What we are seeing is we have seen customers moving.

I think it will be really indicative for us is over the next couple of quarters and now that the formal program is launched. I look at it and say we're seeing bookings growth with a limited amount of that occurring and to me that's the exciting opportunity right now is that with our existing approach now you couple with that, that's where even more opportunity.

Mike Latimore

Great, thanks.

Don Joos

But we're seeing the pace quicken now that Connect is out as well as now that the program that has been launched.

Mike Latimore

Okay, got it. Thanks.

Don Joos

Thanks Mike.


Ladies and gentlemen, this concludes our question-and-answer session and thus concludes today’s call. We thank you very much for attending today’s presentation and you may now disconnect your lines. Take care.

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