Mitel Networks Corporation (NASDAQ:MITL)
Q2 2016 Earnings Conference Call
August 04, 2016 08:30 A.M. ET
Michael McCarthy - Vice President, Investor Relations
Richard D. McBee - President and CEO
Steven E. Spooner - CFO
Todd Coupland - CIBC World Markets
Barry McCarver - Stephens Inc.
Greg Burns - Sidoti & Company LLC
Jonathan Kees - Summit Research
Paul Treiber - RBC Capital Markets
Good day, ladies and gentlemen, and welcome to the Mitel Networks Second Quarter 2016 Financial Results Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions].
I would now like to introduce your host for today’s conference, Mr. Michael McCarthy, Vice President of Investor Relations. You may begin.
Thank you, Vicki and good morning everyone. It’s my pleasure to welcome you to Mitel’s discussion of our fiscal 2016 second quarter results for the period ended June 30th. Earlier this morning, the company issued a press release and filed its Form 10-Q with the SEC and Canadian Securities Authorities. A copy of the release and our 10-Q report are available on our website at mitel.com. Our press release contained as reported U.S. GAAP results as well as a reconciliation of non-GAAP measures to the U.S. GAAP results. To assist in better communicating these results we have posted a set of supplemental slides which you can find in the Investor Relations section of mitel.com.
A replay of this conference will be available on our website until the company reports third quarter results in early November. This morning I am joined by Rich McBee, President and CEO, and Steve Spooner, CFO. Rich and Steve will review the quarter and then open up the call to Q&A.
Before turning the call over to Rich, I’d like to remind listeners of the live call and subsequent rebroadcasts, that some of the statements made during this call will be referencing both GAAP and non-GAAP financial results. Non-GAAP financial measures do not have any standardized meaning and will therefore unlikely to be comparable to similar measures presented by other companies.
We use non-GAAP financial measures to assist management and investors in understanding our past financial performance and prospects for the future. Non-GAAP measures are among the primary indicators management uses as a basis for our planning and forecasting of future periods. Investors are cautioned that non-GAAP financial measures should not be relied on as a substitute for financial measures prepared in accordance with GAAP.
A reconciliation of non-GAAP financial measures to the most directly comparable U.S. GAAP measure can be found attached to our earnings release disseminated this morning. Also please take note of the caution regarding forward-looking statements included in the press release we issued as the matters we will be discussing today includes forward-looking statements and as such are subject to the risks and uncertainties. Those risks and uncertainties are discussed in detail in our most recent annual report on Form 10-K which identifies important risk factors that could cause actual results to differ materially from forward-looking statements we make. All comparisons throughout this call will be on the year-over-year and pro forma basis, unless stated otherwise.
I will now turn the call over to Rich for his commentary on the quarter. Rich?
Richard D. McBee
Well thanks, Mike and good morning everyone. This morning I will walk through a brief review of the highlights for a very strong second quarter we reported this morning before discussing the individual performance of each of Mitel's three divisions. Steve will follow up with a more in depth discussion of our financial results, and then we will open it up to Q&A.
The second quarter was one of the most unique and interesting quarters of my time at Mitel. In the midst of an extremely intense period of integration planning for the Polycom transaction, the Mitel team recorded an exceptionally strong quarter performance, with revenues of approximately $308 million. In addition, we recently paid down another $25 million against our credit facility. We run hard at Mitel. As I've said many times to our global team, I like to sprint the first lap and then pick up the pace. I want to thank each of our employees for outpacing me and the market in the second quarter.
As our results today demonstrate, I have the privilege of leading one of the most professional and disciplined organizations in the industry. Clearly, we put a lot of time and effort into building out a compelling transaction for our shareholders, customers and employees. In the end, it was our decision to walk away from the Polycom transaction with a reflection of the disciplined approach we take to M&A. With a competing bid altering the fundamental economics, the structure of the deal, we determined that it was in our best interest to step aside and collect the $60 million termination fee. We learned a great deal from each M&A experience and further strengthened our competencies. Key lessons and learnings have already been captured and are now cycling into our standard M&A process.
In addition, we also strengthened some important strategic relationships and significantly raised Mitel's profile as a market consolidator. Immediately following the termination of the deal, we experienced a noticeable increase in the number of expressions and interest from other companies seeking a strong, well-positioned partner such as Mitel. As part of our M&A process, each of the opportunities will be evaluated with respect to whether they make strategic and financial sense and whether they culturally and organizationally are a good fit for us.
Now onto the business with our quarterly review. Mitel delivered an outstanding second-quarter by almost every metric, exceeding the high end of our analyst estimates and beating the high end of our guidance. At the halfway point through 2016, we are delivering revenue growth and EBITDA performance exactly as laid out in our target model. Our cloud business posted another quarter of solid performance across all key metrics, including total revenue, recurring revenue, and margins. This marks the 10th consecutive quarter of year-over-year revenue growth exceeding 20%.
In the second quarter, our total cloud seats were up 53% to over 2.4 million. We added 31,000 recurring cloud seats during the quarter, bringing our total recurring seats installed to approximately 451,000. We continued to see strong global growth in our cloud channel in the quarter, with increased adoption by service providers and mobile carriers.
Notable in Q2 were announced service launches by the Zayo Group in Canada and O2 in the UK, along with the geographic addition by another service provider in South Africa. We also signed cloud agreements with five -- with channels in five new countries and are looking forward to launches in China, Japan, Norway, Spain, and Italy with our my cloud -- our Mitel Cloud partners in the near future. We expect to begin recognizing meaningful revenue growth in these new markets in the next year.
Second-quarter results also included the first revenue recognition results from the cross-selling of our cloud and mobile offerings to a carrier customer in Europe. This is the first of what we expect to be several deals with Mitel Mobile carrier customers using our cloud technology in their 4G networks. The mobile division continues to make excellent progress in executing against the strategic growth strategy we put in place a little over a year ago. Post acquisition margin at 62% sets a new record, reflecting increased business maturity as a result of our shift to a profitable growth model and improved operating discipline.
Mobile revenue growth was 5%, while the growth in bookings was 27%, reflecting the typical lumpy nature of a carrier customer base and their required time to market for delivery of new services. On a year-to-date basis, the division's revenues were up 24%. Our mobile division also further expanded its position with several new quality footprint wins, with a number of existing customers transitioning to the network-wide rollout stage.
During the quarter, our total customer technology footprints increased to 50, up from 35 in the previous quarter. These 15 new footprints will be converted to revenues as carriers work through the initial testing and into network-wide rollout over the next 12 to 18 months. In addition, we are now at 19 of our mobile customers in network-wide rollouts. With a broad 4G foundation now in place, we are focusing on expanding our share wallet within our global carrier base by providing the ongoing technical support and solutions required for customers to continue to enhance their next generation services.
On the back of that growth, at the midpoint of the year, Mitel Mobile has already achieved its 2016 target set for customer footprint and rollouts. We are revising our footprint target for 2016 and now expect that we will have 25 footprints moving towards the network-wide launch, up from six at the end of 2015. And in a rapidly changing technology and competitive environment, our enterprise division outperformed to deliver a very strong quarter, characterized by existing customer upgrades and market share gains in Europe and the Americas.
With ongoing margin improvements, our enterprise division continues to contribute strong cash flow for the business. Sequentially, the division revenues were up 15% compared to Q1, with profitability up both sequentially and year-over-year. This strong performance shows the strength of our portfolio, our global footprint, and our ability to take share in the face of weakening competition.
As customer demand for cloud solutions accelerates, we have the right portfolio mix to meet those needs. For customers who prefer on-premise or hybrid solutions, we are equally able to meet those immediate requirements with the flexibility to transition to cloud if and when the customer chooses. Our enterprise strategy and our business model are working as designed.
In addition to a solid Q2 performance, the strength of Mitel's enterprise business has again been acknowledged by Gartner, who positioned Mitel as the leader in both of their most recent industry Magic Quadrant evaluations for unified communications. The first focused on the midmarket in North America and the second, the global enterprise UC market. Mitel remains the only vendor to be positioned in five Gartner Magic Quadrants for business communications.
Our growth and progress as a leader in the enterprise space is also increasingly apparent to a number of channel partners, who are currently selling competitive solutions that are approaching us to directly represent Mitel. On a daily basis, we are talking to potential new partners who are concerned about their position with some of our competitors and who are looking to migrate their business to Mitel.
Before handing the call over to Steve, I want to touch on the impact of Brexit, which has been the source of a lot of questions lately. We view Brexit primarily from the perspective of a multinational organization with customers and operations in Europe. Our market position within the European Union is geographically diverse. The UK represents about 10% of our revenue in the latest quarter, while EMEA in total accounted for approximately 47%.
Obviously we have seen volatility in the currency markets with respect to immediate currency impacts. While we have significant revenue in the UK, the majority is naturally hedged by UK domestic expenses. We continue to monitor the market and customer buying behaviors closely to see whether they take a wait-and-see approach in the wake of the referendum. As of now, it's business as usual with a heightened sense of awareness, and we continue to execute our strategy. We are monitoring our key business indicators closely, and have contingency plans in place should we need to make a change.
To sum things up, we are very pleased to report a strong second-quarter that exceeded both the high end of analyst estimates and the high end of our guidance. The performance was possible because our team of global employees delivered an extraordinary effort with absolute discipline and customer focus in the midst of multiple competing priorities. Our ability to remain focused and to deliver in a very dynamic climate, technology, business and economic, not only show the differentiation of Mitel from the competitors, but enable us to return superior value to our shareholders.
I will now turn it over to Steve to review the financials of the quarter.
Steven E. Spooner
Thank you, Rich and good morning everyone. I will discuss our results for the June 2016 quarter on as-reported non-GAAP basis, whereas the comparisons will be on pro forma non-GAAP basis as if Mitel and Mavenir had been a combined entity for the full second quarter of 2015. I will then move the discussion to our cloud and mobile operating metrics, which were expanded at the start of the year to help investors understand our segment performance. I will conclude with our guidance for the September quarter.
Overall, I am very pleased with our continued execution on our strategy of delivering profitable growth. This quarter we achieved both a solid top-line and solid bottom-line performance. We introduced our target model to deliver profitable growth to the investment community last November, and our results this quarter, and indeed in the first half of 2016, demonstrate that we are executing well against our strategy.
Speaking of growth, our total non-GAAP revenues for the second quarter ended June 30, 2016, were approximately $308 million, up 3% year-on-year in both reported and constant currency. In the June quarter, foreign currency movements did not have a significant impact on our results when compared to the same quarter over a year ago. Our total recurring revenues were approximately $88 million, up 6% year-over-year and representing 29% of total revenue.
Our enterprise division delivered revenues of $214 million, down less than 1% year-on-year amidst a mid-to-high single-digit decline in premises market. Strength in the enterprise segment this quarter came from professional services and recurring support revenues, which both grew helpfully year-over-year, while product revenues declined as we continued the migration of enterprise customers to our cloud solutions. As we've stated previously, we are actively driving the transition of our traditional premise based customers to recurring cloud revenues, and in the June quarter, we estimate the shift to recurring cloud revenues represent a headwind of approximately $12 million.
In addition to our move to a recurring cloud model, we also saw roughly $8 million of CAPEX based product sales in the quarter move from an enterprise segment to our cloud segment as a growing number of large enterprise customers are choosing our private cloud CAPEX solutions. Our cloud division reported total revenues of $46 million, up 23% year-over-year. Recurring cloud revenues were $30 million, up 17% year-over-year.
At the end of the June quarter, our annualized exit month cloud recurring revenue was approximately $121 million, up 15% versus the prior year. The growth in cloud is being driven by strength in both our retail and wholesale offers, and more specifically, our strategy to move legacy premise based customers to our recurring and nonrecurring cloud based solutions. As in previous quarters, we continue to see healthy cloud growth in all geographic regions.
At the end of June, Mitel had over 2.4 million total cloud seats installed, an increase of 53% year-over-year. Our recurring cloud users were 451,000 seats, up 37% from the prior year. During the quarter, our average number of seats for retail cloud customers was 37, and our average monthly revenue per retail cloud user was $50.
Our mobile division reported total revenues of $47 million, up 5% year-over-year. You will recall that last quarter our mobile revenues were up 55% year-over-year and in Q4 it was up 72%. As we've indicated previously, the mobile revenues in any given quarter will be lumpy due to the timing of specific customer rollouts and contract awards. However, on a long-term basis, we expect the division to grow at approximately 20%. Year-to-date our mobile revenues are up 24% as we continued to see new footprint wins and solid execution in this division.
In looking at our total business from a geographic perspective, revenues in the Americas were $152 million, up 7% year-on-year, driven by growth in our cloud and mobile divisions. Europe, Middle East, and Africa revenues were $144 million, up 10% year-on-year driven by growth in mobile and cloud, and strengthen our enterprise business in the UK and Western Europe. Revenues in the Asia Pac region where just under $12 million.
Now turning to gross margins, Mitel's gross margin for the second quarter, at 56.1%, was up 290 basis points in both reported and constant currency. Our enterprise division gross margins were 55.7%, up 110 basis points, driven by growth in higher margin software maintenance revenues and ongoing synergy actions.
Our cloud division gross margins were 51.9%, up 210 basis points year-on-year, largely as a result of growth in our higher margin wholesale cloud offers. Mobile division gross margins, at 62.2%, were up 1,300 basis points year-on-year, due primarily to increased software mix and cost synergies. Margins will continue to be impacted by the mix and timing between the number of new footprints won, and the number of customers that -- or carriers that transition out of the lab and into a broader rollout across our carrier customers' networks.
Total operating expenses for the June 2016 quarter were $133 million, which was consistent with the prior year, but reduced as a percentage of revenues to 43% compared to 45% a year ago. These results exclude special charges and restructuring costs, amortization of acquisition related intangible assets, and stock-based compensation. Operating expenses in the enterprise and mobile divisions decreased year-over-year due to cost reductions and synergies, while cloud division operating expenses increased as we invest for continued growth.
Adjusted EBITDA in the second quarter was $45.9 million, or 14.9% of revenue, up 43% year-on-year and up as a percentage of revenue by 410 basis points. Non-GAAP EPS was $0.19, up $0.08 year-on-year.
The additional disclosures at the segment level that we provide are intended to help analysts and investors track Mitel's performance against the detailed division target models we provided the investment community during our Analyst Day last November. Enterprise adjusted EBITDA came in at $38 million or 17.8% to division revenues, which was up 170 basis points year-on-year. The improvement in enterprise division EBITDA was a result of increased gross margins and lower operating expenses.
Cloud division adjusted EBITDA came in at $2 million or 4.6% of revenue compared to EBITDA of $900,000 or 2.4% a year ago. The growth in cloud division EBITDA is a result of revenue growth and gross margin expansion, which more than offset higher operating expenses. Mobile reported adjusted EBITDA of $5.7 million, which was 12% of revenue, compared to an EBITDA loss of $3.5 million or 8% a year ago. The improvement in mobile division EBITDA is the result of gross margin improvement and discipline on operating spend.
Quickly looking at our year-to-date results on a pro forma basis, our non-GAAP revenues are up 2% year-over-year in reported currency and up 3% in constant currency. Our gross margins are up 220 basis points and adjusted EBITDA is up $21.4 million or 43%. Non-GAAP EPS year-to-date stands at $0.25 versus $0.15 for the same period a year ago, a 67% increase year-over-year.
Turning to the balance sheet, at the end of the June 2016 quarter, Mitel had $61 million in cash and cash equivalents after making a debt prepayment in the quarter totaling $13.6 million. Furthermore, subsequent to the end of the quarter, in July we made an additional payment of $11.5 million against our debt, continuing to further de-lever our balance sheet. Since the beginning of the year, Mitel has paid down $65 million on our debt facility. The break fee we received from Polycom subsequent to the end of the quarter will further strengthen our cash reserves and provides additional covenant flexibility going forward.
Mitel exited the second quarter with a global workforce of 4,424 employees. With respect to our integration efforts, we have now delivered more than $87 million in annualized run rate synergies, significantly above what we have had originally promised in the Aastra acquisition. We continue to see additional opportunities and are taking actions accordingly to drive this number higher. With respect to the acquisition of Mavenir, we have realized approximately $24 million in annualized synergies to date and are well on track to deliver total synergies in the high 20s as we exit 2017, up from the $23 million initially promised when we closed the transaction.
Now to our business outlook, please note that statements regarding our future financial performance targets are forward-looking statements. I refer you back to the forward-looking information caution we provided to you earlier on this call. For the third quarter of 2016 ending September 30th, we currently expect non-GAAP revenues to be in a range of $275 million to $295 million, reflecting typical summer seasonality. For reference, at current period exchange rates, our Q3 2015 revenue was approximately $289 million.
Non-GAAP gross margin percentage is expected to be in the range of 54% to 56%. Adjusted EBITDA margins are expected to be in the range of 11% to 13% of non-GAAP revenue. And non-GAAP EPS is expected to be in the range of $0.10 to $0.15. Share count for the September quarter should be approximately 125 million fully diluted shares. As we highlighted earlier in the year, I would draw your attention to the first half versus second half seasonality of revenue and earnings, which we expect to be pretty much in line with what we experienced in 2015.
Mitel is continuing to execute well. Solid Q2 performance in all three of our divisions demonstrates that our strategies are working. Our enterprise business remains a highly profitable business, and is outperforming the market. Our cloud business is posting overall growth higher than many of our peers. And our mobile business is successfully transitioning from growth at all costs to profitable growth.
This concludes our formal remarks. I will now ask the operator if she could please review the procedures for asking questions and open up the lines. Thank you.
[Operator Instructions]. And our first question comes from the line of Todd Coupland with CIBC. Your line is now open.
Hi, good morning everyone.
Richard D. McBee
Hey, good morning Todd.
My first question, just stepping back from the results, so over the last year, we've seen somewhat inconsistent quarters from Mitel, most of it due to macro events. How should we think about this quarter relative to the last few quarters, are we in a zone now where this is repeatable and the operating leverage that you have built into the model can play out consistently or should we expect choppy results because of the business dynamics that are a reality, color on that would be helpful?
Steven E. Spooner
Todd, it is Steve. I think we are certainly confident that we are continuing to drive the operating leverage with the efforts that we've taken to realize synergies, the steady performance we've had in expanding gross margins. So I think on the whole, our expectations are or our operating model will continue to improve. Having said that, we do have, as we've said from day one, our mobile business tends to be lumpy by nature. And that can be lumpy in terms of top line, it can be lumpy in terms on the gross margin performance.
So I think with that caveat, I would say that directionally, we expect the business model to continue to improve. Again, I would -- the only other caution I would say is we need to make sure that investors reflect in their thinking and expectations the seasonality in our business. So, where obviously we have a seasonally weaker quarter, the operating metrics tend to suffer a bit. And in the seasonally stronger top-line quarters, you tend to see the operating margins expand accordingly.
Okay. Thanks, Steve. One follow-up, if I could. Could I ask on M&A, what types of businesses are you thinking fit with Mitel at this point and specifically, ShoreTel has been in the sights of the company in the past, just give us some specific color on those two questions? Thanks.
Richard D. McBee
Well, obviously we've looked at ShoreTel, along with others. At this time, we see other companies that are much more attractive than they are. There is a lot of targets for consolidation that would be very accretive to our shareholders. And so that is where we are putting our focus at this time. It's a unique time in the marketplace as a result of the heightened awareness, a) of Mitel. I think we've got a lot of people looking at Mitel at a little more depth; the awareness with the Polycom transaction.
So we have a lot of opportunities that have been inbound to us from companies that weren't available or did not want to look at coming together in the past. So we are going to be very disciplined in it. I think that you'll see from Mitel this is a great period of consolidation in the premise to cloud transaction in those kind of companies. And that's where we will be putting our time and effort. So the key with us is really kind of sticking to the core pretty much for our M&A programs for the foreseeable future.
Thanks, gentlemen. Appreciate it.
Steven E. Spooner
And our next question comes from the line of Barry McCarver with Stephens Incorporated. Your line is now open.
Hey good morning guys and good quarter. Thanks for taking my questions.
Richard D. McBee
Let's start off on the mobility side. A big increase in the number of footprints, and you acknowledged that you have kind of changed your goal for install levels by year-end. Can you give us a little more color during the quarter, what kind of changed that sparked this really nice increase, anything to talk about there? And then secondly, just in terms of revenue generation from that segment, are we crossing a threshold where you expect to see more linear improvement in growth there?
Richard D. McBee
Well, first of all, on the first question, I think we are getting a flywheel effect, which means that as we have won carriers, we have the reference accounts. As they start becoming live, that starts to roll. So the first leads to one, one leads to two, two leads to four, four leads to eight. So we feel real good about our solution. We put a lot of time in making sure that we've got high-quality solutions and high-quality customers that we are working with.
The other thing that we are starting to see is the follow-on business for applications right behind the key customers that we've won. So, once you roll out a network deployment of one of these technologies, there's follow-on business and we are starting to see that, too. So this isn't really a surprise to us. This is what we said in the original deal pieces would happen. The team is doing a great job of delivering results against that strategy. And so, it's like we said, it's not growth at all costs. We are doing this very deliberately and very methodically to create value in that business for the long-term.
Steven E. Spooner
And I think Barry, I'll just add, your question about whether we should expect growth rates to change. We are still -- we don't update our target models on a quarterly basis, as you know. We will update our thinking at our analyst event later on in the year, but our best guidance would still be to think about this business as a 20% grower [ph], and we will stick with that kind of directional guidance at this point.
Richard D. McBee
I think that you can see that all the businesses are operating right in line with the model that we presented as part of our Analyst Day deck.
And then if I can, just one follow-up, any thoughts on your on-premise business, is it continuing to perform the way you expect, obviously cloud is doing really well, but are you seeing any change in the purchasing habits there?
Richard D. McBee
Well, obviously we had fantastic results in the premise based business. Our long-term model is that, that market is in a slight decline, and the teams delivered superior results in this quarter. I think that that -- we will continue to watch that, the market dynamics on the market dynamics. The things that I saw in the quarter was -- we are winning a lot of business. A lot of people are in kind of rough shape in that space. It's a massive market when you look at things on a global basis, where our products and solutions are well positioned, our channel partners are well positioned. And then some of the competitors out there are having a tough time. And a lot of the channel partners are looking towards us for an alternate solution for them.
So I think we are benefiting from all those things, and the team is running a pretty disciplined play. And I thought that they did very well. We talked about it in the first quarter, where I didn't think that reflected the annual performance of the business, and I am pleasantly surprised by what they delivered. But at the same time, they are a very disciplined group, and they are managing that business very well.
Very good, thanks, guys.
Steven E. Spooner
[Operator Instructions]. And our next question comes from the line of Greg Burns with Sidoti and Company. Your line is now open.
Good morning. You touched on some of the cross-sell opportunities you are seeing, but I wanted to maybe get your perspective or maybe a little bit more color around kind of Mitel's mobile first strategy and the intersections you are seeing between mobile and the other pieces of the business. Just longer-term, how do you see mobile differentiating Mitel? And when might we see that differentiation really start to drive meaningful market share gains or tangible kind of financial results for Mitel that we could see? Thanks.
Richard D. McBee
The mobile capabilities, the mobile-first is brought based on our strategy that 50% of all business calls start on a mobile phone. And so we have to understand how that impacts the business environment, because that's what we serve. And the reality is, the mobile-first permeates everything we do in the company to make sure that our capabilities can be provided both on a mobile and fixed environment. The mobile area that we sought to achieve with the mobile division was really kind of twofold.
Number one, there is an over the top application, which most providers have some kind of capability to provide that, and we are leading in that. And then there is native capabilities, which are when you are a native element of the network, and that's what our mobile business provides to us. The mobile industry transitions it seems very fast but in infrastructure transitions over long period of time.
The key aspect of the mobile acquisition that we made was for the mobile PBX. So that is an IMS-PBX, which allows a mobile carrier to provide a cloud capability. And this was the first quarter that we actually saw revenue from that model and as I've stated in earlier calls, this was at least a year sooner than we thought that was going to happen.
So that has taken our cloud capability and enabling a carrier to provide a business class cloud offering over his mobile network. So we are seeing it move faster than we originally anticipated in that particular dimension. The other aspect of the mobile business is just for the technology of voice over Wi-Fi, VoLTE and RCS, or risk communication services. We are seeing that uptake be very well. So I think the best thing that I can tell you Greg is that we put forward three year models in our last Analyst Day about each one of our businesses and divisions, and that's what you should expect. That's what we are working towards. And so as we have demonstrated halfway through this year, that we are very comfortable with the models that we have put out there.
Okay. And I guess along these same lines, the Mitel accelerator, can you just talk about maybe the pipeline of new products and services that you have coming out of that, what is -- what if anything, has been commercialized and what can we look forward to? Thanks.
Richard D. McBee
Yes, well, we don't share everything that we are doing in the incubator, obviously, because that's pretty strategic to us. But we have talked about our embedded solutions, where we actually have revenue-generating customers for us today. And the embedded solution is taking our UC applications and embedding them in service worker work streams. So we are right in the deployment phase of the first revenue customer for that, and we've got a lot of customer interest that's been generated specifically from that.
And as a reminder for that model, the embedded solution is a SaaS company. We will take our solution, embed it in their solution, and then sell it to all their customers. So it's really kind of a force multiplier for us. And so what we have is not only a plethora of customers of our SaaS provider, but we have other SaaS providers who are looking at embedding it in their product to sell to a multitude of other customers in several different verticals. So we are very pleased with that business and, like I said, it is an emerging business for us. But it's going to become main stream fairly quickly.
And our next question comes from the line of Jonathan Kees with Summit Redstone. Your line is now open.
Great, thanks for taking my questions, good morning guys. Congrats on the quarter. I just wanted to get a better idea, or if you can get some more color in terms of the cloud growth, was it mainly from I guess in two aspects; one, did you leave a lot in terms of your UC cloud solution, more of the single tenant or was a lot of this more just conversions from your premise location? And I guess if you can throw in pricing there, too, that would be great, did you have to be a very competitive in terms of the pricing of the deals?
Steven E. Spooner
Jonathan it is Steve. So, if we look at our growth overall in cloud as we talked about being -- revenues being up 23%, significant growth driven by both our -- our recurring business is up 16%. So that's largely our retail offerings, a certain amount of our wholesale business is done on a recurring basis as well, but significant growth there. But also, what we noted this quarter is we are already getting traction with service providers for our wholesale cloud offerings.
I think we touched on a number of new countries now that we are starting to offer cloud services through new service providers. Many of those service providers are cash rich and prefer to procure the cloud solutions from us on a CAPEX based model. So you will see in our cloud segment disclosure that the non-recurring portion of cloud this quarter grew rapidly, and that really reflects adoption by, as I say, cloud providers who have chosen to move on a -- or procure from us on CAPEX basis.
We continue to see solid private cloud growth, where we have a lot of installed base customers who, as they look to upgrade to new IP-based solutions, like the fact that they can do so either on-premise, hybrid model, or on a kind of a pure cloud deployment with Mitel. And we offer them that flexibility with technology solutions that they are comfortable with. So, a significant part of our growth comes from the private cloud space as well.
So it was across the board? It's more…
Steven E. Spooner
Basically across the board, all -- whether it's our retail operations, whether it's our private cloud or wholesale, all three areas are growing rapidly.
Richard D. McBee
And I will just add that, I think if you think about the segments of the small customers, the medium customers, and large customers, they are all moving to the cloud in some format. Small customers usually do a retail cloud. Medium customers are a mix, and large customers are usually private cloud. So they run their own data centers. They want to procure the software to provide and run their UC communications themselves. So, we are uniquely positioned that we have retail offerings across all those.
We have private offerings across all of those. And the reality is, there is a significant opportunity for us to serve customers in all three segments in all three types. And then one of our core strategies again, goes back to our M&A strategy, that says we like to buy companies that have legacy premise based solutions and then we will take those customers and we will move them to the cloud.
So we integrate the solutions, and one of the key differentiators Mitel has is the ability to go from a premise to a hybrid to a cloud solution. And so, that ties directly into our M&A strategy as well. And we've been very successful in this. The premise companies that we have consolidated, that's where we are seeing in addition to Mitel, the Inter-Tel customers, the Aastra customers, they are all on that same journey. And as we continue to acquire them, then we start the journey of moving from premise to hybrid to cloud.
So you have been leading more with that, with being the fact that your uniquely positioned offering, the premise, hybrid, cloud, that kind -- your technology solution, you haven't had to lead with pricing?
Richard D. McBee
No, actually it's even in the cloud-based business, I mean we predominantly use three and five year contracts. So we are not going to do the month-to-month stuff. We have the occasional annual contracts, but our sweet spot and our customers are usually looking for three year to five year contracts. And that's where we are. So, we are not going to be a price leader. That is not who we are. That's not the kind of solution that we provide in the marketplace. We will be competitive on price for sure, but as far as we're concerned, the flexibility of our offerings give us the ability to, I think, maintain a price position in the marketplace.
Steven E. Spooner
I think, Jonathan, that's evidenced if you look at our cloud statistics, that our average revenue per user has been solid in that $50 range now for six or seven quarters.
Yes, it has. Great, thanks for that. That helps a lot with the understanding. Thank you, guys. Good luck.
Steven E. Spooner
And our next question comes from the line of Paul Treiber with RBC Capital Markets. Your line is now open.
Thanks very much and good morning. What's your perspective on capital allocation, just given the stock at these levels, just wondering if you have a preference, a greater preference now for debt repayment or perhaps even share buybacks in lieu of additional acquisitions?
Steven E. Spooner
Paul, it is Steve. I think we obviously consider all three of those. We've historically indicated we like to see our net leverage below three. As we have demonstrated since the beginning of the year, I think we've paid down some $65 million on debt. I think that's -- many of the investors that we've spoken to are very supportive of that.
As our cash generation continues to strengthen and our debt levels reduce, we leave the door open to the potential of returning some cash to shareholders. But we are going to stay pretty focused on M&A. As Rich touched on, there are some attractive opportunities in the funnel and I think many of the investors that we've spoken to want to see Mitel continue on its stated strategy of being a consolidator in the market.
So, in the absence of attractive M&A in our core business areas, we will look at either debt repayment or returning cash to shareholders. But we are still very much focused on using excess cash to drive accretive M&A opportunities in the core.
Okay. And then just moving on and looking at the business, forgive me. I missed the earlier portion of the call but how do you think about the seasonality of the premise business for the remainder of the year, I mean this quarter it was quite healthy. Do you see a change in the end market dynamics that have just driven the change over the last quarter and you see that as sustainable, how should we think about it for the second half of the year?
Steven E. Spooner
I think with the comment that I think I made on the call that you might have missed, Paul, was that we expect seasonality overall for our business not just enterprise, but overall for the business to be consistent with kind of first half, second half seasonality we saw in 2015. If you recall in Q1, the enterprise performance was weaker. And we did not believe that to be a trend. But then clearly the solid performance that we demonstrated in Q2 brings our year-to-date results very much in line with our target models.
So, I would suggest again, normal seasonality for the enterprise businesses. The third quarter, the September quarter is the weakest quarter of the year, just given our exposure to Europe and business slowing down with vacation periods and the like, and that historically the fourth quarter is the strongest. And again, that would be consistent with what we saw in prior years.
Okay. Just moving on to profitability and margins by segment, it does look like the mobile margins were quite high this quarter. I think above the targets that you gave at the Analyst Day. And then conversely cloud margins were a little bit lighter. How do we think about the -- what drove the over performance and underperformance relatively and then how do we think about the margins on those businesses going forward?
Steven E. Spooner
We think of our cloud business very much, frankly, in line with our target model. So we don't actually see it as being weaker than our target model. So, if you looked at our target model for cloud for calendar year 2016, we talked about 50% to 51% gross margins, and we are at 52% for the quarter. So we think cloud is performing actually a little ahead of our expectations. On the mobile side again, it speaks to a bit of a lumpiness but higher software content, so greater software mix, improved margins on our services. I think the team is getting more disciplined around bidding, change requests, things like that. Just the kind of profitable growth focus that we have worked with the team on, as opposed to chasing top line. So I think it's a combination of all of those things.
Okay, thanks very much. I will pass the line.
Steven E. Spooner
We have a follow-up question from Todd Coupland with CIBC. Your line is now open.
Yeah, an accounting question if I could. Just wanted to understand the purchase adjustment on the mobile revenue in the quarter, I guess it was about $15 million, and I think last year it was reported $45 million. So, is the baseline for growth actually $30 million or $45 million, how are you thinking about that, Steve?
Steven E. Spooner
I am going to -- you caught me flat here. Just…
We can take it off-line if…
Steven E. Spooner
Yes, why don't we do that, Todd? Just give me a chance to look up the historical there and give you a proper answer.
Okay, that's fine. That was my follow-up. Thanks a lot.
Richard D. McBee
Alright, thank you.
I am showing no further questions at this time. I would now like to turn the call back over to Mr. Rich McBee, Chief Executive Officer, for closing remarks.
Richard D. McBee
Well, thank you all for joining us today. I am looking forward to reporting back to you on our progress when we report the third quarter early in November. I hope you have a good day.
Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone, have a great day.
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