ShoreTel's (SHOR) CEO Don Joos on Q3 2017 Results - Earnings Call Transcript

| About: ShoreTel, Inc. (SHOR)

ShoreTel, Inc. (NASDAQ:SHOR) Q3 2017 Results Earnings Conference Call April 26, 2017 5:00 PM ET


Barry Hutton - Director, Investor Relations

Don Joos - President and CEO

Mike Healy - Chief Financial Officer


Greg Burns - Sidoti & Company

George Sutton - Craig Hallum

Eric Martinuzzi - Lake Street Capital Markets

Dmitry Netis - William Blair

Mike Latimore - Northland Capital Markets


Good day and welcome to ShoreTel's Third Quarter Fiscal Year 2017 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 like to add that we at Chorus Call use ShoreTel Telephone. 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.

Barry Hutton

Hello and thanks for joining us today as we report the financial results for our fiscal third quarter for 2017. 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, LinkedIn 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 on acquisition-related intangibles, other adjustments and related tax charges. 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. Before we provide a quarterly update on our operational and financial progress I'll make a few comments regarding our ongoing strategic review process. We began our strategic review process in August. It has been active for a period of time and continues to remain active. We recognize the need to balance the importance of this strategic review process with any potential impact or near-term operations. I remain excited about our strategic plan, driving execution of our transformation and the market opportunity in front of us.

Throughout this process we've continued to talk regularly with our shareholders, customers, channel and business partners and we appreciate their feedback.

At this point I will recap the key financial results from our fiscal third quarter. Total revenue in fiscal Q3 was $87.7 million. Hosted revenue is our single largest source of revenue representing 44% of the total. On a year-over-year basis hosted revenue grew 17%. In the quarter our cloud bookings grew 7% year-over-year. This was below our historical levels and also below our internal expectations.

With an increasingly competitive landscape we did make a conscious choice in the March quarter to run several promotions and sales incentive programs, thus giving up some near-term pricing in exchange for growth in seats booked. And therefore the bookings growth rate percentage was lower than we desired, but we did create several key outcomes from these actions.

First, the number of new seats booked was up [indiscernible] year-over-year and 37% quarter-over-quarter indicating that our Cloud offering is expanding its presence in the marketplace. This significant increase in the number of seats booked was balanced against a decline in ARPU which impacted the bookings growth percentage rate.

Second, our overall Cloud sales effort had good success with the mid market and enterprise customers. Bookings of customers with over 200 seats grew 33% year-over-year. This is the third consecutive quarter that our highest growth came from these larger customers which tend to have lower churn and be more profitable. Meanwhile we did see a decline in the sub 50 seat volume.

Third, in Q3 our cross-selling to existing cloud customers grew 24% year-over-year and reached its highest level in two years. This indicates our current customers desire to expand and add new applications as we continue to enhance the Connect CLOUD solution. Meanwhile our continued focus on account management led to our solid revenue churn metric of just 5% annualized which remains favorable to our [indiscernible]. Through continued operational actions and discipline we achieved a year-over-year improvement in all three of our gross margin lines as well as a reduction in operating expense level. In total, we earned a non-GAAP operating income of $1 million.

Overall, I'm pleased with the financial results of the quarter, but I'm not satisfied with the overall piece of the strategic shift to driving hosted growth. By no means am I content or complacent with our current progress and we have implemented and will continue to identify actions to further improve the company's growth.

Today we announced an action which will implement a meaningful change through our premise focus channel partners in distribution practice in the United States. I'll take a few moments to recap the key aspects of the change along with its operational and financial benefits. ScanSource handles a two-tier distribution model for a significant portion of our U.S. premise volume. Effective July 1, the start of our new fiscal year we are expanding this relationship with value-added resellers also known as VARs who currently buy product directly from us will now be folded into the ScanSource two-tier distribution model.

At that point ScanSource will then handle the vast majority of our U.S. premise volume, the exception being our continued two-tier distribution relationship with Ingram Micro. The completion of the two-tier distribution in the U.S. better aligns with our overall global distribution strategy. Going forward nearly all of our U.S. premise channel partners will benefit from ScanSource's expertise and logistics, inventory management and the tools and support structure designed for the channel partner community.

Strategically ShoreTel will be able to reallocate resources to strengthen our focus on our cloud service priorities including innovation, service delivery, and hosted revenue growth. In addition, we anticipate this expanded relationship to be neutral or slightly positive to our fiscal 2018 operating profit driven by $6 million to $7 million cost savings. We also expect to gain $3 million in working capital due to improvements in accounts receivable and inventory turns. In a few minutes Mike will provide more details about the financial model related to this expanded arrangement.

Now let me provide a brief update on the execution against our five catalysts for growth which we previously outlined as one, the rollout of ShoreTel Connect's offering; two, the global expansion of our cloud offering; three, the scale of our channel partner community; four, our success with midmarket and enterprise customers; and five, our ability to leverage our premise install base to drive hosted revenues.

Our first two catalysts for growth are the ongoing enhancements to ShoreTel connect and the continued expansion of our cloud offering. We continue to achieve important milestones in each area. At the Enterprise Connect conference last month participants experienced demonstrations of more recently announced enhancements. This included new video collaboration capabilities and our teamwork application designed to 18 [ph] collaboration and document creation for mobile users. These cloud-based apps are available to customers through our bundled packages and inspire recognition across the industry.

Recently TMC named ShoreTel Connect as 2017 Unified Communications Product of the Year winner. As we continue to introduce new enhancements through our Connect offering and continue to expand our global cloud footprint we are winning multinational cloud customers. One such example in Q3 is the signing of the UK-based provider of submarine cable solutions. From a global perspective this customer needed a single solution for service locations in the UK and the U.S. From a feature perspective the customer wanted to utilize our video collaboration and various mobility capabilities. We won this deal against an incumbent provider, a cloud pure play and a larger provider with multiple offerings.

Looking forward I'm excited to see the execution of our development efforts reflected in our near-term roadmap. Our few key roadmap items over the next three to six months includes expanding our global hosted presence including Connect CLOUD in Australia and broader global number coverage, enhancing our teamwork, video collaboration and contact center applications, broadening our service delivery capabilities by giving our customers and partners more self-service capabilities, enhancing our user experience through improvements in our web, desktops, and mobility client and continuing our integrations with Microsoft, Google, Salesforce and several other industry applications as part of our monthly release cycle.

The success in these two areas provide momentum towards our third and fourth catalyst for growth with our channel partner scale and our success with midmarket and enterprise customers.

Let me summarize a couple key points. One, our channel partners continue to contribute over 90% of our cloud bookings. Two, for the fourth consecutive year CRN has given our Champion Partner Program a five star rating which is their highest rating. Three, the development roadmap is generating excitement in key geographic theaters and a meaningful increase in partner activity in both the UK and Australia.

In EMEA our recent expansion of our Connect CLOUD offering has had a solid start and we also signed multiple new channel partners in the theater. Since our acquisition in Australia, we had cloud bookings growth in each of the five quarters since the deal closed. Later this quarter we will launch our Connect CLOUD offering in Australia. In addition of this launch 75% of our on-site channel partners in Australia have already signed their addendums so they can offer our Connect CLOUD solution as well.

The adoption of our cloud offering continues to grow in the Australian market. This was evident by our largest cloud win in that country to date. We closed a retailer of ladies apparel with 124 locations which will result in new hosted revenue of almost $19,000 per month. As I mentioned earlier, our innovation, service delivery and strategic priorities are leading to increased growth in the midmarket and enterprise customers segment. In Q3 our bookings growth in the over 200 seat segment was up 33% versus the prior year. During Q3 we again signed multiple new customers which will each generate over $10,000 per month in hosted revenue.

The scalability of our cloud offering was critical to our signing of a new memorial services customer, the initial contract signed in Q3 provides service for 1000 users and the customer has plans to add an additional 600 users. When fully deployed our cloud offering will serve 64 locations. The customer needed to replace its previous VeriFone system with a solution that could be utilized across the organization while integrating with Skype for business.

Our fifth catalyst for growth is the Premise to Cloud Migration Program. Since launching the program it has contributed approximately 10% of overall cloud bookings. In Q3 specifically we had a 71% quarter over quarter increase in the number of installed premise customers that committed to new cloud contracts.

Each quarter some customers execute a full premise to cloud migration while others decide to simply add new cloud services or locations and choose to migrate over a slightly longer time period. This causes a wider range in the size of our bookings through the program and in Q3 the average seat size of migration customers was smaller than our cumulative average. But overall migration customers continue to represent larger seat sizes and monthly revenue levels than our net new cloud bookings.

The annualized hosted revenue from our migration customers is more than 20 times greater than the support revenues that were replaced. Over the last couple of quarters we have gained valuable insights and are implementing several changes which will enable us to increase the pace of migrations over the next several quarters and beyond. These changes include stronger alignment within our channel and sales incentive programs, new tools to better identify and target migration customers and process changes such as providing budgetary cloud quotes at the time of support renewal. We continue to remain focused on the installed base migrations as it is a strategic asset for us.

As I reflect on our progress I'm proud of what our employees have accomplished as business transformations are not easy, but by no means are we complacent or content with our current progress or results. I recognize that the operational successes we have realized have not always been reflected in the financial results or equity evaluation. We know we can achieve greater results and the market opportunity is there for us. We remain focused and committed to growing our business and creating shareholder value.

In summary, our fiscal Q3 generated a year-over-year improvement in total revenue, gross margins, operating expenses and profitability. Our efforts to grow the cloud business resulted in a 35% increase in the number of total cloud seats booked. The quarter had strength from midmarket and enterprise customers and today we announced an expanded relationship with ScanSource which strengthens our focus on our cloud-based innovation, service delivery and growth. We realize that we still have work to do in order to complete our transformation. I am confident in our strategic direction. I am also confident that the actions we are taking will improve the pace of our strategic shift to drive hosted growth.

Now I'll ask Mike to review the financial results.

Mike Healy

Okay, thanks Don. A review of our fiscal Q3 shows we produced solid financial results and continued our progress in key operational areas. We earned $87.7 million in total revenue a 3% increase year-over-year again led by a 17% increase in our hosted revenue of $38.3 million which was 44% of our total revenue.

We also saw year-over-year improvements across all three gross margin lines, operating expenses and profitability and as a result we earned a non-GAAP net income of $600,000 which kept our street going of non-GAAP profitability for 15 of the last 16 quarters all while transitioning to our cloud business model.

Hosted revenue was $38.3 million in the quarter up 17% year-over-year and up 4% over Q2. We had two hosted acquisitions reaching their one year anniversary in Q3. The 17% increase is now an entirely organic growth. Our worldwide cloud installed base now has 6500 customers following 271,000 seats representing year-over-year increases of 27% and 24% respectively.

Let me highlight a few key cloud metrics that were shown in today's press release. Our cloud customer installed base remained steady and has an average seat size of 41. Our average revenue per seat or ARPU also remained constant at $48. Our average cloud customer pays us $1991 per month and we continue to have a very low revenue churn which in Q3 was 0.43% on monthly basis or only 5% annualized.

Our Q3 product revenue was $30.5 million and we shipped 112,000 licenses. Our product revenue declined by 10% over last year and 5% sequentially and what is typically our softest quarter in terms of seasonality. This is an improvement versus the trend of the prior six quarters as we saw an increase in the average new customer deal size and the sequential increase in a [indiscernible]. However, we do expect to continue to see quarterly variability in our product revenue given our seasonality and our strategic shift towards hosted revenue.

In Q3 support and services revenue was $18.9 million up 2% year-over-year and down 1% sequentially. Our support revenue grew 4% over last year to $17.4 million as we continued to have a high attach rate on initial sales and support contract renewals. The services revenue of $1.5 million includes training, professional services and implementation fees and typically correlates with the product revenue trends.

Our recurring revenue comprise of hosted plus the support revenue that I just mentioned totaled $55.7 million in the quarter or 63% of total revenue. This represents an annualized recurring revenue run rate of $223 million. In our third quarter international revenue was $7.1 million up 4% from the prior year. International represented 8% of our total revenues in the quarter consisting with historical levels.

I'm going to talk about the rest of the income statement, my following comments will refer to non-GAAP results unless otherwise noted. A reconciliation to the related GAAP numbers is attached to the earnings press release we issued this afternoon.

Our third quarter total gross margins were 65.4% up 220 basis points from last year as we had improvements in all three gross margin lines. In particular our hosted gross margins were 57.3% in Q3 up 400 basis points from last year and an increase of 230 basis points sequentially. The increase reflects revenue scale and operational efficiencies. In addition we had a 90 basis point benefit from the release of telecom tax reserves in the quarter. These benefits were partially offset by additional resource investments made to our customer support organization to aid our growth and ramp in data center call.

The product gross margins were 67.4% up 30 basis points year-over-year and up 80 basis points sequentially, reflecting lower operational and product costs. The support and service gross margins were 78.4% and 490 basis point improvement from last year following the shifts of resources to support our growing hosted customer base. On a quarter-over-quarter basis the gross margins declined by 90 basis points.

The Q3 operating expenses were $56.3 million an improvement of $1.4 million from a year ago. We had labor savings in the sales and marking area following our August realignment of resources and also reductions in IT project spending.

Sequentially, operating expenses increased by $2 million primarily in product development and G&A as we increased labor related spending and software expenses in a few specific areas. The year-over-year improvements in revenue, gross margins and operating expense levels led to a non-GAAP operating income of $1 million or 1% of revenue. Our non-GAAP net income was $600,000 or $0.01 per diluted share, a good improvement over last year's loss of $0.06 per share which included the first quarter's impact from our cloud acquisition that closed in early January 2016.

The GAAP results showing a net loss of $2.9 million or $0.04 per share which includes charges of $2.2 million for stock compensation, $2.4 million for amortization of acquisition related intangibles, severance and other costs. Also included in our GAAP results in the other income line is a gain of $920,000 for an investment we obtained as part of our acquisition in Q3 last year. Specifically this investment also helped grow our cash balances in the quarter by $1.1 million.

Now I'll briefly comment on our cash flow and few key balance sheet items. In Q3 we generated $2.7 million in cash flow from operations and we entered the quarter with $104.9 million in cash and short term investments and no debt. The other key elements in working capital included depreciation and amortization in the quarter was $5.1 million, accounts receivable ended the quarter at $26.5 million up 800K was slightly in the timing of customer billings and our days sales outstanding remained relatively constant at 27 days.

Inventory decreased by $1.7 million in the quarter at $40 million. Our deferred revenue increased by $2.3 million to $79.7 million. Our capital expenditures are linked primarily to support our growing cloud business and further technology innovation. In Q3 CapEx was 2.9 million. We ended the quarter with 1166 employees including Q3 hiring of 22.

Before I talk about guidance let me give you few more details on our expanded relationship with ScanSource. The revised contract with ScanSource is effective July 01, of this year, but some of the direct partners may move over to ScanSource during this quarter. A vast majority of our partners already purchased from. The vast majority of our partners already purchased from ShoreTel through a two-tier distribution model in the U.S. This change is effected to moving our remaining direct value added resellers of ours to buy our onsite products and support through ScanSource versus directly buying from us. This is a continuation of a natural evolution of our distribution strategy.

There are numerous financial and operational benefits to ShoreTel that we expect to achieve from this distribution model change throughout fiscal 2018 including the following. In terms of the revenue impact if we assume no change in current projections for sale volume of product and service and support revenue line will decline a little due to the discount levels associated with our two-tier distribution model.

And ScanSource will handle logistics, support, inventory management and operations in support of the direct cloud moving over. We are able to reduce our internal resources dedicated to managing these direct channels partners in the sales channel services and operations groups. Most of the actions related to today's announcement are complete and we expect annualized savings and expenses from these actions will be in the $6 million to $7 million range starting in our September 2017 quarter.

We also expect at least $3 million in working capital benefits from lower DSOs, equipment turns on our inventory. Given the expected slight revenue decline and expense savings a conservative view will yield a neutral to small positive impact to our operating income due to this alignment in our global distribution strategy. Strategically we are excited about our extended relationship with ScanSource which will allow us to strengthen our focus on innovation, service delivery and hosted growth.

Now let's turn to our fiscal Q4 business outlook. The June quarter marks our fiscal year end and this is historically our strongest revenue quarter of the year. We anticipate total revenue to be in the range of $88 million to $94 million. We expect non-GAAP gross margins to be within the range of 64% to 65% and the GAAP gross margins will be roughly 1.5 percentage points lower due to charges for stock based compensation, amortization of acquired intangibles and other adjustments.

We expect our non-GAAP operating expenses to be in the range of $56 million to $57 million with a GAAP operative expense roughly $4.5 million higher due to charges for stock based compensation, amortization of acquired intangibles and other adjustments including severance costs related to today's distribution strategy announcement.

So to wrap it all up, we posted another strong quarter in terms of financial performance in our revenue, gross margins, profitability and cash flow generation. Meanwhile we have taken an important step to strengthen our focus on hosted service by expanding our two-tier distribution model in the U.S. and having ScanSource handle our direct VARs in the areas of distribution support and logistics an area which they excel at.

And finally, this earnings call would not be complete without mentioning our professional support team customers. We recently added the first place Colorado Rockies as a customer and I want to wish good luck to our customers that remain in the NBA and NHL playoffs that include the Boston Celtics and rising center home to the Washington Wizards in Washington Capital and of course my home team the Golden State Worriers.

With that, I'll turn it over to the operator for Q&A.

Question-and-Answer Session


Thank you. [Operator Instructions] Our first question comes from Greg Burns with Sidoti & Company. Please go ahead.

Greg Burns

Good afternoon Don. Could you please expand upon your thought process, the rationale behind the incentive or pricing concessions on the [indiscernible] side of the business and was that proactive on your part or reactive to anything that you are seeing in the market? Thanks.

Don Joos

Yes, I appreciate that Greg. Yes this is a choice that we had made, never happy to be dealing with single digit growth from a bookings perspective, so this was us thinking we will look at the last quarter and wanting to make a change and our change was getting more demand out of the market and under the ShoreTel umbrella. So we made a conscious choice to be a little bit more aggressive in the near-term and driving the volume of booked seats up we achieved that book on a year-over-year and probably more importantly on a quarter to quarter basis, I think a mid 30 range on that.

And yes we did recognize it going in that that would have a near term impact from a price point. The reason I was constable in there is, one is obviously getting more demand through us because from a cross sell perspective it creates more opportunities larger customers are typically have a lower churn and you have more opportunities from cross sell, from an application or additional services.

But I look at our most recent uptick in our cross sell activities predominantly being coming from the contract center application. So for us we believe there are opportunities then to cross sell into those accounts with additional services and thus bringing more revenue and improving the ARPU on that.

Greg Burns

Okay thanks. And then when we look at the guidance, typically I guess the last two years the sequential uptick in product sales was about $8 million into the fourth quarter the guide, you know I guess implying far less seasonality than that. What is your view on the seasonality we should expect from the product business going into the fourth quarter?

Don Joos

I think two things I would say in there, one is that we were pleased with where March quarter is traditionally or historically has been our weakest in the four quarters and that's where we have the seasonality impact and we actually had a good quarter and I'd say we were overall pleased just for the overall financial performance. So that contributes to a quarter-over-quarter view. But as our guidance indicates we do expect an uptick in the overall product numbers going into, that is the end of our fiscal year, so we do expect to see an increase. But we saw a healthier March quarter than we typically see. Mike do you have any other comments there?

Mike Healy

Yes the only other thing I would say is on premises product market is in decline including the synergy of 3% to 6%. We will continue to focus on moving towards hosted revenue. So that factors into our guidance as well as this quarter. Some partners may move over to ScanSource a little earlier and if they do that, there will be a little change in discounting volume is going to ScanSource, so that factored into the guidance range we gave as well.

Greg Burns

Okay, thank you.

Mike Healy

Thanks Greg.


Our next question comes from George Sutton with Craig Hallum. Please go ahead.

George Sutton

Thank you. Guys just a closer loop on the promotions, can you talk about whether this was targeted at new customers, was this targeted at existing customers that you're trying to get to migrate and have you ended that promotion or is that - is there some form of that ongoing?

Don Joos

Okay, George its Don. So, let me take there are a couple of parts in there, one is the promotions and the incentives that we ran in the March quarter. They were targeted at net new customers. So we were looking to get net new customers seats booked and so that was targeted there and as I said right we saw an outcome that we were seeking and we wanted which was a year-over-year and a quarter-over-quarter increase from that perspective.

The premise, the premise installed base migration is a different effort as I talked about is we actually saw in the quantity of customers, we actually saw a 71% increase in the number of customers on a quarter-over-quarter basis migrating, signing contracts to migrate, so we saw good success from there. But, as I said is I don't want to get content anywhere or be complacent. There are improvements that we're going to continue whether it's tooling, whether it's a process perspective or other incentives that I'm referring to just in our channel programs to drive more activity.

As it relates to the March programs around the new business, we are continuing most of those into the June quarter beyond the June quarter, I'll have to assess things at that point, but we are continuing those programs to drive more business from a hosted perspective in that June quarter.

George Sutton

Okay, I did a nice demo of your team work offering at Enterprise Connect and I wanted to understand how are you planning to offer that as, you are offering that as a standalone offering is that part of a combined sale, I'm curious how you're competing with the Slack and HipChat in that kind of an environment? Thanks.

Mike Healy

Yes, good question and we put that - that is not a standalone item that is bundled in to our existing profile. So what we're doing is we're adding additional value into those profiles in the marketplace. When I look at it from a UCaaS perspective I think some, others are probably in that approach also. Someone like a Slack I would say, that is their business so that's a standalone there. Most are bundling it into their existing profiles. We do that the same thing with video in our video collaboration and the reason we do that is really because it's all about the customer experience and how it's integrated into a broader UCaaS solution because teamwork is not really an independent application.

It can't be an independent experience. It has to be integrated into the overall UCaaS solution and for us it's our own intellectual property, so we have much more control over how that experience works.

George Sutton

Understand. Thanks guys.

Mike Healy

Thanks George.


Our next question comes from Eric Martinuzzi with Lake Street Capital Markets. Please go ahead.

Eric Martinuzzi

Yes, I wanted to go a little deeper here on the new distribution domestically, you talked about some of the cost – the benefits there on the cost side I think you sized them as $6 million to $7 million of savings, but then at the end of the day the impact here is going to be neutral to slightly positive. I'm wondering, if I'm from a revenue projection perspective is that to say that I should be pulling, something slightly less than $6 million to $7 million out of the revenue side as the counter point here because now those products and services are all being run through ScanSource?

Don Joos

Mike, you want to.. ?

Mike Healy

Yes, so that's I mean that's certainly what it implies Eric. But like I said in the prepare remarks we characterize that as a conservative estimate and it really depends what you're modeling for next year in terms of products and support and we do think with ScanSource's focus and they will recruit more partners to sell our ShoreTel Solutions, there is a good potential for upsides for those numbers and we're not going to commit anything today, but we're certainly expecting a good amount of increase from what we had predicted our outcome would be as ScanSource is focused.

Don Joos

Yes this is Don, let me chime in a minute. I think this is as we'd said we are ScanSource has a very specific focus here and they have the tools in place, they have the support infrastructure in place to support this channel community, they have their recruitment capabilities in place. And from my perspective what I like is right they're a publicly traded company, so they also work on this quarterly push as they have to produce their results out into the public market.

So what it allows is, it allows us to basically for lack of a better word, outsource to someone have been very, very focused on this area for us from a route to market and allows us to strengthen our focus on the innovation, the service delivery and our hosted program.

Eric Martinuzzi

I want to ask kind of a two part question on the competitive landscape, first just to revisit on the VAR bankruptcy. Last quarter you talked about adding a pretty substantial VAR reseller to your distribution network, but also I guess it's end of 20 calendar 2016 that the Genesys Interactive Intelligence merger or acquisition. Those two different events could you just kind of talk specifically to those two competitors if you're seeing changes in behavior there?

Don Joos

Yes I will touch on both of those. So as it relates to your question was to the VAR, we do continue to see interest coming in from the VAR partners, we have added some of VAR partners under the ShoreTel umbrella, I highlighted one in the last, the last call I was actually down at their headquarters in the March quarter at a very large events where they were bringing in all prospects and we had an opportunity to meet with all of them.

So it was a good go to market activity from that perspective. They are very excited and they're actually really starting to close deals for us, so it's good from that perspective. I would say from the Genesys and with the closing from Interactive Intelligence, I don't think that has had – we have not seen any material impact in regards to market activity or impact to our business. So that hasn't really been obviously we continue to maintain a pulse on the activities within the market, but haven't seen any cause of impact to us.

I would say the one announcement that has come out that we're probably seeing more activity on is really the Toshiba announcement as they're exiting the communications within the U.S. market and I believe, the reason I believe we see more activity there is because nothing much more definitive statement by them that they are exiting and so we have seen a lot more activity coming from that channel talking to us as well as just activities as it relates to the installed base.

So Eric when I think about it probably the VAR, yes I would say over the last 60 days we've seen definitely more activity just because of the definitive nature of Toshiba's announcement.

Eric Martinuzzi

Understand, thank you.

Don Joos

Thanks Eric.


Our next question comes from Dmitry Netis with William Blair. Please go ahead.

Dmitry Netis

Thank you, Don and Mike, just a clarification, I joined a little bit late, so I apologize if this was talked about in your remarks. But on this strategic agreement or continuation of the agreement with ScanSource, is that only covering direct, I'm sorry premise type business or does that include Cloud and if it does include Cloud, what is the situation there on the direct sales side of things, are you going to continue to sell Cloud direct and push it through the ScanSource as well or what sort of – how is that going to work just if you could help us understand that?

Don Joos

Yes, not a problem Dmitry, it's Don. So the announcement about expanded relationship, I mean overall it's really just another important step in the broader transformation of our business. What it is, is the channel partners who were on a single tier they were buying directly from ShoreTel for products for the onsite part of our business the premise. They are now will be moving under the ScanSource umbrella and they will be processing their orders through ScanSource that is where we get our operational efficiencies from the cost savings as well as from the working capital perspective.

As it relates to those VARs and when they are selling ShoreTel Connect CLOUD it's business as usual, nothing changes that does not go through ScanSource that will continue to work as it does today as they work directly with us. So the expanded relationship is specifically for our premise as it relates to the product and the support services.

Dmitry Netis


Mike Healy

Dmitry I would add ScanSource has acquired at least one of our partners that helps us with CLOUD business that is a pretty big volume for them.

Dmitry Netis

Understood. I appreciate that. How many VARs did you have to write that are moving over?

Don Joos

We had about, a little bit under 100 contractually moving over and about half of that were active with the significant amount of volume. But it is a good chunk of revenue because these were our largest VARs.

And some of the minorities are moving over on their own, so this is just again a natural evolution of how we wanted to manage our on-premise distribution strategy.

Don Joos

Yes, so Dmitry, I know you said you joined late, so again this was a couple of problem, but it's a better alignment to our overall global distribution so the channel experience is definitely more consistent. But I think the important thing is as we have all of that now through ScanSource and they're focused on the products for services, it strengthens our focus as it relates to the innovation to service delivery and the hosted growth and that's why it's the next important step in the transformation of our business.

Dmitry Netis

Understood and if I could follow up on the CLOUD, number one is how many channel partners are signed up, I think the last time you have given a number close to 350 or 400 channel partners that are selling your Connect product, is that has that improved and if it did, how many of those are actually contributing to bookings, not just sort of signed up as a partner, but also actually producing or is it 80:20 as usual or is it something else to talk to kind of the productivity of those channel, CLOUD VAR that you have signed up?

Mike Healy

So I will take it in a couple of parts Dmitry because I think from a U.S. perspective as we had said in the prepared marks over 90% of our CLOUD bookings comes through the channel. I would say the number of partners in the U.S. hasn't materially changed I would say in the last couple of quarters.

I think what's more important is that the contribution from the partners continues to expand now that we have our Connect CLOUD offering in the UK we're obviously getting more partners on a global basis signing up because in the UK we're not only getting our existing VARs, but we've got new partners under the ShoreTel umbrella that we didn’t have before and then in Australia we've already had 75% of the existing VARs already signed up in anticipation when we launched the Connect CLOUD offering in Australia later this quarter.

Dmitry Netis

And on the premise to CLOUD migration, I might have missed it if you said it so I apologize again, what was the total sort of contribution in terms of CLOUD bookings from that initiative alone?

Don Joos

Yes the premise to CLOUD migration has been relatively consistent at about 10% of our overall bookings. The important thing that we saw this quarter was we continue to see a material increase in the amount of customers, so we saw 71% increase quarter-over-quarter in the number of customers. This particular - that signed contracts to migrate. This particular quarter we happen to see the average seat size of those deals was lower than our cumulative average and that's going to move up and down as different parts in the installed base move, but for me the most important part was we did see a material increase in the number of customers and we're also implementing a variety of actions based upon our lessons learned because we really want to increase the overall pace of that migration.

Mike Healy

And as a reminder, yes I'm sorry Dmitry, this is Mike. As a reminder...

Dmitry Netis

No, go ahead Mike.

Mike Healy

Yes the average revenue pop we get the support we lose is still over 20 times for the cumulative program today.

Dmitry Netis

And you guys have a number and sort of plan where you want to drive that 10% it’s been sort of, I won't call it sluggish, but it sure seems like it because you've been doing it for now three or four consecutive quarters and it hasn't really changed and I appreciate the fact that customers are starting to migrate, so that may indeed indicate that there's a potential to move that number higher as the deals are up so get larger with those customers that you migrated over. But what is that number if you have that number it would be great to know what that percentage of total CLOUD booking that you're shooting for maybe for the next fiscal year or for the next couple quarters however you want to define it?

Don Joos

Yes, there are two ways I look at this, one is we're not necessarily looking at it as what percent of the overall CLOUD bookings because we obviously want to be growing on both sides of the equation here and that's, that's obviously a good scenario for us. Where we are looking at is the number of customers that are migrating and then the volume coming from that, that's just a number we have not put out from a public perspective at this moment.

Dmitry Netis

Okay and then maybe last one for me as far as the strategic view that was probably opening statement and if it wasn't can you give us any sense of what the timeline here looks like? I mean are you going to end it on sort of 12 months kind of time or was that going to continue further then the next quarter or the quarter we're in now and how we should think about that strategic process that is underway?

Don Joos

Yes, I mean as you can probably expect there's not a lot I can say as it relates to the strategic review process. We never set a specific timeframe around the process but at this moment there is just there's not a lot I can comment on at this moment as it relates to the process.

Dmitry Netis

Okay, fair enough. I'll cede the floor. Thank you.

Don Joos

Thanks, Dmitry.


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

Mike Latimore

Sure. Thanks, yes just on ScanSource so, what percent of product revenue roughly is moving over and then I guess assume with the cost reductions is there some headcount reduction there, how many employees are involved there?

Mike Healy

Yes, so I’ll it and let Don add what he wants to add. As you know ScanSource is public company and so we're not at liberty to give out that material information that is coming over to them. The good chunk of volume for us today, but I'll let them comment on that when they want to comment as appropriate because it does seems like its material information. And in terms of reductions, yes it was people reductions have been made in a few other areas in let's move warehousing cost is built into that $6 million to $7 million reduction and most of those actions have already been taken. They're going to be run rate as of this week and a little bit more starting July 1.

Mike Latimore

Got it. And then on just on just on the [indiscernible] but its, you’re seeing some benefit is that mostly on the premise side at this one.

Don Joos

Actually I would say so, when I look at from the via [ph] so the example that I was sharing earlier with Eric, so I was at a they are a large partner who have now signed on with ShoreTel. I was at their event with a lot of prospects in there. There's probably 75, 100 prospects at this event here and 80% of them are cloud. They were looking for cloud solutions, so although they were historically a premise partner for a buyer, what they are bringing in the marketplace is more cloud opportunities.

They also have installed base opportunities that are going to be looking for cloud solutions too. So that's what we're seeing from these partners here is the ability to bring net new cloud opportunities because that's the bulk of what they're getting from an opportunity right now as they work with us and leverage our a lot of our marketing programs to help them in the marketplace.

Mike Latimore

Yes and then I understand the solution for cloud, I mean are you think sort of maybe more movement on the, master agent or services distribution side of things are both of the VAR at this point or is this one getting any more momentum versus the other?

Don Joos

Yes, I mean we continue to see good momentum from our VARs, but when I look at the master agents and again you’re rising an important point because there's just two parts to that channel, there's the VARs and the master agents. We actually saw activity wise in the March quarter we saw a 64% increase on a year-over-year basis in the bookings coming from our master agents. So at the healthy increase that was coming from there. I think they, as the VARs we have the master agents will continue to be important part of our channel scale.

Mike Latimore

So I guess, you said 64% increase in bookings in master agents and then 7% total bookings increase?

Mike Healy

Yes total bookings in dollars was the 7% increase, the number of seats that we booked was 65% on a year-over-year pretty much that number on a sequential basis too.

Mike Latimore

And then in the past you have given a little bit of guidance on your Cloud revenue bookings growth throughout it, should we think of fourth quarter Cloud growth being to more of the third quarter Cloud growth let's say?

Mike Healy

Well again, Mike we gave the guidance on total revenue number and we don’t split out that guidance number between the products, but we are expecting increase in product revenue implied in the guidance as well as on the cloud number and typically support and services has been relatively flat over the last couple quarters. Those two were up in support and service flat if that helps you.

Mike Latimore

Last, I think the summit deal is some 200 bookings but any wins with some anything material there?

Mike Healy

No, we didn’t highlight, I mean we didn’t highlight, that's still part of like you’re correct in that they are not part of the bookings number just because of the nature of them they are right into the hosted revenue number. Overall, the overall business the summit is still a small part of that equation, so we just didn’t highlight it on this particular call.

Mike Latimore


Don Joos

Thanks Mike.


And this concludes our question and answer session. The conference has now concluded. Thank you for attending today’s presentation. And you may now disconnect.

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