Avaya Holdings Corp.
Q1 2020 Earnings Call Transcript

Published: 10 Feb 2020

[Operator:]

Greetings. Welcome to the Avaya First Quarter Fiscal 2020 Conference Call. At this time, all participants are in listen-only mode. A brief question-and-answer session will follow the formal presentation [Operator Instructions]. At this time, I'll turn the conference over to Michael McCarthy, Vice President, Investor Relations. Mr. McCarthy, you may begin.

[Michael McCarthy:]

Thank you. And welcome to Avaya's Q1 Fiscal Year 2020 Investor Call. Jim Chirico, our President and CEO and Kieran McGrath, our Executive VP and CFO will lead this morning's call and share with you some prepared remarks before taking your questions. Also joining us this morning are Anthony Bartolo, EVP and Chief Produce Officer and Shefali Shah, EVP, General Counsel.The earnings release and investor slides referenced on this morning's call are accessible on the Investor page of our Web site, as well as the 8-K being filed today with the SEC, which should aid in your understanding of Avaya's financial results. We will reference non-GAAP financial measures and specifically note that all sequential and year-over-year comparisons reference non-GAAP numbers, except where otherwise noted. We have included a reconciliation of such measures to GAAP in the earnings release and in our investor slides, which are available on the Investor Relations page.We make forward-looking statements that are based on current expectations, forecasts and assumptions, which remain subject to risks and uncertainties that could cause actual results to differ materially. Information about risks and uncertainties may be found in our most recent filings with the SEC, including our Form 10-K and subsequent Form 10-Q reports. It is Avaya's policy not to reiterate guidance and we undertake no obligations to update or revise forward-looking statements in the event facts or circumstances change, except as otherwise required by law.I'll now turn the call over to Jim. Jim?

[Jim Chirico:]

Thanks Mike. Good morning, everyone and thank you, for joining us. This morning, I'll provide you with highlights of our Q1 performance along with an update on the progress we've made on our strategic priorities. Kieran will then walk you through the details of the quarter and our outlook for the fiscal year, and then we'll open it up for questions.We got off to a strong start for the fiscal year. Our Q1 non-GAAP revenue was $717 million, above the midpoint of our guidance range, a positive reflection on our sales and operational execution. The composition of our revenue continues to reflect our deliberate and successful shift to a software and cloud-based business model. Notably, software and services, as a percent of revenue, increased to 86%, up from 83% the prior quarter and prior year. Also significant, our Cloud, Alliance Partner and Subscription revenue or CAPS grew to 18% from 15% in the prior year.The programs we've initiated to activate our base and to provide a seamless transition path for enterprise customers to consumption-based subscription and cloud models are beginning to gain traction underscoring the successful execution of our strategic shift. Consistent with our customer-led strategy, subscription provides customers with an accelerated return on their investment, the ability to flex license usage up and down, and allows for faster and easier access to new technology, which can simply be added to the subscription bundle. In fact, our subscription model was the contributor to growth of our CAPS revenue.Equally important, subscription contract secures customers into longer term agreements with Avaya. Below the line, our margin performance was above our guidance. Adjusted EBITDA came in at $174 million or 24% demonstrating our consistent top quartile operational excellence. Importantly, we closed the quarter with over $760 million of cash. Our profitability and cash position fuels our ability to invest in talent and innovation at levels most others in the industry cannot.During the quarter, we executed on our capital allocation actions as we committed. We paid down $250 million of long-term debt, which will deliver meaningful annual interest expense savings of approximately $15 million a year. I am also very pleased with the execution and overall success of our stock buyback program. We initiated our buyback on November 25 with less than six weeks left in the quarter. During that period, we repurchased nearly 11 million shares using $132 million of the $500 million our Board had approved for the program, representing approximately 10% of our outstanding shares in the market at the time.Now, let me shift gears and provide you with an update on our strategic priorities. We identified four key areas that we are executing on as we continue our momentum. We first focus on building private and hybrid cloud solutions along with the necessary services capabilities. Private and hybrid cloud uniquely tackles the many variables large enterprises have to consider, such as geographical reach, compliance and security, and application integrations just to name a few. Importantly, it allows our customers to evolve their core infrastructure with a stepwise approach that aligns with their very specific enterprise business requirements. Our private cloud offers including APCS and ReadyNow continues to gain traction. TCV now stands at over $660 million.Second, we extended the benefits of public cloud to our entire customer base with our all-in cloud initiative. We closed an important gap in UCaaS through our strategic partnership with RingCentral, which I'll talk more about in a moment. We are now focusing on CCaaS through our own cloud native development efforts. CCaaS remains on track for release in calendar Q3, our fiscal fourth quarter.Third, our new OpEx consumption models like subscription allows our customers to more easily take full advantage of our expanding set of cloud-native, micro-services, which drives further innovation and also provides new methods of collaboration through a variety of capabilities, including video, mobile, AI, and open APIs.For enterprise customers who are looking for a path to the cloud, subscription can provide a transitionary first step to an OpEx cloud model for many customers. Subscription also moves them to the latest release and gives them the ability to leverage their prior investments and customize business process flows. For our channel partners, they moved to a cloud customer success model that results in greater customer collaboration, the ability to up-sell and cross sell and increase consumption of value by the customer.Fourth, our cloud technologies which blend UC and CC are being used to power the digital workplace, including AI capabilities like virtual assistant, speech recognition, transcription, and behavioral pairing along with analytics and reporting. The combination of these capabilities are unique to Avaya and addresses our customer needs to recreate a more personalized and customized journeys for their customers.Now turning to Avaya Cloud Office. In the area of enablement, our internal sales teams have been fully trained, nearly 500 of them. On the partner front, we have certified dozens of partners. In last week at our Annual Customer & Partner Conference, Engage, we held multiple ACO training and information sessions with well over 700 partner personnel in attendance. In area of technology, we remain on track to release ACO at the end of this quarter. In fact last week, we showcased the demo version of the product and its initial feature set.Later this month, Avaya Endpoints will be available for auto provisioning, not only with ACO but as part of RingCentral's own RCO offering, providing another demand engine for our devices. Our initial launch will focus on the U.S. and will quickly expand to three additional countries in the next release cycle. Additionally, we've identified and prioritized exclusive Avaya features to incorporate into ACO that not only differentiates ACO from other UCaaS solutions, but also maintains the customer and user experience that the highly loyal Avaya customer base has come to expect.Lastly, on the go-to-market front. I can tell you that the momentum from master agent to SMB to enterprise companies for ACO in terms of pipeline growth is outpacing my expectations. By the time we launch, we will have five master agents in place and we already have 200 plus agents sign to complement our existing channel partner base. In fact, although ACO is not yet available, we have already had the opportunity to pressure test many of our sales and operational processes by conducting joint calls. These sales opportunities are indicative of the types of deals that Avaya and our partner base will aggressively pursue at launch.Let me give an example. In one such engagement, we had an Avaya install base customer who had evaluated several UCaaS platforms, and had chosen to move to a competitor. Upon the announcement of ACO, the account team was able to position the benefits and value of ACO and win back the customer based on the fact that they would have access to a world class UCaaS platform and thus, would remain an Avaya customer. There are many more examples where competitive threats to our base have installed as a direct result of ACO, all proof positive of the importance of having closed this gap in our portfolio.Now I'll share some key highlights and wins. In the first quarter, we added roughly 1,300 new customers, including over 110 competitive displacements. We signed 68 deals with a TCV over $1 million, including six over $5 million and three over $10 million TCV. Our total TCV is that approximately $2.3 billion consistent with our expectations.Let me give you a couple examples of the size, scope and significance of the deals we are signing. For a global insurance provider seeking to upgrade their existing Avaya infrastructure, we positioned our new subscription offer. The economics of the offer allows the customer to accelerate their modernization efforts flexibility allows them to easily add new technology like spaces collaboration. And for Avaya we were able to close a five year $25 million deal.And another Q1 win, we worked with a business services company that has over 100,000 employees to help streamline their communications infrastructure. We booked $20 million opportunity that simplifies their software licensing structures and provides them with a consumption based pricing and bundles the cost a future upgrades into a ratable master agreement across their six global regions.I'll wrap by thanking many of you on the call for joining us at Avaya Engage in Phoenix last week. This year’s Engage was our best attended and most successful customer and partner event we've ever had. Customer and partner feedback was excellent and the level of engagement as measured through attendance, feedback and the overall buzz at the event was beyond our expectations. By the numbers, there were approximately 3,000 attendees, 95 partner sponsors, 150 breakout sessions and nearly 100 press and analysts to help amplify our message.At Engage, we announced several solution offerings, including new capabilities for our cloud collaboration product called Spaces, AiRo, our new AI routing engine partnered with Afiniti and held a hackathon with Google and GitHub and included over 100 participants who used our communications platform as a service solution to create apps on the fly. This Engage was also different from prior ones, featuring heavy involvement from our ecosystem partners like Amazon, Google, Ring, Salesforce, Verint and Verizon, just to name a few. These partners drive scale, reach and accelerate our technology capabilities, while growing our addressable market and deliver additional value to our customers. Avaya Engage was truly representative of the momentum here at the company and a testament to the strength to reach of the Avaya brand.With that, Kieran will now take you through the details of the quarter, the mechanics behind our capital allocation and our outlook for Q2 and fiscal '20.

[Kieran McGrath:]

Thank you, Jim and good morning everyone. As a reminder, unless otherwise stated, all financial metrics referenced in this call are non-GAAP and the supplementary slides posted on our investor relations Web site set forth the GAAP to non-GAAP reconciliations. All figures mentioned in this call are as reported, unless otherwise indicated in constant currency.For the quarter, non-GAAP revenue was $717 million, compared to $748 million reported in the year ago period, which is equivalent to $744 million in constant currency. Sequentially, this compares to $726 million as reported in Q4 of fiscal 2019. Revenue results were at the high-end of guidance we provided during our last earnings call, driven by continuing growth in a number of clients looking to consume product content under OpEx models, whether it’d be for our on-premise or as a service offerings.While our subscription offering is still in its early phase, we have seen real enthusiasm from our customers. We believe it will enhance the stickiness of our solutions and act as a first step for many of our customers who are interested in migrating to the public and/or private cloud.As we discussed during our fiscal year end call, we're expanding upon the cloud KPI that we have historically utilized to measure our success in the transformation of our business to the cloud, as well as our ability to reduce our dependence on premise-based perpetual licensing models. Therefore, we're enhancing this metric with a new KPI, which will measure the total revenue contribution of cloud, combined with the revenues from our strategic alliance partnerships and subscription revenue or CAPS for short. The revenue contribution from CAPS represented 18% of total revenue for Q1, up from 15% for the full year fiscal 2019.First quarter product revenue was $298 million, compared to $326 million in the year ago period. There are two dynamics at play here. Firstly, we witnessed our strongest contact center quarter in the first fiscal quarter of 2019, which contributed to a very difficult compare. This was due primarily to a very large deal that we closed with the European bank. Secondly, we continue to experience headwinds to our UC business. This has been driven by the lack of a robust UCaaS offering, which now will be fully addressed with the availability of Avaya Cloud Office or ACO, which is planned for release in the U. S. at the end of March, our fiscal second quarter, followed by several more countries in the second half of our fiscal 2020.First quarter services revenue was $418 million, relatively flat when compared to $422 million in the year ago period. Growth in revenue generated by our subscription offerings almost entirely mitigated the declines in hardware maintenance and software support.Turning to gross profit metrics. Non-GAAP gross margin was 61.4% in the first quarter compared to 62.7% in the year ago period, sequentially up from 60.6%. Non GAAP product gross margin was 65.1% compared to 65.6% in the prior year, sequentially up from 64.4%. Non-GAAP services margin was 58.7% compared to 60.4% in the prior year, sequentially up from 57.7%.Turning to total profitability margin and cash flow metrics. First quarter non-GAAP operating income was $151 million, representing a non-GAAP operating margin of 21%, year-on-year down 160 basis points, while adjusted EBITDA was $174 million, representing an adjusted EBITDA margin of 24%, down 100 basis points year-on-year and consistent with our guidance for the first quarter.Recall that in our fourth quarter of fiscal 2018 earnings call, we highlighted that in fiscal 2020 we were planning for a one point reduction in our adjusted EBITDA margin as we increased our investments in our cloud go to market, cloud development and in bringing the ACO offering to market.Further, we generate $12 million in cash flow from operations or 2% of total revenue. If we exclude the one time payments related to the strategic process, which we completed in October of 2018, our cash flow from operations was $58 million or 8% of total revenue. During the quarter, adjusted for the one time payments we referenced above, free cash flow came in at $32 million contributing to a first quarter ending balance of $766 million in cash and cash equivalents on our balance sheet.Before moving on to our second quarter guidance, I'd like to spend a moment expanding on our capital allocation strategy and specifically on our execution against the previously announced share buyback program, which was approved by our board of directors in October 2019. As a reminder, we launched an open market repurchase program utilizing a 10B5-1 in late November, following our fourth quarter fiscal 2019 earnings release.As we have said, we believe that this construct from its flexibility to transact in the market during quiet periods and allows us to be opportunistic from both a volume and pricing perspective, which has resulted in the swift pace of our execution. As Jim mentioned, we bought back approximately 10% of our outstanding shares of the company in less than six weeks. In the first quarter, this equates to 10.7 million shares and a settled a cash cost of approximately $132 million in the aggregate and at an average price of $12.27 per share.In fact, you'll note that our outstanding common stock as of January 31st, which will be reported in our 10-Q filing later today, reflects a reduction of approximately 16 million shares since our last filing or an incremental 5 plus million shares we purchased in the month of January alone. We believe this fast start positions is very well in achieving our guidance objective of buying back $400 million worth of shares in fiscal 2020 under the total board approved $500 million repurchase program. In terms of the debt pay down, as a reminder, $250 million was deployed in November to pay down our long term debt. This will generate an estimated $15 million of annualized ongoing cash and expense savings.Now turning to guidance. Please note that all year on year revenue changes are expressed on a custom currency basis, and all revenue amounts reflecting rates as of December 31, 2018. As a reminder, historically, our second quarter revenue compared to our first fiscal quarter revenue represents a mid single digit decline sequentially as seasonally the second quarter is normally the lowest quarter of the year.For the second quarter, we anticipate non-GAAP revenues of $675 million to $700 million, representing minus 5%five to minus 2% annual decline as measured in constant currency. This quarterly range is wider than normal due to the fluidity of the corona virus situation in China. While the size of our revenue generated in China is relatively small when compared to the size of our global business, there is the potential that the current health crisis could have an impact on the closing of current quarter transactions within our China operations.Regarding the supply chain side of our operations, we expect no material impact this quarter as we have adequate supplies in place and we have been developing alternate sources of supply. Similar to the first to second quarter revenue seasonality experienced this year, non-GAAP operating margins and adjusted EBITDA margins are generally at their lowest point each year in the second fiscal quarter. This has been the case in seven of our last nine years.This is driven by a handful of annually recurring factors. Firstly, revenue is lower in the second quarter due to the seasonality highlighted above. Secondly, annual employee social taxes, the employer matching and employee benefit increases kick in during the first calendar quarter of each year, especially in the U.S. Thirdly, two of our largest marketing events Avaya Engage and Enterprise Connect take place in the first calendar quarter of each year.Additionally, this year we had the added expenses associated with the ACO launch as we ramp up our sales, marketing and R&D investments in anticipation of the ACO product launch in the U.S. in late March. Accordingly, we expect non-GAAP operating margin for the second quarter to be between 17% and 18% and our adjusted EBITDA margin to be between $140 million and $150 million dollars or approximately 21%.Now turning to the full year guidance. When we began fiscal 2020, we expected that the first half of the fiscal year would have a revenue profile in terms of year-on-year growth performance that would look like the performance we experienced for full year fiscal 2019, which was down low to mid-single digits on a constant currency basis across the quarters. For the second half of fiscal 2020, we expected that with the availability of the ACO and the ramping of the ReadyNow and subscription offerings that we would experience revenue that was flat to modestly up on a custom currency gross basis. We believe that this continues to be the case.As such, we are reaffirming our expectations for full fiscal year 2020. Non-GAAP revenue is expected to be flat to down minus 2% on a constant currency basis. As at foreign exchange rates as of December 31, 2019, this translates to non-GAAP revenues between $2.84 billion and $2.92 billion. Additionally, we continue to expect that the adjusted EBITDA margin for the full fiscal year is expected to be between 23% and 24%.We continue to expect cash flow from operations for the fiscal year to be 5% of revenue or 7% when adjusted for the one-time strategic deal payments that were made in the first quarter of fiscal 2020. With $200 million already spent through January on the share repurchase program, we expect our weighted-average outstanding shares to be between 93 million and 97 million shares and the outstanding share count to be between 80 million to 83 million shares at the end of fiscal 2020.Now before I turn the call back to Jim, I want to give a brief update on the status of the large SSA deal that had been awarded to Avaya that is currently under appeal. While we continue to be very optimistic on the final outcome of the Social Security Administration Award appeal and expect to learn the outcome of the appeal sometime late in Q2, given recent experience and been abundantly cautious, revenue generated from the SSA award in question is excluded from our Q2 guide, although, it is still included in our full year expectations.With that, I'd now like to turn the call back to Jim. Jim?

[Jim Chirico:]

Thank you, Kieran. Before opening the call for Q&A, I would like to close by highlighting that Avaya continues to strengthen our portfolio of offers across UC, CC and collaboration to expand our total addressable market. We continue to execute to a purposeful and deliver technology roadmap. We are committed more than ever to a customer-first model and we've never been better positioned to empower our customers to customize and extend their communications infrastructure.In closing, I'm extremely pleased with the significant progress we've made on executing on our strategy. We remain focused on our core enterprise base. We've invested in and delivered blended UC and CC communication solutions, leveraging our NextGen all-in cloud portfolio. We will continue to differentiate with our world-class services in our unmatched scale and breadth. We will stay the course. We will continue to invest to deliver the technology, the solutions, the applications that deliver the experiences that matter. Great to see the momentum that’s building in 2020, and I remain bullish on our long-term growth perspectives.With that, operator, we're ready to take questions.

[Operator:]

Thank you [Operator Instructions]. First question today is from the line of Lance Vitanza with Cowen. Please proceed with your question.

[Lance Vitanza:]

I actually wanted to ask you about Spaces for enterprise. I don't think that that's been discussed much up to at this point. And I'm wondering if you could sort of -- I was one of the people that saw it out at Engage and thought it seemed pretty interesting, but could you talk a little but about the genesis of this product and whom you expect to target, and any thoughts on how wide in circulation we could be talking about if it goes well?

[Jim Chirico:]

Lance. It's Jim. Thank you very much. A couple of things. So, one is we've actually been working on a collaboration platform, i.e. Spaces for the last couple of years. In fact, we actually acquired a lot of the technology a few years ago. And over the last, I'd say 12 months or so, we've actually invested quite a bit in it. The real key here for us is we needed a platform that we could provide to our customers around basically meeting and sharing and providing, again that collaboration capability.We see this fitting into a number of different opportunities for us. First of all, a number of our large enterprise customers who use prem view it as a great enhancement to the productivity of their companies, also in areas like private cloud, assets on books, and equally as important with our new subscription offer, we see an excellent fit for the Spaces application. We'll also take a look frankly as providing it as sort of a collaboration platform for the company, a little bit more work to do on that piece of the business, but we clearly see a large opportunity across, if you will at least our mid-market and enterprise customers today.

[Lance Vitanza:]

And just as a follow-up then, I mean, is this something that you think will be more likely to go to your existing customers as sort of an additional feature or product or do you use this -- could this be the tip of the spear to get you into new customers?

[Jim Chirico:]

Initially, we're really focusing on providing the capability to, if you will, activate our base. We've not had the platforms and the product set in the past, but most of the releases that we announced last week in Engage, and in fact even their relationship with Ring on Avaya Cloud Office is really around being a customer-led company and really providing the technologies that our customers want and activate and therefore grow their overall base. So, we've spent a lot of time over the last couple of years making sure that we sort of fortify and expand our positions with our current customers.Do I see it as a potential where we -- from a Greenfield perspective, the answer is yes. Now, there's some further developments for Spaces that we will make through the balance of this fiscal year, and I think we'll be in a better position later on in the fiscal year to take it if you will and really move to a Greenfield position. I think also important is it's built on our CPaaS solution, our communications platform as the service. So again, bringing more technology into our portfolio based upon the investments that we made.I'll also point out that last year we invested roughly $100 million more than we had in previous years on innovation. And as we pointed out this year, we're going to take a 1%, if you will, impact to the overall EBITDA of the company to continue to build out not only innovation aspect of the business, but also the go to market as we move more and more to cloud.

[Operator:]

Our next question is from the line of Raimo Lenschow with Barclays. Please proceed with your question.

[Unidentified Analyst:]

This is Mike on for Raimo, just a question on the CC side of things. I wanted to -- wondering if you could kind of double click and talk a little bit more about the development there of the cloud offering. I know you said you're expecting a release in fiscal Q4. And then can you also maybe touch on the relationship that you guys have now with Google Cloud that you’ve touched on at Avaya Engage, go into a little more detail there on like what Google Cloud can bring to that offering?

[Jim Chirico:]

So, this is Jim. I will kick it off and then we're here with Anthony Bartolo, our EVP of Products and he'll add a little bit more color. When we looked at our strategic process roughly about 12 months or so ago, 12 to 18 months or so ago, we kind of scanned the landscape and really determined that from a UCaaS perspective. It really made sense for us to go off and do some form of partnership. But because of our market position, our leading market position on contact center and the experience that we had within our R&D organization on CC that we're going to go and develop a cloud native, if you will, solution on contact center.So, we've actually been at this, and really the acquisition of Spoken was really sort of if you will spearheaded the opportunity for us to go and drive that development, so we've been at it for a while. We will come out with our iX-CC/CCaaS solution by the end of our fiscal year. And we believe at least we'll have an initial release on that probably sometime next quarter. So, we've already gotten some positive feedback as we've worked with a number of our key large enterprise customers.We have about 12 of them right now that we're working with to bring this solution to market by the end of our fiscal year, so we're pleased with our efforts. Obviously, the opportunity with Avaya Cloud Office has also allowed us to focus and invest more on the CCaaS space, which we have certainly done, and I'm pleased with the progress and where we are with our development milestones to-date, and I would say that we're certainly on track. As far as Google, I'll turn it over Anthony and maybe Anthony can add a little bit more commentary around where he sees us on our CCaaS solution that we're bringing forward.

[Anthony Bartolo:]

The other thing I'd probably add Dave is that journey for us is already started with iXCC. It's coupled with our workspaces agent desktop solution, which is also delivered from the cloud and is sold today. You couple that with our iXCC solution it will give our customers the option to either deliver their solutions on cloud, public or private. And in hybrid situations, which will be the predominant deployments that we're going to be seeing in the contact center space. Given that the contact sensor is so tightly coupled and intertwined with the customer’s business processes, the hybrid solution will be the predominant sort of deployment path.And we're seeing a lot of really good interest from on this particular solution as we saw at Engage last week. So we’re well on the path there and actually some of the customers have really, as I’ve mentioned little earlier, the customers have already begun that journey, because they've deploying workspaces already, which is a key part of the solution.The Google CCAI activity that we're probably the most deeply integrated of Google's partners on the on the CCAI solutions. So that is something that has gotten a lot of attention. Our AI portfolio in shops has increased tremendously at least from what I can tell being here at the short tenure over the last probably two to three quarters. We've got a series of other partners as well that we work with, as well as homegrown AI, which is integrated throughout the portfolio.So you'll see us really put a lot of energy behind the AI, conversational AI parts of the portfolio, because our customers are looking for very customized journeys within their product roadmap, but customize as their end customers come into the interactions with their companies. So you will see a lot of energy in that space. And given the base that Avaya has, you'll see a lot more of us having a conversation around that with you guys over the course of the next two to three quarters.

[Jim Chirico:]

Just to close out, we've actually done a fair amount of work on really building AI back into the contact center, whether it’s the virtual assistance, speech recognition, transcript as Anthony mentioned, have already we announced an enhancement of the behavioral pairing with Afiniti last week at Engage. So we take a look at our overall contact center solutions. We've greatly enhanced the AI capability across the board. And our customers are receiving that and are very, very pleased with where we're positioned and more importantly where our roadmap is as continue to build out additional capabilities.

[Operator:]

Our next question is from the line of Nandan Amladi with Guggenheim Partners. Please proceed with your question.

[Nandan Amladi:]

So as you've shifted your our emphasis to subscription, how dramatically have you changed your R&D budgets and also your sales compensation structure to become more subscription friendly?

[Jim Chirico:]

This is Jim, I'll start and I’ll turn it over to Kieran to provide some insights. But from an overall R&D budget perspective, I wouldn't necessarily call it a significant shift in our R&D budget. It's really an opportunity for us to offer that subscription/OpEx service to our overall customer base, really driving enhancements to sort of the cloud native micro services around video, mobile, AI, APIs, et cetera. As far as our sales comp, we have shifted in turn our sales comp but more emphasis on driving SaaS oriented solutions across the board with the company, whether it’d be subscription or be it cloud and that’s consistent with the market.

[Kieran McGrath:]

So maybe just to clarify Jim's initial comment, I think a lot of the changes and an increased investment that we put over the last year to 18 months as it relates to cloud is beneficial here. We see even if the customer decides to stay with an on-premise solution, we see this as a real gateway or real opportunity to step in toward the cloud whether its private cloud, public cloud or whatever. As Jim pointed out, we pay a premium for cloud and subscription offering. So our sales teams are absolutely incented and I would say, actually heavily incented to sell recurring revenue overtime.

[Jim Chirico:]

And as we mentioned, we announced the subscription in September timeframe in 2019. In the last quarter, we signed $25 million deal since the first quarter since we announced it. So again the enthusiasm from our customer base and more importantly our partner base, and giving them yet another opportunity to go sell and activate the base so it initially is actually quite exciting. So we believe that we will see a lot of our revenues being driven, not only from our direct channel but also through our partners, which is again exciting as it opens up new opportunities for us.

[Nandan Amladi:]

And a quick follow up on the new CAPS metric moving from 15% to 18%. What is that now made up of, because ACO hasn’t kicked in yet?

[Kieran McGrath:]

So as we pointed out in our last earnings, Nandan, clearly we have our public private cloud, which were always the key underlying components of it. We talked about enhancing for our strategic alliance partnerships and you've heard Anthony and Jim talk about a couple of them today and we talk about Google and Ring obviously, which as you're right you don't have an ACO offering out there yet that comes later in the quarter. But we have some longstanding relationships with other companies like Afiniti and Verint, Nuance, et cetera that are in that. And then obviously there is also some minor benefits from subscription in there as well.

[Operator:]

The next question coming from the line of Meta Marshall with Morgan Stanley. Please proceed with your question.

[Meta Marshall:]

Maybe first question sort of going back on CAPS, you know you’d mentioned after the announcement of ACO deal that you would see kind of a long-term target of that of around 30% with it being that 18% already, how does that change your perspective on where you think that could go? And then maybe just a quick question on the cash conversion maybe seems a little bit low in fiscal ‘20 and I know clearly you have the RingCentral prepayment in there. But are there any other factors that we should be mindful of? Thanks.

[Kieran McGrath:]

Yes, so first of all, I'd say that even though the intent of the CAPS metric is to really more completely represent recurring, there are elements of point in time revenue within that, especially with some of our strategic partners where you take the revenue at a point in time if our portion of the performance obligation is done. So even if I looked across last year, we could see couple of points change in any given quarter just due to the timing of some of our partnership revenue. So I don't really see anything and we're pleased with the start that we had for the year, but you know I still see us driving to that 30% as we talked about over that long return objective.As it relates to this year’s guidance, I think what we talked about, we expected two things would impact. If you recall last year we had about 8% of our revenue was CFFO. This year, we really called out 5%. If we adjusted it for the one time transaction fees associated with the strategic process, which were paid in October of last year so in our first fiscal quarter, that number is about seven points. The reason we're declining a point is really due to the fact that we actually were reinvesting one point of EBITDA margin back into business this year.

[Operator:]

Our next question is from the line Rod Hall with Goldman Sachs. Please proceed with your question.

[Unidentified Analyst:]

This is Ashwin on behalf of Rod. I just want to ask about the guidance or implied guidance for fiscal second half. Looks like your revenue and EBITDA guidance implies better than better fiscal second half performance than what we saw last couple of years. So just from a timing perspective, when should we expect to see like a positive deviation in revenue and EBITDA versus historical seasonality? Any color you could give there will be helpful. And sort of related to that, how should we think about the size of CCaaS contribution in fiscal Q4?

[Kieran McGrath:]

So if you think about as we said, we expected that the second half of the year would see just with the guidance that we’ve given you be flat to modestly increase. Clearly, we will start to ramp ACO in the second half of the year, as well as the ReadyNow revenue, we've been talking about that for quite some time and we'll start to see a pretty significant increase second half versus first half for ReadyNow.Also as I alluded to the fact that the Social Security deal, which we really feel very strongly about, still should be a second half event. And then finally, we should also see some continuing contribution from subscription business. So while seasonality, our second and third quarters seem to be a little bit like each other, I would expect that our second half of this year, we’ll see a stronger fourth quarter and a modestly improved Q3 as well.

[Jim Chirico:]

This is Jim, on the contact center CCaaS solution. I don't expect to see much revenue this fiscal year in fairness. We will bring the solution out in the fourth quarter and that ramp and go throughout 2021.

[Unidentified Analyst:]

Just to follow up on ACO, Jim, I want to check if you guys are planning any sales compensation, further sales compensation structure changes to incentivize the base, any comments there?

[Jim Chirico:]

No, I mean, obviously, from a partner perspective, we have our edge programs that we have in place as we look through sort of, if you will, our master agent network. We've been at this now because we announced it back in October. It will be consistent with where the industry is, but I don't see it at this particular point anything other than as we run our quarterly programmatic and such, but I don't see anything that's with very much from what we have in the process today.

[Kieran McGrath:]

And clearly as we alluded to before, our own sales teams are highly incented to drive ACO, as well as any of our other cloud initiatives.

[Operator:]

The next question is coming from the line of Asiya Merchant with Citigroup.

[Asiya Merchant:]

At a high level, I just want to talk about the KPIs that you're talking about now within cloud. It seems like from the commentary the shift was primarily driven by customers moving from on-prem to more like a OpEx driven model. As you think about transition to that 30% goal that you've outlined over the next three to four years. How should we think about EBITDA margins moving as you guys make that transition, especially given you guys talked about incentivizing your go-to-market, your partners and your sales force more heavily towards shifting from the perpetual licensing to the subscription model? Thank you.

[Kieran McGrath:]

So you may recall in some of the discussions that we've had some of the past earnings calls. We actually believe that short-term through a combination of some of the investments that we have to make to bring ACO as well as our CCaaS offerings to market, as well as just some of the transition itself that there would be some short-term headwinds to our margins. But that over time, as we scale, especially as we scale something like ReadyNow, which is really highly dependent on getting some scale that we would start our see our margins increase from the 24-ish percent level that we're at as we close last year up to as much as 27% to 20% over time. So tactically practically being this year probably next year as well relatively muted. In fact on our EBITDA margins overall but overtime as we start to scale them, we would expect to see more favorable bottom-line.

[Operator:]

The next question is from the line of Michael Latimore with Northland Capital. Please proceed with your question.

[Michael Latimore:]

In terms of the services revenue growth in the quarter, the growth rate improved throughout the last several quarters and it sounds like ReadyNow hasn't really kicked in a big way yet, but I'm just trying to figure out a little bit more what was driving improvement in the service in the quarter?

[Kieran McGrath:]

This is Kieran. I'd say there was a couple of elements here. First and foremost, our professional services business actually showed some improvement both sequentially, as well as versus last year. As Jim has you pointed out, we believe that our APS business is a key differentiator for us as we work with many of our customers to help implement their very heavily customized solution. So APS was a help. The other thing and as I pointed it out was, we were able to mitigate some of the, I'd say, planned decreases that we would experienced from a GSS perspective from our hardware maintenance and software support, as more customers were actually starting to convert over to the subscription model as well. So many of these customers we’re able to take them instead of losing them from a maintenance perspective, actually convert them on subscription. So that helped mitigate some of the decline there. I'd say at a high level, those are the two really big items.

[Jim Chirico:]

I'd just add to that, Mike, that subscription is key in a number of fronts but obviously with our maintenance business even though we have long-term contracts it provides an opportunity for, if you will, yearly updates. As with subscription, those are three to five year deals sort of locked in if you will, so better predictability in the business, obviously better recurring revenue stream. And as Kieran pointed out we did see an uplift obviously with the first quarter that we had it out from a product perspective, additional revenues associated with subscription. So that worked closer with our customers building that loyalty, exclusivity if you will, in with those longer-term subscription contracts actually is a real benefit for the company.

[Michael Latimore:]

And then just on your CAPS business. Is the EBITDA margin there, is that sort of below corporate average now, in line, above, sounds like it’s going to improve overtime? But like where is it now relative to corporate?

[Kieran McGrath:]

I would say that it can vary depending on which are the partners that we're booking a transaction in any given quarter. You know right now I would say that as a whole, it’s probably running under the corporate because there is a lot of investment that is taking place in there even from a cost, as well as expense perspective.

[Jim Chirico:]

And I would agree with that, bear in mind a fair amount of that today is really off of our Avaya private cloud services, which from an overall margin and EBITDA perspective is lower than average. But as we start to improve sort of the revenue construct as we move more to Avaya cloud office and as we move more to subscription, you will start to see that change as we move on. So I would agree with Kieran.

[Operator:]

[Operator Instructions] Our next question is from the line of Hamed Khorsand with BWS. Please proceed with your question.

[Hamed Khorsand:]

First off, what kind of reaction you've seen from the current install days as far as you know pushing out potential contracts or maintenance contracts given…

[Kieran McGrath:]

You’re breaking up a little bit. Could you repeat the question?

[Hamed Khorsand:]

What kind of customer push outs or questions are you getting as far as delays in purchasing when it comes to Avaya Cloud from the current install base?

[Jim Chirico:]

This is Jim. Actually, we're not seeing any push outs, if you will, in buying behavior in fairness. We obviously don't and haven't had an offer in the market, the offers coming out obviously by the end of this quarter. What I can tell you what we are seeing is we are seeing as we now presenting this to our partners and we've actually communicated this throughout our ecosystem, if you will, in fact when we were at Engage last week, we trained a number of our personnel. We have over 500 Avayans trained and we had 700 certifications we gave out at Engage last week, so really a lot of momentum.What we are seeing though is we are seeing from a competitive perspective where deals were, if you will, in the pipeline to move to our competitors. In fact, those have indeed been installed. If you're an Avaya customer, you've been an Avaya for years, obviously, you don't have any real desire to move and bring someone else into your structure but without an Avaya offer obviously it was free gain. What we've seen with ACO now is the fact that folks do want to stay with Avaya. We now have a competitive offer to Avaya Cloud Office. We're bringing the best technology in support of that. And we're seeing folks now waiting to move to ACO when the product is available at the end of this quarter, which is actually quite exciting.So we're pleased with the momentum. We're pleased with the backlog that we have. We're pleased with the product and how it's progressing through the sort of the R&D process in order to provide that differentiation and uniqueness that Avaya brings to the marketplace. So we're not seeing it’s at all. In fact, just the opposite, I would say stalling others and eliminating others as people stay on the Avaya platform.

[Anthony Bartolo:]

It’s Anthony, just to add to that a little bit. I think what we've seen is we’ve seen a portfolio now that is actually activating in the space. So it's not delaying as much as now starting to have an engagement conversation with the customer on a base that is obviously quite nice and we believe it's readily available for a path to a cloud or a consumption model conversation and that's what we're seeing.

[Operator:]

Thank you. At this time, we've reached the end of our question and answer session. And I'll turn the floor back over to Mr. McCarthy for any closing comments.

[Michael McCarthy:]

Thanks Rob and thanks everyone for joining us this morning. If you have any additional questions, please feel free to follow up with my office. We'll be happy to tackle them for you and look forward to seeing you at the different conferences and enterprises connect as move to the next reporting period. Thanks very much.

[Operator:]

Thank you. This will conclude today's conference. You may disconnect your lines at this time. Thank you for your participation.