Avaya Holdings Corp.
Q1 2022 Earnings Call Transcript

Published: 9 Feb 2022

[Operator:]

Greetings, and welcome to the Avaya First Quarter Fiscal Year 2022 Earnings Conference Call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host Mike McCarthy. Thank you, Mike. You may begin.

[Mike McCarthy:]

Thank you, Paul. Welcome to Avaya's fiscal 2022 first quarter investor call. Jim Chirico, our President and CEO; and Kieran McGrath, our EVP and CFO, will lead this morning's call and share with you some prepared remarks before taking your questions. Joining them this morning will be Stephen Spears, our Chief Revenue Officer; Todd Zerbe, our Senior Vice President of Engineering; and Dennis Kozak, Senior Vice President of Strategic Operations. The earnings release and investor slides, which include highlights of our ESG initiatives and performance referenced on this morning's call are accessible on the Investor page of our website as well as in the 8-K filed today with the SEC. These should aid in your understanding of Avaya's financial results. All financial metrics referenced on this call are non-GAAP with the exception of revenue. We have included a reconciliation of such non-GAAP metrics to GAAP in the earnings release and investor slides. We may 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. In particular, the global economy continues to be impacted by COVID-19 and the extent of its continued impact on our business will depend on a number of factors that include, but may not be limited to, the virus' severity and duration, the emergence of new variants, changes in infection rates, the vaccine participation rate, the effectiveness of vaccines and the speed with which the vaccine can be distributed as well as regulations and requirements impacting the return to our offices and our ability to visit customer sites and actions taken or not taken by governments, businesses and consumers in response to the pandemic, all of which continue to evolve and remain uncertain at this time. Information about risks and uncertainties may be found in our most recent filings with the SEC, including our Form 10-K and our Form 10-Q. 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 Chirico:]

Thanks, Mike. Good morning everyone and thank you for joining today's call. This last year was an important one for Avaya. If I take a step back to reflect, I would characterize it as a continuation of a multi-year journey and one of accelerated transformation for the business. And it's clear that we are in a stronger position than when we started. I give our team a lot of credit as they have executed on the company's three value drivers and have remained focused on solidifying our business for our long-term success. Entering this fiscal year, we have successfully navigated a period that is best characterized by high volatility and unpredictability. And despite this extremely dynamic business environment, we've made steady progress on our objectives and strategy. Over the last two years, we've gained new insights about our customers, their needs and seen their expectations and behaviors evolve. The future is currently moving in our direction and we are fortunate to have so many assets to leverage. Overall, I cannot be more pleased with the momentum of our business. So when I look at our first quarter results, while we made progress on our key cloud objectives, which I'm quite proud of, our top-line results and profitability were below our expectations, primarily pressured by two temporary dynamics. First, the mix of content and the final deal terms of some contracts did result in a delay of revenue recognition. One example is a significant multi-year Avaya OneCloud public CCaaS contract we won with a large global financial services company. This deal is roughly $400 million over a seven year life of the agreement. It is significant not just because of the size of the deal, one of the largest in the history of the company, but also because it leverages a significant number of our latest innovations, including AI, biometric security and advanced analytics, and represents a displacement of several incumbent competitors because of the nature of the CCaaS deal we were unable to recognize revenue we had assumed would be realized in Q1, which will now materialize beginning in the second half of FY 2022. Second, with respect to the environment, there was no doubt it caused to pause. The fact is that many of our customers, especially in the U.S. and Western Europe were in lockdown and commercial activity simply slowed at the end of the quarter. And as a result, the necessary approvals and contracting activities with many of our customers stalled. What’s important to note is that these deals were not lost and projects have not been canceled, but we did see a number of deals slip by a few weeks, many of which have since been closed. While it is not unusual to see deals push and pull at any given quarter, the magnitude in Q1 was amplified. It is clear that demand remains extremely strong as evidenced by our continued traction with new logos, where we signed over 1400, this quarter. Success with large deals where we signed over a 100 greater than one million TCV for the seventh consecutive quarter. And importantly, with the increase in Avaya cloud bookings for private and public solutions, which grew 31% year-over-year. These are proof points that the underlying fundamentals of our business remain strong. And I am more pleased with the progress on the key KPIs for our business, including One Cloud ARR. Cloud revenue, hybrid subscription growth, and continued enterprise traction improvements to these areas, validates that the investments we are making and transitioning to cloud invests are yielding the desired outcomes. Let me expand on our progress in each of these key areas. Avaya OneCloud™ ARR is our most significant metric and represents the combination of our entire hybrid, private and public cloud portfolio. We added another $90 million to ARR during the quarter, up 17% sequentially and 137% year-over-year ending at $620 million. We remain well on track to meet our $1 billion ARR target at the end of calendar 2022. And Kieran will take you through our increased ARR guidance. The growth in ARR is driven by several factors. First, is our contact center business, which continues to represent approximately 60% of total ARR and grew nearly 130% year-over-year, further proof of our leadership in CC. Second, is the underlying momentum from our enterprise segment, which comprise is 95% of our total ARR. And third, is the adoption of innovation by our customers. The bundling of additional value into hybrid cloud subscription offers through adding innovation, such as Avaya Spaces, cloud contact center AI, Avaya Conversational Intelligence and our cloud notification service, among others is helping to fuel our ARR growth. In fact, if you take a step back and look at our hybrid subscription deals on average, we are seeing a 20% uplift in total contract value. As we migrate customers off their maintenance models. Our investments and innovation will remain strong. We have invested a lot and we are not slowing down because our customers are looking to Avaya to help them improve their customer workforce experience. Our technology along with the scale at which we can operate is a competitive advantage for us. And the investments we have made are clearly showing dividends in the form of ARR growth up from $262 million to $620 million in just one year. Kieran will provide additional color on our financial performance and outlook in just a few moments. But before I turn it over, let me share some highlights from the quarter. Our strength in the enterprise sets us apart from all others in our peer group. And overall, large deal volume remained consistent with the prior six quarters. We signed 108 deals greater than $1 million TCV, nine deals were greater than $5 million, six greater than $10 million and we had two over $25 million TCV. To us, these deal sizes emphasize that customers are voting with their wallets committing to large, strategic, multiyear contracts that align their business needs with Avaya’s technology roadmap. In addition, we once again signed a significant number of new logos well over 1400, reinforcing the competitiveness, differentiation and value of our solutions. Turning to subscription hybrid. Within our ARR and CAPS KPI, our Avaya OneCloud hybrid subscription remains one of the most effective on ramp to a cloud native model for enterprise customers. Since launching two years ago, we just passed the $1.5 billion TCV mark last quarter, making this the most successful solution offering in the company's recent history. Not only are we converting current customers, but in Q1, we signed nearly 200 hybrid subscription deals with new customers, our highest contribution from new logos since launch. Customers are committing to our cloud vision with three plus year contracts, they are making these commitments based on the deliberate and compelling roadmaps we have laid out. This is validation of the value our solutions can drive for our customers, their customers and of course, our shareholders. An example of one of these customers is Ascension Health, the largest nonprofit hospital system in the U.S. They signed a five-year contract to standardize on Avaya across 110 hospitals with options to include clinics and professional offices in the future. Turning to CCaaS, this quarter we grew seats at a rate and pace faster than the previous four quarters combined, equally notable as the funnel growth hit an all-time high. We continued to invest materially increase in the number of primary quota carriers, digital sales and presales for our CCaaS offering. OneCloud channel partner network of distributors and agents has grown into the thousands and we are expanding our CCaaS geographic availability to 100 countries by the end of the calendar year. We offer a fully integrated platform and that differentiation is helping us grow the size and quality of our funnel, even in the highly competitive mid-market segment and below. Cupola Teleservices, one of the Middle East largest BPOs and outsourced contact center service providers chose of Avaya OneCloud CCaaS and Avaya basis as the basis for their new customer onboarding and agent training. We beat out Genesys to win a three-year deal that significantly improved user and customer experience for Cupola’s customers. In Ontario, Canada, McMaster University, with over 35,000 students and 10,000 staff chose Avaya OneCloud to extend our long running partnership for a future five years. McMaster selected our cloud solution to address the challenges of increasing digital engagement across seven unique contact centers, reducing handling times and improving analytics and workforce agility. Avaya Cloud Office traction remains solid. We continue to add specific Avaya capabilities to the platform that differentiate our offering and including integration with our own CCaaS. One example of the importance of bringing Avaya content into the ACO platform is a recent win. Medical West Hospital Authority, an affiliate of UAB Health System, they are a long time Avaya customer through our partner AT&T. They selected Avaya Cloud Office for 1,400 staff members at their hospital and off-campus locations. Key features such as faxing, video conferencing and integration with Office 365 helped ticked every box Medical West had on their list. ACO channel partner enablement efforts continue to yield positive results, well over 700 partners globally have now sold ACO seats. Overall seat growth was up 14% and the number of new customers was up 16%, both from the prior quarter. So if I had to sum it up, the fundamentals of the business remain strong. As I said, we have already seen a number of deals that have moved out booked in January, and the team's execution remains steady and focused. And as a result, we remain committed on delivering the full year guidance for revenue that we previously communicated. With that, let me turn it over to Kieran to take you through the numbers.

[Kieran McGrath:]

Thank you, Jim. Good morning, everyone. As a reminder, all figures mentioned on this call as reported unless otherwise indicated in constant currency. We are pleased with the progress made in Q1 in continuing to expand our ratable revenue base. We added $90 million of new ARR ending the quarter with a balance of $620 million. Further, we had very strong OneCloud signings and bookings in the quarter, highlighted by the signing of a multi $100 million CCaaS contract with a very large global financial institution. This is the largest Avaya OneCloud signing since the introduction of Avaya OneCloud and is one of the largest Avaya wins in our history. Q1 revenue at $713 million was below our guidance driven by two primary issues. Firstly, current quarter revenue contribution primarily related to signed One Cloud subscription hybrid contracts was lower than guidance expectations. This resulted in approximately $20 million of revenue to be recognized in future periods upon the delivery of specific contract milestones and deliverables. This revenue was not lost, but rather will be earned in future periods. Secondly, as Jim mentioned, several large deals dive at just over $10 million stalled very late in their closing stages at the end of December, due to key personnel being unavailable to finalize contracts and approve and release POs. While the top line during a transition can experience some choppiness. The true measure of our transition is seen in ARR growth, and that has continued to rapidly expand in Q1. Our One Cloud ARR metric exited the quarter at $620 million, which represents 17% in sequential growth and is up 137% year-over-year. This quarter, we note the especially strong contribution internationally through increased demand and adoption. We continue to see a strong contribution from our contact center within ARR with that portion number of business contributing about 60% of total ARR. Our status as enterprise leaders is further demonstrated in the number of customers paying greater than $5 million in ARR and in particular, a growing number of customers paying greater than $10 million annually. Similarly customers paying greater than $1 million represents approximately 60% of total ARR. Getting deeper into the numbers, for the first quarter of our fiscal 2022 revenue was $713 million down 4% as reported and in constant currency against the $743 million in the year ago period. Revenue contribution from CAPS or Cloud, Alliance Partner and Subscription, another indicator of the transformation of our business represented 44% of total revenue flat sequentially, and up from 34% in the year ago period. For our first fiscal quarter, recurring revenue accounted for 66% of total revenue in line with recent levels. Meanwhile, software and services revenue represented 86% of total revenue. Hardware revenue at 14% of total revenue is relatively flat in revenue dollar terms versus the fourth quarter of fiscal 2021, reflecting continued strong demand for devices that accompany our software offerings. Subsequently software revenue, our newest KPI as a percent of total revenue came in at 62% in Q1. Turning to our gross profit metrics. Non-GAAP gross margin was 57.6% in the first quarter, compared to 61.8% in the year ago period and 60.4% sequentially. This was impacted by two key factors. First, lower level of contribution from software revenue due to less high margin point in time in quarter revenue recognized from our One Cloud subscription hybrid deals and the handful of slipped software deals that I referenced above. Second, the stronger hardware contribution mix within the product segment. Additionally, hardware gross margins were significantly impacted due to industry-wide elevated supply chain costs. Turning to total profitability, margin and cash flow metrics for the quarter. First quarter non-GAAP operating margin was $102 million representing a non-GAAP operating margin of 14% down 760 basis points year-on-year. Adjusted EBITDA was $129 million representing an adjusted EBITDA margin of 18% down 750 basis points year-on-year due to the revenue and gross margin impacts referenced as well as the increased cloud investments in R&D and go-to-market. Non-GAAP EPS was $0.42 in the first quarter, compared to $0.90 in the year ago period and $0.77 sequentially. Cash flow from operations was negative $111 million or negative 16% of total revenue contributing to a first quarter ending cash balance of $354 million. As discussed in our last earnings call, our large negative CFFO was expected during the quarter due to payments of our annual incentive plan and large commission payments due to our sales reps for fiscal 2021 results. This quarter CFFO was further impacted by a single large collection worth nearly $40 million related to a federal government contractor, which was pushed out of the quarter. This receivable is on track to be collected in Q2. As discussed an Investor Day, contract assets, which largely reflects deferred billings continues to grow from $606 million at the end of Q4 of fiscal 2021 to $664 million at the end of Q1. This represents a strong pool of future cash collections for Avaya. Now turning to guidance. Please note that, all year-on-year revenue changes are expressed on a constant currency basis and all revenue amounts, reflecting rates as of January 31, 2022. In terms of our forward-looking OneCloud ARR metric, we are increasing our guidance for the full year and now expect to exit fiscal year 2022 between $900 million and $920 million. At the midpoint, this represents growth of 72% year-over-year. This expectation reaffirms the previously committed target of exiting 2022 calendar year with OneCloud ARR at or above $1 billion. Turning to revenue. We are reaffirming full year revenue guidance. As such, we continue to expect the full year revenue to be between $2.975 billion and $3.025 billion. This has year-on-year revenue growing between 0% and 2% on an as reported basis and 1% to 2% on a constant currency basis. We note that a continuing strengthening of the U.S. dollar in 2022 beyond current levels would pose a headwind to our guided revenue. For the second quarter of our fiscal year 2022, we anticipate revenues of $730 million to $745 million, which at the midpoint represents constant currency growth of about 1% and flat on an as reported basis. We expect full year adjusted EBITDA to be between $680 million and $700 million. The reduction from our prior full year adjusted EBITDA guidance of $700 million to $720 million reflects the impact of higher supply chain costs. At the midpoint, this implies a 23% adjusted EBITDA margin. We expect non-GAAP operating margin for the fiscal year to be approximately 19%. For the second quarter, non-GAAP operating margin is expected to be between approximately 17% and 18% and our adjusted EBITDA to be between $155 million and $165 million or between 21% and 22% of revenue. We expect non-GAAP EPS for the full year to be between $2.72 and $2.88. This compares to $3.16 in the prior year period. For the quarter, we expect non-GAAP EPS to be between $0.58 and $0.66. This compares to non-GAAP EPS of $0.74 in the year ago period. For the full fiscal year, we continue to expect CFFO as a percent of revenue to be approximately 1% or unchanged from prior guidance. Before I turn the call back to Jim, I want to announce that Mike McCarthy will be leaving Avaya to pursue another career opportunity. So this will be his last earnings cycle with Avaya. Mike and I joined Avaya within six weeks of each other and we’ve worked very closely over these past three years. We will miss him and wish him the best of luck in his new role. Replacing Mike as VP of Investor Relations will be Nandan Amladi. Nandan is known to many of you already from his time as an equity analyst before he joined Avaya and as a member of the Avaya team since June of 2020. With that, I would now like to turn the call back to Jim. Jim?

[Jim Chirico:]

Thank you, Kieran. Last year was the year of continued transformation for our business. I’m optimistic about how we’re positioned entering 2022, and I have high confidence, not only in the strategy we laid out, but most importantly, in our global team and their ability to continue executing to it. It’s important to recognize the magnitude of the changes we have made over the past few years. As we now move along the inflection point of our business model transformation, we will continue to generate additional successes and there have been many, but there’s always more work ahead. We remain focused on solidifying our business for long-term success and the lessons we’ve learned and implemented will help us do just that. Long-term, the markets we address are robust growing and as we move forward, our performance will accelerate and we believe there is significant opportunity in front of us to drive sustainable growth. Finally, I’d like to thank the over 8,000 Avayans along with our 4,000 plus partners around the globe for their tireless efforts and focus on driving value for our customers. And I especially want to thank those same customers for their commitment and trust in Avaya. With that, operator, please open it up for questions.

[Operator:]

Thank you. We will now be conducting a question-and-answer session. Thank you. Our first question comes from Ryan MacWilliams with Barclays. Please proceed with your question.

[Ryan MacWilliams:]

Thanks for taking the question and congrats, Mike McCarthy, he will be missed, but he leaves you guys in good hands for sure. Kieran, I appreciate your color in the prepared remarks. Just on revenue coming in lower than guidance in this quarter. Can you expand upon the puts and takes there, like, should we expect the majority of that $20 million revs to come the next quarter? And then were these push deals, the reason that you maintain the full year rev guide in light of this print? Thanks.

[Jim Chirico:]

Yes. Ryan, this is Jim. I’ll – I think I’ll start now and turn it over to Kieran to add a little bit more color. So first, as we stated in our prepared remarks, we had a really strong Avaya OneCloud signing and bookings in the quarter and clearly highlighted by the largest deal in the history of the company with a multi hundred million dollar CCaaS contract. Once again, we’ve added $90 million of ARR as I pointed out. We’re now up to $620 million. So if you take a look at Q1, kind of sum it up, our signings were actually quite strong and largely in line with expectations. One of the important notes, however, and we sort of touched on that in our remarks is the fact that customers are accelerating to cloud. And in fact, we saw a number of our customers choose private and public instead of what we had originally modeled in as subscription. So this is obviously very important. It’s in line with our strategy and that is to moving customers to the cloud. And that obviously had a – what I’ll say an impact on short-term revenue. But it really solidifies our position not only in cloud, but also to be a strategic partner to a number of our large enterprises, our customers. And in fairness, I’d make that trade off in that deal, each and every time. So, the overall goal of the company is to continue to move to a cloud model. It’s continuing to build out our ARR and long relationships and success with our customers. But I’ll turn it over to Kieran to add a little bit more color.

[Kieran McGrath:]

So, Ryan, specifically to your question, so I break the revenue under guidance into two forms. First, roughly about $20 million what I’ll call was really pushed out of this quarter. So the deal was signed and inked. What we thought we would get from those deals in terms of point and time revenue in the quarter is going to be different. And that will come back to us. Some of it will come back this year, roughly about $5-ish million, over the next couple quarters. I would say the bulk of it, probably more like 15-ish million of that $20 million will come at us over the next couple of years. And why is that? It’s really because of the unique final terms, the flexibility that we might give to the customer as they sign the deal, any of the future deliverables, that’s all what can drive revenue variability in the quarter. So as I say, it doesn’t affect the size of the overall deal, the signings, but it can affect the endpoint. So I would say we get about $5 million of that back this year. The rest comes over time. Then related as Jim talked about of the roughly $10 million-ish of deals that slipped, we expect those deals here in Q2 and in fact several of them already in-house. If you think about these deals, these are large complex deals with TCVs all over $1 million. And as you can imagine, they go through approval cycles many times from the CEO down, but certainly from C-office down. And I would tell you, I’ve been at this for 40 years and it was highly unusual at the end of the year that we saw several companies, literally go into a shutdown with key personnel, just simply not available to finalize either issue a PO or to finalize. So it’s really not a reflection of demand and good confidence that that $10 million comes back to us here in Q2.

[Ryan MacWilliams:]

Understood. Glad to hear you’re prioritizing the cloud versus subscription wins. And then just on profitability in the quarter. It looks like it stepped down with lower EBITDA and free cash flow. I know things can be messy as you transition subscription you mentioned kind of one time item, but how do you feel about your cash position as we get closer to your minimum cash balance range in your long term target?

[Kieran McGrath:]

Right. So as you know, we’ve said before that, we’ve like to have optimally $400 million on hand, but really that provides us with liquidity to support incremental flexibility, such as doing tuck-in acquisitions. I’m quite confident that the team is able to operate at a cash balance of about $250 million without having to draw on any revolving credit facility. So very comfortable at the levels that we’re at. We, as you know, we do maintain the revolving ABL facility and that has about a $100 million plus of availability, based on ARR and on hand inventory balances. But honestly, don’t foresee any need to utilize that in the near term. As we’ve talked about towards the back end of this year, we begin to see the swing now, as we start to level out in terms of the new signings and the new ARR and the other stuff coming off of expiring. And I think we start to hit more of a steady state in the back end half of this year. So that’s why I’m comfortable with the 1% guidance still for this year.

[Mike McCarthy:]

Okay. Next question, Paul.

[Operator:]

Thank you. Our next question comes from George Sutton with Craig-Hallum Capital Group. Please proceed with your question.

[George Sutton:]

Thank you. Guys, I’m particularly interested in the competitive dynamics on the $400 million win that you had. You mentioned several vendor takeaways, I’m curious was this a previous customer of yours that move forward with you and obviously the message that this makes on your public cloud capabilities is obvious, but I’m curious if you could just address that as well.

[Jim Chirico:]

Yes. Hey George, it’s Jim, thanks for the question. Yes, first and foremost, we were one of many providers for this customer and basically what they did is they consolidated their footprint. But this deal is unique and really highlights the differentiation of relevance we bring to the market because it’s not what I would call your traditional CCaaS, UCaaS deal. It’s really one that we really are driving a true business transformation via integrating digital technology, across their complete enterprise. We are reimagining for lack of better term their entire customer experience journey. We’re starting initially with 20,000 agents. But we will be expanding to north of 40,000 agents in the next five years or so. So it’s a combination if you will, our platform capability, the ecosystem, the innovation we’re bringing and really the competency that Avaya has that others simply do not in designing building in developing apps, machine learning, automation, all of sort of those innovative capabilities really to build out stronger sort of functionalities for the customer. So, the other interesting note is this is the first that we believe in line with a dozen to 18 other large enterprises that we’re currently working within the market today may not be as large as this, but we are the only provider that can really manage the complexity. I’ll call customer sensitivity, compliance, regulatory measures and provide this sort of personalized complex business use cases. So, we’re winning these projects, not solely because we have the right technology, but we have a strong, innovative roadmap. We’re the right partner to manage the sort of the complete management system, domain expertise with our services, organization and helping really guide these large complex enterprises through this very complex transformation journey. So a very exciting win not just on the value, but really how it’s positioning us and really solidifying the work that we really been focusing on for the last three years around our public CCaaS journey.

[George Sutton:]

Got it. If I could just ask one from a follow-up perspective coming off of your Analyst Day, the big differentiator that I took away was the MPC is that starting to make its way into your marketing message? Is that proving to be a differentiator as it certainly sounded like us?

[Jim Chirico:]

The answer is yes, but I’ll turn it over to either to augment or Todd to provide a little additional color, to give you an update on exactly where we are and enroll on to the marketplace.

[George Sutton:]

Media process core anchors.

[Jim Chirico:]

Yes. Todd?

[Todd Zerbe:]

Can you guys hear me?

[Jim Chirico:]

Yep. Can we hear you.

[Todd Zerbe:]

Okay. Sorry. So media processing core is the technology anchors all of our media. We use it in our spaces product today, and it will be available in our CCaaS public mid this year. It's a next generation cloud architecture with global scale 50 millisecond failover. It has 80% lower bandwidth utilization. It offers features like AI noise reduction, and it really is a next generation cloud architecture. We feel puts us at least two years ahead of our competition and it demonstrates Avaya’s ability to lead in cloud. So it's a technology that we are going pretty heavily to the market with knowing that it's something that's we've already released and we've demonstrated with our spaces product and it is something that's going to be providing additional value into our public CCaaS.

[Operator:]

Thank you. Our next question comes from Lance Vitanza with Cowen and Company, please proceed with your question.

[Lance Vitanza:]

Hi guys. Thanks for taking my question. I have a follow up as well, but let me start with just on the One Cloud ARR, great work that metric continues to outperform our expectations. But could you discuss whether the metric itself is inflated perhaps by virtue of larger upfront payments you receive or upfront revenue that you recognize for? Or do you guys control for that when you report that metric?

[Kieran McGrath:]

Hey, Lance its Kieran. That's a great question, happy you asked it. So the – what we essentially do is we take the annual contract value of the metrics. So the ARR is nothing more than the total TCV divided by the duration has really nothing to do with when we recognize the revenue. So it's an annualized recurring metric. So no impact from revenue.

[Lance Vitanza:]

Okay, great. Thanks. And just my follow up is the 1,400 new logos that you added in the quarter. And I apologize if I missed this, but could you give us at least a rough sense for how many of those new logos are taking One Cloud ARR services?

[Kieran McGrath:]

Well, essentially just by – just looking at it, it's well over 60% are actually going for either cloud or a subscription hybrid offering.

[Lance Vitanza:]

Okay, great.

[Operator:]

Thank you. Our next question comes from Catharine Trebnick with Colliers. Please proceed with your question. Thank you. Next question comes from Rod Hall with Goldman Sachs. Please proceed with your question.

[Bala Raghav Reddy:]

Hi thanks for taking my question. This is Bala on for Rod. If I look at the full-year guidance looks like you are implying a significant ramp in second half, not just in revenue, but also more significantly so in operating margins in the second half. I just want to better understand what is driving that better margin guidance, particularly.

[Kieran McGrath:]

Sure. Well, obviously – Hi, Bala, it’s Kieran, I mean, clearly – cloud that drives a great deal of profit, right to the bottom line. You know, that we've been ramping up our investment from both an R&D and a go-to-market perspective for quite some time. What literally impacted us in Q1 was just the absence of that very high margin revenue. So as we look out into the back half of the year, we see our revenue bouncing back and continuing to start to a ramp now with many of the cloud, the public and private cloud dealings that we’ve booked. And that starts to generate revenue. Some of that cost was sitting already in our numbers in the first and second quarter. And without the revenue and as that revenue starts to ramp now it absorbs all of that cost and the margin start to get significantly better in the back half the year as well.

[Jim Chirico:]

Yes. And maybe I’ll just add a little bit at Kieran. So if you take a look at the profile, obviously with our move to cloud, you can imagine based on the size and the complexity of these deals, they take anywhere between say three to six months, the design scope agree on the full execution plan with customers and actually begin to activate. So as I mentioned in my script on CCaaS, we did more last quarter than we did the previous four quarters combined. So we will start to deploy those and roll those out in second half of the year, same frankly with our private cloud solutions. Thirdly is the fact as I mentioned, that large deal will start to realize revenue on that in the second half of the year. And then, the success that we’ve had with our subscription hybrid offer, where we’re able to claim roughly 60% or so point in time revenue that residual 40% continues to build ratably quarter after quarter after quarter. So there’s obviously a significant backlog. And that’s the point about how we’re sort of reaching this inflection point now with recurring revenues, which now are 66% of our overall revenue really starting to yield in the second half of the year consistent frankly with our overall strategy. So as we continue to win these large deals, and now we’re activating and then monetizing as we roll through the balance of this year and into 2023, is why we’re confident on what our ability to make the second half of the year. And don’t forget at the point that we mentioned the fact that we didn’t lose any of the volume in the first quarter. It was pushed for lack of a better term or valued moving more from subscription to recurring. So that’s why guidance is actually the same and why we’re confident in our ability to make sure that we obviously come in and meet the guidance range.

[Bala Raghav Reddy:]

Got it. Thanks. Also I want to touch up on the slow down in commercial deal activity. Could you maybe expand on that a bit more, Jim? I think you mentioned, I think I heard lack of personal might have caused that, but I just want to better understand what’s really caused that like what was the unexpected surprise that really drove this push out of deals?

[Jim Chirico:]

Yes. I mean, listen, deals push and come into the quarter and go out of the quarter all the time and we’re used to that. But we had a handful of deals that we were pretty much rock solid on that. Quite frankly at the end of the quarter, mostly in North America, there was due nobody there. I mean, they did not – they stopped engaging in terms of finalizing it and getting the contracts over the line and issuing the POS highly unusual, right. And again, I do think there was obviously an impact that many customers and many people felt from the Omicron in Q4, not saying that was it or not, but these folks they just literally were not there the last several days of the quarter to close on deals. And that is highly unusual even in Q4s.

[Operator:]

Thank you. Our next question comes from Catherine Trebnick with Collier. Please proceed with your question.

[Catherine Trebnick:]

Thank you. Let’s hope I don’t get dropped again in the middle of the question. Mike, sad to see you go congratulations. So my question asked you with the product revenue you came in at 231 million, can you parse that between the hardware, the perpetual license. And then if the perpetual licenses were light, did that affect the gross margins as well? Thanks.

[Jim Chirico:]

Sure. So Catherine, you are spot on it. Our hardware was actually in and about $97 million relatively flat for where we were in Q4. So we continued to see a lot of like, sort of pent-up demand for devices. And therefore that was pretty consistent. That hardware is generally more in the 40% to 60% margins historically. So that’s going to have an impact on in period margin. Addition to that, we actually saw on a volume adjusted, we actually saw about $10 million worth of incremental supply chain cost, roughly about $7 million from a commodity perspective which was in the base manufacturing cost, and about $3 million with incremental shipping and freight costs in the quarter. And that’s something we expect will probably continue a little bit here in Q2, but what we’ve been hearing from some we’re expecting that starts to ease in the second half of the year. So there is definitely a margin overall, if I was to look at our margins overall on a year-on-year basis, clearly a – even though hardware was relatively flat, it had a larger percentage in total that impacted margin. The supply chain margin, it was also about a point of increase, lower software product revenue, that's north of 90% gross margin clearly has a very large impact on revenue and margin as well. Although remember, we would've expected some of that to shift away from product and into services as part of subscription as we move and migrate customers away from the traditional CapEx buying to subscription hybrid sales.

[Catherine Trebnick:]

All right, thanks.

[Operator:]

Thank you. Our next question is from Samik Chatterjee with JPMorgan. Please proceed with your question.

[Joe Cardoso:]

Hi, this is Joe Cardoso on for Samik. Just one question from me guys. As we look at your updated ARR guide and the activity that you're seeing in the first two months of the year. Just curious to hear how you're thinking about the dynamics between penetration of your existing install base to new customer wins as well as content increases? And whether you're seeing any changes between those dynamics versus let's say like last quarter? Thank you.

[Jim Chirico:]

I guess what I would say is in general the vast predominance of the dollars continue to be driven by the migration of our existing customers. As we said last quarter, over the last couple of quarters we started to see a big step up in the number of new logos from a subscription hybrid perspective and this quarter at almost 200 was the biggest that we've seen so far. But in all candid those are relatively small landing points, right? They go into the traditional layer model, right? We land, adapt, expand – expand it out to renew over time. So that's not having as big an effect on the overall dollars, but I would say migration continues to be the engine behind most of it Albeit supplement with some, as I talked about earlier over 60% of our new logos are coming from cloud and subscription hybrid.

[Stephen Spears:]

Yes. Just maybe just say a little bit to Kieran. So first of all, ARR is really important to us. But ARR is driven by our innovation that we're bringing to the market. And over the last 12 months, we've added over 6,000 new customers. We've added now seven consecutive quarters of roughly over 100 deals, greater than million of TCV. We're starting to see a real acceleration from our subscription hybrid to now more private and public cloud. So demonstrating continued value with what we're bringing as far as technology into the marketplace and that technology be it around new AI capabilities social media, management platforms, video and voice capabilities, the list goes – the list goes on and on. So really driving a higher degree of relevance. So the successful implementation of the plan with our lens really on – and really focusing and recognize the importance of building ARR, I think is really starting to, to take hold and right in line with our long-long term strategy. So it's important for us to make sure that we keep this disciplined approach, which we're doing. It's important for us as we continue this transformation and transition to think about steady progress, which obviously we believe we're doing quite well on. You may have fluctuations in movement in deals days to weeks or product preference to product preference. But the more – the most important thing is continued growth, steady progress and I think equally important, which sort of differentiate us from, from many others is the skillset and expertise that we have in the number of years that we've been doing UC and CC the technology we bring our customer base and, and our global capabilities. So we believe we are "very robust" in these areas and your to see it take hold, and again, you may get a sway one way or another, but the long-term strategy is stronger than stronger than ever. And this move that we're seeing now to more of cloud is exciting for us because it's driving long-term – long-term value with our customer base and it obviously reflective in ARR. As I said, a year ago, we were 262, at the end of this year we're going to be 1 billion. That significant growth is just a two year period of time.

[Operator:]

Thank you. Our next question comes from the Asiya Merchant with Citigroup. Please proceed with your question.

[Asiya Merchant:]

Great. Thank you. And congrats, Mike on the new opportunity, we'll definitely miss you and thank you for all the help that you've provided. Most of my questions have been answered, but I did have a question on something that you guys talked about, and maybe you can talk about, any updates to that. You talked about it at your Analyst Day about the monthly recurring revenue that you were seeing. And if you can just talk about, during the quarter, or as you guys kind of think about how that's progressing, relative to the kind of model that you guys put out, the current monthly recurring revenue that you referenced that your Analyst event was a little bit lower, relative to the potential that CC and UCC could generate. So if you could, you know, talk about out what you're seeing in those areas, that would be great. Thank you.

[Kieran McGrath:]

Hey, Asiya its Kieran. So I think what you're talking about, obviously, MRR is just a divided by 12 from our ARR, right? And, and we obviously continue to build on our existing base of recurring revenues in aggregate that hasn't, that really hasn't changed. Obviously, you are correct that just given the revenue recognition around the subscription hybrid portion of that. You know, we did see a blip in the last quarter just because of some of that point in time versus overtime, but we continue to actually, build off a good base of recurring revenue and more and more of it, as we said in the last, in our Analyst Day, we would expect that right now it's about 80/20 between subscription hybrid and cloud. And we expect that will, as we go through time, we'll continue to move towards a 50/50 and beyond for cloud. What you don't see represented in our ARR or our recurring revenue yet, because we don't start counting it until we start billing it are some of these rather large, enterprise complex deals, like the one that Jim referenced, we'll start to see, we'll start to see that contribute to our MRR and ARR on an ongoing basis. Once we start billing that towards the second half of the year. So, quite honestly, we were very pleased within our $90 million of ARR that we recognized this quarter to see a nice distribution across all facets between cloud and subscription hybrid. But in addition to that, starting to generate some pretty significant backlog, if you will. Now, let me just spend one moment on that. So, we have pretty conservative booking. We are pretty conservative, in our overall booking. So this multi $100 million deal that we booked for this large global financial enterprise, we only actually booked a little less than 10% of that in the most recent quarter. And that's because we really do based on our bookings, based upon committed milestones. And we would expect that we will add on that as we achieve milestones as we go through the year. So again, that's backlog that we have that we're not necessarily representing yet in our RPO that we publish, in our queue.

[Asiya Merchant:]

Okay, great. Thank you.

[Operator:]

Thank you. Our next question comes from Hamed Khorsand with BWS Financial. Please proceed with your question.

[Hamed Khorsand:]

Hey, good morning. I just wanted to see with the lockdowns that happened, what happened to the sales funnel? Did the sales team just stop and have to restart everything over again?

[Jim Chirico:]

I'm sorry; I missed the first part of your question. This is Jim.

[Kieran McGrath:]

About sales funnel.

[Jim Chirico:]

No, I mean, no far from it. I mean, in fact, these were deals that were in, early either in January or it'll be done here in February. Listen, I mean, the world of the world of reality is procurement teams will always take another bite at the apple if they can. Right. I mean, that's a given, but no, the deals were there. They were there to be done. And they're going to close this quarter, those deals again, it's worth about $10 million in total.

[Hamed Khorsand:]

And then my other question was how much of the expenses related to this $400 million deal were recognized in the December quarter?

[Jim Chirico:]

We're early days, we're starting to staff, obviously, we're staff, it's going to be a pretty, a pretty large, service delivery and hosting. And that would be relatively small. Obviously we have some ongoing, infrastructure that we have to stand up already to give, proof-of-concepts to our customers, et cetera, that is in our number, but that's going to be small in comparison to the size of this multi $100 million deal.

[Operator:]

Thank you. There are no further question at this time. I would like to turn the floor back over to Mike McCarthy for any closing comments.

[Mike McCarthy:]

Thanks, Paul. And thanks everyone for joining us this morning for the December quarter conference call. We'll look forward to speaking with you soon. Have a good week.

[Operator:]

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