Avaya Holdings Corp (AVYA) 2020 Q3 法說會逐字稿

Greetings welcome to Avaya Quarterly Earnings Call, Third Quarter of Fiscal 2020 Conference Call. (Operator Instructions)

Please note, this conference is being recorded. I will now turn the conference over to your host, Michael McCarthy, Vice President of Investor Relations. Thank you. You may begin.

Thank you, Melissa, and welcome to Avaya's Fiscal 2020 Q3 Investor Call. Jim Chirico, our President and CEO; and Kieran McGrath, our Executive Vice President 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 Anthony Bartolo, EVP and Chief Product Officer; and Dennis Kozak, Senior Vice President of Business Transformation.

Consistent with our social distancing mandates, each of us on this morning's call are assembled from our remote locations. The earnings release and investor slides 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, which should aid in your understanding of Avaya's financial results. We will reference our non-GAAP financial measures and specifically note that all sequential and year-over-year comparisons reference our non-GAAP numbers except where otherwise noted.

We have included a reconciliation of such measures to GAAP in the earnings release and in the 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, our business is currently being impacted by COVID-19 and its effect on the global economy. The extent of its continued impact on our business will depend on a number of factors that include, but may not be limited to, severity and duration as well as 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, uncertainties may be found in our most recent filings with the SEC, including our Form 10-K and subsequent 10-Q reports. It is devised 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 otherwise required by law.

I'll now turn the call over to Jim.

Thank you, Mike, and thanks to everyone for joining the Avaya Q3 Conference Call. A little over 2.5 years ago, we laid out a very deliberate 3-step strategy: one, execute on our plans for growth; two, leverage the strength of our business model; and three, rapidly grow our cloud alliance partner and subscription revenue or CAPS. Thanks to the team's execution, we were able to deliver outstanding results.

For the first time, Avaya achieved year-over-year and quarter-over-quarter revenue growth. And it's these results that give me confidence we're on the right path. More importantly, the guidance that Kieran will share for the fourth quarter, reflects continued momentum in our business.

In Q3, GAAP revenue was $721 million, above the high end of our range, and this was up $4 million year-over-year and $39 million from the prior quarter. Contributions from software and services rose to 89% of revenue, up 5 points year-over-year and recurring revenue, which gives us a solid book of business going into any given quarter, was 64%, also up 5 points year-over-year. No question, our growth plans have taken hold and are yielding positive returns.

Our operating results also exceeded guidance and continue to deliver on our business model. Adjusted EBITDA was $187 million, or 26% of revenue. We drove cash flow from operations of $45 million and ended the quarter with $742 million of cash on hand, and that was an increase of $189 million from the prior quarter.

Looking forward, we will continue to maintain the same executional discipline, while making the necessary investments in the business to maximize our customer shareholder value. Our CAPS revenue has maintained an accelerated ramp to reach 30% of our revenue, hitting our published target over a year ahead of schedule. And here's how I think about CAPS. First, it represents the traction of our Avaya OneCloud family of offerings, which includes CCaaS, UCaaS, CPaaS spaces and subscription.

Second, it's a key indicator of our transition to cloud and SaaS. The fact is CAPS, as a percent of revenue, was 30%, up from 23% the prior quarter. This represents an increase of nearly $60 million quarter-over-quarter. Third, CAP underscores the importance of strategic partners and the value that we, along with our extensive ecosystem, unlock for our customers.

Lastly, the subscription component of CAPS is materially important for a number of reasons. The contracts are generally 36-plus months, double the length of our typical maintenance contracts, it allows us to activate our base by bundling in additional innovations like spaces, video, remote working, AI and contact center, which our customers continue to consume on demand. And it provides a seamless gateway to transition from on-premise deployments to cloud deployments.

Clearly, our product strategy and investments in innovative offerings, cloud, new consumption models and recurring revenue streams are paying off. This is a very different company from 2.5 years ago. Avaya has shown amazing resilience. We are outperforming expectations, and we are accelerating rapidly in key growth areas. The reimagine Avaya has never been more relevant to our growing base of customers and partners globally, and I'm especially proud of what the team accomplished during these unprecedented times.

It's important to note that the shift to work from home has been smooth for us, and we've not experienced any meaningful disruption in our business. Remote capabilities are core to our DNA, and we've long been a leader in enabling work-from-anywhere solutions. Simply stated, our technology and capabilities have put us in the right place, at the right time and our highly differentiated solutions will continue to drive strong demand well into the future.

Now I'd like to spend a couple of minutes on our growth initiatives, beginning with subscription. Customer demand for Avaya OneCloud subscription is extremely strong. The TCV or total contract value, doubled this quarter to over $200 million. And to give you an appreciation of the size of these deals, 14 had a TCV of over $5 million and 7 were over $10 million.

Initially launched in the U.S., we have expanded internationally and are now closing deals globally. The subscription consumption model delivers customers the latest innovations and provides a path for premise-oriented customers to transition to cloud-delivered models when they choose and at their own pace.

One customer, a large U.S.-based retailer and a longtime Avaya client, signed a new 3-year agreement and is upgrading its Avaya infrastructure to support 75,000 UC users and 25,000 contact center agents. This OpEx model is ideal in advancing our customers' digital transformation journey at a time when support for their work from home requirements has become an immediate priority.

Subscription is also key in driving new customer acquisition and competitive displacements. A European financial services company based in the U.K., will be using our subscription offering to replace their UC and contact center systems. The customer wanted an OpEx model that provides them flexibility, access to innovation like spaces on demand and the ability to integrate new digital applications.

Shifting gears, our second quarter earnings call, we discussed several actions Avaya initiated to help our clients in response to the spread of COVID-19. This included the use of our spaces video collaboration app and providing over 2.5 million temporary remote licenses. We are starting to see a commercial benefit from these actions and customer conversions have exceeded our expectations.

I would characterize conversions in 3 broad buckets. First group are those customers that simply needed to convert many of these temporary licenses to permanent. And this is accretive to our existing contact center business. The second and largest group has incorporated these licenses into new subscription contracts. The need for remote license helped accelerate our sales conversions, and we are seeing similar opportunities in Q4.

The third group of customers is extremely important and represents companies going through digital transformation. They are now in the process of upgrading and looking to implement new Avaya technologies and developing differentiated solutions for their customers. We are guiding them on their journey and we'll realize results of these efforts over time.

Avaya Cloud Office, fiscal Q3 was our first full quarter in the U.S., and we launched in Canada, U.K. and Australia on June 30. In addition, we added new features and automated capabilities to accelerate adoption. Although still early in its rollout, Avaya Cloud Office is yielding positive results. The strategic partnership is proving itself true.

And let me give you a couple of highlights. First, we are activating our base of customers and partners by providing a UCaaS offer that they were demanding. We are also winning a significant number of new locos versus our competitors, like Mitel, Cisco, 8x8, FUSE and others. And on the go-to-market front, we are on track. We've signed deals in each of the 4 markets where we are available. We are now up to 19 master agents and nearly 2,400 agents. We've launched demand generation campaigns that are generating a solid pipeline, and I'm pleased with how we're ramping our inside sales and customer success teams to handle the volumes. Our next release in September will further expand functionality and bring Avaya Cloud Office to France, Ireland and the Netherlands.

On the CCaaS front, our public cloud offer continues to gain momentum for customers looking to shift aspects of their contact center operations to the cloud. Cincinnati Bell experienced a 50% plus increase in call volumes during the onset of the COVID-19 pandemic. They immediately turn to Avaya for a stable and reliable solution that could be implemented quickly and cost effectively. As a result, Avaya OneCloud CCaaS empowered nearly 300 agents to work remotely, while ensuring end-to-end management of the customer experience and improving service and generating cost savings.

Our funnel is building nicely, and I'm pleased with the uptake. We continue to invest significantly in CCaaS. And in July, we added digital channel capabilities to our base offering. Our next release at the end of the quarter delivers attribute-based routing, integrated reporting and enhanced analytics. Avaya Spaces, our UCaaS collaboration platform has also experienced a high demand of usage.

Spaces include voice, video, messaging and team rooms. It's available in nearly 100 countries and is offered with Avaya OneCloud subscription as well as on a stand-alone basis. Spaces usage was up over 550% from Q2, driven largely by increased demand for work-from-anywhere-capabilities and state government and local education usage.

Lastly, Alliance Partners contributed significantly to our overall cash performance this quarter. Our investment in partnership is driving entirely new innovation and capabilities for customers to consume. One example is partnering with Google. We delivered a new virtual adviser solution, to General Motors on Star division.

The Google Dialogflow application combined with Avaya contact center capabilities, to replace a legacy platform. By using machine learning and AI, the system learns and responds more effectively. This results in a better driver experience and lower cost of on Star to deliver that service. Our work with Google is just one proof point of the power of marrying innovation from Avaya with world-class leaders and a complementary technologies to deliver highly innovative offerings that drive significant value, differentiation and competitive advantage for our global base of customers.

In summary, I'm thrilled with our progress and how we are executing on our strategy in the face of this global uncertainty. But what I'm most proud about is in the face of a worldwide pandemic, we added over 900 new customers with 139 competitive displacements, including takeaways from Cisco, 8x8, Mitel and Genesis. And to further punctuate our strength on the enterprise, we signed 104 deals with a TCV of over $1 million, including $14 million over $5 million and $7 million over $10 million TCV. The $7 million over $10 million is the strongest in the last few years.

Especially noteworthy, we won a 3-year private cloud contract with a TCV of just over $20 million and a competitively-bid deal against Genesis and Twilio. This customer will migrate more than 10,000 contact center agents now operating across multiple business lines and locations into a fully upgraded and modernized platform. The company had piloted these alternative solution providers for more than a year and concluded that Avaya best addressed their global business needs today and into the future.

One last note. After a protracted procurement process, I can confirm that the 10-year social security administration contract worth more than $300 million has been awarded to Verizon and Avaya. We couldn't be more pleased with the award, and Kieran will share more of those details.

In summary, many areas of our business are growing, and we are experiencing strong demand for our solutions. We will continue to maintain our profitable business model. And today, we are in a stronger financial position than ever before. We look forward to a strong finish of our fiscal year in September. And I have great optimism for where we are headed.

I'd like to thank our global employees and our customers and partners for what we have accomplished together.

With that, let me turn it over to Kieran.

Thank you, Jim. Good morning, everyone. As a reminder, unless otherwise stated, all financial metrics referenced on this call are non-GAAP, and the supplementary slides posted on our Investor Relations website 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 $722 million compared to $720 million reported in the year ago period. Sequentially, this compares to $683 million as reported in Q2 of fiscal 2020.

As a reminder, during the quarter, GAAP and non-GAAP revenue have converged, and the non-GAAP differences generated by fresh start accounting are now immaterial, and we expect to move forward similarly. However, non-GAAP adjustments were material still in FY '19. And so for year-on-year comparisons, we speak to non-GAAP revenue for proper comparisons. We are very pleased that we have closed our third quarter well above the revenue guidance we provided in May, and that our revenue results represent year-on-year growth for the first time in recent history.

Further, if you recall, when we kicked off fiscal 2020, we said the first half of the fiscal year would be down in the low to mid-single digits. Then in the second half of the year, as our growth initiatives began to take hold, Avaya's business would return to growth. Our Q3 results are in line with this projection and validation that we are executing in line with the projected business plans.

Revenue contribution from CAPS or Cloud, Alliance Partner & Subscription represented 30% of total revenue for Q3, up from 23% from the prior quarter and 15% for the full year fiscal 2019. CAPS revenue increased by approximately $60 million quarter-on-quarter, while largely driven by subscription, which has seen an enthusiastic reception by our both new and existing customers, we also witnessed strong growth from our strategic Alliance Partners, including the ramp of Avaya Cloud Office, which provides a measurable contribution to the metric this quarter.

With subscription revenues growing at such a rapid pace, combined with the continued ramp of our strategic Alliance Partners, we achieved our long-term target for CAPS as a percentage of revenue much faster than initially anticipated. Subsequently, we will be revising upwards our long-term expectations for the CAPS metric as we enter fiscal 2021, but it's clear that CAPS will continue to be a key contributor to Avaya's top line in the coming year.

Third quarter product revenue was $262 million compared to $298 million in the year ago period and $245 million in Q2. Hardware revenue was down almost 30% year-on-year as we continue to witness the impact of the pandemic and our partners and customers. Total software revenue was flat with declines in UC, offset by contact center, which grew strongly as we successfully converted many of the temporary licenses that have been issued back in Q2. Third quarter services revenue was $460 million, up compared to $422 million in the year ago period and $438 million in fiscal Q2. Continuing new product placements, upgrades and temporary license conversions under a subscription model, represented a key growth driver for our services revenue and more than offset declines in traditional maintenance and support.

Now turning to gross profit metrics. Total GAAP -- total non-GAAP gross margin was 61.1% in the third quarter compared to 60.8% in the year ago period and 61.1% sequentially. Non-GAAP product gross margin was 60.7% compared to 63.8% in the prior year and 62.9% in the second quarter. Non-GAAP services margin was 61.3% compared to 58.8% in the prior year and 60% even in Q2.

Turning to total profitability margin and cash flow metrics. Third quarter non-GAAP operating income was $164 million, representing a non-GAAP operating margin of 22.7%, up 260 basis points year-on-year. While adjusted EBITDA was $187 million, representing an adjusted EBITDA margin of 25.9%, up 270 basis points on a year-on-year as well as above the guidance we provided in May due to a strong mix of products and services.

Turning to cash flow. We generated $45 million in cash flow from operations or 6% of total revenue, contributing to a third quarter ending balance of $742 million in cash and cash equivalents. I'd like to take a moment to delve further into our strong liquidity and our substantially increased cash position this quarter. As you may recall, as part of our strategic partnership with RingCentral, we received the majority of the prepayment in common shares of their stock. Approximately 80% of those holdings were monetized in November of 2019 as we disclosed during our Q1 earnings call.

To further our liquidity position within this tumultuous macroeconomic climate, we opportunistically executed open market trades for the remainder of the shares held. This provided for incremental $118 million that you will see recognized in cash flow from investing this quarter. Included in our cash flow from operations for the quarter was a $54 million tax payment related to the RingCentral prepayment.

In light of our strong liquidity position, in July, we chose to pay back the $50 million draw, we had made on our revolver at the start of the third quarter in April. Even with the resurgence of COVID-19 that we have witnessed in certain U.S. states and internationally, we feel, given our current cash on-hand and the quality of our customer base, that we have sufficient liquidity.

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 June 30, 2020. For the fourth quarter, we anticipate non-GAAP revenues of $720 million to $740 million, representing modest growth at the midpoint, both quarter-on-quarter and year-on-year. We are pleased to inform you that in mid-July, the social security administration formally issued the 10-year next-gen telephony project award to Verizon, the prime contractor with which Avaya is partnered.

This modernization project for voice and contact center communications consolidates nearly 120,000 endpoints onto one platform and displaces 2 other competitors. The initial value of the award is well over $300 million. We are thrilled that the significant long-term contract has finally been awarded. We believe this represents validation of Avaya's best-in-class contact center and unified communication solutions.

We expect non-GAAP operating margin for the fourth quarter to be between approximately 20% and 22%, and our adjusted EBITDA margin to be between $170 million and $190 million or between approximately 24% and 26% of revenue. As we incorporate fiscal fourth quarter guidance, we expect full year non-GAAP revenues of $2.84 to $2.86 billion, representing a minus 2% to minus 1% annual decline as measured in constant currency. We expect non-GAAP operating margin to be approximately 21% for the full fiscal year.

Similarly, our adjusted EBITDA margin should range between $680 million and $700 million or approximately 24% of revenue. In terms of cash flow from operations for the fiscal year 2020, we expect to be approximately 4% of full year revenue. Excluding the Q1 onetime payments from the strategic process and the impact from the accelerated prepayment taxes in Q3, this equates to 7% to 8% of full year revenue. At this time, we expect no material change to our shares outstanding before the end of our fiscal year, which currently sit at approximately 83 million shares.

With that, I'd now like to turn the call back to Jim. Jim?

Thank you, Kieran. I'm really excited about the tremendous opportunities in front of us as a company. Avaya is an industry leader with scale, global reach, and a rich portfolio of technology and solutions to address the challenges and opportunities that businesses face today. We have an incredible base of customers. And I'm inspired by the team of Avaya around the globe. I have a strong belief that we are well positioned for the future.

We are now happy to take your questions. Operator?

(Operator Instructions) Our first question is from Samik Chatterjee with JPMorgan.

You had a strong sequential move in CAPS revenue. And I wanted to see if you can unpack that for me a bit, particularly if subscriptions were the primary driver like last quarter. And how should we think about headroom for growth there? And also if there was any benefit from conversion of some of the complementary licenses to that? And I have a follow-up.

Yes. This is Jim. Thanks for the question. Kieran, do you want to first touch on the GAAP revenue? And then me then can add some color.

Yes. Sure. So I think GAAP or non-GAAP revenue, the change quarter-on-quarter is pretty consistent in terms of being up $39 million. I would say that, obviously, we've seen a significant increase in our CAPS revenue, which we talked about being up $60 million on a quarter-on-quarter basis. So you can see the growth really is coming predominantly from subscription, which makes up the lion's share of that CAPS revenue.

And then we've seen some falloff in the traditional premise-based CapEx purchases most certainly, the revenue that we've seen coming from our hardware business, hardware was down almost 30% on a year-on-year basis.

Yes. No, I would agree with that. And maybe just add a little bit more color. As far as subscription, obviously, we're still only in the transition. As we pointed out, we had a couple of hundred million of TCV, but our overall TCV is north of $2 billion. So there's still a lot of work, not only from an Avaya customer base perspective, but also as we continue to win new competitive deals.

And just to add to that, if you take a look at an ACO, as we mentioned, we just basically had the U.S. last quarter. So we have 3 additional countries, and then obviously, we're adding 3 more. So we expect to see ACO continue to gain momentum as we go through not only the balance of this calendar year, but well into '21 and beyond.

And then probably the other 2 growth areas for us is, we're very excited about the progress we've made on CCaaS and continued quarterly deliverables on that as we continue to gain traction. And then certainly, last but not least, is the amount of work that we've done with our large enterprise customers really with our private cloud offer, and their movement to more of a private than a public cloud. And we're starting to see nice traction.

As I mentioned, we had a very significant win in Q3. And our pipeline is building a quarterly. So we have -- we're seeing our new products really starting to gain the momentum, not only in this quarter, but backlog building as we go into FY '21.

Got it. Can I just follow-up on the issues of security contract? I think last quarter, you had mentioned to expect about $20 million of revenue in fiscal third quarter with the contract now awarded, how should we think about the ramp in that revenue as we go through fiscal 4Q and into next year relative to the $20 million you had guided to for fiscal third quarter?

Yes. I would say that just due to some COVID limitations, we weren't able to get the full $20 million in Q3, probably more like about half of that. And I would think we're going to be somewhere around the $20 million again in Q4 outlooking that. And then as we go forward, we would expect, given the 10-year nature of the deal, that rough number as the managed service aspect or private cloud aspect of it should be roughly about $30 million a year as we go out through time.

Our next question is from Catharine Trebnick with Dougherty & Company.

Mine has to do with, how are -- excellent quarter, by the way. And how are you seeing the competitive landscape, in particular with Microsoft has been really pretty actionable and working with a lot of the carriers, which happens to be one of your end-user routes to market? And if you could just kind of give us some color around those relationships and how solid they are.

Yes, I'll start, and then I'll turn it over to Anthony to give some additional insights. Obviously, it's a fairly competitive marketplace. We are seeing Microsoft more on the SMB business than in the large enterprise businesses today. But one of the things I think that's most encouraging is the fact that as I talk to a number of my peer CEOs, especially in the time of uncertainty, they are very comfortable in turning to, if you will, a business partner that offers more than just a product to their platform.

And I believe that's what's differentiating us from a number of competitors, the fact that we have deep global expertise, the technology innovation, financial strength. And probably, sort of, what's most important is the fact that we have a world-class services organization in support of that. So the point is, they turn to an industry expert that can provide them with the breadth and scale that they need in order to deliver other solutions that they need and obviously, in a very timely basis, especially with COVID.

So we're starting to see more Microsoft, but again, it's probably more on the SMB side of the business right now. So I don't know, Anthony, if you want to add any more to that or not?

Yes. Thanks, Jim. I think you got that fairly right. I think the only other thing I would add is we cohabitate a lot with Microsoft already in a lot of accounts. They're obviously quite large and integrated in the IT side of the organizations. And also on the experience economy side, with our CCaaS solutions and our contact center solutions as a whole, you really see us both side by side working well together and integrating well together for our customers collectively.

So that cohabitation seems to work pretty well for our customers. We service them fairly well. I expect that to continue in that landscape to not materially changed too much because at the end of the day, as Jim mentioned, what we've shown over the -- particularly over these last few quarters is the mission criticalness of the product portfolios that we both respectively deploy in market, and we're respected in this particular space. And as a result, customers choose us in cohabitation with other people that we integrate with, and Microsoft being one of them.

Our next question is from Rod Hall with Goldman Sachs.

I wanted to dive into CCaaS a little more and see if there's anything you could do to give us some sizing on that, how big it was? And then maybe talk a little bit about sustainability of that business, too. It seems like something that would have pulsed quite a bit here because of what's going on with lockdowns. But then maybe on into the September quarter, but then after that, maybe not as strong. So just curious what your thoughts on sustainability are and anything you can tell us about the size of that. And then I have a follow-up.

Yes. Anthony, do you want to take that?

Sure. I think the size of it is still in its relatively nascent stage relative to the rest of our CCaaS -- rest of our contact center portfolio, from a relatively upsize perspective. What we're finding is a customer would come in -- the nature of your question also talks about the environment or the macro environment. What we find is customers coming in asking initially for a CCaaS solution. And as we give them -- because we're not really (technical difficulty) deploy a CCaaS in the pure cloud, you can deploy it in a private cloud, you can deploy a hybrid scenario. We end up finding that we give customers optionality with regard to their journey. And a lot of the time, they may start with the CCaaS solution and then may move into one of the other parts of the portfolio.

So we don't chew hone them into just a singular part. So as a result, we're seeing CCaaS growing and growing nicely. But as a result of having CCaaS part of our portfolio, we're seeing attractiveness. It's floating ore boat in our contact center solution base, which is quite interesting and not surprising at the same time.

Okay. And then I wanted to go back to the SSA contract, the $10 million this quarter and then your expectation for $20 million. Can you give us any idea how you expect that generally to split between products and services? And whether that split would be any different this quarter than next and so on?

Yes. This is Kieran. If you don't mind, Jim, I'll take that one. So I would think 3Q and 4Q will have a very similar split mostly product with a little bit of professional services built in, pretty similar to 3Q and 4Q. But I think once we get out into next year, you're going to see early on in the year, some professional services and then really after that, it's going to be part of our private cloud-managed services offering.

Okay. So this initial revenue, Kieran, is probably less than 10% services, most of its product and a little bit like installation services, I guess, as you put it on…

Yes. It's actually -- It's actually a little bit -- yes, a little bit more than that because there is quite a bit of professional services involvement in embedding the product. But yes, I think you're thinking about it right. Longer term, the bulk of it will be really more services oriented.

Our next question is from Meta Marshall with Morgan Stanley.

Great. Just wanted to dive into any trends that you're seeing that kind of didn't meet your expectations on kind of how customers are electing private cloud versus kind of your multi-tenant cloud solutions for communications, either size of customers that are validating or invalidating assumptions would be helpful?

And then just second question, just what are the future features we should be expecting to roll out on the cloud contact center product this year?

Sure, Meta. Do you want to start on that, Anthony? And then I'll add a little color at the end.

I think I missed the first part of the question, someone could repeat that. But on the second part, what you'll see is, fundamentally, we've laid out milestones with our CCaaS solutions, as we'd highlighted previously. So we delivered on the voice part of our CCaaS solution in early March. We then met our milestone, as Jim had highlighted, about a month ago on introducing our digital channels to that particular part of the CCaaS solution.

You'll see us then start to expand the capacity of that in the public offering over the course of the next few months moving into the November, December time frame. And at the same time, we'll be increasing the deployment speed of our customizable CCaaS private solutions. And that's an area where we're really seeing a lot of attention. So as I mentioned a little bit earlier in one of my answers, we see customers come in under CCaaS. And then splintering off and saying, "Okay, maybe I don't want to deploy in public, I would like to deploy in public -- in a private cloud offering, and you give me that choice." That is something that compliance offices like, et cetera, et cetera, within the organization.

So that -- we're seeing a lot of traction there. It starts the dialogue and then it splinters into any part of our portfolio.

Yes, Meta, can you repeat the first question again, please? Thank you.

Yes. The question was just what trends you're seeing in UCaaS as far as who's looking to elect the private cloud, who's like -- like they are multi-tenant solution?

Sure. On the -- thank you for repeating that. So on the UCaaS side, what we tend to see is large regulated industries tend to move to the private cloud. That's -- they really have an oversight from compliance or they're susceptible to issues associated with security and they want balanced components for this (technical difficulty) the manner, and that's what they do. So they'll come in, they want the elasticity of a cloud but they wanted to be on their cloud within their firewalls, et cetera, and under their remit and mandate.

So that's where -- that's a trend that we're seeing. I don't think it's a new trend. I think now that we've seen that trend happen for quite some time. And I suspect that we'll continue to see that.

Yes. And maybe just to add to that, what we're seeing right now, obviously, with multi-tenant only being in the market in the U.S. for a few months and globally now for the third quarter, basically just a day in a few countries. But it's pretty consistent to what we've seen in the past, and that's where on the larger enterprise side of the equation, we're seeing private or hybrid, and we are seeing an uptick in hybrid, which is unique, obviously, for us around driving those solutions for the large enterprise customers.

The multi-tenant solution is still predominantly SMB and mid-market, and that's where we're seeing the growth. And again, the prominence, if you go from an overall percent adoption. In fairness, I would suspect that to stay the same, at least through probably the end of this calendar year as we continue to define and roll out the multi-tenant ACO solution. And so I don't see that changing significantly one way or another is at least we go through the balance of this calendar year.

And if I may add one more thing to that, Meta, is that one of those capabilities that we're introducing upcoming is that we can deploy private clouds in a matter of hours now. And that is really gaining a lot of attention and traction. So being able to deploy a cloud solution in hours that is highly customizable, is a unique attraction, whether that's in -- purely in a cloud or inclusive of hybrid deployments. And that's quite unique to Avaya, as Jim had mentioned.

Our next question is from Raimo Lenschow with Barclays.

Congrats from me as well. Two questions. First, Jim, can you talk a little bit about what you're seeing in terms of customer behavior? We kind of -- have we moved on post-COVID thing more structurally again? So is there kind of more as you think about investment decisions, is that more longer term versus like kind of still -- kind of looking more to fix gaps that occurred in the last couple of months?

And then, Kieran, for you, can you talk a little bit about your -- what's driving your decisions around cash buybacks? Obviously, we're still somewhat in the middle of the crisis, but your performance is really, really nice, stable, strong. How are you thinking about usage of cash?

Yes, sure, Raimo. Yes, thanks for the question. So look, the pandemic, obviously, has had a horrible impact on -- just on everyone. That being said, it has accelerated our customers' digital transformation by 2, 3, some even say, 5 years, but I don't quite see that. But it does align perfectly with what we laid out from a strategy perspective. So as I said, sort of at the right place at the right time and really helping customers deliver work-from-home capabilities.

And last quarter, and again, this quarter, we're seeing many of the CFOs putting dollars back on the table, if you will, to drive work-from-home initiatives. And as we deployed those 2.5 licenses last quarter in the Spaces, a few weeks to large companies and organizations and governments, it initially started out really to protect the safety of the employees.

Now what we're seeing is increased demand. We're still obviously converting a lot of those temporary licenses to subscription deals and also working with our customers, as I mentioned, on their digital transformation journey, which will extend the opportunity for revenue growth. But we are starting to see projects now moving away from, if you will, the safety of the employees now that, that is, for the most part, been resolved.

And now what everyone is looking to do is drive efficiencies and productivity, effectiveness, such that they can operate their work-from-home agents, if you will, as if they were in the office. So ways to serve their customers, better ways to build a better customer experience.

And we've implemented a number of solutions along the lines there, and we are continuing to develop tools and solutions to continue to build on that, whether it's through video and collaboration technology, again, whether it's around the ease of use and effectiveness and we believe that working remotely has proven that there's opportunities there today and then there will certainly be opportunities there as we go out through time. So we're seeing a lot of opportunity and, frankly, a lot of dollars being spent on and really now driving the efficiencies of these supporting more of our employees. Kieran, do you want to take the second one?

Sorry. Okay. Having some IT issues here this morning. So Raimo, first of all, we still -- I think it's important to note we still retain Board approval for the repurchase program, up to the $500 million in total. So the program does remain open. And obviously, we have the right to restart that without any notification. So just putting that out there. I would say that due to the current still ongoing uncertainty, I think it's pretty safe to say that we believe it's prudent right now to maintain a healthy cash balance at this time.

And I would say we're working very closely with the Board and our advisers. We've got a number of the banks in to talk to us and focus on the right balance within our capital allocation. We were very pleased with the effectiveness of the program that we ran earlier this year. We were able to retire 26% of our shares outstanding. However, I think we also have seen that in times of extreme market volatility, both in debt and equity markets, companies with single B ratings get hammered, increased just a lot of volatility. So that certainly is in our mind as well as we work on the Board and think about what the future will be whether we focus more on improving our leverage and debt paydown versus the buyback.

So all of that is in the calculus that we have to come through. But right now, we're pretty pleased with our cash position. And at the same time, we are very pleased that we were able to achieve the objectives that we put in place at the beginning of the year to retire 26% of our shares.

Our next question is from Chris Sinnott with Cowen and Company.

I have 2, and I wanted to start on CAPS revenue getting to 30% of revenue. It's great you've hit your target. Can you talk about where do you think that target is going? And/or what that new target itself says about first, your gross margin outlook and then on top of that, your capacity or desire to reinvest, say, more than the point of EBITDA that you talked about redeploying into R&D and elsewhere for 2021 and beyond?

Yes. Kieran, you want to take the initial one?

Yes. So I think, first and foremost, obviously, from a subscription perspective, right now, we have a fairly healthy mix split between premise-based product as well as cloud-based. For the premise-based, obviously, the customer is hosting that portion of it and therefore, the gross profit margin in that is quite lucrative. As we start to see a larger and larger portion of the subscriptions being driven via more cloud, obviously, the margins will decline modestly. Once you're at scale, obviously, you have -- you're able to generate pretty good margins there as well.

So we would see that transitioning over time, but I think that's probably over the next several years. We'll try to see -- we'll see those trends. Don't see a huge impact there because I believe that we'll be able to -- as Anthony was pointing out, as we are able to put up our -- as we're able to put up our scale, our private cloud much quicker, I think the margin -- our time to margin is pretty strong. So first and foremost there, I think margin is going to maintain pretty strong in subscription.

As we think out -- remind me again the second part of the question.

Just as we move below gross margin, the capacity, the desire to reinvest.

Yes. Okay. Got you. The investment. Yes. So I think this year, if you recall, we did say we were going to invest a point in margin this year. So I think, first and foremost, we did that. It actually has been mitigated in terms of visibility externally just because of the COVID-related implications, obviously, with no customer travel and the people not traveling in general, we've been able to actually underrun and expense in other areas while still making the investments in this space.

I think the more we've learned as we continue to work and deploy a cloud-based business, I think, we're -- we do see the continuing need for increased and enhanced investment inside of our inside sales, our digital sales engine. So I think we'll probably continue to see that investment as we go out next year as well. Obviously, we're not ready to provide guidance for next year, but I do think it's one of the things that we're seeing in a competitive landscape investment in go-to-market is really the most critical along the way, and we'll probably continue to do that into the early part of next year as well.

Yes, I just might add, yes, we haven't pulled back on any of our R&D investments in light of the crisis that basically started back in the February and March time frame. So we haven't slowed that investment. In fact, I would say we probably have accelerated some of that spending simply because of the opportunities we see in front of us. That unfortunately, COVID has brought forward, and that's around a lot of new work-from-home type capabilities as well as sort of an acceleration of what we see with the opportunities with CCaaS opportunities as well as CPaaS, frankly.

As we go out into next year, I don't suspect that we will be slowing our investments in R&D at all because the teams have made great progress this year, and we'll keep that momentum going as we continue to build out this new portfolio. So it's pretty robust now. And as we go through the next 12 months, we'll become that much more robust. So we'll continue to invest in R&D. And fortunately, for us, having a strong liquidity position allows us to continue to do those investments and make us stronger, if you will, at the end. So we'll continue that focus.

That's really helpful. My only other question is on the relationship between contract value or backlog value and your revenues. Because over the last 12 months to 15 months to 18 months, you guys are really standing (inaudible) year-over-year revenue decline. And obviously, now you've turned a corner to positive revenue growth, but all happening over a period, over a course in which backlog sort of flattened it calls it $2.4 billion to $2.3 billion, down to $2.2 billion today. So as we think about subscription models and customer preferences for OpEx going forward, how helpful is contract backlog as a metric versus how we used to look at it?

You want that Kieran, or you want me to address?

Yes. So listen, from my perspective, obviously, the backlog continues to be an important metric overall. I would say that any time you look at backlog, you do have to be cognizant of the fact that you do go through periods of renewal cycle where a larger portion of the business is up for renewal at any given point in time. So that's going to have implications sometime within quarters and the like. What you will hear from us as we move out into our next fiscal year is we're going to be working on having some metrics in addition to our CAPS metric that give a better indication of the annual -- the recurring nature of our business overall.

And I think that will start to move to the forefront as being more of a meaningful metric and meaningful track of the progress that we've made in addition to supporting with the CAPS metric. So backlog, not that are important, but I think the MRR nature of that backlog will become what we want to focus on. And as we enter into our new fiscal year, we'll be introducing those metrics. We just didn't think it was right to introduce them halfway through the year, we'd like to do that as we get out into the new fiscal.

Our next question is from Asiya Merchant with Citigroup.

Just a quick question regarding the guidance. I think seasonality-wise, typically, the fourth quarter, fiscal fourth quarter for you guys is pretty strong, if I recall, up 4% to 5%. And you have, obviously, secular tailwinds here. You have one Avaya Cloud to rolling out across different geographies. You have the incremental social securities. If you can help me on that seasonality, that would be great. And then I have a follow-up as well.

Sure. So I think the first thing that we recognize is, obviously, Q3, from a seasonality perspective, was a little better than history. And again, some of that had to do with the fact that we were able to monetize as many of those temporary licenses as Jim referenced. So clearly, our Q3 stepped it up versus our historical view of it. I'd also say as a larger portion of our business becomes recurring in nature, we would expect not that there'll be an absence of complete seasonality, but the business, as you start to sell less of a CapEx model, the business is going to start to look a lot more linear within quarters.

And I think we're seeing that now, especially for 3 quarters now, up to $200 million worth of TCV under subscription is starting to flatten out some of the deltas between the quarters. And I think that's what we're starting to see as well. Obviously, Q3 a little better because of some of the high subscription helped, obviously, from some of the COVID and Q4, obviously, continuing the momentum forward. And as I said, we did put a guide in there. It would be unfair to put a guide out there that didn't acknowledge still the presence of -- the presence of COVID and still implications out there. So we are trying to be -- we are trying to cover all bases with the guide that we put out.

Yes. And Kieran I -- I'm sorry, I'd just add one other. If you look under the numbers, Q4 -- first of all, first half for us was typically higher than second half. Secondly, if you look at Q4, most solely uptick in Q4 was driven by federal on the end of the year and increased spending with federal. That's going to be somewhat mitigated, obviously, with COVID this year, and we just signed the SSA deal and so on.

And then I would agree with Kieran that seasonality is much different now "with the cloud and SaaS business", large recurring revenues, so on. So we -- but Q4, again, was mostly driven by an uptick in federal.

Okay. And then relative to 30% of having achieved that, and I know you guys are going to update this when you provide your next fiscal guide. I think initially, metrics were around -- when you kind of hit this target to 30% cloud and subscriptions, you would get to growth of about 2% to 4%, you would get to EBITDA margins covering in high 20s, 27% to 28%. How should we think about that relative to your guide, and as we look out into '21, where you could have more private cloud offerings as well, which, as I understand, typically have lower EBITDA margins?

Sure. So from my perspective, I think, obviously, the guide we put out there a year ago, last October, really doesn't contemplate the implications of COVID. So as you rightly say, we'll be looking ahead as we enter in the new year, and think about the long-range model all in all. But as we thought about what we said we were going to do this year, I think we're executing pretty consistently and that we would start to return to growth, modest growth, obviously, because of the implications of COVID, but growth nonetheless, here in Q4.

And at least with what we have line of sight out here into Q4, into early year, I think momentum should continue in that way. But I think it's a little early, Asiya, to really go out there and confirm what we see about the long-term aspects of the 2% to 4% and the high-20 margin at this point in time. We would like to get through this year-end, get through a revamp of our long-range plan and then come back out of that as well.

And now our final question is from Hamed Khorsand with BWS Financial.

I'll be quick. Is the COVID driving the process to the cloud or is it customers who are anxiously waiting for you to have this public cloud solution? And my second question is, how much of the decline in selling equipment could become permanent?

Yes. Thanks. Great question. Actually, what COVID has done for us is really showcased, I would say, sort of the value that still remains with voice, and it's a key element. And in fact, premise-based seats are still very relevant in a work-from-anywhere world. So if you take a look at our subscription growth, that's on-premise seats, frankly, that we have converted to subscription.

Well, COVID does provide the opportunity because, obviously, those subscription seats are certainly a gateway to cloud if and when our customers want to move. So we see this as a real opportunity. And more importantly, some over time, there's been a fair amount written about the fact as premise debt are not debt. In fact, with subscription, it, by far, is not debt. All those 2.5 million licenses are on-prem seats. I do think COVID has moved -- is moving close to the cloud faster. Someone's on talking, I believe. I do believe, COVID is playing a role of and really moving.

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COVID has accelerated the move to digital transformation. So you are seeing a bit of an uptick in the mid-market end of the business associated with movement to the cloud. But on the higher end, large enterprise businesses, it's really, for us, we see it has to move the subscription and then, therefore, they move the club right behind that, which is really important about our private cloud offers that Anthony just referenced. And how they fit into the equation as we go into FY '21 as well as our hybrid offers. We see those as real differentiators. And in fact, we're seeing nice traction with our customers to date.

This does conclude our question-and-answer session. I would like to turn the conference back over to Michael for closing remarks.

Thank you very much for joining us this morning. We look forward to speaking with you soon. If you have any additional questions or follow-up, please feel free to give me a call in my office. We look forward to reporting back to you in November. Take care.

Thank you. This does conclude today's conference. You may disconnect your lines at this time, and thank you for your participation.