Avaya Holdings Corp (AVYA) 2020 Q2 法說會逐字稿

Greetings. Welcome to Avaya Fiscal Second Quarter 2020 Conference Call. (Operator Instructions) Please note, this conference is being recorded.

I would now like to turn the conference over to Mike McCarthy, Vice President of Investor Relations. Thank you. You may begin.

Thank you and good morning. Welcome to Avaya's Q2 Fiscal Year 2020 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 on the call this morning will be Anthony Bartolo, EVP and Chief Product Officer. 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 be referencing non-GAAP financial measures and specifically note that to all sequential and year-over-year comparisons reference non-GAAP numbers, except where otherwise noted. We have included a reconciliation of such measures to GAAP in the earnings release and in 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, the duration and severity of the pandemic as well as governmental and business responses to it, 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 subsequent Form 10-Q reports. It is Avaya's policy not to reiterate guidance, and we undertake no obligations to update or revise forward-looking statements in the event facts or circumstances change, except otherwise required by law.

I'll now turn the call over to Jim. Jim?

Thanks, Mike, and thank you, everyone, for joining us. This morning, I'll provide you with highlights of our second quarter performance and a summary of our progress as we execute our strategy. Kieran will then take you through the details of the quarter and our updated guidance. Afterwards, we'll open it up for questions.

We are living in extraordinary times. And before we begin, I'd like to thank the health care and other frontline workers who have worked tirelessly supporting our local communities throughout this crisis. Our thoughts go out to everyone affected.

In the face of the significant number of global challenges associated with COVID-19, which began to take hold in early February, Avaya delivered a strong second quarter on multiple fronts. Let me share some highlights.

Our Q2 GAAP revenue was $682 million, well within our guidance. Software and services as a percent of revenue was 88%, an all-time high. Recurring revenue was over 64%, up more than 5 points quarter-over-quarter and year-over-year, also a record. Both measures are evidence we have transformed to a software and services company. Especially noteworthy was the continued growth in our Cloud Alliance Partner & Subscription metric or CAPS. Simply stated, CAPS is our metric for SaaS and cloud, and we grew to 23% of revenue compared to 18% in Q1 and up from 15% in all of FY '19. We expect that percent of revenue from CAPS will continue to increase at a steady pace. We have the largest and most valued installed base in the industry, and the rapid growth of this metric underscores the commitment of our customers to our company and the mission-critical nature of our solutions.

By design, the continued mix shift to this high-value revenue reflects the vision and strategy we laid out is taking hold. This will serve as a growth engine and shows that our transformation to a software SaaS and cloud-focused company is irreversible.

On the profitability front, the company delivered adjusted EBITDA of $149 million or approximately 22% of revenue, at the high end of our guidance. Our performance accentuates our continued best-in-class execution and the resiliency of our business model and scale.

Lastly, we continue to execute on our capital allocation strategy. We ended the quarter with $553 million in cash while having repurchased approximately 29 million shares since launching our buyback plan in November. Our thoughtful and deliberate approach during recent market conditions allowed us to achieve our targeted repurchases on an accelerated time line and lower aggregated costs. We utilized only $330 million versus the $400 million originally contemplated. Our strong balance sheet and liquidity position not only allows us to weather the current COVID-19 storm but provides us with flexibility on how we grow shareholder value and allows us to continue to make key technology investments.

In summary, I couldn't be proud of how the company has responded on all fronts in the face of this epic global crisis. The results we delivered were driven by our purposeful march down a path to address the growing demand in digital consumption models and cloud. Over the last 2 quarters, we have brought dozens of new offerings and capabilities to market, including Avaya Cloud Office, our public UCaaS offer; ReadyNow, our private cloud offer; video huddle rooms; extending our private and hybrid cloud capabilities with IBM, Microsoft and Amazon; artificial intelligence with Google; introducing our subscription offer; launching Spaces; our video collaboration solutions and CCaaS, just to name a few. These new solutions give us breadth and depth of technologies that others simply don't have.

To punctuate the extent of these capabilities, in just the last 2 months, we have provided over 2 million remote agent licenses to companies around the world to allow their employees to work from anywhere. We launched our much anticipated Avaya Cloud Office offering and closed multiple deals on day one. We introduced a CCaaS offer and are already seeing customer wins and growing demand. We accelerated global availability of secure business-to-business Spaces video collaboration, providing it to health care, education and nonprofit organizations for free and deploying hundreds of thousands of new seats.

Lastly, our subscription volumes grew nearly 100% quarter-over-quarter, demonstrating customer demand for the value created through flexible cloud consumption models, upgrades to the latest innovations and while bundling of a rich set of features and functionality into one simple contract. We've long been leaders in work-from-anywhere capabilities, from devices to video collaboration to the ability for contact center agents to seamlessly work from home. This has enabled our customers to secure the safety of their employees while maintaining productivity and delivering a superior customer experience. Only Avaya can do it at scale and with the geographic reach.

Let me give you just two examples. [Bartella] Performance, a global leader in digitally integrated business services. We provided the capability for more than 100,000 agents to work remotely and deliver the same customer experience as a traditional brick-and-mortar contact centers. And for global financial services company, we provisioned over 100,000 temporary licenses for over a dozen locations across the globe in less than 3 days. There are many more examples of how quickly we responded and working with our customers.

Globally, we have deployed over 2 million seats in just the last 2 months. These new offers are fueling our ability to activate our base along with making significant strides with new customer acquisitions. Let me share some numbers.

During the quarter, we added over 1,200 customers with more than 100 competitive displacements, including a significant number of takeaways from Cisco, Genesys and API. Customers continue to make significant investments in Avaya. During the quarter, we signed 79 deals with a TCV of over $1 million, including 12 valued at over $5 million and 3 over $10 million TCV. And we have a TCV of $2.3 billion coming out of Q2.

This traction further demonstrates that our technology is mission-critical to the global enterprises and high-value segments we serve. In short, the strategy we architected and our focused investments in SaaS-based offers and cloud technologies are paying dividends.

Let me provide some additional color on our strategic priorities, including private, hybrid, public cloud and new consumption models. Avaya's ability to deliver private and hybrid cloud solutions is unmatched and is a key differentiator, especially for our large enterprise customers. There are several significant new wins that underscore the value we deliver. One such example is with the American Red Cross, who chose our ReadyNow private cloud platform as part of their One Red Cross initiative. Under this program, the Red Cross is transforming their disparate legacy contact center technology platforms to a single cloud-based Avaya solution in order to lower operational costs, improve efficiency and streamline a response to customers and clients and further rents of Red Cross mission. This multiyear deal includes key capabilities from our ecosystem partners, Nuance and Verint, along with Avaya's own mobile experience and CPaaS solutions.

On the public cloud front, we successfully launched Avaya Cloud Office in the U.S. The on-time launch was the culmination of months of hard work by the joint RingCentral, an Avaya teams. Our go-to-market motion is supported by 5 of the most influential master regents in the market, including Advent, Intelisys, Jenne, Synnex and Solaris.

We have over 1,700 agents on boarded and trained as of today to sell Avaya Cloud Office. Along with Avaya and the RingCentral sales forces, this gives us a huge network of coverage from day one. And I'm extremely pleased with the progress.

What I'm even more pleased about is the warm reception Avaya Cloud Office has received from our partners and customers. Pent-up demand that we couldn't previously address made us vulnerable to attacks on our base. The effectiveness of those attacks has diminished. Clearly, the rationale we laid out for this strategic partnership is coming true before our eyes. We are building on the momentum with the launch of Avaya Cloud Office in Australia, Canada and the U.K. later this quarter. This is indicative of how we are moving at cloud speed.

On the CCaaS front, we introduced our initial offer in March, as planned. We have already signed several customers. Our next milestone is slated for June when we will deliver additional digital capabilities, from which point we will have regular quarterly milestones in motion as a matter of course. One of our early CCaaS customer wins was Hydro Ottawa. With more than 335,000 customers, Hydro is a critical utility company serving Canada's capital. The company was faced with the possibility of disruption of their call center operations. The implementation of our CCaaS solution allowed them to seamlessly transition with no interruption of service, ensuring all customers could communicate with the company while allowing employees to safely work from home.

Another key growth lever is our video collaboration and teaming solutions called Avaya Spaces. Spaces is pure cloud and purpose-built for enterprises with scale, reach and security you would expect. Spaces is unique from typical video-only solutions in many ways. First, it's a business-to-business application, meaning security and availability are table stakes. Security extends to customer data, which is not sold, and there's no room for a notion to pop-up ads. Equally as important, it combines the best of cloud-based video with voice collaboration and team room capabilities. Spaces exist as a room where conversations, documents and discussion threads remain. The solution is a platform to bring teams together at any time, which represents the power of true collaboration.

Let me share a couple of real life examples. Large universities, with geographically diverse student populations such as Forest State University, Michigan State University and Ikona Liceo in Italy are among thousands of schools globally now using Spaces for their virtual classroom needs as they keep their students and teachers connected.

In the area of health care, hospitals have been hit hard. Spaces eases the strain on their system. Hospital staff can now consult virtually and collaborate over video and connect more frequently with patients. This reduces use of PPEs, increases health care provider patient engagement along with greater overall care. We first saw a use of our video collaboration in Wuhan province, the original epicenter. Usage of our Spaces offering was up more than 2,500% through the end of April and continues to grow.

Moving on to subscriptions. This consumption-based model is a real highlight for the company and has generated a total contract value, or TCV, of nearly $100 million in just 6 months. It is an important pillar in our strategy to activate the base and our customers are embracing it. And let me give you a couple of examples. Humana needed to enable 17,000 agents to work remotely. We quickly enabled temporary enhanced software entitlements to move these agents. The new normal will require these and other capabilities. Hence, within short order, Humana moved to trade their perpetual licenses and signed a 3-year IX subscription to tap into the wealth of our features, giving them what they need when they needed it.

In the area of UC, we had a long-standing university client that was on an older, reliable version of telephony. They quickly realized the benefit of IX subscription because Spaces was included. They signed a 5-year subscription agreement and are beginning to upgrade their infrastructure. And more importantly were able to quickly enable Spaces for the university. We are seeing the realization occurring across our entire base. The bundling of these capabilities into subscription delivers an accelerated return on our customers' investments, moves them to the latest releases, leverages their prior investments and allows customers to rapidly pivot to meet their specific needs.

It is also important to note the continued momentum we have within our strategic partners, and to share a couple of proof points that accentuate how Avaya is successfully executing on our commitment to grow our ecosystem. First, Avaya was named by Nuance as both top producing channel partner and top growth partner for AI-powered solutions.

Second, Avaya also received the Global Partner of the Year Award from Verint Systems for its ability to accelerate successful transitions to the cloud. Additionally, last week, IBM recognized Avaya with its Hybrid Cloud Excellence award for the outstanding performance of our Avaya OneCloud, ReadyNow private cloud solution. Together, we offer unmatched capabilities that drives significant and lasting value to our customers.

Avaya is breaking new ground, shaping the future of how communications and collaboration technology addresses both the future of work and the modern customer and employee experience setting. The current macro environment has only accelerated what was a developing trend and the way people work is going to fundamentally change and move to a work-from-anywhere model. It will become the norm. Work will be more distributed, whether it's allowing remote workforces to stay connected or helping our customers respond to their customers' urgent needs. From a business perspective, this is a real opportunity and Avaya is positioned to lead.

With that, Kieran will now take you through the details of the quarter, the mechanics behind our capital allocation and our Q3 outlook. 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 on this call are as reported, unless otherwise indicated in constant currency.

For the quarter, non-GAAP revenue was $683 million compared to $714 million reported in the year ago period. Sequentially, this compares to $717 million as reported in Q1 of fiscal 2020. We finished the second quarter in line with the revenue guidance we provided in February. Please note that during the quarter, GAAP and non-GAAP revenue have converged, and the non-GAAP differences generated by fresh start accounting are now immaterial. However, non-GAAP adjustments were material in fiscal year '19, and so for year-on-year purposes we speak to non-GAAP revenue for proper comparisons.

Revenue contribution from CAPS, or Cloud Alliance Partner & Subscription, represented 23% of total revenue for Q2, up from 18% for the prior quarter and 15% for the full year fiscal 2019. CAPS revenue increased by $31 million quarter-on-quarter primarily driven by subscription.

Second quarter product revenue was $245 million compared to $289 million in the year ago period and $298 million in Q1. Hardware revenue was down over 30% year-over-year. Total software product revenue was down modestly in the low single digits, with contact center software revenue growing, and UC software revenue declining.

Second quarter services revenue was $438 million, up compared to $425 million in the year ago period and $419 million in fiscal Q1. Continuing new product placements, upgrades and conversions under a subscription model represent a key growth driver for our services revenue and more than offset any declines in maintenance and support.

Turning to our gross profit metrics. Non-GAAP gross margin was 61.1% in the second quarter compared to 61.5% in the year ago period and 61.4% sequentially. Non-GAAP product gross margin was 62.9% compared to 63.7% in the prior year and 65.1% in the first quarter. Non-GAAP services margin was 60.0% compared to 60.0% in the prior year and 58.7% in Q1.

Turning to total profitability, margin and cash flow metrics. Second quarter non-GAAP operating income was $125 million, representing a non-GAAP operating margin of 18% year-on-year, down 260 basis points, while adjusted EBITDA was $149 million, representing an adjusted EBITDA margin of 22%, down 140 basis points year-on-year while landing at the high end of our guidance range.

Before I discuss our second quarter cash flow and liquidity in greater detail, I'd like to address the goodwill impairment charge that was disclosed in our earnings press release this morning. Following the decline in the company's stock price, during the period, which was consistent with the way the broader market was affected by the COVID-19 impact on the global economy, we determined that a triggering event occurred and consequently performed an interim goodwill impairment test. As part of the goodwill impairment test, we compared the fair values of all our reporting units to their respective carrying amounts as well as the allocated goodwill that was established as part of fresh start accounting in December of 2017. Based on our analysis, we determined our projections of future revenue in the product and solutions reporting unit have been adjusted to reflect increased risk from higher market uncertainty and the accelerated reduction of product sales related to our historical on-premise perpetual license or CapEx model sales.

We anticipate this decline will be partially offset by the continued shift and acceleration of customers upgrading and acquiring new technology innovation through the utilization of our subscription offerings, which is now included in our services reporting unit. As a result, the carrying amount for product and solutions reporting unit exceeded its estimated fair value and resulted in a noncash impairment charge of $624 million.

Turning to cash flow. We generated $20 million in cash flow from operations or 3% of total revenue, contributing to a second quarter ending cash balance of $553 million in cash and cash equivalents. COVID-19 impacted the cash collection process in a few key areas. Firstly, we took a $7 million reserve on a receivable owed by a large distributor in our international theater of operations due to the aging of their past due. Secondly, a handful of customers that typically take advantage of early pay discounts did not do so this quarter. And finally, in an effort to address the challenges some of our customers and partners are experiencing, we have opted to extend payment terms temporarily for some of the hardest-hit creditworthy customers benefiting our business near term and long term.

With this practice being relatively commonplace in our industry right now, we're staying competitive with our peers while strengthening relationships and building loyalty. We are fortunate to have more than adequate liquidity to support this initiative.

While on the topic of cash balances, I'd like to provide an update on Avaya's capital structure and liquidity. To start, management has the utmost confidence in our continued ability to generate positive cash flow from operations. That being said, out of an abundance of caution, and not out of immediate or forecasted business necessity, in early April, we initiated a $50 million drawdown on our revolving credit line to boost liquidity. We view this as an insurance policy only, reinforcing our stability in an economically turbulent environment. As a reminder, the company has no financial covenants in its term loan or convertible notes. Furthermore, our schedule of maturities does not factor into any of our near- or mid-term liquidity considerations.

Regarding our share repurchase program, in Q2, we bought back an additional 18.2 million shares at a cash cost of approximately $198 million. Our year-to-date share repurchases under the existing Board-approved plan now totals nearly 29 million shares or more than 26% of the shares that were outstanding when we implemented the program in November of 2019. As a result, we have achieved our fiscal year 2020 objective while only utilizing $330 million of the $400 million contemplated to be spent in fiscal 2020. While we still retain Board approval for a repurchase program of up to $500 million in aggregate, for the time being, we have suspended additional purchases, given the existing macroeconomic conditions.

Now turning to guidance. In light of the uncertainties in the global business environment arising from the effects of the COVID-19 pandemic, the company will be withdrawing our full year guidance. Instead, we will provide an update only on our expectations for the fiscal third quarter ending in June, for which we have line of sight and a high degree of confidence in attaining. Please note that all year-on-year revenue changes are expressed on a constant currency basis and all revenue amounts reflecting rates as of March 31, 2020.

For the third quarter, we anticipate non-GAAP revenues of $675 million to $705 million, representing a negative 5% to negative 1% annual decline as measured in constant currency. The top end of the range includes $20 million of expected revenue contribution related to the Social Security Administration opportunity that we've been discussing over the past several quarters. We expect non-GAAP operating margin for the third quarter to be between 19% to 21%, and our adjusted EBITDA margin to be between $150 million and $170 million or between 22% to 24%. At this time, we expect no material change to our shares outstanding before the end of our third quarter or our fiscal year-end, which currently sit at approximately 83 million shares.

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

Thank you, Kieran. In closing, throughout this period, Avaya has been decisive in taking quick action to provide safety for our global workforce and to maintain continuity of the business while responding to new customer demand that accelerated overnight. I want to thank the Avaya global team who has worked so hard and moved rapidly during the rise of this pandemic to respond to the needs of our customers. It's because of their hard work and the mission-critical nature of our technology that we delivered a strong quarter in context of this crisis.

I'll wrap up with this thought. The way we work and engage has changed in front of our eyes. In this new world of work, Avaya's innovation, scale and services capabilities differentiate the way we keep businesses, government schools and vital health care organizations running. This has created an inflection point, and Avaya is at the forefront and well positioned to help our customers and capitalize on the opportunity.

Operator, we are now ready to open the line for questions.

(Operator Instructions) Our first question is from Raimo Lenschow with Barclays.

Congrats on a great quarter. Two quick questions. First for Jim. If you look in terms of the client behavior that you're seeing at the moment, how much of that would you qualify as, like, tactical to keep the lights on versus strategic? And how do you think that will kind of impact your business as people kind of slowly coming out and lifting their head up and just trying to think like how the new world will look like? Just talk to what you're seeing in terms of your client conversations.

And then one for Kieran. If you think about the cash, you mentioned you kind of offered some of the payment held for some of your clients. Can you talk a little bit about how you see the cash situation evolve for you as the current crisis unfolds?

Yes. Raimo, this is Jim. Thank you very much. I appreciate it. Actually, I would say, as we take a look, we're seeing -- we're really seeing it more as strategic than, I'll say, tactical. If you take a look at our overall business, we had, as I mentioned, a huge increase in our recurring revenues as well as in our services and software. So an overall percent of revenue. So with that, obviously, we're relying less and less on hardware, what I'll say 1x-type revenues. We also expect to begin to monetize the $2 million seats that we actually gave out for free as part of moving to remote worker. And that's going to be important for us for growth engines, not only in this quarter but as we go out through into Q4. And we're really starting to see that take shape in a number of areas, but mostly in our overall subscription business.

So we're seeing continued demand. I see we're seeing further strengthening in our relationships with our large enterprise customers. We're seeing the fact that what we run is mission-critical applications. There's an ever increasing demand. So companies continue to invest in the business. Some are slowing on the implementation side, but we're still seeing a movement to change, a movement to improve their overall customer experience and an improvement to become more distributed in how they operate their business.

I'll give you one example. There's a government over in the Middle East who's declared that of their top 200 personnel, no more than 20 can be in any one location. So therefore, you're seeing that, obviously, being much more distributed and playing right into our hands and from a technology perspective. So I would say what we're seeing is a strategic, long term, 3-year, 5-year type contracts. So we're proof points that the strategy we have laid out is taking hold. Kieran?

Yes. Raimo, so I guess I'd start by saying that, first and foremost, really the effective change that we saw in the current quarter was really all due to the share repurchases, which was almost $200 million. I think we ended last quarter with about $766 million worth of cash and it's then at $553 million now.

Certainly, we're watching very closely all of our customers and their creditworthiness and their liquidity. We're pretty fortunate, I think, just to say at a high level, that we have a relatively small percentage of our customers in what I'll call the most affected industries, like the travel, hospitality types of industries.

We have no customer across our entire base, from a private sector perspective, who is really more than 1%. And clearly, our federal government in places like that are significantly larger, but from a private perspective, there's no one customer that has any significant share of our business in total. So as we go out for the next several quarters, obviously, we're going to want to watch and ensure continued credit worthiness of our customers, but we are quite confident with the cash that we have on hand that we're quite well positioned, even if many of these customers want to extend for 60, 90, 120 days in terms of their payments. From that perspective, we're feeling pretty good.

We did take one charge in the quarter, actually an impairment against a potential reserve, quite frankly, even that customer itself is working with us and actually paying on a to-go basis. So it's not like we don't expect to recover sooner or later, but just under the rules of our accounting models, we did have to take a reserve at that point in time.

So honestly, I think we're really well positioned here. We've obviously talked about just suspending temporarily our repurchase of the shares.

That gives us, as I said, an extra $70 million worth of cash this year. We had planned to spend $400 million this year in our -- this fiscal year in share repurchases. We're now only spending $330 million. So it really gives us quite a nice buffer as well.

Our next question is from Samik Chatterjee with JPMorgan.

Just again, two quick ones from my side. You talked about the strength you're seeing in the business given kind of the dispersed location, et cetera, that customers are trying to price to, maybe if you can comment on the balance, which are the customer verticals you're seeing the weakness in and maybe if there's a way to size what your exposure is to those verticals? And then a quick follow up. You're guiding to flat revenues quarter-on-quarter, but improving margins. So how should I read into that in terms of your mix going into the next quarter -- into the fiscal third quarter?

Yes. Sure. This is Jim. I'll address the first question, and then I'll turn it over to Kieran to provide some insights into the -- your revenue question.

So as far as the overall verticals and the strength of our business, actually, we're seeing strength across the business, in fact. So not any one vertical, I would say, is up and/or down. We're seeing it across, whether it's financials, government, health care, we are seeing a slight dip, though, however, in hospitality, but most of that, frankly, is a small percentage, as Kieran mentioned, in overall revenue. So it's not really a needle mover for us as far as impacting overall revenue.

But for those key segments, we're basically seeing strength across the business. And actually, we're seeing that come in a number of forms. But as we pointed out, our subscription offer has been very successful for us. And the fact that we're able to move customers that were more CapEx oriented to an OpEx model, which is a benefit, but the additional benefit is the fact that we've been able to really drive our technology and innovation into these offers as well as far as the overall bundling of this solution. So they're not only seeing an opportunity in reducing overall cost, but they're seeing added benefit of getting the latest and greatest technology, so sort of a win-win.

I would point out, as I mentioned, in the government areas, not only in -- not only here in the U.S. but across the globe. That's really been sort of a highlight for us as far as strengthening the overall business, and we expect that continue to strengthen as we go through the balance of the fiscal year. So overall, it really isn't a huge, what I'll say, dislocation because we really weren't over allocated, if you will, to one particular vertical versus another.

So with that, Kieran, do you want to take on the question associated with revenue?

Sure. So I'd say from a midpoint perspective, actually, what we're seeing operationally is quarter-on-quarter, so sequentially, actually growth of about 2%, but we're actually facing some headwinds from FX. So as the dollar has strengthened, as we all know, quite substantially, over the last 60 to 90 days, we do see some increased headwinds from that.

I think your point was, though, as to the margins expanding where we were this quarter, if you recall, in the prior quarter, we announced that we were actually investing quite a bit additionally in the launch of ACO as well as, as Jim has been talking about the launching of our CCaaS offerings as well, so we always knew that Q2 was going to be a low point from us from a margin perspective in the quarter due to some of our investments that we were making to really launch go-to-market as well as from a development perspective. So that should start to snap back here, coupled with the improved operational revenue quarter-on-quarter.

Our next question is from Meta Marshall with Morgan Stanley.

Congratulations. You noted that you said that this was a security contract is in the numbers. And so just wanted to get a sense of whether resolution had been achieved and kind of if there are any changes in that timing or project we should be thinking of.

And then you noted that you were extending some terms, but just had -- you had any customer request for flexing of seat counts and just how you're accommodating those?

Yes. Sure. Meta. This is Jim. Thanks. I'll turn the question over to Kieran, but just a little bit of insight on SSA. Yes. We do expect that we should see some of that revenue begin later on this quarter, which is good news. But I will turn it over to Kieran to give you some additional insights not only to the SSA book, what we're doing as far as working with our customers on payment terms. Kieran?

Sure. Meta, so clearly, it's been a long road with the deal. We expect final awarding of the contract to actually take place in early July.

There's been several iterations then. I'd say in a very positive note, there's only 2 key partners, general contractors who are in position at this point, and we are partnered with both of them.

So in either case, we expect that Avaya will be a key clear benefactor from the awarding of this contract when it actually occurs. What we have been able to do, though, is the government under the CARES Act has been able to act fairly quickly here and to just override some of the traditional procurement requirements to ensure that the SSA has been able to avail themselves of some contact center product and offerings and services to enable them to continue to enable their own employees to work remote as well as to obviously support their clients.

So we're seeing some of that work is likely to get pulled into this quarter even before the official awarding of the contract, and we think that's goodness. And as I said in my script, there's a potential that we could see anywhere, even up to maybe even $20 million of that revenue in the quarter. So it's -- finally, it's taken a little longer than any of us anticipated 9 months ago, but finally all heading in the right direction for us.

Related to your question about customers, in terms of flexing their seat counts or recasting their amount of seat counts, that's pretty much a standard that you see anytime you either do a renewal of a maintenance contract or from a subscription perspective as well as customers have become more efficient in their business over time. That's fairly regular. What you see though is, at the same time, as you're resetting the old offering, whether it's a maintenance offering or now going forward a subscription offering, you're also selling additional content into the account.

And that's, as Jim has pointed out several times in his script, is the real beneficiary of subscription, where our customers can reset where they were with their base business, but take advantage of actually upgrading that older technology to the latest technology releases as well as availing themselves of the new technology that we have, especially video collaboration Spaces.

So I'd say, didn't see anything unusual this quarter compared to what we see over time. The one, I'd say, real exception would be the fact that as more customers utilize subscription, it enables them to actually take more content from an Avaya perspective.

Yes. I might just add one comment to that, Kieran touched on it, but the new technology and being able to bundle innovation with the subscription offer, a couple of things. Number one, we had maintenance contracts, we had typically 3 years, but they were -- they came up, if you will, for renewal each and every year.

Secondly, on maintenance contracts, where we didn't have the extendability and we had customers that were greater than 2 releases down, they were, if you will, exposed to moving to a different provider. What subscription does for us, and we're seeing it across the board, is it enables our customers who are 2 levels down to get the latest and greatest technology. So therefore, moving and showing that extendability. And secondly, a subscription contract is a firm contract for 3 or 5 years, not open for renegotiation after 1 year like our overall maintenance business.

So it really enables us to get closer to our customers; enables us to put in a defined roadmap with those customers and really also enables us to get better predictability in our overall revenue, one of the reasons why we saw a significant jump in our recurring revenues and overall as part of software and services as a percent of our overall business. So we, like our customers, are quite excited about this offer.

Our next question is from Rod Hall with Goldman Sachs.

This is Ashwin on behalf of Rod. I have one question on the guidance. Can you tell us how much of an impact on the hardware business are you assuming in fiscal Q3 and maybe comment on how that piece performed so far this quarter? And I have a follow-up.

Sure. Kieran?

Sure. So I think when we look at what occurred in Q2, I'd say we break down the hardware performance into 3 major buckets. First of all, as we've been talking about for quite some time, there is a movement away from the traditional device attaches, more customers are utilizing their softphones, et cetera. And that has been ongoing as people have moved to the cloud. I'd say that was probably about 1/3 of the decline that we've seen.

Secondly, we actually did have some modest supply constraints as we went through the quarter, and Jim will -- Jim pointed out, we're off to a pretty good start with settling up on many of those in this particular quarter. So I'd expect to see some modest bounce back as it relates to that. And that's probably about 1/3 of it as well.

And then finally, there's 1/3 of it, which, quite frankly, were customers who are at the point in time in March didn't know how their liquidity was going to look, and they just put a pause on things and therefore held up. So I would expect that we'll certainly get any supply constraints back this quarter.

And as we look to the first 40 days of the quarter so far, we seem to be on track to be recapturing some of that. But I still think, as we said all along, you're really seeing the shift to much more of a software and services company here and hardware is increasingly a much smaller portion of our overall product portfolio.

Got it. Then my follow-up is on ACO. Just wondering if you could comment on what you're seeing in terms of customer response, the level of engagement and if you can talk about sales cycle, that would be helpful.

Yes. Sure. Yes. This is Jim. So as we mentioned, and consistent with earning's call, we just launched this a little over a month ago, so on schedule on March 31. We have 17 agents and partners signed up and we're quickly onboarding those and training those. But probably the most important thing is that our pipeline continues to grow, and I would say that we're making great progress.

I'll share 2 data points with you that I -- that's indicative of where we -- not only where the relationship is with Ring, but more importantly, where we believe it's heading and where the opportunities lie.

So just last Friday, we signed a 7-figure TCV deal in the U.K. It's some thousands of seats for ACO, not only currently worked with the Avaya and the RingCentral teams but was also a partner-led deal with one of our largest partners, ConvergeOne. And the solution was developed to address a requirement for the national government in response to COVID-19.

The deal is significant on a number of fronts. Number one, it shows the geographic reach. Number two, it shows that it's copartner led. It also shows how the Avaya and RingCentral teams are working and coordinating with the customer. So extremely important. The first of what we trust will be many 7-figure TCV deals.

The second is really around is this relationship sort of capturing what we had intended it would capture? And the answer to that question is, if you take a look at the number of deals that we've won thus far, it's actually falling right in line with our expectations.

What I mean by that is 1/3 of those are what I'll call new logos, and that's really through our

1,700 agent partner network, which is significant. The other 2/3 are from the Avaya base, and they were all competitively bid in all one by Avaya, which shows the customer loyalty. It shows you the technology that we're driving into our customer base. It shows you the fact that there was indeed this demand for UCaaS solution in our base. And probably, more important, there has been 0, sort of, what I'll say, defects or quality issues associated with any of the installations to date, which means that not only relationship but the work between both organizations is really driving an extremely competitive solution in the market. So granted, just 50-odd or whatever it is, 40-odd days in, but all indications are that it's sort of hitting on all 8 cylinders and meeting all of our expectations.

So we're quite excited, and we're rolling it out to, as I mentioned, 3 additional countries, even though this deal was a U.K. deal, which is going to -- is rolling out now, but we're quite excited about the progress and the results that we've achieved to date. Still early, but very excited.

Our next question is from Mike Latimore with Northland.

On subscription, when a customer goes from maintenance to subscription, can you talk a little bit about the revenue change there, if there is any, and the EBITDA margin on subscription versus the maintenance?

Yes. Sure. Kieran, why don't we start with you? And then, Anthony, if you want to add just a little bit of color on some of the solutions that we're driving into subscription, I think, would be important as well. But why don't we start with you, Kieran?

Okay. Mike, so obviously, what happens is, it depends on the form of subscription you've sold. If we're selling, which we're seeing the bulk of our conversion so far from a maintenance perspective, tend to be traditionally premise-based products. As we said all along, we see this as the roadmap to driving the customers into cloud, whether it's a public or private cloud longer time.

But for point -- just initially, what we would expect is that some of that revenue, we will give the customer some credit for the existing licenses that they've already owned from a perpetual basis.

So it's a -- it's not leaving the customer exposed from that perspective. We will then increase or change the amount of content that they're purchasing. And we will take a significant portion of that revenue if it's premise-based point in time. The rest of it becomes ratable over time.

Obviously, if we get the customers onto the latest releases, obviously, if we get the customers utilizing its, exclusively, software, we would expect the margins on this business to be quite high, mimicking the kind of margins that we see in our -- that we see in our software maintenance as we get through time.

Great. And then on Professional Services, how did they do in the quarter? Did they grow sequentially? And then do you get Professional Services when they go from maintenance to subscription as well?

So -- yes. Go ahead.

Go ahead, Kieran. No. Go ahead. Go right ahead.

Yes. So interesting, and I think this is a real kudo for our services leaders. In spite of the fact that for most of the quarter our teams were not allowed to work on site, our Professional Services revenue was almost flat on a quarter-on-quarter basis.

So real kudos to the teams who have been able to do a lot of that work. Clearly, there were some things that they probably couldn't -- that they couldn't get to because they needed to be on site, but for the vast preponderance of it, we were able to keep relatively flat revenue quarter-on-quarter.

Yes. There will be some work required for the APS business with subscription primarily as we upgrade customers from down level releases to the latest release. And relatively straightforward, simple work, but there will be work nonetheless that will continue for them as we go through time.

Our next question is from Asiya Merchant with Citigroup.

If you could just, again, talk about -- a little bit about -- you mentioned some declines in maintenance revenues during the quarter, which were obviously offset by growth in cloud and subscription, if you can just give us some indication of the range of the decline there.

And then another question on guidance. I understand, fourth quarter guidance, it's difficult to predict right now, but if you can talk a little bit about the puts and takes there, given the high degree of recurring revenue that you guys have. And clearly, with the CCaaS offerings and the ACO getting -- gaining steam, what are some of the puts and takes to the fourth quarter and for the initial fiscal year guide that you guys had?

Yes. Sure. I'll start, and then I'll turn it over to Kieran. So if you take a look at sort of the declines, if you will, in the traditional maintenance business, it was consistent to what we've been seeing in the past, which has been in the range of sort of mid-single digit declines. So it has remained consistent. So not a lot of change in the decline of GSS. And as Kieran pointed out, we've seen the increase in overall services, and that's been a result of subscription and continued growth within that offer. But we haven't seen any, what I'll say, anomalies around maintenance continuing to track as we had projected.

As far as ACO and fourth quarter and so on, we didn't -- I'll turn that over to Kieran to provide some -- maybe some color on that.

Sure. So obviously, we are playing it 90 days at a time, which is the reason why we pulled back in the fourth quarter. Again, we're 40 days into the current quarter, so it gives me a lot more comfort and line of sight, which is why we were quite comfortable showing the Q3.

Your point about recurring revenue certainly are important, and we do think we should continue to see that momentum that we're getting from subscription as well as for the rest of our recurring business as well as we head into the quarter. I don't think CCaaS is going to be a major contributor at this space because it is a purely ratable. It's not going to have a very significant benefit in the second half of the year, whether it's Q3 or Q4 in that regards.

I guess the one thing that I would point out for the year, when we were factoring our full year guidance last quarter, when I resized that guidance just based upon the change in the dollar, actually, we've seen about a $20 million headwind from just the strength of the dollar to our operations overall. So while I feel really good about the ratability and the recurring aspect of our business overall, we are facing some headwinds, and I think they'll be a little bit more severe in Q4 than they were in Q3 or earlier in the year.

And that should be neutral from an EBITDA perspective because we're naturally hedged in most of our countries, but it will be a top line headwind.

Our next question is from Lance Vitanza with Cowen and Company.

This is Chris Sinnott on for Lance Vitanza. You guys kind of alluded to this already, but I did want to dig into how COVID is maybe physically impacting your business in terms of demand destruction itself from customers versus Avaya actually having difficulty accessing customer premises to fulfill orders and service calls and issues like that.

And then if we think about that forgone revenue in March and in April and May time period, can you talk about in the sense which that revenue is lost or deferred? And if deferred, how long until after all this work from home, shelter at home ends before that really starts to come back?

Yes. This is Jimmy. I'll kick it off and maybe turn it over to Kieran to provide some additional insights.

But where we've seen a little bit of disruption associated with COVID has really been sort of on our on-prem through the channel-type business. And as Kieran pointed out, as we exited the quarter, we had some minor supply chain disruption. And then we also had just a physical disruption where people actually couldn't get to the warehouse to fulfill the orders.

There weren't people and locations to actually place the orders. So we saw a bit of an impact on our product revenues. And as Kieran pointed out, we're starting to see those recover back as countries start to open up little by little as we go through the balance of this quarter.

We've seen, however, significant remote services capabilities that we have in the company along with remote implementation. So we are seeing an uptick in our overall business associated with subscription primarily as well as on some of our contact center solutions and then just some of the work that we're doing around the overall services, be ReadyNow or even a little bit of GSS, which is our maintenance business, because of our remote capabilities.

We're starting to also see, as I mentioned, as we deployed those 2 million seats counts for remote agent worker, as we also provided our capabilities in the hundreds of thousands with our video Spaces offer in the market, we're starting to see those now come to fruition in the sense of being monetized, and we expect that monetization to continue.

And then as we pointed out with ACO, just launching, we have expectations that, that will continue to increase and add growth to the overall revenue of the company. So overall, really, the only sort of fiscal impact that we're seeing or had seen with C-19 was really more around sort of our 1x hardware business. But we are, as I said, seeing increases. And one of the reasons why we saw such a huge pop, if you will, in recurring revenue going up close to 5 points as well as software and services.

So COVID has helped in that aspect on accelerating the offers that we had out in the market and really driving strength in our product line. So Kieran, I don't know if you want to add any more or Anthony any more to that.

I think, Jim, just maybe one other area. We did see a couple of our bigger transformational private cloud deals just get pushed just from a decision-making perspective as more customers were more tactically focused. Really, none of those deals, just given the size and the implementation period, would have really impacted revenue

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Okay. Understood. And then real quickly, if I can, on repo, you intended to spend $400 million, you spent $330 million. We thought of that $70 million delta as extra cash, if you will, "extra". And I think, Kieran, you may have also referred to it as extra cash as well. So if the repos aren't early, or not permanently, what do you intend to do with this extra cash once COVID is behind us? Would you return to share repo or further the debt repayment?

Yes. This is Jim. I'll take that one. Look, we obviously are still sort of in the throes of COVID-19. We have some ideas as we go through our capital allocation strategy. As you know, we executed on not only paying down debt but also buying back a significant number of shares.

For now, we'll have those discussions with the Board, if and when the situation allows for it. But we're not looking to do anything, as Kieran pointed out, through this quarter, around, what I'll say, any -- what I'll say execution around a capital allocation process, but it's something we review regularly. But as COVID eases and when it eases, we'll get back to you guys on what we plan on doing.

Our final question is from Hamed Khorsand with BWS Financial.

I was just trying to understand the dynamics of COVID-19 on your business, you have all these companies announcing layoffs and furloughs, what would that have on your subscription revenue going forward, if any?

Yes. It's a great question. Actually, what we do when we convert the existing folks over to subscription is we balance out the number of core licenses that are required, and then we provide flexibility the first, when needed. So actually, we reset the perpetual licenses to the subscription offer to rebalance, if you will, the number of users.

So I think we have a pretty good handle on exactly what that looks like associated with the overall license demand, if you will, associated as we drive subscription out into the marketplace. So as we modeled, not only this quarter, but obviously, as we've taken a look at Q4, Q1, as we take a look at the pipeline and backlog that we have on the deals, I think we have a very good understanding of what that will mean.

And I don't believe that will have a sway, if you will, the decisions that we're making with these large enterprise customers and moving them over to subscription. So Anthony, I don't know if you have any additional insights you want to add to that as we run in the product guides, but I don't see any impact.

Actually, what we're actually seeing is we're seeing through this particular activity that our customers are actually prioritizing their digital investments. And subscription represents one of those digital investments. Bringing it up to the floor, it allows them to activate. And what it does for us is it allows us to activate that base, and they're starting to consume some of our higher order and the newer product capabilities on top of what they already had. So that's what we're actually seeing through this crisis as well as what subscription is really opening up for us.

Okay. And then how many deals do you think were delayed because of the pending release of Avaya Cloud and customers want to move to that product?

I don't think anything has actually been delayed in fairness. I don't know, Anthony or Kieran, I've not seen anything that's been delayed. In fact, I've seen just the opposite.

Yes. I think what actually happens is, an engaging conversation occurs between our customers and ourselves. We talk about what our roadmap looks like, the time frame that it's coming about and how they can get ready for the shift. Because there is an element of a customer getting ready for a shift to -- particularly if they're a complicated or a complex environment. So we find that the relationship gets quite tight, and then they understand the time frame they need to be prepared for such a move.

We have reached the end of our question-and-answer session. I would like to turn the conference back over to Mike for closing remarks.

Thanks, Sherry, and thanks, everyone, for joining us this morning for our March quarter conference call and remarks. If you have any questions or further comments, please feel free to give me a call, and we'll be happy to touch base and see you in a couple of the different conferences that will take place virtually now through the end of the quarter. Everyone, have a good afternoon, and please stay safe. Thank you.

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