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Avaya Holdings Corp (AVYA) Q2 2019 Earnings Call Transcript

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Avaya Holdings Corp (NYSE: AVYA)
Q2 2019 Earnings Call
May. 9, 2019, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, this is the operator. Today's conference is scheduled to begin momentarily. Until that time, your lines will again be placed on music call. Thank you for your patience.

Good morning. My name is Christa and I will be your conference operator today. At this time, I'd like to welcome everyone to the Avaya's Second Quarter Fiscal 2019 Financial Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions).

Thank you. Mr. Michael McCarthy, Vice President of Investor Relations, you may begin your conference sir.

Michael W. McCarthy -- Vice President Investor Relations

Welcome to Avaya's Q2 fiscal year 2019 investor call.

Jim Chirico, our President and CEO; and Kieran McGrath, our Senior Vice President and CFO will lead this morning's call and share with you some prepared remarks before taking your questions. Shefali Shah, our Senior Vice President, Chief Administrative Officer and GC; and Chris McGugan, Senior Vice President of Solutions & Technology are also here for this morning's call.

The earnings release, CFO commentary, and investor slides referenced on this morning's call are accessible on the Investor page of our website as well as the 8-K filed today with SEC and should aid in your understanding of Avaya's financial results.

We will reference non-GAAP financial measures, and specifically note that all sequential and year-over-year comparisons reference our non-GAAP numbers, except or otherwise noted. A reconciliation of such measures to GAAP is included in the earnings release and investor slides which are available on the Investor page of our website. 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.

Information about risk and uncertainties may be found in our most recent filings with the SEC, including our Form 10-K and subsequent Form 10-Q reports. It is Avaya's policy not to reiterate guidance and we undertake no obligations to update or revise forward-looking statements in the event facts or circumstances change except as otherwise required by law.

I will now turn the call over to Jim.

Jim Chirico -- President and Chief Executive Officer

Thanks, Mike. Good morning everyone and thank you for joining us. My comments this morning are focused mostly on our Q2 FY19 performance and then Karen will take you through the numbers. Our top line results and earnings fell short of expectations and this was not the way we wanted to begin the calendar year. In response, we have implemented a number of corrective actions to drive improved performance. While I am disappointed in our results last quarter, overall I remain confident about our path forward given the momentum and traction we are seeing in many segments of our business, including cloud, services and emerging technologies. Our revenue shortfall was due to a combination of two factors. Number one, we experienced product transition execution issues, specifically in Contact Center, we missed a key internal technical deliverable associated with a new partner offer. We have moved quickly to address this issue and it will be rectified later this quarter. And you see we experienced operational execution issues in channel inventory related to the transition from our older model endpoints to the new J series. We have addressed the root causes and implemented corrective actions, but it will likely take us until early Q4 to return to normal operating levels. The second was the result of the Reuters story published in late March, about a potential transaction involving the company. This created uncertainty among our customers and partners and led to a noticeable change in buying behavior. We have implemented a customer outreach and communications plan that emphasizes our innovation, strength and market leadership to help address the situation. But bottom line, the timing of the speculation, while difficult to pinpoint a quantitative impact, clearly had an effect.

Moving forward, I continue to believe in the long-term outlook for Avaya, as it remains solid. We've invested in our technology and talent and reengineered our go-to-market systems and processes to drive a customer-led strategy. We have and are implementing our playbook to deliver against the company's long-term growth strategy. In the second quarter, the team maintained an aggressive focus on our key growth initiatives which are investing in our core, accelerating innovation, and bringing new and emerging technologies to market, growth in cloud and providing high value services to our clients. We made progress and showed strength in a number of key areas. Our transition to software and services now stands at 83% and recurring revenues were at 59%. Public cloud seat growth of over 165% year-over-year and 25% quarter-over-quarter to over 290,000 seats. Private cloud traction with over 60 million in new total contract value bookings in Q2 led by our launch of ReadyNow private cloud. In the area of services, we had our best professional services revenue performance in the last four quarters and we see improvements in our maintenance space. Our total contract value remained at approximately $2.4 billion and grew 3% year-over-year. We are building out a broader ecosystem including alliances with big friends such as Salesforce, IBM and Google. Our continued focus is to identify and capitalize on key growth opportunities in the market. Let me provide a few examples. We continue to see traction with both new and existing customers and in the second quarter, we added approximately 1500 new logos, signed 78 transactions with a value of over $1 million in total contract value. This included 9 deals over $5 million and 2 deals over $10 million. Of these key deals, one was with the Department of US Military to modernize their entire communications infrastructure. Avaya was the only company able to address this agency's specialized needs and interoperability challenges with unique systems. Our continued ability to deliver differentiated solutions is commonplace. Another example is CHRISTUS Health, an Avaya customer for over 20 years. They chose to migrate from a multi-vendor environment that included a mix of Mitel, ShoreTel and Cisco products to an Avaya contact center solution. They chose Avaya because of the value we bring from an improved customer experience perspective. Their full implementation of 60 hospitals and 175 clinics will be completed later next year.

Now let me turn to cloud. In cloud, we saw continued momentum in both our mid-market and enterprise offerings. We added nearly 60,000 public cloud seats, bringing our total to just over 290,000 seats, (inaudible) 56:05. Two-thirds of our seat growth came from outside of the US and was spread across South America, Asia, Europe highlighting the strength of our global capabilities. Additionally, we are beginning to see traction with storefront, a simple online purchase and fulfillment portal. This has been available to US-based customers since early this year and is now available in Germany. Rollouts into Canadian and UK markets are on the road map and we'll move through the second half of this year. This expands our go-to-market approach into the SMB space where customers can leverage the benefits of buying UC and CC cloud offerings from one vendor online. In private cloud, we ended the quarter with 3.4 million seats. Our private cloud strategy and ReadyNow solutions just launched in January are being embraced by mid-market and global enterprises as they look to move to the cloud in a secure and reliable way. We are still early in ramping this solution, but we are already signing customers. I would like to take a moment to highlight two notable private cloud customer wins. 57:28 (ph) Any deal (ph) worth approximately $11 million, a large Mexican telecommunications company chose us to consolidate approximately 10,000 contact center seats in a private cloud model. As part of the deal, we will displace 3500 Genesys seats and a workforce management solution from NICE. This transaction also provides further upside in new applications and the ability to potentially replicate globally. Additionally, a US-based insurance company signed a deal in excess of $30 million to migrate 60,000 Unified communications, along with 30,000 contact center seats to our private cloud solution. This customer also chose to leverage our newly released device as a service offering. The ability to offer compelling solutions through multiple delivery models and market segments is a unique differentiator for Avaya and our embrace of emerging technologies is clearly resonated. We are at the forefront of delivering innovation at scale and made important progress across our mobility and artificial intelligence offerings in Q2.

In mobility, we signed transactions with an innovative business process outsourcer and an 58:55 (ph) 811 (ph) provider for high fidelity mobile routing. The disruptive impact of our technology is showing itself with increased frequency. Last month, we signed a new customer that had just learned about our mobility solution at our Users Group Conference that occurred a couple of weeks prior. The customers anxious to begin accelerating their digital transformation journey.

In artificial intelligence, we are continuing proof of concept work for two high-profile customers, a large retail and a large infrastructure provider testing our conversational intelligence solution. Both are eager to leverage their existing contact center investments to improve overall customer experience. Also in the area of AI, our partnership with Afiniti continues to provide real and measurable benefits to our customers. We now have over 20 joint customers benefiting from Avaya and Afiniti enterprise behavioral pairing and pair over 20,000 agents with their customers. These are some of the world's largest wireless, cable, healthcare and hospitality providers in the US, Mexico, Canada, Australia, Brazil, UK and Turkey. We have 5 customers running on our new native integration and expect two more customers to go live just this month. Our success in bringing innovation to the market was again recognized by third-party industry analysts; Aragon Research again rated Avaya as a leader for Unified communications and collaboration in 2019 while Avaya also earned the Gartner Peer Insights Customer Choice in unified communications for the second year in a row.

Now I'd like to shift gears and I would like to reiterate comments shared on our earnings release this morning. Following the receipt of expressions of interest, the company has engaged JPMorgan, a leading investment banking firm to assist in exploring strategic alternatives intended to maximize shareholder value. The Board has not set a timetable for the process nor has it made any decisions related to any strategic alternatives at this time. There can be no assurances that the exploration of strategic alternatives will result in any particular outcome. The company does not intend to provide updates, unless or until it determines that further disclosure is appropriate or necessary. Let me share my thoughts on our full year reset. Our conversations with partners and customers over the last several weeks have made several things clear. They are confident in the company, in our innovation and the value we are driving along with our capabilities, but with our performance in the first half, the product transition issues that will continue in Q3 and the announcement that we engaged JPM, we believe it's prudent to reassess and revise our full year expectations.

Before I turn it over to Karen, I'll end by restating that my confidence in our company, partners, people and customers remains high. Our brands and pipeline of new products has never been more relevant, more customer-driven and we continue to make strides on our path forward. Karen will now walk you through second quarter financials and second half guidance in more detail. Kieran?

Kieran McGrath -- Senior Vice President and Chief Financial Officer

Thank you, Jim and good morning everyone. Before we begin, I'd like to mention that all references to financial metrics are non-GAAP unless otherwise indicated. Additionally, please note that we have posted supplementary commentary on our quarterly financial results as well as any relevant tables and GAAP to non-GAAP reconciliations on our Investor Relations website.

Turning to our second quarter fiscal 2019 results, non-GAAP revenue was $714 million and was well below our guidance range. Software and services accounted for approximately 83% of our revenue in the second quarter and 59% of our revenue is recurring. Cloud was approximately 11% of our revenue in the period. Second quarter non-GAAP product revenue was $289 million, compared to $317 million in the year ago period. Within our product business, both Contact Center and Unified Communications significantly underperformed our expectations. As Jim mentioned in his remarks, product transition issues within our control accounted for approximately $20 million to $25 million in the shortfall, while we believe that the remaining balance was attributable to the Reuters story published at the end of the quarter. Second quarter non-GAAP services revenue was $425 million compared to $440 million in the year ago period. The year-over-year decline in service revenue was again driven by our lower maintenance revenue, while professional services and private cloud revenue was largely unchanged compared to last year. Although we expect maintenance revenue to remain a headwind to total revenue growth, we are encouraged by the ongoing improvement in our renewal rates, which we believe will help mitigate maintenance revenue declines over time. The improvement in our renewal rates coupled with encouraging data points like another quarter of year-over-year growth in our total contract value gives us visibility and consequently increased confidence in our revised outlook for the second half.

Geographically, the US accounted for 53% of our revenue, while EMEA, Asia-Pacific and Americas International represented 27%, 11% and 9% of our revenues respectively. Before moving on from our revenue performance, I want to spend a few minutes discussing the impact of ASC 606. As mentioned on our last quarter earnings call, the most significant impact of the accounting change relates to how we account for professional services contracts, which under the new standard are largely recognized as performed as opposed to upon completion and acceptance of services. Additionally, when service contracts also include products, product revenue is recognized when those products are delivered as opposed to the completion and acceptance of services. At the beginning of our fiscal year, we proactively aligned our internal key performance indicators, as well as our incentive compensation plans to drive performance under the new standard. Given these operational changes, our fiscal '19 financial results are not directly comparable using the ASC 605 reconciliation table disclosed in our press release. Further, in addition to the aforementioned impact to revenue, this change also has a corresponding effect on our cash flow performance as revenue recognition now precedes customer billing and cash collection in many cases. We anticipate the difference between the two standards will normalize as services engagements reach completion milestones throughout the subsequent quarters.

Turning to profitability metrics. Non-GAAP gross margin in the second quarter was 61.5% compared to 62.4% in the year ago period. Overall, our gross margin was negatively impacted by lower volumes and unfavorable mix resulting from lower software revenues in the quarter, partially offset by a decrease in platform costs and productivity improvements across our offerings. Non-GAAP product gross margin was 63.7% compared to 68.5% in the prior year and non-GAAP services margin was 60% compared to 58% in the prior year. Despite our lower than expected non-GAAP gross margin in the quarter, we continue to believe that non-GAAP gross margin will trend upward as the mix of our businesses better aligns with our shift toward software-centric model.

Second quarter non-GAAP operating income was $149 million, representing a non-GAAP operating margin of 20.9% and adjusted EBITDA was $166 million representing an adjusted EBITDA margin of 23.2%. Further, we generated $37 million in cash flow from operations, a $11 million free cash flow, and ended the quarter with $735 million in cash and cash equivalents on our balance sheet. Our cash balance decreased sequentially due primarily to an increase in cash tax payments.

Moving to our third quarter and fiscal 2019 outlook. As mentioned in our press release issued earlier today, we are lowering our guidance for fiscal 2019. Our revised outlook is both prudent and conservative as it contemplates the impact of the uncertainty created by the inbound interest and lower than expected product sales in the first half of our fiscal year. Further, our quarterly historical sequential pattern support a fiscal third quarter roughly in line with our second quarter revenue, followed by a stronger fiscal fourth quarter. Our outlook for the second half of the year is supported by both our current backlog, as well as current visibility into our pipeline coupled with an expected ramp up in cloud seats, further traction with service providers and system integrators, and most importantly, improved sales and channel execution across geographic areas. Specifically for the third quarter, we anticipate non-GAAP revenue of $710 million to $725 million. Our non-GAAP operating margin is expected to be approximately 20% and our adjusted EBITDA margin is expected to be approximately 23%. We expect our third quarter weighted average shares outstanding to be roughly 111 million shares. For the full fiscal year, we currently expect our non-GAAP revenue to be in the range of $2.925 billion to $2.975 billion. We now anticipate that cloud revenues will be between 11% to 12% of our revenue compared with our previous expectation of 12% to 14%. Our updated view reflects a higher than anticipated mix of public cloud seats sold by our partner channel, which due to associate rebid fees correspond to lower net revenue for the fiscal year. Additionally, although we are very pleased by the market traction of ReadyNow since our launch in January, the conversion from bookings to revenue is somewhat slower than expected given the size and complexity of early transactions.

While we anticipate that the early mix of customers would be more heavily weighted to simple deployments, encouragingly early adopters have been the large complex global enterprises with a unique set of requirements reflecting the broad appeal of the platform. We expect this dynamic to abate over time as a more diversified customer base leverages the platform. Further, going forward apart from cloud revenues, we are no longer going to provide annual guidance as it relates to our anticipated revenue mix. While we will continue to report actual results so that investors can understand what our software, services, and importantly, recurring revenues are in any given period, our mix of revenue can have a great degree of variability due to the timing and composition of large transactions, which are very difficult to forecast with precision. As such, we believe it's more appropriate to view our revenue mix in the context of our longer-term expectations.

Turning to margin, for the full year, we expect our non-GAAP operating margin to be approximately 22% and our adjusted EBITDA margin to be approximately 24%. Additionally, we expect our cash flow from operations to be in the range of 7% to 8% of our revenue. Finally, we expect our full year weighted average shares outstanding to be approximately 111 million shares.

Operator, we're now ready to take questions.

Operator -- Senior Vice President and Chief Financial Officer

Certainly (Operator Instructions). Your first question comes from the line of Raimo Lenschow of Barclays. Please go ahead, your line is open.

Raimo Lenschow -- Analyst

Jim, can you talk in more detail about the issues

Questions and Answers:

Raimo Lenschow -- Barclays -- Analyst

Jim, can you talk in more detail about the issues around the product side, I guess, I think I get it, but then, I'm still wondering why it takes a couple of quarters to rectify it and then 72:15 (inaudible), can you, like on the 605 -- 606 comparisons like, what would the numbers be if I do like an apples to apples comparison? Thank you.

Jim Chirico -- President & CEO

Yeah, hey Raimo, thanks. It has to do with not -- with our endpoints, not products in general and we did a transition from the current product set to a new J-Series, the fact of the matter is that, we were a little bit aggressive in shipping some of the older endpoints into the channel early on in the beginning of the quarter predicated on what we thought would be some -- predicating we thought would have sales out velocity. The fact of matter is our new endpoints frankly had taken on from a brand perspective, more aggressively than we thought, and as such, those actually performed better than expectation, but unfortunately we -- the channel had still a fair amount of our older 96XX phones. So as a result, obviously, you only can afford so much within the channel and obviously we have mechanisms in place to ensure that we do not over populate the channel. So there was a slower turn, if you will, on the older endpoints and it's not going to take us through the end of the year, it will take us through the end of this quarter and maybe into early July, which is the fourth quarter, before we get those back to normal operating levels. But I can tell you the J series is actually doing much better, but the 96X series is a bit slower. As you take a look at where we are through the first five or six weeks of the quarter, we're actually on track, if not a bit head of track on the flow through of the 96X phone. So I think we're aligned to our expectations that we set, but again it's a good news, bad news story and the good news is the J series are moving faster than we had anticipated and as a result of that the bad news is the 96XX's are moving a little bit slower, but it will all be balanced out probably in the July time frame.

Kieran McGrath -- Senior Vice President and Chief Financial Officer

Hey, Raimo. So, as I said before, with the changeover from 606 to 605, we actually realigned a lot of our internal key performance indicators as well as incentive compensation plans to really to focus on driving revenue on the new standard. With the adoption of 606, the concept of install complete or customer acceptance is less critical for quarterly revenue recognition. So what we found, year-to-date as a result, our business experience is that a greater percentage of our products are not hitting the

Are not hitting the IC or the install complete criteria nearly as quickly as what our historical experience would have suggested. So, let me give you an example. We flushed $96 million of our deferred revenue from the end of our last fiscal year to retained earnings in terms of the opening balance restate. History would have said that through the first six months of the year that over 3/4 of that would already have been formally accepted by the customer and signed off in this install complete criteria. What we -- what we're currently tracking is that, in reality, only about a third has been closed by the end of the second quarter. So if you think, that we've talked about the value of 606 was worth about $50 million incremental in Q1 and $36 million in Q2. Of that $86 million, essentially $40 plus million of it is really due to the fact that we haven't hit this install complete criteria just yet. We think this is going to balance out at the end of the year, we've actually put in some system implementations to drive this on a more proactive and faster basis to help with this. But certainly, I just don't think we have an apples and apples comparison. So if you look at 605 versus 605 on a year to date basis, it's -- we would say we would be down about 10%. I'd say of that half of it is literally due to this first half -- this opening balance restate taking longer to reach install complete, a point of it is actually going to be related to currency where we've taken a small impact, and then the rest of it is going to be a combination of existing -- existing professional services contracts that are bundled not getting to install complete as close -- as quickly as we would have wanted as well as the operational issues that we just addressed in our script today. So certainly it's something that is unintended consequences and we're working to really get our arms around that much quicker, but I do think we have probably over rotated a bit in terms of our shift in focus.

Raimo Lenschow -- Barclays -- Analyst

Okay, that's clear, thank you very much.

Operator

And your next question comes from the line of Lance Vitanza with Cowen. Please go ahead, your line is open.

Lance Vitanza -- Cowen -- Analyst

Hi, thanks for taking the questions. And Kieran thanks for that helpful explanation on why you look at it the way that you do and I think you answered part of this, but on the currency side, I wanted to ask you, you mentioned one point of negative growth, but that was in the context, I think, of 605 to 605, in the context of -- if we look at it as reported versus, as reported, which is the way I think we are supposed to look at it, what was the impact of those currency headwinds, does that change at all or is it still sort of about a point?

Kieran McGrath -- Senior Vice President and Chief Financial Officer

Yeah, in the quarter, it was

Yeah, in the quarter, it was slightly more than a point.

Lance Vitanza -- Cowen -- Analyst

Okay. Slightly more than a point. Okay. And then I wanted to ask you also about the cloud seats. I apologize if I -- I think that you called this out and I missed it, but how many cloud seats, did you add in the second fiscal quarter?

Kieran McGrath -- Senior Vice President and Chief Financial Officer

Actually, we added about 60,000 public cloud seats in the quarter.

Lance Vitanza -- Cowen -- Analyst

60,000 public and do you have the number for the private cloud seats as well?

Kieran McGrath -- Senior Vice President and Chief Financial Officer

So from a private perspective, the way we've currently been doing is actually, those that are physically booking from a revenue perspective. Clearly, we added a lot more contractually, but just as I discussed, given the rate and pace time to -- time to time money, so to speak on those are not reporting those as seats just yet. (ph) Particularly (ph) , I want to stay consistent and really just tracking revenue 78:50 (inaudible).

Lance Vitanza -- Cowen -- Analyst

Sure. Okay. So that's a change I think from last quarter, right, when you had the big, the (ph) 200,000 (ph) private cloud seat number which, and I think those were all just announced, but had not yet begun booking, is that right?

Kieran McGrath -- Senior Vice President and Chief Financial Officer

So I think you just have to separate the private or what we calling now are ReadyNow versus our public. So from a public cloud perspective, there isn't much quicker time to money and time to building on those and in aggregate, we added about 60,000 of those seats this quarter, and we are now about 290,000.

Lance Vitanza -- Cowen -- Analyst

Okay. And then on the revenue guidance, the revenue guidance for the full year, down $150 million at the midpoint. If we go back to those three factors, you had the technical deliverable on the contact center side, you have the, obviously the endpoint piece in UC, and then this Reuters story, could you sort of bucket, the $150 million down draft into those three categories, give me just rough numbers?

Kieran McGrath -- Senior Vice President and Chief Financial Officer

Yeah. So what I think about this, I'd say, first and foremost, our services business, which is actually performing very close to our plan through the first half of the year is going to be impacted just because any of our subscription revenues or any of our maintenance that was dependent on the first half of product shipments is going to be impacted, and I would put that somewhere probably in the -- I'll look at one of my guys here, the 10%, the 20% of the total reduction related to the less maintenance and subscription that I'll get from the first half of the year. I also think that just from an operating perspective, we're probably talking about another 20% to 25% as well, just coming from the fact that we're going to take us a little while to shake out the operational issues that we had mostly in the first half of the year. And then finally, a couple of big items that we have, we've got some really large government contracts within our eyesight, the issue that you always have when you're dealing with the government is the partners that end up getting selected actually help do the actual physical delivery to the customer, the timing of the SOWs that get released will have an implication *** EOF ***

Will have an implication on our timing of revenue so, prudently while I see some really substantial opportunities for us in the second half of the year in that space, I really think that somebody is going to probably timeout in the -- potentially in the first part of next year. And I'd say that's probably worth almost half of what my number is in aggregate. And then I'd say after that. I'm just being somewhat conservative that this uncertainty related to the rumors and the like hanging over our head could probably drag a little bit more.

Lance Vitanza -- Cowen -- Analyst

Great number. Just one more question for me, it's sort of Segway's from that. Jim, if you believe in the fundamental trajectory of the business as you've laid it out, isn't this the absolute worst time to consider a sale of the company. Wouldn't you be better off proving out the return to growth and then engaging with some wind in your sales. I mean, I understand that you received unsolicited expressions of interest, but why not tell them, no thanks, this isn't the right time.

Jim Chirico -- President and Chief Executive Officer

Look, first and foremost though, maybe I'll answer it two ways. First is obviously directly to what we -- the clearance 82:09 (ph) emphasized (ph) sort of disclosure that we provided this morning in our earnings call, but maybe in the spirit of making this, because there may be more questions following you on the same thing, we would make it a bit more productive. Maybe I'll just add a little bit more color at this time as well. Like every other public company, our goal is to create shareholder value. So we retained JPMorgan to evaluate strategic alternatives and they include, sort of if you will, the full spectrum of exactly those strategic alternatives. So the evaluation of a stand-alone valuation of capital allocation, valuation of acquisition versus other strategic financial transactions and so on. So, I guess, I will end up by just saying like every other public company, there really isn't much, I could say beyond that in fairness Lance, so.

Lance Vitanza -- Cowen -- Analyst

Okay, thanks very much guys.

Jim Chirico -- President & CEO

Yes.

Kieran McGrath -- Senior Vice President and Chief Financial Officer

Yes.

Operator

And your next question comes from the line of 83:22 (inaudible) with Guggenheim. Please go ahead, your line is open.

Analyst

Hi, good morning. So, I wanted to ask about maintenance renewals in relation to transitioning our migrating customers from maintenance contracts to some sort of subscription arrangement, can you characterize how that's going? And if any of this news from the Reuters article has had any impact on that?

Jim Chirico -- President & CEO

Yes, sure. Yes, this is Jim. First and foremost, we didn't see the impact on the Reuters article

Jim Chirico -- President and Chief Executive Officer

On the Reuters article so much associated with what I'll say renewals to shift to cloud. We saw more based on what I'll say buying habits traditionally at the end of the quarter, which it's fairness more lines to contact center software type shipments where people just took a pause if you will for like for better term based upon the first article obviously just been following subsequent speculations since then. As far as overall renewals in the move to cloud, I'll turn it over to Kieran for some additional color, but we are doing quite well from an overall renewals perspective in the business. There has been a significant focus on that and as Kieran pointed out, our maintenance business is actually on plan and fairly stable, but the expectation going forward is, just 84:55 (ph) curious (ph) conservative and prudent based upon some of that -- where we finished, if you will, overall from a first half perspective, but I'll turn it over to Keiran for some additional color.

Kieran McGrath -- Senior Vice President and Chief Financial Officer

Yeah, I guess, I would just say to that in term s of how I think about the maintenance, clearly, clearly some of this is going to move to the cloud, but I would say that's still relatively early days. A lot of the public cloud seats that we've gotten actually are -- many of them are new logos as well. I'd say, what you're seeing here is proof in our private cloud and our ReadyNow that we're starting to see some of that shift occurring, but in terms of wholesale impact on maintenance related to the conversion to the cloud real-time, I don't see it being a very material impact on the second half revenue. I would put more of the issue on the maintenance in the second half of the year really related to the product shipments shortfalls that we've talked about in the year in the first half of the year.

Jim Chirico -- President and Chief Executive Officer

Yeah. And just as Karen pointed out earlier, we are very encouraged by the traction of the Avaya private cloud ReadyNow. But those are large complex deals, we have 15 to 18, I'll say significant POCs under way. I highlighted two specific deals in my commentary, one of $11 million and one of $30 million, and so they are significant. But based upon these being obviously subscription oriented, cloud-oriented, and we indeed are starting to get revenues even this quarter from those, but by the time it gets into sort of a -- more of a steady state ramping perspective, it will be into 2020. So it won't have a significant impact on FY19 numbers but it's a great baseline for us as we move into 2020 and beyond. And I can tell you that all of the POCs are going along quite well

And I can tell you that all of the POCs are going along quite well and we're encouraged, but it's not something that we'll see significant revenues this year but provides opportunity for us as we move into 2020.

Analyst

Thank you.

Operator

And your next question comes from the line of Meda Marshall with Morgan Stanley. Please go ahead. Your line is open.

Eric Lapinski -- Morgan Stanley -- Analyst

Hi, this is (ph) Eric (ph) on for Meta. Thanks for taking the question. Maybe just looking at the public cloud product, can you comment on where master agents are finding some of the most traction? And what's the typical seat size that they are having success with?

Jim Chirico -- President & CEO

Yes, sure. Thanks, Eric. I'll probably, Chris will do this. I'll turn over to Chris after, but when you take a look at the master agents that's more on your SMB portfolio anywhere typically for us, in fairness, based upon the current product offering, the storefront is just starting to gain traction, it has been in the neighborhood of say 25 to 50 seats up to say 200 seats max. The traction in fairness has been a little slow for us and one of the reasons why we've come out with the storefront, in fairness revamped the storefront, which Chris will talk about. Our Germany storefront that we recently announced is actually gaining good traction, that is targeted more for your lower end, your 5 to 50 versus sort of where we are currently with our offer here in the States. So, that's at the lower end of the SMB market.

Chris McGugan -- Senior Vice President, Solutions and Technology

Yeah. I think Jim characterized it very, very well. The storefront, we have made some optimizations to it to enhance the offer that goes out through our master agents enabling them not only to sell just UC service but also trunking and our CPaaS platform as well. So we've expanded the offers that are available to them and we think that creates additional stickiness in the market for those master agents and opens up additional opportunities for them to drive revenue.

Eric Lapinski -- Morgan Stanley -- Analyst

Thank you. That's really helpful, and if I could just one more real quick. If you're thinking through your channel partners, is there anything they're asking you for today and maybe more incentives or anything around refreshed products?

Jim Chirico -- President and Chief Executive Officer

Yeah, this is Jim. No, I wouldn't say that they're asking for anything incentive wise or anything like that. I would -- we work fairly closely with our channel partners. Our IP Office mid-market solution is actually doing quite well in the marketplace as Kieran said, equal to our -- if not a little bit above our expectation. I think the place that we are running with them, the incentive programs that we have in place for them

Jim Chirico -- President & CEO

the incentive programs that we have in place for them, I would say are adequate. And so they're not asking, if you will, the new storefront opportunity opens up some additional opportunities with a couple of our partners as well. So -- and even the private cloud solution will also be sold through the channel. So they're actually quite excited as we are now rolling that out and providing that capability to our channel partners as another go-to-market vehicle for them. So they're actually very excited about the ReadyNow private cloud solution.

Analyst

Thank you.

Operator

And your next question comes from the line of Rod Hall with Goldman Sachs. Please go ahead. Your line is open.

Balaji Krishnamurthy -- Goldman Sachs -- Analyst

Thanks. This is 90:55 (ph) Balaji (ph) on behalf of Rod Hall. I wanted to follow up on the cloud common -- private cloud comment you made earlier. So the cloud seat count was about 3.7 million last quarter and it was 3.7 this quarter. So I just wanted to confirm that the private cloud seats did not decline? And then I have a follow-up.

Kieran McGrath -- Senior Vice President and Chief Financial Officer

There's a little rounding in there. As you would expect anytime you're renewing with customers they will have some reset of the amount of seats that they drive some productivity in 91:26 (inaudible). So there would be some slight reductions there that actually lead to rounding, which is why probably hearing 3.4 million implication in the private. As I said before, if we start counting all the revenue producing ones -- we are really counting revenue producing, if we start counting those under contract, the number would be a little higher than that, but just trying to be consistent in how we call it out.

Balaji Krishnamurthy -- Goldman Sachs -- Analyst

Okay. And then on the guide, can you quantify the Spoken contribution to your June and September guidance? And beyond that, I think if we look at your full year guidance even though you've taken it down, you do need a pretty meaningful improvement in Q4 to hit your -- hit the low-end of the guide and you are looking at a couple of quarters of significant declines here. So can you comment on the visibility to the fiscal year and then how confident you are on hitting that target?

Kieran McGrath -- Senior Vice President and Chief Financial Officer

Yes. So, I guess, let me start with the last part of your question first. If we go back and look, we have seven, eight years of history, looking at the company. There is a pre-consistent seasonality by quarter between our business, and in general, honestly, even though we guided, we certainly -- we are guiding more aggressive in Q1 in anticipation of where we want to drive the business toward but history would have said that Q2 versus Q1 would always have been down roughly

Would always have been down roughly 4% to 5%, actually closer to 7%, we ended up 93:05 (ph) turnaround 4%, (ph) , so turnaround 7%. History also says that Q2 to Q3 is roughly flat to maybe up a 10% (ph) to 12% (ph) Q2 to Q3 and is always followed by a very strong Q4. Traditionally for any company Q4 is stronger, ours is made even stronger just because it's also the government year-end as well. So, actually when I -- when we selected this guidance, I mean, I did it really looking at a lot of the history, as well as, as I said in my prepared remarks, having a pretty good visibility into my backlog, into my pipeline and the rates of what I would expect to monetize that pipeline as well. So, you're absolutely right. I would expect that we will have a stronger Q4 and that would be very consistent with historical performance as well as supported by the pipeline and the backlogs that I see. Related to your question 94:00 (inaudible), I mean, we don't guide at that level of granularity in the business, just suffice to say that it's obviously a critical part of our offering to date.

Balaji Krishnamurthy -- Goldman Sachs -- Analyst

Okay. And maybe if I could sneak in one more, so SG&A costs, you have delivered on reducing those as you talked about earlier in the year, but at the same time, your products sales declines have been accelerating, do you feel like you need to maybe invest more in SG&A to support some growth toward the end of the year. I know you had elevated spend last year, but is this SG&A cost reduction, much -- is it harmful to your revenue growth in anyway is probably what I am trying to ask?

Kieran McGrath -- Senior Vice President and Chief Financial Officer

Yeah. So I would say that the focus, really a lot of what we see on a year-on-year basis, in terms of the reduction is actually based upon two key items. One is going to be that actually the variable commissions is actually down, just because the teams as a percentage of what they were expected to do have not delivered as much. That's not a headcount statement. That's just their -- earning their variable compensation. The other way is actually I'd say half of the reduction is actually also attributable to the fact that FX is also reducing the amount of dollars when we convert our non-US spend back into dollars, similar to having less revenue, I also have less expense. So if I look at my year-on-year reductions, I say it's probably split pretty much 50-50 half being commissions attainment by our sales force and the other half being really related to FX.

Jim Chirico -- President & CEO

Yeah, this is Jim (multiple speakers). You shouldn't 95:50 (ph) leave (ph) that as a reduction in (inaudible) carrying headcount at all and in fact we're expanding in our go-to-market footprint, in a lot of areas as we transform as we move more to a cloud

As we transform as we move more cloud-oriented, subscription oriented, go-to-market companies in areas like consultative services, in areas of driving architects that actually can work on complex solutions in one of the areas where you see professional services doing better. So, I wouldn't do that as we're pulling back the reins on, if you will, headcount. The other thing we're doing also is building out our partner community with strategic alliances that provides us the opportunity there as well, not only leverage our partners and customers but also leverage the expertise through strategic alliances to generate and drive more sales. So it's by no stretch of imagination should be interpreted by pulling back the reins on sort of your front-line go-to-market organization (ph) piece at (ph) 96:54 all.

Balaji Krishnamurthy -- Goldman Sachs -- Analyst

Okay, that's helpful. Thank you.

Operator

And your next question comes from the line of Dmitry Netis with Stephens Inc. Please go ahead, your line is open.

Dmitry Netis -- Stephens Inc. -- Analyst

Great, thanks guys. I had two questions, if I may. One on the competitive environment and the other is on channel. So, I'll packet into one if you allow me. On the competitive side, if I bucket your business into three buckets, the small business, mid-market and then large enterprise, is the SMB where you still continue to experience kind of the biggest drag from the competitive dynamic or whether it's other buckets that you're seeing pressure as well. I suppose you do, but just wanted to get some color how maybe that competitive landscape is changing as you step quarter over quarter here? And then the second question more on the channel and you did mention kind of the down trend mix shift in cloud as you progress through the year or as you exit the year and your expectations there. And, relative to the rebates, the step-up that you mentioned, if you could give us your puts and takes there and maybe explain what really is going on, and you're driving bigger submissions with your channel partners. Is that what's causing the rebates to step up, give us a little bit of an outlook there as well? Thank you.

Jim Chirico -- President & CEO

Yeah, this is Jim. I will hit the first -- second question first and I'll turn it over to Chris to provide color on the competitive landscape. So, first on the channel, obviously, so a couple of things. Number one, aside from, if you will, the transition where you think you can sort of understand and how you move the market to the reality fact that is just how the market moves is why we have currently a little extra inventory, if you will, versus the old versus what one would have if they were looking at sort of optimal levels. And again, the good news is the J series

Jim Chirico -- President and Chief Executive Officer

And again, the good news is the J series are selling through faster but there's only so much room at the end and we obviously get revenue on sales in, but the velocity still remains strong on the sales outside. If you take a look at the cloud business, and what we're doing associated with the cloud and as Kieran pointed out, especially on IP Office mid-market, we do have some space like everybody else associated with the program. So, the good news, bad news story there as we're seeing sort of the demand being higher than we anticipated; therefore, the rebates being adjusted and it is going to just take us a period of time to get that into a sort of steady state. The point is, so, we provide free phones in our promotions associated with IP Office typically takes us in the neighborhood of about three to four months before those are 99:55 (ph) flushed (ph) through based upon the sort of the bill of material price that we get (ph) for them (ph) . So, we've seen an increase in sales over the last couple of quarters; therefore, an increase in and rebates and the overall cloud revenues are down slightly, but that's more from a sort of an MRR perspective, but if you look at ARR, it's actually quite strong and we'll get balanced out as they go through the balance of the next few months. But our incentive programs, everybody has different programs, whether it's through master agents and how they pay agents or master agents, and 100:35 (inaudible) with partners. I would not say that we're normal and consistent and we're certainly not jeopardizing anything or trying to do anything to move to market differently than with the overall competition.

On the differentiation of the different segments of the market associated with competitive landscape, I'll turn it over to Chris to give you some insights.

Chris McGugan -- Senior Vice President, Solutions and Technology

Yeah. Thanks, Jim. Dmitry when you asked about the three market segments and where we're seeing competition, definitely seeing competition in the small side of the market as it relates to many of the UCaaS players and the CCaaS players taking some of the smaller spaces there and a small amount in the mid-market sector, but we still see strong demand for our UCaaS in the mid-market from a cloud perspective as well as our premise-based technology that services that particular market.

Dmitry Netis -- Stephens Inc. -- Analyst

Okay, great color guys. Thank you very much. Appreciate it.

Operator

And our next question comes from the line Asiya Merchant with Citigroup. Please go ahead, your line is open.

Asiya Merchant -- Citigroup -- Analyst

Great, thank you. A lot of my questions have been answered, but one for Kieran, CapEx, took a step up relative to your prior requirements that management shared at Analyst Day. Maybe, you can give a little bit more color

Little bit more color, seems like restructuring and some of the other ones took a step-down. Is this -- yeah, if you can just provide some more color on that, that would be great?

Kieran McGrath -- Senior Vice President and Chief Financial Officer

I am just making sure, I heard you, probably you said the CapEx.

Asiya Merchant -- Citigroup -- Analyst

Yes, your capital expenditure requirements, as I understand, took a step up relative to what was shared earlier, I think $75 million to $85 million, now you're expecting $100 million and, -- (multiple speakers) if you can just give a little bit more color on that.

Kieran McGrath -- Senior Vice President and Chief Financial Officer

I think part of that, yes, I think part of that has to do with what we're seeing in terms of the rate and pace acceptance and piloting of a lot of our big enterprise customers in our private cloud, so obviously you have to start building up that infrastructure, as I described, we initially thought that much of the early acceptance of our private cloud offerings will be more of 102:49 (inaudible) type. What we're seeing is actually much more complexity from the largest of our big enterprises. And with that, we're just trying to get ahead of it from a buildout perspective. I don't think it's anything that we would say is going to be long-term any difference than what I've built into our long-term model in terms of annual CapEx.

Asiya Merchant -- Citigroup -- Analyst

Okay. And then so related to that, I mean as the private cloud offerings require more complex CapEx or the CapEx transaction, is that -- you guys at the Analyst Day had talked about margin expansion as we go into fiscal '19 and then the longer-term targets were shared as well relative to the actuals and fiscal '18, how did this incremental CapEx, 103:33 (ph) hence (ph) higher depreciation, I didn't know changes in OpEx related to rebates or et cetera. How does that factor in then to your long-term outlook for margin expansion? Thank you.

Kieran McGrath -- Senior Vice President and Chief Financial Officer

Yeah, I think our overriding piece really is unchanged. As we shift more to away from a traditional hardware device that business to more of a software and more importantly, recurring software type of business, I think our margins are going to mix more positive. Clearly, there's a couple of quarters or tactically of some short-term hits, but we don't see any change to the longer-term remixing of the model toward software and the higher gross margins that that should bring along with it.

Asiya Merchant -- Citigroup -- Analyst

Okay. And then if I may one more. Cloud tends to be a very scale oriented game and maybe and if you can clarify this, when you talk to customers and they look at the trajectory in your cloud revenue growth relative to some of your other competitors and admittedly, they might be smaller scale of digital buyers installed base and customer base, do you get pushback that your trajectory is underperforming the overall market. And does that get into any discussion, because cloud tends to be a much more of a scale game and compared to your competitors you're clearly underperforming on the cloud side in growth 105 (inaudible)?

clearly underperforming on the cloud side in growth 105 (inaudible)?

Jim Chirico -- President & CEO

If you take a look at, we grew 165% year-on-year, we grew 25% quarter-on-quarter. We're not actively engaged in low margin-low profit SMB space. If you take a look at our private cloud, we didn't touch on the overall size of 105:28 (inaudible) said, we're going to be prudent in how we publicize because we'll do it based upon when we actually received the overall bookings, we're actually doing quite well. We have, as I said 15 POCs, there will be more that we will obviously highlight as a result this quarter's performance as it continues to gain momentum and traction, in fact no one in the marketplace as a private cloud solution geared at 105:55 (ph) our large (ph) enterprise and personally, if you're -- I would much rather focus on what we have, which is the crown jewel of the enterprises versus trying to be one of many fighting for a piece of turf in the world of SMB. So, I think that's how you look at it, but I personally am quite proud of the fact that the IP Office mid-market is growing at the rate and pace that it is growing at, in fact, the expectations are for it to continue to grow at past performance levels and the private cloud as we mentioned, these are a $30 million deals, $11 million deals, so on and so forth and we have 15 POCs, that are going well and the funnel behind that is actually quite strong. So, stay tuned for that message. So I think you need to look at what the value prop you bring, what differentiation you bring, probably more importantly in the long run is what technology you're actually able to bring to market as well and that's what our focus is as we continue to focus on our long-term strategy.

Asiya Merchant -- Citigroup -- Analyst

Okay, great. Thank you.

Operator

And our next question comes from the line of Hamed Khorsand with BWS Financial. Please go ahead, your line is open.

Hamed Khorsand -- BWS Financial -- Analyst

Hey, good morning. So first off, could you just talk about this rounding you're talking about in private seats, because I mean, it's almost 10% that can't be a rounding error going from 3.7 million to 3.4 million.

Kieran McGrath -- Senior Vice President and Chief Financial Officer

(Multiple speakers) We are talking about in aggregate 3.7 million seats in total of which we have, I think we said almost 300,000 in the public cloud seats, which implies 3.4. I think the implication was last quarter that private was probably closer to 3.5. What I'm saying is, is a little bit of rounding between the 3.5 and the 3.4 in the private only, in total, we're still talking about 3.7 million seats.

Hamed Khorsand -- BWS Financial -- Analyst

I guess the seat count hasn't changed then. Okay. That's what does that was confusing me. And then lastly

And then lastly I wanted to ask you was, if you're adding to headcount, why hasn't there been any kind of improvement, where are those headcounts being added in the business and the improvement I'm referring to as far as just customer retention and actual revenue growth?

Jim Chirico -- President & CEO

Yeah. So we began the year at 7,900 people. I think we closed the quarter at 8100 folks, but overall from a company level we've actually grown as committed to the best of thesis about putting more resources across the board and new and emerging technologies both go-to-market, R&D and some other things, services, are the three main functions. I honestly don't know the specifics off the top of my head where everybody actually ended up but the R&D continuing to invest in what I call new growth opportunities. We're also rebalancing as one would expect as well as you move from a hardware-oriented company to one that's more of a software services subscription-oriented company. So there is also a bit of rebalancing underneath of that as well. So we're actually hiring quite a few folks within the company. So, not quite sure how to provide any more color if there was any questions on the overall headcount.

Hamed Khorsand -- BWS Financial -- Analyst

So it is more of a -- is it really like a product development issue as far as being able to get customers to spend more with you or is it really more of a relationship standpoint that just created some issues because of the Reuters headline?

Jim Chirico -- President & CEO

Reuters headline could probably best be characterized as article came out, people didn't know how to interpret the article, our customers per se, competition in fairness, took advantage of that article to provide their kind of perspective to customer base and they basically, even though we were very proactive when it comes out and you do a fair amount of your business in the last week to 10 days of the quarter, it was where they came out basically and wanted to get a better understanding about where we're going, so we've spent a fair amount of time as I mentioned in my earnings script being proactive and talking our customers through it, but it did have a change in the buying behaviors that we've historically seen at quarter end based upon the timing of that article. It was just ---

Kieran McGrath -- Senior Vice President and Chief Financial Officer

It might be interesting just to add here that we get somewhere around approximately 50% of our revenue in the last month of every quarter and of that -- a very substantial percentage of that actually happens in the last week of the quarter.

Hamed Khorsand -- BWS Financial -- Analyst

But why would the customers -- why would these customers actually start changing with

Actually start changing the order habits when -- they didn't do this kind of activity when you're in bankruptcy, I mean, now you're in better footing and not in bankruptcy and you're getting -- you're talking about someone taking you over having more of a negative consequence than going into chapter 11?

Jim Chirico -- President & CEO

Yeah, I mean, we saw the same.

Kieran McGrath -- Senior Vice President and Chief Financial Officer

I mean this is actually absolutely what we saw with bankruptcy and customers freezing and procurement people coming in and driving strategic people coming in questioning (multiple speakers) ---

Jim Chirico -- President & CEO

I hate to go back to the past, but that day in November when the Wall Street Journal article came out with speculation 2.5 years, 3 years ago, the US orders basically stopped overnight until people wanted it sorted out. People interpret things the way they do and it was similar in design only around the fact of uncertainty. So they -- we saw a pretty significant change in buying patterns, like can someone please explain to me what's going on and what this does mean and how do I interpret this and the launch of this goes on, which I won't bore everybody on the call, but, so it just took a little bit of time, but again the timing of that article and the speculation in customers' minds had an effect on the buying base, and in fact as Kieran said we're prudent in our going-forward business based upon what we announced in the earnings release. So I think that's probably fair 112:29 (ph) to us (ph) .

Hamed Khorsand -- BWS Financial -- Analyst

Okay, thank you.

Kieran McGrath -- Senior Vice President and Chief Financial Officer

Yeah.

Operator

And we have no further questions at this time. I'll turn the call over to Mr. Jim Chirico, President and CEO for closing remarks.

Jim Chirico -- President & CEO

Yes. Thank you, Operator. Before we conclude the call, I just want to take a moment to reiterate a couple of the key points. First, Avaya is uniquely positioned to lead our customers through this digital transformation journey with a reach that spans the globe as we continue to operate at scale. Our growth investments are aligned with opportunities opening up as our mid-market and enterprise customers turn more aggressively into cloud based solutions where we can deliver the full and feature rich functionality in both private, hybrid, as well as public offers in both UC and CC. We are layering in the right strategic partnerships and those partnerships are with companies that are in the forefront of shaping the cloud landscape, companies that include Salesforce, IBM, Google, Afiniti and Verint, and we're taking advantage of the opportunities to work with these partners to drive solutions to the market that our customers are demanding. We are continuing to invest in our growth areas as well. So with that I do want to thank you for your time this morning and hope you have a great day. Thank you.

Operator

And this concludes today's conference call. You may now disconnect.

Duration: 66 minutes

Call participants:

Michael W. McCarthy -- Vice President Investor Relations

Jim Chirico -- President and Chief Executive Officer

Kieran McGrath -- Senior Vice President and Chief Financial Officer

Jim Chirico -- President & CEO

Chris McGugan -- Senior Vice President, Solutions and Technology

Raimo Lenschow -- Barclays -- Analyst

Lance Vitanza -- Cowen -- Analyst

Analyst

Eric Lapinski -- Morgan Stanley -- Analyst

Balaji Krishnamurthy -- Goldman Sachs -- Analyst

Dmitry Netis -- Stephens Inc. -- Analyst

Asiya Merchant -- Citigroup -- Analyst

Hamed Khorsand -- BWS Financial -- Analyst


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