U.S. Markets closed

Edited Transcript of SHOR earnings conference call or presentation 26-Apr-17 9:00pm GMT

Thomson Reuters StreetEvents

Q3 2017 Shoretel Inc Earnings Call

SUNNYVALE Apr 28, 2017 (Thomson StreetEvents) -- Edited Transcript of Shoretel Inc earnings conference call or presentation Wednesday, April 26, 2017 at 9:00:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* Barry Hutton

* Donald Joos

ShoreTel, Inc. - CEO, President and Director

* Michael E. Healy

ShoreTel, Inc. - CFO and SVP

================================================================================

Conference Call Participants

================================================================================

* Dmitry G. Netis

William Blair & Company L.L.C., Research Division - Equity Research Analyst

* Eric Martinuzzi

Lake Street Capital Markets, LLC, Research Division - Director of Research and Senior Research Analyst

* George Frederick Sutton

Craig-Hallum Capital Group LLC, Research Division - Partner, Co-Director of Research and Senior Research Analyst in the Equity Research Department

* Gregory Burns

Sidoti & Company, LLC - Analyst

* Michael James Latimore

Northland Capital Markets, Research Division - MD and Senior Research Analyst

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Good day, and welcome to ShoreTel's Third Quarter Fiscal Year 2017 Conference Call. (Operator Instructions) Please also note that today's event is being recorded. May I also like to add that we at Chorus Call use ShoreTel telephones. In fact, I'm speaking to you right now on a ShoreTel telephone.

I would now like to turn the conference over to Barry Hutton, ShoreTel's Director of Investor Relations. Please go ahead.

--------------------------------------------------------------------------------

Barry Hutton, [2]

--------------------------------------------------------------------------------

Hello, and thanks for joining us today as we report the financial results for our fiscal third quarter of 2017. Joining me on the call today are ShoreTel's President and Chief Executive Officer, Don Joos; and ShoreTel's Chief Financial Officer, Mike Healy.

Before we begin, I will remind you that during today's call, management will make forward-looking statements within the meaning of the safe harbor provision of federal securities laws regarding the company's anticipated future revenue, gross margins, operating expenses and other financial and business-related information. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected. Additional information concerning the risk factors that could cause actual results to differ materially from those in the forward-looking statements can be found in the company's most recent Form 10-K and 10-Q and the current report on Form 8-K furnished today.

The information in this conference call related to projections or other forward-looking statements is based on management's current expectations. The company does not intend to update its forward-looking statements should circumstances change. As a matter of policy, ShoreTel does not comment on financial guidance during the quarter unless it is done in a public forum. Additionally, ShoreTel maintains a presence on Facebook, Twitter, LinkedIn and Google Circles that it uses from time to time to republish company news.

We will be discussing both GAAP and non-GAAP results throughout this call, and I ask that you refer to our press release issued today for the reconciliation between these amounts. Our non-GAAP numbers exclude stock-based compensation charges, amortization on acquisition-related intangibles, other adjustments and related tax charges. We ask that you please keep your questions to the operational and financial results announced today.

And now I'll turn the call over to Don.

--------------------------------------------------------------------------------

Donald Joos, ShoreTel, Inc. - CEO, President and Director [3]

--------------------------------------------------------------------------------

Thanks, Barry. Before we provide a quarterly update on our operational and financial progress, I'll make a few comments regarding our ongoing strategic review process.

We began our strategic review process in August. It has been inactive for a period of time and continues to remain active. We recognize the need to balance the importance of the strategic review process with any potential impact to our near-term operations. I remain excited about our strategic plan, driving execution of our transformation and the market opportunity in front of us. Throughout this process, we've continued to talk regularly with our shareholders, customers, channel and business partners, and we appreciate their feedback.

At this point, I will recap the key financial results from our fiscal third quarter. Total revenue in fiscal Q3 was $87.7 million. Hosted revenue is our single largest source of revenue representing 44% of the total. On a year-over-year basis, hosted revenue grew 17%. In the quarter, our cloud bookings grew 7% year-over-year. This was below our historical levels and also below our internal expectations. With an increasingly competitive landscape, we did make a conscious choice in the March quarter to run several promotions and sales incentive programs, thus giving up some near-term pricing in exchange for growth in seats booked. Therefore, the bookings growth rate percentage was lower than we desired, but we did create several key outcomes from these actions.

First, the number of new seats booked was up (technical difficulty) year-over-year and 37% quarter-over-quarter, indicating that our cloud offering is expanding its presence in the marketplace. This significant increase in the number of seats booked was balanced against a decline in ARPU, which impacted the bookings growth percentage rate.

Second, our overall cloud sales effort had good success with the mid-market and enterprise customers. Bookings for customers with over 200 seats grew 33% year-over-year. This is the third consecutive quarter that our highest growth came from these larger customers, which tend to have lower churn and be more profitable. Meanwhile, we did see a decline in the sub-50 seat volume. Third, in Q3, our cross-selling to existing cloud customers grew 24% year-over-year and reached its highest level in 2 years. This indicates our current customers' desire to expand and add new applications as we continue to enhance the Connect CLOUD solution. Meanwhile, our continued focus on account management led to our solid revenue churn metric of just 5% annualized, which remains favorable to our UCaaS peers.

Through continued operational actions and discipline, we achieved a year-over-year improvement in all 3 of our gross margin lines as well as a reduction in operating expense levels. In total, we earned a non-GAAP operating income of $1 million. Overall, I'm pleased with the financial results of the quarter, but I'm not satisfied with the overall pace of the strategic shift to driving hosted growth. By no means am I content or complacent with our current progress. And we have implemented and will continue to identify actions to further improve the company's growth. Today, we announced an action which will implement a meaningful change to our premise-focused channel partners in distribution practice in the United States. I'll take a few moments to recap the key aspects of the change, along with its operational and financial benefits. ScanSource handles a 2-tier distribution model for a significant portion of our U.S. premise volume. Effective July 1, the start of our new fiscal year, we're expanding this relationship with value-added resellers, also known as VARS, who currently buy product directly from us, will now be folded into the ScanSource 2-tier distribution model. At that point, ScanSource will then handle a vast majority of our U.S. premise volume, the exception being our continued 2-tier distribution relationship with Ingram Micro. The completion of the 2-tier distribution in the U.S. better aligns with our overall global distribution strategy. Going forward, nearly all of our U.S. premise channel partners will benefit from ScanSource's expertise in logistics, inventory management and the tools and support structure designed for the channel partner community. Strategically, ShoreTel will be able to reallocate resources to strengthen our focus on our cloud service priorities, including innovation, service delivery and hosted revenue growth.

In addition, we anticipate this expanded relationship to be neutral or slightly positive to our fiscal 2018 operating profit, driven by $6 million to $7 million cost savings. We also expect to gain $3 million in working capital due to improvements in accounts receivable and inventory turns. In a few minutes, Mike will provide more details about the financial model related to this expanded arrangement.

Now let me provide a brief update on the execution against our 5 catalysts for growth which we previously outlined as: one, the rollout of ShoreTel Connect offering; two, the global expansion of our cloud offering; three, the scale of our channel partner community; four, our success with mid-market and enterprise customers; and five, our ability to leverage our premise installed base to drive hosted revenues.

Our first 2 catalysts for growth are the ongoing enhancements to ShoreTel Connect and the continued expansion of our cloud offering. We continued to achieve important milestones in each area. At the Enterprise Connect conference last month, participants experienced demonstrations of our recently announced enhancements. This included new video collaboration capabilities and our Teamwork application, designed to aid team collaboration and document creation for mobile users. These cloud-based apps are available to customers through our bundled packages and inspire recognition across the industry. Recently, TMC named ShoreTel Connect as 2017 Unified Communications Product of the Year winner.

As we continue to introduce new enhancements to our connect offering and continue to expand our global cloud footprint, we're winning multinational cloud customers. One such example in Q3 is the signing of a U.K. based provider of submarine cable solutions. From a global perspective, this customer needed a single solution to serve its locations in the U.K. and the U.S. From a feature perspective, the customer wanted to utilize our video collaboration and various mobility capabilities. We won this deal against an incumbent provider, a cloud pure play and a larger provider with multiple offerings.

Looking forward, I'm excited to see the execution of our development efforts reflected in our near-term roadmap. A few key roadmap items over the next 3 to 6 months includes: expanding our global hosted presence, including Connect CLOUD in Australia and broader global number coverage; enhancing our Teamwork, video collaboration and Contact Center applications; broadening our service delivery capabilities by giving our customers and partners more self-service capabilities; enhancing our user experience through improvements in our web, desktop and mobility clients; and continuing our integrations with Microsoft, Google, Salesforce and several other industry applications as part of our monthly release cycle.

The success in these 2 areas provide momentum towards our third and fourth catalysts for growth, which are channel partner scale and our success with mid-market and enterprise customers. Let me summarize a couple of key points. One, our channel partners continue to contribute over 90% of our cloud bookings. Two, for the fourth consecutive year, CRN has given our Champion Partner Program a 5-star rating, which is their highest rating. Three, the development roadmap is generating excitement in key geographic theaters and a meaningful increase in partner activity in both the U.K. and Australia. In EMEA, our recent expansion of our Connect CLOUD offering has had a solid start, and we also signed multiple new channel partners in the theater. Since our acquisition in Australia, we've had cloud bookings growth in each of the 5 quarters since the deal closed. Later this quarter, we will launch our Connect CLOUD offering in Australia. In addition of this launch, 75% of our on-site channel partners in Australia have already signed their addendums, so they can offer our Connect CLOUD solution as well.

The adoption of our cloud offering continues to grow in the Australia market. This was evident by our largest cloud win in that country to date. We closed a retailer of ladies' apparel with 124 locations, which will result in new hosted revenue of almost $19,000 per month. As I mentioned earlier, our innovation, service delivery and strategic priorities are leading to increased growth in the mid-market and enterprise customer segment. In Q3, our bookings growth in the over 200-seat segment was up 33% versus the prior year. During Q3, we again signed multiple new customers, which will each generate over $10,000 per month in hosted revenue. The scalability of our cloud offering was critical to our signing of a new memorial services customer. The initial contract signed in Q3 provides service to 1,000 users and the customer has plans to add an additional 600 users. When fully deployed, our cloud offering will serve 64 locations. The customer needed to replace its previous disparate phone system with a solution that could be utilized across the organization, while integrating with Skype for Business.

Our fifth catalyst for growth is the premise-to-cloud migration program. Since launching the program, it has contributed approximately 10% of overall cloud bookings. In Q3 specifically, we had a 71% quarter-over-quarter increase in the number of installed premise customers that committed to new cloud contracts. Each quarter, some customers execute a full premise-to-cloud migration, while others decide to simply add new cloud services or locations and choose to migrate over a slightly longer time period. This causes a wider range in the size of cloud bookings through the program. And in Q3, the average seat size of migration customers was smaller than our cumulative average. But overall, migration customers continue to represent larger seat sizes and monthly revenue levels than our net new cloud bookings.

The annualized hosted revenue from our migration customers is more than 20 times greater than the support revenues that were replaced. Over the last couple of quarters, we have gained valuable insights and are implementing several changes, which will enable us to increase the pace of migrations over the next several quarters and beyond. These changes include stronger alignment within our channel and sales incentive programs, new tools to better identify and target migration customers and process changes such as providing budgetary cloud quote at the time of support renewal. We continue to remain focused on the installed base migrations as it is a strategic asset for us.

As I reflect on our progress, I'm proud of what our employees have accomplished as business transformations are not easy. But by no means are we complacent or content with our current progress or results. I recognize that the operational successes we have realized have not always been reflected in the financial results or equity valuation. We know we can achieve greater results, and the market opportunity is there for us. We remain focused and committed to growing our business and creating shareholder value. In summary, our fiscal Q3 generated a year-over-year improvement in total revenue, gross margins, operating expenses and profitability. Our efforts to grow the cloud business resulted in a 35% increase in the number of total cloud seats booked, the quarter had strength from mid-market and enterprise customers, and today, we announced an expanded relationship with ScanSource, which strengthens our focus on our cloud-based innovations, service delivery and growth. We realize that we still have work to do in order to complete our transformation. I'm confident in our strategic direction. I'm also confident that the actions we are taking will improve the pace of our strategic shift to drive hosted growth.

Now I'll ask Mike to review the financial results.

--------------------------------------------------------------------------------

Michael E. Healy, ShoreTel, Inc. - CFO and SVP [4]

--------------------------------------------------------------------------------

Okay. Thanks, Donald. A review of our fiscal Q3 shows that we produced solid financial results and continued our progress in key operational areas. We earned $87.7 million in total revenue, a 3% increase year-over-year, again led by a 17% increase in our hosted revenue of $38.3 million, which was 44% of our total revenue. We also saw year-over-year improvements across all 3 gross margin lines, operating expenses and profitability. As a result, we earned a non-GAAP net income of $600,000, which kept our streak going of non-GAAP profitability for 15 of the last 16 quarters, all while transitioning to a cloud business model.

Hosted revenue was $38.3 million in the quarter, up 17% year-over-year and up 4% over Q2. With our 2 hosted acquisitions reaching their 1-year anniversary in Q3, this 17% increase is now entirely organic growth.

Our worldwide cloud installed base now has 6,500 customers, totaling 271,000 seats, representing year-over-year increases of 27% and 24%, respectively. Let me highlight a few key cloud metrics that were shown in today's press release.

Our cloud customer installed base remained steady and has an average seat size of 41. Our average revenue per seat, or ARPU, also remained constant at $48. Our average cloud customer pays us $1,991 per month. And we continue to have a very low revenue churn, which in Q3 was 0.43% on a monthly basis or only 5% annualized.

Our Q3 product revenue was $30.5 million, and we shipped 112,000 licenses. Our product revenue declined by 10% over last year and 5% sequentially in what is typically our softest quarter in terms of seasonality. This is an improvement versus the trend of the prior 6 quarters as we saw an increase in the average new customer deal size and a sequential increase in add-on billings from the installed base. However, we do expect to continue to see quarterly variability in our product revenue, given our seasonality and our strategic shift towards hosted revenue. In Q3, support and services revenue was $18.9 million, up 2% year-over-year and down 1% sequentially. Our support revenue grew 4% over last year to $17.4 million as we continue to have a high attach rate on initial sales and support contract renewals. The services revenue of $1.5 million includes training, professional services and implementation fees and typically correlates with the product revenue trends.

Our recurring revenue, comprised of hosted plus the support revenue that I just mentioned, totaled $55.7 million in the quarter or 63% of total revenues. This represents an annualized recurring revenue run rate of $223 million.

In our third quarter, international revenue was $7.1 million, up 4% from the prior year. International represented 8% of our total revenues in the quarter, consistent with historical levels.

And to talk about the rest of the income statement, my following comments will refer to non-GAAP results unless otherwise noted. A reconciliation to the related GAAP numbers is attached to the earnings press release we issued this afternoon.

Our third quarter total gross margins were 65.4%, up 220 basis points from last year as we had improvements in all 3 gross margin lines. In particular, our hosted gross margins were 57.3% in Q3, up 400 basis points from last year and an increase of 230 basis points sequentially. The increase reflects revenue scale and operational efficiencies. In addition, we had a 90 basis point benefit from the release of telecom tax reserves in the quarter. This benefit -- these benefits were partially offset by additional resources -- resource investments made to our customer support organization, to aid our growth and ramp in data center costs. The product gross margins were 67.4%, up 30 basis points year-over-year and up 80 basis points sequentially, reflecting lower operational and product costs.

The support and service gross margins were 78.4%, a 490 basis point improvement from last year following the shift of resources to support our growing hosted customer base. On a quarter-over-quarter basis, the gross margins declined by 90 basis points. The Q3 operating expenses were $56.3 million, an improvement of $1.4 million from a year ago. We had labor savings in the sales and marketing area following our August realignment of resources and also reductions in IT project spending.

Sequentially, operating expenses increased by $2 million, primarily in product development and G&A as we increased labor-related spending and software expenses in a few specific areas. The year-over-year improvements in revenue, gross margins and op expense levels led to a non-GAAP operating income of $1 million or 1% of revenue. Our non-GAAP net income was $600,000 or $0.01 per diluted share, a good improvement over last year's loss of $0.06 per share, which included the first quarter's impact from our cloud acquisition that closed in early January 2016.

The GAAP results show a net loss of $2.9 million or $0.04 per share, which includes charges of $2.2 million for stock compensation, $2.4 million for amortization of acquisition-related intangibles, severance and other costs. Also included in our GAAP results in the other income line is a gain of $920,000 for an investment we obtained as part of our acquisition in Q3 last year. The sales of this investment also helped grow our cash balances in the quarter by $1.1 million.

Now I'll briefly comment on our cash flow and a few key balance sheet items. In Q3, we generated $2.7 million in cash flow from operations, and we ended the quarter with $104.9 million in cash and short-term investments and no debt. The other key elements in working capital include depreciation and amortization in the quarter, was $5.1 million. Accounts receivable ended the quarter at $26.5 million, up $800,000 reflecting the timing of customer billings and our days sales outstanding remained relatively constant at 27 days. Inventory decreased by $1.7 million to end the quarter at $14 million. Our deferred revenue increased by $2.3 million to $79.7 million. Our capital expenditures are linked primarily to support our growing cloud business and further technology innovations. In Q3, CapEx was $2.9 million. We ended the quarter with 1,166 employees, including Q3 hiring of 22.

Before I talk about guidance, let me give you few more details on our expanded relationship with ScanSource. The revised contract with ScanSource is effective July 1 of this year, but some of the direct partners may move over to ScanSource during this quarter. A vast majority of our partners already purchase from -- the vast majority of our partners already purchase from ShoreTel through a 2-tier distribution model in the U.S. This change is effectively moving our remaining direct value-added resellers, or VARS, to buy our on-site products and support through ScanSource versus directly buying from us. This is a continuation of a natural evolution of our distribution strategy.

There are numerous financial and operational benefits to ShoreTel that we expect to achieve from this distribution model change throughout the fiscal 2018, including the following: In terms of the revenue impact, if we assume no change in current projections for sales volume, the product and service support revenue line will decline a little due to the discount levels associated with our 2-tier distribution model. As ScanSource will handle the logistics, support, inventory management and operations in support of the direct VARS moving over, we are able to reduce our internal resources dedicated to managing these direct channel partners in the sales channel services and operations groups. Most of the actions related to today's announcement are complete, and we expect the annualized savings in expenses from these actions will be in the $6 million to $7 million range, starting in our September 2017 quarter.

We also expect at least $3 million in working capital benefit from lower DSOs and quicker turns on our inventory. Given the expected slight revenue decline and expense savings, a conservative view will yield a neutral to small positive impact to our operating income due to this alignment in our global distribution strategy. Strategically, we're excited about our expanded relationship with ScanSource, which will allow us to strengthen our focus on innovation, service delivery and hosted growth.

Now let's turn to our fiscal Q4 business outlook. The June quarter marks our fiscal year-end and is historically our strongest revenue quarter of the year. We anticipate total revenue to be in the range of $88 million to $94 million. We expect non-GAAP gross margins to be within the range of 64% to 65%, and the GAAP gross margins will be roughly 1.5 percentage points lower due to charges for stock-based compensation, amortization of acquired intangibles and other adjustments.

We expect our non-GAAP operating expenses to be in the range of $56 million to $57 million, with the GAAP op expense roughly $4.5 million higher due to charges for stock-based compensation, amortization of acquired intangibles and other adjustments, including severance costs related to today's distribution strategy announcement.

So to wrap it all up, we posted another strong quarter in terms of financial performance around revenue, gross margins, profitability and cash flow generation. Meanwhile, we've taken an important step to strengthen our focus on hosted service by expanding our 2-tier distribution model in the U.S. and having ScanSource handle our direct VARS in the areas of distribution, support and logistics, an area which they excel at. And finally, our earnings call would not be complete without mentioning our professional sports team customers. We've recently added the first place Colorado Rockies as a customer, and I want to wish good luck to our customers that remain in the NBA and NHL playoffs that include the Boston Celtics, Verizon Center, home to the Washington Wizards and Washington Capitals, and, of course, my home team, the Golden State Warriors. With that, I'll turn it over to operator for Q&A.

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) And our first question comes from Greg Burns with Sidoti & Company.

--------------------------------------------------------------------------------

Gregory Burns, Sidoti & Company, LLC - Analyst [2]

--------------------------------------------------------------------------------

Don, could you please expand upon your thought process, the rationale behind the incentive or pricing concessions on the hosted side of the business? And was that proactive on your part or reactive to anything that you're seeing in the market?

--------------------------------------------------------------------------------

Donald Joos, ShoreTel, Inc. - CEO, President and Director [3]

--------------------------------------------------------------------------------

Yes, appreciate that, Greg. Yes, this is a choice that we had made. Never happy to be dealing with single-digit growth from a bookings perspective. So this was us taking a look at the last quarter and wanting to make a change. And that change was getting more demand out of the market and under the ShoreTel umbrella. So we made a conscious choice to be a little bit more aggressive in the near-term, in driving the volume of booked seats up. We achieved that both on a year-over-year and probably more importantly on a quarter-over-quarter basis, having a mid-30 range on that. And yes, we did recognize going in that, that would have a near-term impact from a price point. The reason I was comfortable in there is, one is obviously getting more demand through us because from a cross-sell perspective, it creates more opportunities, larger customers typically have a lower churn, and you've more opportunities from a cross-sell from an application or additional services. When I look at our most recent uptick in our cross-sell activities, predominantly they've been coming from contact -- the contact center application. So for us, we believe there are opportunities then, to cross-sell into those accounts with additional services and thus bringing more revenue and improving the ARPU on that.

--------------------------------------------------------------------------------

Gregory Burns, Sidoti & Company, LLC - Analyst [4]

--------------------------------------------------------------------------------

And then when we look at the guidance. Typically, I guess, the last 2 years, the sequential uptick in product sales was about $8 million into the fourth quarter. The guidance, I guess, implying far less seasonality than that. What's your view on the seasonality we should expect from the product business going into the fourth quarter?

--------------------------------------------------------------------------------

Donald Joos, ShoreTel, Inc. - CEO, President and Director [5]

--------------------------------------------------------------------------------

I think 2 things I would say in there. One is that we were pleased with where our March quarter is traditionally, or historically has been, our weakest of the four quarters, and that's where we have the seasonality impact. And we actually had a good quarter. And I'd say we were overall pleased just with the overall financial performance. So that contributes to a quarter-over-quarter view. But as our guidance indicates, we do expect an uptick in the overall product numbers going in because that is the end of our fiscal year. So we do expect to see an increase. But we saw a healthier March quarter than we typically see. I don't know if you have any other comments there?

--------------------------------------------------------------------------------

Michael E. Healy, ShoreTel, Inc. - CFO and SVP [6]

--------------------------------------------------------------------------------

Yes, I mean, the only other thing I would say is that on-premises product market is in decline according to Synergy, 3% to 6%. We're continuing to focus on moving towards hosted revenue. So that factors into our guidance as well as this quarter. Some partners may move over to ScanSource a little earlier, and if they do that, there would be a little change in discounting volume that's going through ScanSource. So that factored into the guidance range we gave as well.

--------------------------------------------------------------------------------

Operator [7]

--------------------------------------------------------------------------------

Our next question comes from George Sutton with Craig-Hallum.

--------------------------------------------------------------------------------

George Frederick Sutton, Craig-Hallum Capital Group LLC, Research Division - Partner, Co-Director of Research and Senior Research Analyst in the Equity Research Department [8]

--------------------------------------------------------------------------------

Just to close the loop on the promotions, can you talk about whether this was targeted at new customers? Was this targeted at existing customers that you're trying to get to migrate? And have you ended that promotion? Or is that -- is there some form of that ongoing?

--------------------------------------------------------------------------------

Donald Joos, ShoreTel, Inc. - CEO, President and Director [9]

--------------------------------------------------------------------------------

George, it's Don. So let me take, they're couple of parts there. One is the promotions and the incentives that we ran in the March quarter. They were targeted at net new customers. So we were looking to get net new customers seats booked. And so that was targeted there, and as I'd said, right, we saw an outcome that we were seeking and we wanted, which was a year-over-year and a quarter-over-quarter increase from that perspective. The premise installed base migration is a different effort. As I talked about is, we actually saw -- in the quantity of customers, we actually saw a 71% increase in the number of customers on a quarter-over-quarter basis migrating, signing contracts to migrate. So we saw good success from there. But as I said, as I don't want to get content anywhere or be complacent. There are improvements that we're going to continue, whether it's tooling, whether it's a process perspective or other incentives that I'm referring to, just in our channel programs to drive more activity. As it relates to the March programs around the new business, we are continuing most of those into the June quarter. Beyond the June quarter, I'll have to assess things at that point, but we are continuing those programs to drive more business from a hosted perspective in that June quarter.

--------------------------------------------------------------------------------

George Frederick Sutton, Craig-Hallum Capital Group LLC, Research Division - Partner, Co-Director of Research and Senior Research Analyst in the Equity Research Department [10]

--------------------------------------------------------------------------------

Okay. I did a nice demo of your Teamwork offering at Enterprise Connect. And I wanted to understand how are you planning to offer that as part -- are you offering that as a stand-alone offering? Is that part of a combined sale? I'm curious how you're competing with a Slack and a HipChat in that kind of an environment?

--------------------------------------------------------------------------------

Donald Joos, ShoreTel, Inc. - CEO, President and Director [11]

--------------------------------------------------------------------------------

It's good question. And we put that. That is not a stand-alone item. That is bundled in to our existing profile. So what we're doing is we are adding additional value into those profiles in the marketplace. When I look at it from a UCaaS perspective, I think some -- others are probably in that approach also. Someone like a Slack, I would say, that is their business. So that's a stand-alone there. Most are bundling into their existing profiles. We do that the same thing with video in our video collaboration. And the reason we do that is really because it's all about the customer experience and how it's integrated into a broader UCaaS solution, because Teamwork is not really an independent application. It can't be an independent experience. It has to be integrated into the overall UCaaS solution. And for us, it's our own intellectual property. So we have much more control over how that experience works.

--------------------------------------------------------------------------------

Operator [12]

--------------------------------------------------------------------------------

Our next question comes from Eric Martinuzzi with Lake Street Capital Markets.

--------------------------------------------------------------------------------

Eric Martinuzzi, Lake Street Capital Markets, LLC, Research Division - Director of Research and Senior Research Analyst [13]

--------------------------------------------------------------------------------

I want to go a little deeper here on the new distribution domestically. You talked about some of the costs -- the benefits there on the cost side. I think you size them at $6 million to $7 million of savings, but then at the end of the day, the impact here is going to be neutral to slightly positive. I'm wondering if I'm -- from a revenue projection perspective, is that to say that I should be pulling something slightly less than $6 million to $7 million out of the revenue side as the counterpoint here because now those products and services are all being run through ScanSource?

--------------------------------------------------------------------------------

Donald Joos, ShoreTel, Inc. - CEO, President and Director [14]

--------------------------------------------------------------------------------

Mike, you want to?

--------------------------------------------------------------------------------

Michael E. Healy, ShoreTel, Inc. - CFO and SVP [15]

--------------------------------------------------------------------------------

Yes. So that, I mean, that certainly what it implies, Eric. But like I said in the prepared remarks, we characterize that as a conservative estimate. It really depends what you're modeling for next year in terms of product and support. And we do think with ScanSource's focus, and they'll recruit more partners to sell our ShoreTel solutions, there is a good potential for upside to those numbers. We're not going to commit to anything today, but we're certainly expecting a great amount of increase from what we have predicted our outcome would be via ScanSource's focus.

--------------------------------------------------------------------------------

Donald Joos, ShoreTel, Inc. - CEO, President and Director [16]

--------------------------------------------------------------------------------

Yes, this is Don. Let me chime in a minute. I think this is, as we said, where ScanSource has a very specific focus here. They have the tools in place, they have the support infrastructure in place to support this channel community, they have the recruitment capabilities in place. And from my perspective, what I like is they're a publicly traded company. So they also work on this quarterly approach, as they have to produce their results out into the public market. So what it allows is, it allows us to basically, for lack of a better word, outsource to someone and have been them very, very focused on this area for us from a route to market. And it allows us to strengthen our focus on the innovation, the service delivery and our hosted growth.

--------------------------------------------------------------------------------

Eric Martinuzzi, Lake Street Capital Markets, LLC, Research Division - Director of Research and Senior Research Analyst [17]

--------------------------------------------------------------------------------

Okay. I want to ask kind of a two-part question on the competitive landscape. First, just a revisit on the Avaya bankruptcy. Last quarter you talked about adding a pretty substantial Avaya reseller to the -- to your distribution network. But also, I guess it's end of calendar '16 that the Genesys, Interactive Intelligence merger or acquisition. Those 2 different events, could you just kind of talk specifically to those 2 competitors, if you're seeing changes in behavior there?

--------------------------------------------------------------------------------

Donald Joos, ShoreTel, Inc. - CEO, President and Director [18]

--------------------------------------------------------------------------------

I will touch on both of those. So as it relates to your question as to Avaya. We do continue to see interest coming in from Avaya partners. We have added some Avaya partners into -- under the ShoreTel umbrella. I highlighted one in the last call, and I was actually down at their headquarters in the March quarter at a very large event where they were bringing in all prospects, and we had an opportunity to meet with all of them. So it was a good go-to-market activity from that perspective. They're very excited and are actually really starting to close deals for us. So it's good from that perspective. I would say from the Genesys, with the closing from Interactive Intelligence, I don't think that has had -- we have not seen any material impact in regards to market activity or impact to our business. So that hasn't really been -- obviously we continue to maintain a pulse on the activities within the market, but haven't seen any cause of impact to us. I would say the one announcement that has come out that we probably have seen more activity on is really the Toshiba announcement, as they're exiting the communications within the U.S. market. And I -- the reason I believe we'll see more activity there is because that's a much more definitive statement by them, that they are exiting. And so we have seen a lot more activity coming from that channel, talking to us as well as just activities as it related to the installed base. So Eric, when I think about it, probably the Avaya, yes, I would say over the last 60 days, we've seen definitely more activity just because of the definitive nature of Toshiba's announcement.

--------------------------------------------------------------------------------

Operator [19]

--------------------------------------------------------------------------------

Our next question comes from Dmitry Netis with William Blair.

--------------------------------------------------------------------------------

Dmitry G. Netis, William Blair & Company L.L.C., Research Division - Equity Research Analyst [20]

--------------------------------------------------------------------------------

Don and Mike, just a clarification. I joined a little bit late. So apologize if this was talked about in your remarks, but on the strategic agreement or continuation of the agreement with ScanSource, is that only covering direct -- sorry, premise type business? Or does that include cloud? And if it does include cloud, what is the situation there on the direct sales side of things? Are you going to continue to sell cloud direct and push it through the ScanSource as well? Or what sort of -- how is that going to work? Just if you could help us understand that.

--------------------------------------------------------------------------------

Donald Joos, ShoreTel, Inc. - CEO, President and Director [21]

--------------------------------------------------------------------------------

Yes, not a problem, Dmitry. It's Don. So the announcement of that expanded relationship. I mean, overall, it's really just another important step in the broader transformation of our business. What it is, is the channel partners who are on a single tier, they were buying directly from ShoreTel for product, for the on-site part of our business, the premise. They are now -- they'll be moving under the ScanSource umbrella, and they'll be processing their orders through ScanSource. That's where we get our operational efficiencies from the cost savings as well as from the working capital perspective. As it relates to those VARS and when they are selling ShoreTel Connect CLOUD, it's business as usual, nothing changes, that does not go through ScanSource. That will continue to work as it does today, they work directly with us. So the expanded relationship is specifically for our premise, as it relates to the product and the support services.

--------------------------------------------------------------------------------

Michael E. Healy, ShoreTel, Inc. - CFO and SVP [22]

--------------------------------------------------------------------------------

I would add just one thing. Dmitry, I would add ScanSource has required at least one of our partners that helps us with cloud business, and that's a pretty big volume for them.

--------------------------------------------------------------------------------

Dmitry G. Netis, William Blair & Company L.L.C., Research Division - Equity Research Analyst [23]

--------------------------------------------------------------------------------

Understood. I appreciate that. How many VARS did you have direct that are moving over?

--------------------------------------------------------------------------------

Michael E. Healy, ShoreTel, Inc. - CFO and SVP [24]

--------------------------------------------------------------------------------

We had a little bit under 100 that are contractually moving over. About half of that were active with a significant amount of volume. But it is a good chunk of revenue, because these were our largest VARS. And some of that has already started moving over on their own. So this is just again a natural evolution of how we wanted to manage our on-premise distribution strategy.

--------------------------------------------------------------------------------

Donald Joos, ShoreTel, Inc. - CEO, President and Director [25]

--------------------------------------------------------------------------------

Yes. So Dmitry, I know you said you joined late. So again this was just a couple of [prong], but it's a better alignment to our overall global distribution. So the channel experience is definitely more consistent, but I think the important thing is as we have all of that now through ScanSource and they're focused on the product and support services, it strengthens our focus as it relates to the innovation, the service delivery and the hosted growth. And that's why it's the next important step in the transformation of our business.

--------------------------------------------------------------------------------

Dmitry G. Netis, William Blair & Company L.L.C., Research Division - Equity Research Analyst [26]

--------------------------------------------------------------------------------

Understood. And if I could follow-up on the cloud, #1 is how many channel partners are signed up? I think the last time you've given a number close to 350 or 400 channel partners that are selling your Connect product. Is that -- has that improved? And if it did, how many of those are actually -- contribute to bookings, not just sort of signed up as a partner, but also actually producing -- I don't know, is it maybe 20 of them, as usual? Or is it something else, the top 2 kind of -- the productivity of those cloud VARS that you've signed up?

--------------------------------------------------------------------------------

Donald Joos, ShoreTel, Inc. - CEO, President and Director [27]

--------------------------------------------------------------------------------

So I'll take it in a couple of parts, Dmitry, because I think from a U.S. perspective, as we had said in the prepared remarks, over 90% of our cloud bookings comes through the channel. I would say the number of partners hasn't -- in the U.S. hasn't materially changed, I would say, in the last couple of quarters. I think what's more important is that the contribution from the partners continues to expand. Now that we have our Connect CLOUD offering in the U.K., we're obviously getting more partners on a global basis signing up because in the U.K., we're not only getting our existing VARS, but we got new partners under the ShoreTel umbrella that we didn't have before. And then in Australia, we've already had 75% of the existing VARS already signed up in anticipation when we launch the Connect CLOUD offering in Australia later this quarter.

--------------------------------------------------------------------------------

Dmitry G. Netis, William Blair & Company L.L.C., Research Division - Equity Research Analyst [28]

--------------------------------------------------------------------------------

And on the premise-to-cloud migration, I might have missed it if you said it, so I apologize again. What was the total sort of contribution, in terms of cloud bookings from that initiative alone?

--------------------------------------------------------------------------------

Donald Joos, ShoreTel, Inc. - CEO, President and Director [29]

--------------------------------------------------------------------------------

Yes, the premise-to-cloud migration has been relatively consistent at about 10% of our overall bookings. The important thing that we saw this quarter was we continue to see a material increase in the amount of customers. We saw 71% increase quarter-over-quarter in the number of customers. This particular -- that signed contracts to migrate. This particular quarter, we happen to see the average seat size of those deals was lower than our cumulative average. And that's going to move up and down as different parts of the installed base move, but for me, the most important part was, we did see a material increase in the number of customers, and we're also implementing a variety of actions based upon our lessons learned because we really want to increase the overall pace of that migration.

--------------------------------------------------------------------------------

Michael E. Healy, ShoreTel, Inc. - CFO and SVP [30]

--------------------------------------------------------------------------------

Dmitry, this is Mike. As a remainder, the average revenue pop we get versus the support we lose is still over 20 times for the cumulative program to date.

--------------------------------------------------------------------------------

Dmitry G. Netis, William Blair & Company L.L.C., Research Division - Equity Research Analyst [31]

--------------------------------------------------------------------------------

And do you guys have a number and sort of plan where you want to drive that 10%? It's been sort of, I won't call it sluggish, but it sure seems like it because you've been doing this for now 3 or 4 consecutive quarters and it hasn't really changed. And I appreciate the fact that customers are starting to migrate. So that may indeed indicate that there is a potential to move that number higher, as the deals or upsell get larger with those customers that you've migrated over. But what is that number? If you have that number, it will be great to know. What that percentage of total cloud bookings that you're shooting for, maybe for the next fiscal year or for the next couple of quarters, however you want to define it?

--------------------------------------------------------------------------------

Donald Joos, ShoreTel, Inc. - CEO, President and Director [32]

--------------------------------------------------------------------------------

We -- 2 ways I look at this. One is we're not necessarily looking at it as what percent of the overall cloud bookings, because we obviously want to be growing on both sides of the equation here, and that's obviously a good scenario for us. Where we are looking at is the number of customers that are migrating and then the volume coming from that. That's just a number we have not put out from a public perspective at this moment.

--------------------------------------------------------------------------------

Dmitry G. Netis, William Blair & Company L.L.C., Research Division - Equity Research Analyst [33]

--------------------------------------------------------------------------------

Okay. And then maybe last one for me. As far as the strategic review, I bet that was probably your opening statement. And if it wasn't, can you give us any sense of what the timeline here looks like? I mean, are you going to end it on sort of 12 months kind of time? Or was that going to continue further than the next quarter or the quarter we're in now? How should we think about that strategic process that is underway?

--------------------------------------------------------------------------------

Donald Joos, ShoreTel, Inc. - CEO, President and Director [34]

--------------------------------------------------------------------------------

Yes, I mean, as you can probably expect, there's not a lot I can say as it relates to the strategic review process. We never said a specific time frame around the process, but at this moment, there's just -- there's not a lot I can comment on at this moment as it relates to the process.

--------------------------------------------------------------------------------

Operator [35]

--------------------------------------------------------------------------------

Our next question comes from Mike Latimore with Northland Capital Markets.

--------------------------------------------------------------------------------

Michael James Latimore, Northland Capital Markets, Research Division - MD and Senior Research Analyst [36]

--------------------------------------------------------------------------------

Just on ScanSource a little bit. So what percent of product revenue roughly is moving over? And then, I guess, I assume with the cost reductions, there's some headcount reduction there. How many employees are involved in?

--------------------------------------------------------------------------------

Michael E. Healy, ShoreTel, Inc. - CFO and SVP [37]

--------------------------------------------------------------------------------

So I'll take it, and I'll let Don add what he wants to add. As you know, ScanSource is a public company and so we're not at a liberty to give out that material information that's coming over to them. It's a good chunk of volume for us today, but I'll let them comment on that when they want to comment as appropriate because it does seem like it's material information. And in terms of reduction chat, it was -- people reductions have been made in a few other areas like some of the warehousing costs are built into that $6 million to $7 million reduction, and most of those actions have already been taken. So they're going to be out of our run rate as of this week and a little bit more starting July 1.

--------------------------------------------------------------------------------

Michael James Latimore, Northland Capital Markets, Research Division - MD and Senior Research Analyst [38]

--------------------------------------------------------------------------------

Got it. And then on -- just on Avaya (inaudible) you are seeing some benefit. Is that mostly on the premise side of this one?

--------------------------------------------------------------------------------

Donald Joos, ShoreTel, Inc. - CEO, President and Director [39]

--------------------------------------------------------------------------------

Actually I would say so. When I look at it from the Avaya, so the example that I was sharing earlier with Eric. So I was at a -- they're a large partner who have now signed on with ShoreTel. I was at their event with a lot of prospects in there. There's probably 75, 100 prospects at this event here and 80% of them are cloud. They were looking for cloud solutions. So although they were historically a premise partner for Avaya, what they are bringing in the marketplace is more cloud opportunities. They also have installed base opportunities that are going to be looking for cloud solutions, too. So that's what we're seeing from these partners here, is the ability to bring net new cloud opportunities, because that's the bulk of what they're getting from an opportunity right now as they work with us and leverage a lot of our marketing programs to be -- to help them in the marketplace.

--------------------------------------------------------------------------------

Michael James Latimore, Northland Capital Markets, Research Division - MD and Senior Research Analyst [40]

--------------------------------------------------------------------------------

And then just on the distribution for cloud, are you seeing sort of maybe more movement on the master agent or services side -- services distribution side of things as opposed to the VARS at this point? Or is one getting any more momentum versus the other?

--------------------------------------------------------------------------------

Donald Joos, ShoreTel, Inc. - CEO, President and Director [41]

--------------------------------------------------------------------------------

Yes, I mean, we continue to see good momentum from our VARS but when I look at the master agents and, again, you're raising an important point because there's 2 parts to that channel. There is the VARS and the master agents. We actually saw activity-wise in the March quarter, we saw a 64% increase on a year-over-year basis in the bookings coming from our master agents. So that's a healthy increase that was coming from them there. I think they will -- they -- the VARS we had, the master agents will continue to be an important part of our channel scale.

--------------------------------------------------------------------------------

Michael James Latimore, Northland Capital Markets, Research Division - MD and Senior Research Analyst [42]

--------------------------------------------------------------------------------

So I guess you said 64% increase in bookings in master agents and then 7% total bookings increase?

--------------------------------------------------------------------------------

Donald Joos, ShoreTel, Inc. - CEO, President and Director [43]

--------------------------------------------------------------------------------

Yes, our total bookings in dollars was a 7% increase. The number of seats that we booked was 65% on a year-over-year, and pretty much that number on a sequential basis too.

--------------------------------------------------------------------------------

Michael James Latimore, Northland Capital Markets, Research Division - MD and Senior Research Analyst [44]

--------------------------------------------------------------------------------

Right. And then, in the past you gave a little bit of guidance on cloud revenue, bookings growth periodically. I mean, should we think of fourth quarter cloud growth being similar to third quarter cloud growth, let's say?

--------------------------------------------------------------------------------

Michael E. Healy, ShoreTel, Inc. - CFO and SVP [45]

--------------------------------------------------------------------------------

Well, again, Mike, we give the guidance on a total revenue number and we don't split out that guidance number between products. But we are expecting increase in product revenue implied in the guidance, as well as on the cloud number and typically support and services has been relatively flat over the last couple of quarters. So those 2 are up, and support and service flat a bit, if that helps you.

--------------------------------------------------------------------------------

Michael James Latimore, Northland Capital Markets, Research Division - MD and Senior Research Analyst [46]

--------------------------------------------------------------------------------

And then -- and lastly, I think the Summit deals don't go into the bookings, but any wins with Summit, anything material there?

--------------------------------------------------------------------------------

Donald Joos, ShoreTel, Inc. - CEO, President and Director [47]

--------------------------------------------------------------------------------

No, we didn't highlight -- I mean, we didn't highlight. That's still part of -- Mike, you are correct in that they are not part of the bookings number just because of the nature of them, they're right into the hosted revenue number. Overall, the overall business, that Summit is still a small part of that equation. So we just didn't highlight it on this particular call.

--------------------------------------------------------------------------------

Operator [48]

--------------------------------------------------------------------------------

And this concludes our question-and-answer session. The conference is now concluded. Thank you for attending today's presentation, and you may now disconnect.