Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

ShoreTel, Inc. (NASDAQ:SHOR)

F1Q11 Earnings Cal

October 28, 2010 5:00 pm ET

Executives

Tonya Chin - Director of IR

Don Girskis - Interim CEO

Mike Healy - CFO

Kevin Gavin - VP of Marketing

Analysts

Steve O’Brien - JP Morgan

Troy Jensen - Piper Jaffray

Ryan Hutchinson - Lazard Capital Markets

Chris - Stifel Nicholaus

Greg Burns - Sidoti

Rohit Chopra - Wedbush Securities

Mike Latimore - Northland Capital

Lynn Um - Barclays Capital

Davers Arovan - JMP Securities.

Operator

Welcome to the ShoreTel First Quarter Fiscal Year 2011 Earnings Announcement. 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.

I would now like to turn the conference over to Tonya Chin, Director of Investor Relations. You may begin your conference.

Tonya Chin

Hello, and thanks for joining us today as we report our first quarter fiscal year 2011 financial results. Joining me on the call today are ShoreTel’s interim CEO, Don Girskis; and Chief Financial Officer, Mike Healy, and our Vice President of Marketing, Kevin Gavin who will be participating in the Q&A session.

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 margin, 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 Annual Report on Form 10-K, for the fiscal year ended June 30th, 2010; 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's done in a public forum.

We will be discussing in both GAAP and non-GAAP results throughout the 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, other adjustments, and the related tax impact.

Now, I’ll turn the call over to Don Girskis, CEO of ShoreTel. Don?

Don Girskis

Thank you, Tonya, and thanks to all of you for joining us today. First, I will review the highlights of our Q1 financial performance. We were pleased to build on our record revenues last quarter and deliver revenues of $44.3 million in the quarter, up 5% sequentially over the previous quarter and 31% over the first quarter of fiscal 2010.

Non-GAAP gross margins were also another record at 67.2% and we recorded a very small non-GAAP loss of $197,000 in the quarter or breakeven on a per share basis.

Before I move into the operational highlights of the quarter let me take a minute to introduce myself. As most of you know, I have stepped into the CEO role on an interim basis as our ShoreTel’s Board of Directors completes a comprehensive search for our new CEO. We have hired Heidrick & Struggles to lead our search and our board of directors have received a lot of interest and are in the process of vetting candidates.

We will continue to move quickly to execute our plans as evidenced by our recent acquisition of the Agito Networks, which I’ll cover more in detail later in the call. I want to take a minute to thank John Combs to facilitating the very efficient transition for me into this new role and I can assure you that the senior team of ShoreTel is very engaged and excited to continue to build on the significant momentum we have been seen in our business.

One of the clear data points that demonstrate this momentum is ShoreTel’s growing market share position. In the June quarter ShoreTel once again showed strong improvement in its market share as reported by Synergy Research. In fact Synergy recently declared ShoreTel the fastest growing IP telephony vendor worldwide.

Additionally Synergy ranks ShoreTel as the number one UC Desktop Solution Provider on a world wide basis in the SMB market. During the June 2010 quarter ShoreTel’s US IP telephony market share improved to 5.6% further extending our number three position in the United States in the enterprise IP telephony market based on revenues.

In the pure IP market, which excludes hybrid systems our share grew to 8.2%. We see double-digit market share in the US pure IP market within our reach. Revenues from national partners, returned to growth in first quarter with a strong sequential improvement of 12%. US regional partner revenues also grew during the quarter building on the strong Q4 revenues from last quarter. We saw strength across our US based business with professional services, education, and financial being the largest revenue segments in quarter.

After two quarters of solid growth, international revenue declined $300,000 to $4.8 million and represented 11% of our total business. This was mostly driven by a few deals pushing to Q2 in Asia Pacific region, leaving us with the strong pipeline in that region going into the second quarter.

While down sequentially this performance represents strong growth of nearly 50% from Q1 last year. We are pleased to see billings from new customers improve to 45% of total business up from 41% in the fourth quarter as the new customer drove an increasing amount of our total sales in the quarter. This was further evidenced by our number of new customers in the quarter reaching an all time high at over 900, significantly up from 800 in the fourth quarter.

Our sales from larger enterprise customers were up 26% sequentially achieving an all time record in large sized deals in Q1. Last week, we announced ShoreTel’s acquisition of Agito Networks. Agito’s technology complements and extends our current ShoreTel mobile solution by allowing us to offer ShoreTel mobility, which puts the full power of the desk phone on a smartphone.

We believe that this is an important strategic acquisition because the enterprise communication industry is experiencing a powerful market transition in which the workforce is becoming increasingly mobile.

These mobile workers need seamless access to their enterprise communications capability while away from their desk phone. The recent explosion in smartphone adoption is accelerating this transition by putting an application device in virtually every mobile knowledge workers hand.

With this technology, ShoreTel will provide mobile users with some of the most sophisticated voice and UC features available today, that no other enterprise communication vendor could match.

Building on ShoreTel’s strength of having the lowest TCL in the industry, ShoreTel mobility allows smartphone users to reduce mobile and long distance costs and enables customers to use smartphones as PBX extensions to complimentary desk phone.

Customers are able to use any Wi-Fi or cellular network to take advantage of industry-leading call quality and cost controls from their smartphone. The ability to begin a call over Wi-Fi and have it switch seamlessly to the cellular network when you leave the building is transparent for users.

The uniqueness of this solution is that ShoreTel mobility now provides heterogeneous PBX support for other vendors, including Cisco, Avaya and Microsoft on many different smartphone devices including the Blackberry and iPhone.

To give you a real life example of how it works, our Managing Director in Asia Pacific is a perfect candidate for Agito’s technology. It will allow him to avoid roaming charges completely when a WiFi network is available, which will be a significant savings since he could incurs between $5000 to $6000 in roaming charges on a monthly basis.

So for example if he is in Singapore at a Starbucks, he can use the WiFi network to avoid $2 a minute roaming charges. It will also allow him complete identity management. With a simple click he can decide which number his personal cell phone or his desk phone extension that the person who is calling will see. This technology has a positive impact on productivity but also positively impacts the bottom line with significant savings on mobile and international usage fees providing a robust ROI and quantifiable dollar savings to customers.

The customers that comprise Agito’s current customer base and sales pipeline are impressive. Their current customers and prospects include many Fortune 1000 companies that we hope to leverage in to ShoreTel PBX customers over time.

Agito has a very prestigious list of national and international service provider partners giving ShoreTel access for future expanded partnership. By acquiring this technology we gain access to the enterprise mobility market, which we estimate at approximately $200 million and 2010 growing to nearly $1 billion in 2015. The cost of the acquisition was approximately $11.4 million that was paid for entirely from our existing cash on the balance sheet. Michael will go in to more on the detail on the background and the economics later in the call.

Next, I will review the other investments we have made during the quarter. As planned we continue to expand our worldwide sales team by adding 21 new sales team members during the quarter. This brings our total sales team to 153. A significant number of new hires in the sales area are aimed at expanding our enterprises customer base, a very important and growing segment of our business.

As evidence of growing enterprise customer base our major accounts team now delivers nearly one third of total revenues. As expected sales productivity declined in the quarter due to a large number of new hires that had only just began their productivity ramp.

I am also very pleased to be able to share with you a few examples of recent customer wins that further illustrates ShoreTel’s growing success with the enterprise customers. ShoreTel was recently selected by Panera Bread, which has annual revenues of over $1 billion and over 12,000 employees. The initial sale includes our contact centre solutions and will be implemented at three of Panera’s corporate locations.

Another great customer example is Schnuks Markets a US based grocery with $2.5 billion in annual sales and 15,000 employees. ShoreTel was chosen by Schnuks for their corporate offices and warehouses because of seamless integration with their existing network.

Another area of focus for our sales team is expanding and improving our partner network. During the quarter, we added over 50 new partners bringing our total partner count close to 900 worldwide. Over the past year, we have significantly shifted our focus from quantity of new partners towards a growing focus on quality of new partners.

A few quarters ago we launched a new group within ShoreTel focused on signing and launching new super regional partners. This group has been very successful; and we have added several high quality partners in Q1.

A recently signed partner Zeta Technologies, a NASDAQ listed company with over 80 million in annual sales, that sells, installs and services advance communication technologies for Fortune 1000 enterprise customers.

We have also added some large new partners internationally. In the U.K. we added several strong new partners including the U.K. operations of Vodafone’s Unified Communications Group. Vodafone is the worlds leading global telecommunications company with a significant global presence. We are looking forward to expanding our relationship with Vodafone over the coming quarters.

We also added the U.K. operations of Insight Technology Solutions, which has over $4 billion in revenues annually worldwide. Insight is a leading provider of brand name computing products, software and advanced IT services with operations worldwide.

Another key area of investment for ShoreTel has been a sustained branding initiative that was launched nearly a year ago. Recently ShoreTel launched our newest campaign, the Anti-Complexity Movement. The campaign focuses on the critical questions we are asking our prospective customers, when their complexity becomes a norm and why do you tolerate complexity. We are perplexed by the industry’s acceptance of complicated and non-intuitive technology that’s difficult for end users to use.

ShoreTel’s billing simplicity is the antithesis of complexity and that is the key driver of how we will win against our competition and that’s also what creates our intensely loyal raving candidates. Launched in September the Anti-Complexity Movement is an integrated campaign that consists of online and print ads in the Wall Street Journal and other industry publications.

A significant amount of our spending is directly aimed at lead generation and we have been very pleased that the number of leads that we give to our distribution partners has nearly doubled from last year. Our message has really begun to take hold and we are noticing that more and more customers and partners have heard of and are favorable toward ShoreTel than ever before.

In addition in having an increasingly known brand we continue to have the industry’s best customer satisfaction ratings. This was highlighted in the quarter by Nemertes Research an independent research firm in their annual benchmark survey. For 2010 ShoreTel came in first place against every competitor including Cisco, Avaya and Microsoft in every category including technology, customer service and value.

We also remained the best overall IP telephony provider for the seventh consecutive year. This comprehensive survey is based on feedback from over 2000 users of IP telephony systems. We are pleased that our commitment to outstanding customer satisfaction continues to be independently validated and we were gratified to once again dominate every category that Nemertes in his Pilot House Awards.

With that, I will turn the call over to Mike. Mike?

Mike Healy

Thanks, Don. I am very pleased that ShoreTel delivered 5% sequential revenue growth to $44.3 million, and achieved record non-GAAP gross margin performance of 67.2%. We continue with our hiring and branding campaign to support our strategic objectives, which resulted in non-GAAP operating expenses increasing to $30.5 million. Therefore we had the small non-GAAP net loss of $197,000 or breakeven on per share basis.

Let me review some of the important financial metrics for the quarter. Product revenues grew 5% sequentially to 31% year-over-year to $35.2 million. Service and support revenue grew 3% to $9.1 million.

Business from our national partner was very strong with a sequential increase of 12% during quarter and now represents 18% of revenue in the quarter. Four out of five national partners grew up by at least 20% sequentially [Aviva] showing the largest quarter-over-quarter increase of over a 100%.

Volume from our US regional partners was up 3% in the first quarter after showing extremely strong growth in the previous quarter. We sold a 103,000 end user licenses in the quarter compared to 96,000 in our June quarter an improvement of nearly 7%.

We added an all time record of over 900 new customers during the quarter, bringing our total customer counts to nearly 15,000. Our revenue concentration continues to be well distributed with only one partner between 5% and 10% of revenue for the quarter and no single end customer over 5% of revenue.

This quarter marks the fifth and second quarter of gross margin expansion in the third quarter in a row to break our all time high. Our non-GAAP service and support gross margins were 69.3% and our product gross margins were also strong at 66.7%, down slightly from Q4.

The spike in gross margin this quarter was due to an increase in services support margin as revenue continued to climb upwards and support costs were actually down $200,000 sequentially. I do not expect service and support gross margins to continue to increase as we expect to catch up in our hiring for the support team.

\

As expected our non-GAAP operating expenses increased by $1.6 million to $30.5, which was within our guidance ranged. The biggest costs increases in Q1 were due to the hiring of 33 employees in our July partner conference, which was an incremental $1 million.

As Don mentioned, we continue to hire sale executives and added 21 in the quarter bringing our total sales to 153.

Our non-GAAP net loss of $197,000 were breakeven was significantly better than consensus as a result of better gross margins and a favorable foreign exchange gain in other income of $380,000. We had a GAAP net loss for $3.6 million or a loss of $0.08 per share, which included approximately $2.8 million of stock base compensation expenses and $525,000 for executive severance.

We are still working to determine our NOL recovery amount which currently stands at $25 million. There is some valuation work to do the in order to complete this, but the good news is that we did receive our refund from the IRS for $1.6 million in the September quarter which was included in our cash flow from operations. We also received back interest rate to this refund, which helped our income line by about $60,000.

Next I let me review some highlights from our balance sheet at the close of Q1. Day sale is outstanding or DSOs were 45 days, which was an increase from our great performance last quarter of 36 days. The main reason for the increase DSO was in the June quarter where we had a few large customers pay early and this did not happen in Q1. Our receivable again remained very strong with only 6% of our total receivables being over 60 days old.

Inventory increased by $579,000 to $10.5 million as we grew our levels on hand in anticipation of further revenue growth over the next couple of quarters. Deferred revenue increased 7% or $30.6 million driven by continued sales and maintenance contracts to growing customer base.

Capital expenditures were approximately $2.4 million with about $500,000 being for reimbursable leasehold improvements and $800,000 for our new ERP system and implementation costs.

Depreciation and amortization were approximately $800,000 for the quarter. We generated over $3 million in cash flow from operations and we ended the quarter with 512 employees, which represented a 7% increase in headcounts sequentially, but does reflect the 17 new Agito employees that joined ShoreTel in October.

As Don mentioned we closed our acquisition Agito Networks last week (inaudible). The all cash deal was approximately $11.4 million. The purchase of the start up company follows our M&A strategy of evaluating key IP technology in the market place, and evaluating if we should build or buy that technology. The Agito technology and employees provide us a superior mobility solution and will enhance our current offerings.

Several of Agito’s features were on our product development road map that we estimate would have taken us at least 3 years to build similar technology and bring it to market. In terms of the specifics, we hired 17 employees including the two founders and nine engineers all of whom joined ShoreTel on October 19th.

The deal has an install base of approximately 50 customers and has recognized a very small amount of revenue today since its inception in 2007.and has six patent pending. We have not completed the purchase price evaluation work, but I do expect a large part of purchase price to be allocated to goodwill.

Today Agito’s revenue is not immaterial but we do have solid and growing pipeline of the customers. We expect to recognize revenue from selling the current technology as part of our mobility solution in the December quarter. Meanwhile, it won’t be material to our revenue stream initially, we are excited about the potential opportunity, this brings us both from technology standpoint and a customer and distribution stand point.

Based on our current revenue and cost projection, which include incorporating this technology in to our product line, we expect this transaction to be accretive to our operating results within four to five quarters.

Next, let’s discussed our outlook for the December 2010 quarter. Based on our backlog in business to-date we expect revenue be in a range of $44 million to $48 million. For the December 2010 quarter we expect non-GAAP gross margins to be in the range of 65.5% to 66.5% and GAAP gross margins are expected to be approximately 50 basis points lower due to inclusion of $250,000 in stock base compensation charges.

We expect non-GAAP operating expenses to be in a range of $31 million to $32 million and we expect GAAP operating expenses to be in a range of $33.5 million to $34.5 million including $2.5 million in stock base compensation expenses.

The increase from Q1 is almost entire integral to the Agito transaction and the 17 new employees and some transaction related expenses. We remain committed to returning to non-GAAP profitability at some point during year and we are very pleased of the strong step we towards that goal in Q1.

In summary, I am happy with the progress we are making on many fronts and feel the acquisition of the Agito will open up new opportunities that were not available to us before. It will take a few quarters for to absorb their run rate expense that is associated with the additional headcounts but as soon as we start ramping up the mobility revenue along with our core business, we expect to see overall revenue growth lead to solid leverage on P&L.

We are winning more and more, just like my home town team, a valued customer, the San Francisco Giants who are now playing in World Series with a 1:0 lead.

One last thing I would like to remind there, we are hosting Investors Day in San Francisco on Dismember 7th and hope you can join us for a more in-depth look at ShoreTel.

With that, let me turn it back to Don for some closing remarks.

Don Girskis

Thank you, Mike. So to wrap it up I would like to say that the excitement level at ShoreTel is extremely high. Employees and partners alike feel the momentum that is clearly in action.

I believe we all have good reason to feel bullish with growing revenues, all time high gross margins, increasing brand recognition, an enhanced distribution channel and a very exiting acquisition that significantly accelerates our mobility strategy. I am optimistic on our ability to deliver our market share growth over the coming year. Operator?

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the Steve O’Brien of JP Morgan.

Steve O’Brien - JP Morgan

Thanks for taking my question. The outlook next quarter and I guess the market share results today this year have been pretty positive but maybe Don and Mike if you do have some more commentary what you are hearing from national partners and regional partners about the spending environment here in the States and may be to a lesser extent abroad us well. Are you gaining share in the market that continues to decline or how was the selling environment and I guess the closure rates?

Don Girskis

All right. Thank you, Steve. So, in terms of the market itself, the quarter ending in September has always been a bit of a difficult one for us to ascertain the market growth based upon the amount of federal government spending that goes on in the September quarter and traditionally, they were strong and the governments state and local, and we do the business in the federal government.

The federal government is now one of our larger verticals and so, sometimes the market increases, but to us it is really hard to estimate did the market grow, did it contract during the September quarter, and we will see when the data comes out here in a few months.

But, I would say that the customers spending habits, have definitely changed in the last year and half as people are more willing to invest in infrastructure moving forward. So, I would say that the selling environment has been good for us.

And to your question about closing rates and such I was just taking a look at our rates over the last four quarters and we continue to see small incremental increases on our closing rates on a sequential basis for four quarters in a row now.

So, that’s good news for us. And with our new business growing last quarter, that really was a bulk of our growth, was with the new customers. So, that is a good sign that people are investing moving forward.

Steve O’Brien - JP Morgan

Thanks, Don, I appreciate that. And then, if I could on the channel for this quarter, very strong results from the national partners and not bad you had very decent result too from the regional partners, but kind of a flip-flop versus last quarter, where there some fundamental reasons in terms of the selling patterns of these channels that kind of caused the different times of the year one growing stronger than the other. I guess what I am getting at is when will they both kind of take off and both post the real strong quarter?

Don Girskis

Yes, there is a lot of variables in the national partner business. People tend to have stronger quarters than fiscal years end. There are a lot of compensation, planned changes that affect the business and to drive for pdf, excels, etc. So I agree, I am happy that they both went up and I would like to see stronger growth rates in all channels all the time obviously.

In other factor here too especially when it comes to the regional guys and specifically in the international operations is there an effect in the summer season especially if you look at the continent of Europe when people take holidays. The Europeans understand how to do holidays and every year that does affect the regional partner business.

Steve O’Brien - JP Morgan

Okay, great, thanks, and then one last one, just on the gross margin guidance. Is this normal conservatism here or is there versus the results just posted is there anything in the pricing environment or promotions that change in the view?

Mike Healy

Steve it’s Mike. So, nothing really in the pricing environment, it’s been pretty consistent in terms of our competitors and what they are doing. Some are little bit more desperate than others and given away free support and things like that, but I wouldn’t say huge change.

The gross margin guidance is the midpoint as it drop off a point. It is really all about the civil support line which was 69% which is really good not the good news bad news, good news gross margin and in that we are behind in hiring in that area and our cost actually declined a little bit, quarter-over-quarter, which was unexpected so we got a little bit catch up to in hiring and we expect to do that this quarter and that’s what will drive the gross margin in that area down little bit. The gross margins declined by 20 basis points so they are pretty much flat so no big change there.

Operator

Your next question comes from Troy Jensen of Piper Jaffray.

Troy Jensen - Piper Jaffray

So a couple of questions on sales expansion. I guess, I am curious to know how far along we are here, just the last quarter there was aggressive hiring, and just what are your plan going forward on sales expansion.

Don Girskis

Okay, so you should expect our sales expansion will continue at the current phase for next quarter. As long as our close rates are high, our customer satisfaction is high, and our market share has a lot of room improve still. There is no reason to not continue on sales expansion and continued to take share.

Mike Healy

And Troy I would add, its Mike we are incurring some cost as Don mentioned about the super regionals kind of a new group of partners we are going after, it does take little bit more money in terms of demo kits and training and marketing collateral and those kind of things to get those partners launched but obviously there is a much bigger return typically to have a much bigger footprint in some of our regional partners. So that contributes to the cost, its not just sales head count and that’s certainly bigger piece of it.

Troy Jensen - Piper Jaffray

Are you guys still targeting to have profitability in the fourth quarter of this fiscal year?

Mike Healy

Yes I believe our balances, sometime during the year I think the consensus estimate is out there on the fourth quarter.

Troy Jensen - Piper Jaffray

Okay and quickly on the Avaya Nortel I can believe that you guys has been able to pick up some channels share. Its a shake out in the combined entities channel plans now. Is that still the case? Is most of that behind us now as it still existing Nortel Avaya channels within that you guys for new client to offer?

Don Girskis

Yeah, Troy that definitely is still the case, there is some concern regarding potential road map changes, especially from the Nortel partners more than the Avaya partners. There was concern regarding some changes in the support pricing to the partner community, so we do continue to pickup the partners of Avaya-Nortel over the calendar year so far, we are north of 40 in terms of new partners from that channel.

Troy Jensen - Piper Jaffray

And then Mike, just last one and then I will get off here but I am, I think previously you guys had advertising campaigns at the Giants stadium are you guys getting national publicity now? First of fall is there still an ad campaign going on in the stadium and are you seeing national publicity because of the World Series.

Mike Healy

No actually I will let Kevin that because he had spearheaded) the whole marketing campaign with the Giant which is a great customers but….

Kevin Gavin

Yeah, so the couple of couple of aspects of the advertising in view of the giants. The primary one is the signage behind the home play, which is on per game and that’s three or four minutes of television time over the picture, so that is doing the regular season only.

During post season play, major league baseball picture over those spots and sell them for substantially more than the regular season slots. In addition we have in ballpark and in program advertising and we do have a program ad in the in the program during playoffs as well. So we do some continued visibility that’s not beyond television, national exposure we have been getting during the regular season.

Troy Jensen - Piper Jaffray

I got it.

Kevin Gavin

If we have that your expenses kind of flip up a little bit more.

Operator

Your next question comes from the line Ryan Hutchinson of Lazard Capital Markets

Ryan Hutchinson - Lazard Capital Markets

Good afternoon so few questions first just a follow up on the sales investments, it sounds like you’re going to had another 20 this coming quarter, I just wanted to talk about the productivity with the new reps, in terms of perhaps, tracking to or ahead of plan and then you touched on over all productivity being down.

But wanted to get a better understanding when you thought overall productivity being down but I wanted to get a better understanding of or your thought when overall productivity would turn the other way and begin to show improvement?

Don Girskis

Okay. So in terms of the productivity, when we look in to productivity numbers, I mean look at all of the reps that have one board. The productivity did go down, which you would expect of course you’ve hired people during different points with the quarter. But whether we take out the sales hires of the last six month, and we look at the productivity of our more veteran seasoned sales team, now that productivity was actually up sequentially.

And there is different jobs in different positions within the company but typically it really does take about a year before some one is fully productive and off the ground. So it will take a while, as we continue to add sales reps for the productivity to return back to more normal levels, one we weren’t in the sales hiring phase.

Ryan Hutchinson - Lazard Capital Markets

And then the productivity within the new reps to date I mean, I assume the reason you’re hiring more reps is because the existing ones you hired are tracking ahead of plan or to plan. Is that fair?

Don Girskis

Yes. We were kind of right on plan, pretty close to it in terms of our productivity measurement compared to plans we set forth at the beginning of our fiscal year, so. Yes, all the metrics should go continue to go on the right place, Ryan whether sales productivity or market share all those leading revenue indicators make us to continue to invest to get bigger faster and continue growing market share.

Ryan Hutchinson – Lazard Capital Markets

Okay, and then the second question on the branding initiative, it’s always kind of tough to quantify but you did touch on leads being up. What percentage or doubling, what percentage of those leads have translated into revenue?

Don Girskis

I guess the closing percentage; we gave a lead to a partner. The partners are closing those north of 50% at the time. Somewhere in the mid 60s percentage of the leads we give to partners closed in favor of ShoreTel.

Ryan Hutchinson - Lazard Capital Markets

Okay. And then finally just more housekeeping, product deferred revenue what was that in the quarter?

Mike Healy

I don’t have the number with me, it was up a little bit, there was about $200,000 of product revenue we deferred this quarter, so nothing significant. The majority of what’s in deferred revenue is, all the support maintenance contract but nothing out of the ordinary came through on the product side.

Operator

Your next question comes from Sanjiv Wadhwani of Stifel Nicholaus.

Chris - Stifel Nicholaus

Hi there. This is [Chris] for Sanjiv. Just a follow-up on the last question. When you’re talking about the leads that you give to your partners. What percentage of revenue to those type of leads do you account for in the given quarter. If you really can historically before they double what percentage of them, what percentage could you account for I guess going forward?

Don Girskis

Yes, that’s a number that we don’t probably disclose. So I am going to have hold off on answering that one Chris.

Chris - Stifel Nicholaus

Okay, fair enough. How long does it take those leads to convert?

Don Girskis

So, the normal cycle time varies on average from between 60 days to 6 months as we become more successful in the enterprise space those also have longer cycle times that that, there are occasions where we work on a deal for two years before it closes and as we get more successful in the enterprise space the sales cycle tends to elongate somewhat.

So it really depends between a customer who is looking at 10,000 phones versus one is looking at 50, two very different cycles there.

Chris - Stifel Nicholaus

Okay, and in terms of your super regional partners, did you mention exactly how many you have added in the last quarter?

Don Girskis

No, I did not. But in terms of our total partners we added 50 total partners during the quarter with number of them super regional.

Mike Healy

There was few, Don listed a couple but certainly a key focus in both again typically take a little bit longer to ramp up. So when we say sign, that means sign and then the next quarter they get to start generating some revenue but we have got a pretty good funnel there and a lot of guys in the pipeline. So that’s a key area of focus for us and certainly we will be a key area of growth going forward.

Chris - Stifel Nicholaus

Okay. And then one last question just switching to the Agito acquisition. You mentioned that you are increasing OpEx, are you going to have an increase in OpEx mainly associate with just Agito. Do you expect that burn to hold at constant rate and have revenues that are associated with Agito so is that burn associated with catch-up or is the burn associated with the [Agito] integration into the ShoreTel platform kind of increased over the coming quarters?

Don Girskis

Yes, it’s a little bit both, let me be a little bit more articulate then the prepared comments. So we do expect some revenues from the Agito standalone business to increase under the ShoreTel name and we have got a good full pipeline ramping up.

And then in my [recent] analysis it certainly was absorbing the 17 employees and then adding some extra R&D resources and product management resources to incorporate the Agito technology into our product line. So the cost will ramp-up, but right now my analysis shows the revenue increase will offset those that cost increase. So I think our max burn from the Agito transaction will be next quarter, the third quarter of fiscal year and then start ramping down from there. Does that answer your question?

Operator

Your next question comes from Greg Burns of Sidoti

Greg Burns - Sidoti

Good afternoon, thanks for taking the call. Just a question on gross margins, I understand why it’s going to be coming down quarter-over-quarter but still higher than the guidance you had given for this quarter. So I was wondering ShoreTel has to rethink about those service gross margins.

Mike Healy

Yes, service gross margin I think if you model kind of the mid 60s on a non-GAAP basis that’s kind of what we are modeling from a comfort level and that seems to be about for the right mix in terms of how many resources we need on the [tech] and supporting our customers implementation services and things like that.

So our normal expectation is around the mid sixty, in terms of gross margin and then, our job really to drive costs out of the product as a volume gets up you will get better discounts from our manufacturers in terms of the product cost, which leveraged obviously would be in the product side of business.

Greg Burns - Sidoti

Okay thanks, and can you just give us a little update on what’s going on with IBM foundations product and are you ramping up the partner base at last quarter. How is that trending?

Don Girskis

Yeah our relations with IBM is very strong in multi accessories, they have recently announced some change in their approach to the hardware platform. So we are taking at under consideration and working through that with them. In parallel we are also continuing our focus on integration with same time for a larger customers where we have a number of larger customers, creating increased demand for same time integration. So its multifaceted and its been and will continue to be very valuable.

Greg Burns - Sidoti

And one last follow up on, I just wondering how the kind of virtual relation software how that’s impacting the cost curve for some of your competitors are they making them more competitive the server centric kind of competitors out there and I guess how are you implementing that kind of software to your advantage?

Don Girskis

Yeah, we just introduced support for virtualization for our solution. As you know our solution involves some dedicated appliances, which continue to exist but we did have and we do have our HQ server and that is now able to be run in a vitalized environment. So we write that same cost curve, the customer has large data centre that has been deployed virtualization, they can deploy short-term on top of there platform as well.

Operator

Your next question comes from Rohit Chopra of Wedbush Securities

Rohit Chopra - Wedbush Securities

Hey guys, sort of few questions here just wanted to get a sense of the average deal size in the quarter and maybe you could bracket, I don’t know if you can do this but tried the bracket over the number of deals by size of the deal greater than the 50,000 greater than 500,000, Is that a way to do that.

Don Girskis

Yes some what well so our average deal size and total went down and it was so slightly I think down 5% for this quarter but good news is the number of large deals as we count them was up about 25% quarter-over-quarter, so that’s both new deals and add-on deals over our large deals size fresh hold. So that’s the good news is continues to go up that was probably the best increase we’ve had in quite a while in terms of number of deals number large deal 25% that’s pretty big increase from what we’re seeing in the past quarters.

Rohit Chopra - Wedbush Securities

Okay and then maybe you could just address linearity what was the light during the quarter was there pick up towards the back half to the summary flows normal or what’s going on there?

Don Girskis

Yeah. Usually saw its pretty busy in the September month and it certainly was less but our linearity was actually a little bit better than the June quarter, because the June Quarter where every one pushing hard. So typically we said 50% the last month of the quarter and 50% in two months. In the September quarter, we’re under 50% that came through in the month of September so wasn’t as that as typical in terms of linearity for the quarter.

Rohit Chopra – Wedbush Securities

Alright. And then, let me ask you this question. Why not take your foot off the pedal for the spending plans?

Don Girskis

But we believed that we have an incredible market opportunity out there right now and if we can gain distribution, and we can gain share by driving the top line revenue that enables us to increase the leveraged going forward and we got an opportunity to make that happen right now. Any how there is a certain scale with the business that you need to retain in order to really drive leverage. And I believe that we need to hit that scale sooner rather than later. So, in our operating plan is to continue to make some of these investments, drive market share and really establish our place in the market place.

Rohit Chopra – Wedbush Securities

And Don let me just add to your follow up on that if you are trying out the key scale to get there, you guys must have a number in line for revenue before you begin to feel comfortable about where you are and then may be let the model show the leverage that you actually had. Is something you could share with us?

Don Girskis

So, in terms of your certain revenue goal where we turn out the spending growth and convert to more profitable growth. Its not something you talked about externally. It’s really somewhat depending on what the markets doing, a lot of variable into it. The markets and how our internal metrics are going in terms of market share, discount and all those kind of things, so, yeah, I’ve not prepare to give you a number where we kind of slow down hiring and then we start generating more, more profitable growth. But I will tell you that we are focused and looking at a few key spending areas our opinion now dial in options to make sure that you are having more profitable revenue growth as we would like to call it.

That is underway in terms of OpEx concerning about profitability and like I said we are a little about $800,000 this corner. With the mid-point of the guidance we gave breakeven on revenues about $48 million now, which is within the guidance range we gave.

Operator

Your next question comes from Mike Latimore of Northland Capital

Mike Latimore - Northland Capital

Hi, good evening, nice quarter. Just on the telco national partners [rising plus 18 key] can you maybe give a little update on any initiative there, I think you had some additional training in Horizon over this summer, maybe just a little update on some of your initiates within those carriers?

Don Girskis

Yes, we actually track the number of people who are trained and certified for beginning sales, advance sales ton of those certifications by national partner. We look at that on the monthly basis and we absolutely had a record number of people trained in our national partner community last quarter.

I am saying now anytime we can increase the number of full time equipment people selling ShoreTel brining us into deals it’s a good thing for us. And that is one of the reasons why we hire new employees just to support our partnered community and be out there and doing the training and the more people we can train you know that give us leverage out there in the field. But yes, we have been very happy with the progress we made on that front last quarter.

Mike Healy

And I would add, this is Mike, two more recent additions to the national partners, both showed very good gains quarter-over-quarter. So it takes a while for these guys to ramp. But we are expecting both of them to continue to increase.

Mike Latimore - Northland Capital

Great. And then on the sales force additions, I think say about 20 in this December quarter, how many of that will be serviced on to the major accounts to enterprise accounts?

Mike Healy

Well, I don’t know it’s really one way out this quarter.

Don Girskis

No, he is talking about I am talking about through the next quarter. No, that there are number of those, sorry, I don’t know what the ratio is up for the top of my head Mike, but number of them are in the corporate account category.

Mike Latimore - Northland Capital

And just on the services revenues, any change in maintenance there and also how should we think service revenue growth, as just modestly slower than the entire quarter, but it shouldn’t have a similar growth rate going forward?

Don Girskis

Yes, the only change we kind of warned you about maybe last quarter call before is some of the national partners. We’re taking on their own installation services so that would contribute to a little decline in revenue if they do that, work versus us, but in terms of support renewals everything’s on track there. So it’s really some of these other revenues they can go up and down a little bit whether it’s a training, implementations services or professional services.

Operator

Your next question comes from Lynn Um with Barclays Capital.

Lynn Um - Barclays Capital

Hi, thanks for taking my question. A quick question on deals that you had done. I was wondering if maybe if you could comment a little more about that and if there might be a way you can quantify that something that you could share with us?

Don Girskis

Sure. So in the Asia-Pacific, really worthy issue was very country’s specific was Australia and we have actually been pretty successful in going upstream in Australia and that life cuts both ways. So if you involved in a lot more larger deals there is more of an effect, if you have a portion of the next quarter and you may be aware there was some issues in Australia in terms of the government and with the elections and there was some uncertainty and uncertainty in a sale situation is a never good thing. So it’s kind of a natural progression that a couple of larger deals rolled over into the next quarter. But the good news we are going to loose some and we have got a strong pipeline going into the Q2.

Lynn Um - Barclays Capital

Okay, great. And let me just on the new customer end obviously a nice 800 it’s pass few quarters it’s 900, would you characterize that more business partners that being share gains over everything above?

Mike Healy

Yes, I would say it’s kind of across the board from even from the regional perspective and abroad perspective. It was an any one area that’s stood out substantially that contributed to the new partners it just overall revenue in the business contributing to the large increase in new customers.

Don Girskis

And we did see on a year-to-year comparisons our partner productivity increase as well as so that’s another way to meet the goal which is to have our existing being partners become more productive and so more ShoreTel and that was the case last quarter compare to a year ago.

Operator

Your final question comes from [Davers Arovan] of JMP Securities.

Davers Arovan - JMP Securities.

I was wondering if your hiring and marketing spending is also going on in the international market so that’s really focused on the domestic market?

Don Girskis

So in terms of the hiring, the hiring is going on in the international markets as it is domestically, as there is certain regions that we make conscious decisions to become more aggressive and you have to have feet on the street in order to build distribution and support your part as properly. And for example, and some of those investments that we made in the region we definitely saw some good results in that region last quarter of the strong increase in a revenues and without those sales that’s been higher than prior quarter that had never would have happened. On the marketing inside of [the house].

Kevin Gavin

Yes, so we definitely do marketing on a global basis in all of our market, so you will see region invents various partner co-operation activities so we absolute do invest in marketing in every market when it comes to sort of the pure branding we do kind of heavy laid up to try and make sure we get critical mass and so the branding spend is mostly in North America and sort of the more legion and immediate kind of lowering the pipeline, not lower in the tunnel spending for marketing happens every in North America and rest of the world.

Davers Arovan - JMP Securities.

Okay I just wanted because we’re not seen the same kind of more growth. It doesn’t seem like we’re seeing same growth internationally that we are in the U.S.?

Don Girskis

Actually, in the last quarter, if we look at on the year-to-year sequential comparison, we were up 50% internationally last quarter up 50%. Sorry, 40% last quarter on a year-over-year its up 50%. So this is the first quarter we’ve actually seen a little different in international but certainly a year-to-date is up and sequentially, its been up pretty heavy quarter-over-quarter. And again, I think that…

Davers Arovan - JMP Securities.

At this quarter?

Don Girskis

Yes, just this quarter, and we consider the kind of and normally in some push outs, and we do expect it will come back strong in the next quarter, at different quarter.

Davers Arovan - JMP Securities.

And then, I was just wondering if the Agito acquisition will enable you to do kind of desk phone less deployments, is there any plan for that and how would you use the interrupt ability that’s sort of the native capability of the platform?

Don Girskis

Yes. Two is there. First of all, we’re seeing continued tax rate of our desk phones with our purchases today and we see, from most of our customers, this interest in the mobility largely involves around complementing the desk phone with a smartphone to be used in coordination with it. And so, we’re very optimistic and anxious to continue satisfy that demand.

The second question around inoperability is also kind of interesting. The Agito team initially launched this and developed these products to be PBX diagnostic. It works with ShoreTel as well as Cisco, Avaya and others and as part of this acquisition we had some interesting conversation and prudent approach for us and we have made informative decision that we are going to continue supporting various PBX’s.

So you can imagine one deployment, one customer might have ShoreTel in one office and CISCO in second office and Avaya in a third office and we would sale short-term mobility to overlay across all three of those offices because short-term mobility does work with any flavor PBX.

And can you take that one step further build the customer whatever reason it was all CISCO or all Avaya they two can choose short-term mobility to over lay mobility solution on top of there PBX does we think the short-term mobility is the best mobility solution in the market even better than what’s CISCO and Avaya had for there own platform.

So it opens up new opportunity for us to expand beyond just ShoreTel and frankly position us if the underline PBX needs an upgrade, we are very well positioned then to sell ShoreTel as we like.

Don Girskis

Alright so thank you all for your attendance today and now we look forward to seeing many of you December 7th an analyst day in San Francisco bye, bye.

Operator

Thank you this concludes today’s conference you may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: ShoreTel CEO Discusses F1Q11 Results - Earnings Call Transcript
This Transcript
All Transcripts