Good day and welcome to the ShoreTel fourth quarter and fiscal year 2011 earnings conference call. Today's conference is being recorded. At this time I would like to turn the conference over to Ms. Tonya Chin. Please go ahead ma'am.
Hello and thanks for joining us today to report our fourth quarter and fiscal year 2011 financial results. Joining me on the call today are ShoreTel’s CEO, Peter Blackmore; Chief Financial Officer, Mike Healy; and Kevin Gavin, Chief Marketing Officer is joining us for participation in our question-and-answer 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 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 Annual Report on Form 10-K for the fiscal year ended June 30, 2010, and 10-Q for the quarter ended March 31, 2011 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 both GAAP and non-GAAP results throughout this call and I ask that you refer to our press release issued today for a reconciliation between these amounts. Our non-GAAP numbers exclude stock-based compensation charges, other adjustments and the related tax impact.
During today’s call, we will be discussing both our fourth quarter and fiscal year 2011 results. Now I’ll turn the call over to Peter.
Thank you, Tonya and thanks to all of you for joining us today. I am please to end our fiscal year on a high note and to enter fiscal 2012 with positive momentum. The investments we have made in our sales channel, product development and branding over the past several quarters have helped us to close fiscal 2011 strongly. In the fourth quarter, we recorded revenues of $56.5 million, which is slightly above the high end of our guided range of $53 million to $56 million. And once again an all time high for ShoreTel. This represents a 10% increase sequentially over the previous quarter and a 34% improvement of the fourth quarter fiscal 2010 revenues which were $42.2 million.
Non-GAAP gross margins were 66.3% and our non-GAAP net income was $1.3 million or $0.03 per share which represents a solid improvement over last year’s numbers. For the year, we were pleased to cross the $200 million threshold for our fiscal 2011 revenues which were up 35% over last year’s revenue of $148.5 million. Non-GAAP gross margins for the fiscal year were 67.3%, up from 65.6% in fiscal 2010.
We were also pleased to deliver a non-GAAP profit of $681,000 or a $0.01 per share as we continue to balance ongoing investments in our business with the desired show leverage in our model.
Looking at the market place we are pleased to see continued evidence of market share gains, both worldwide and in the United States. According to Synergy Research’s most recent published data based on revenue in the March 2011 quarter ShoreTel increased to share of worldwide pure IP telephony market from 4% in the December quarter to 4.5% in the March quarter, a substantial quarterly improvement. Additionally, the company continues to command a greater share of the US market. In the pure IP telephony market, you’ve seen a solid improvement in our market share from 8.4% in the December 2010 quarter to 9.1% in the March 2011 quarter.
In fact, ShoreTel grew revenue by 35% over the past four quarters, while the US enterprise IP telephony market grew 8%. This growth makes ShoreTel the fastest growing major vendor in the enterprise IP telephony market this year by a significant margin.
I will now review several highlights of the fourth quarter. Overall, we saw a strong growth across our various segments, channels and verticals. We continue to enjoy increasing success of selling to enterprise customers.
Revenue from our major accounts group was strong this quarter, up 20%, with revenues from transactions over $100,000 increasing 43% from the fourth quarter of last year. We are pleased with the increasing traction of enterprise customers deploying more than 500 licenses.
Our international business experienced strong improvement with revenue outside of the United States up 13% from quarter three. This was driven primarily by returned strength in Australia, which last quarter experienced delays in closing certain deals.
As expected, these transactions were finalized in quarter four and helped to deliver the best quarter in the company’s history in that region. In July, we hosted our 2011 Champion Partner Conference in Chicago. The theme mobilized growth was well received by our partners and the level of enthusiasm and excitement was very high.
We were oversubscribed and that maximum capacity with nearly 1000 attendees representing all of our major partners. We delivered keynote presentations on the overall market and the company’s position in it, we reviewed our strategy for fiscal 2012 and also offered breakout sessions on how to leverage our prudent success with brilliantly simple solutions and unified communications and mobility opportunities.
Additionally, we held mobility workshops focused on the rapid changes in the mobility technology and how ShoreTel’s unique solution can enable customers to lower their cellular cost while improving their efficiency.
The conference generated quite a bit of social media buzz and we were also very pleased with the overall response from the 29 industry analysts who attended was very positive.
Next, I will update our progress in strengthening our distribution in the United States. Our move to two tier distribution using ScanSource and Westcon is proceeding on plan. We have moved more than half of about plan partners as of now and are on track complete the transition by the end of August.
Based on our best estimates we believe the volume through our US value-added distributors could be 20 to 25% of our volume in the September quarter. As a reminder we do expect that the business going through our US value added distributors will be two to three gross margin points lower than the balance of our business. But we also expect to recoup most of that impact over time with increased revenues and lower operating costs.
The response from the partner community to this transition has been positive. We have also been pleased with the quantity and quality of new partners that ScanSource has brought to us through this new relationship. In fact we have signed nearly 100 new partners through this arrangement over the past few quarters.
The fourth quarter marked another record number of new partners with 61 new partners in North America, a sample of our quarter four partner additions include Tel Networks based in New York City with annual revenues in excess of $30 million. Tel Networks sells to enterprise customers with a focus on financial trading companies and is known for its strong engineering capabilities.
Another notable new partner is Ronco Government Solutions based in Raleigh, North Carolina. Ronco has offices nationwide and annual revenues in excess of $100 million. Ronco is focused on local, county, state and federal accounts and is an expert in GSA scheduled selling.
I will now move on to a customer update. During the quarter we added over 1100 new customers, another record for ShoreTel. The percentage of revenue from new customers improved to 48% in the fourth quarter, up from 44% last quarter. We made solid progress with enterprise customers during the quarter and we have recorded our largest ever revenue from transactions over $100,000.
Some examples of this progress include first, increased business with ARM Holdings, which is one of the world’s leading semiconductor intellectual property suppliers. Headquartered in Cambridge, United Kingdom with more than 1,700 employees ARM has offices around the world including design centers in France, India, Sweden and the United States.
Another very important focus with Sunkist. Sunkist is the oldest continually operating citrus cooperative in America and the largest marketing cooperative in the world’s fruit and vegetable industry with over 1 billion in revenues in 2010. Recently, Sunkist was faced with costly upgrades to its ageing Nortel PBX system and began evaluating unified communications solutions. Sunkist chose ShoreTel over Avaya and Cisco because of our single-image solution across multiple sites, our lower total cost of ownership and ease of administration.
Additionally, in quarter four, ShoreTel sold to Ventas one of the United States’ leading healthcare, real estate investment trusts. Its portfolio includes 600 healthcare-related facilities located in 44 states and two Canadian provinces, beating out Cisco, ShoreTel’s low total cost of ownerships and ease of use clinched the deal with Ventas’ 7,000 extensions and 600 locations.
We have now completed a comprehensive strategic review of the entire senior management team and [doubled]. ShoreTel’s strong growth and operating results testified the strengths and appropriateness of our business model. We approached this review from a position of strength, focusing and ensuring that we maintain this group, successfully stay in our business to meet the significant opportunity and do so profitably. So it should come as no surprise that we plan to continue our investments in our core business as we have done over the last several quarters.
Our growth is driven primarily by our outstanding win rate coupled with our ability to steadily attain a higher consideration rate. This is the result of strengthening on go-to-market capability with our partner channel and building ourselves in marketing activities. So long as we can sustain our momentum, while enhancing sales and partner performance, it is logical to continue our investments in growth.
Maintaining a strong R&D engine is a critical component for ensuring a leadership position in the years ahead. We will deliver on our planned road map and also maintain our quality to ensure we offer the very best customer experience in the industry.
We shall also grow our international presence taking a focused pragmatic approach. Doing business internationally is a core part of my background and the key is to focus on getting the critical mass. We will set very clear criteria of when, where and how we invest to ensure we get a proper return.
If you look at where we have been successful in international markets, it has occurred when we’ve achieved scale in a country; in the markets where growth has been slower, we found that we do not make adequate investments in manpower in those countries.
In fiscal 2012 we shall target a small number of new countries and strengthen our position in selected existing markets. Essentially, we want to focus our efforts and investments on markets that will generate the highest shareholder value.
To further bolster our position internationally, we recently hired a new Managing Director for the Asia-Pacific region, George Atrash. George joins us from Dimension Data, where he headed up connectivity; its largest line of business. We are pleased to attract talented people like George and look forward to working with them to accelerate our growth in Asia-Pacific. Our previous Head of Asia-Pacific returned to the United States as planned and has accepted a role leading our Mobility sales team.
Moving on to Mobility, we are still in the process of ramping the business and revenues, which were up from quarter three, but modest in quarter four. We remain convinced that Mobility will be a key element of our growth going forward and we are very pleased with our technology position in this market in large part due to the Agito acquisition last October. This market holds tremendous potential.
The smartphone market for phones has exploded over a 100 million smartphones sold every quarter. We plan to capitalize on this by increasing our Mobility investment and as such we are tripling our spend on Mobility R&D. The world is going mobile. So the big push here on Mobility will enhance the relevance of our entire ShoreTel unified communications solutions.
To take advantage of this opportunity, we also need to recruit and train partners who can sell and support our Mobility unified communications solution. In particular, we want partners who can successfully sell into the Cisco and Avaya install base as well as sell Mobility to existing ShoreTel customers.
ShoreTel Mobility is particularly unique and that it is PBX agnostic. We will support this effort with a new dedicated sales team that will target large opportunities Mobility and work with our Mobility partners to successfully fulfill and install these systems.
So in summary, I would like to quickly recap the highlights of our 2011 fiscal year. As a reminder, we told you when we started this year we’ve continued to focus on expanding our sales and distribution channels and building brand awareness which would help drive revenue growth. That growth has led to the beginning of leverage in the P&L. Fiscal 2011 was a year of significant progress for ShoreTel Incorporated. First, growing both in United States and worldwide enterprise IP telephony market share and ending the fiscal year on the threshold of double-digit share of the United States solidifying our hold of third largest IP telephony vendor in North America.
Second, implementing a two-tier distribution model in the United States to strengthen our ability to drive rapid growth while continuing to deliver a world class customer experience.
Third, achieving significant improvement in ShoreTel awareness as a result of our investment in brand building and focus on brilliant simplicity.
Fourth, acquiring Agito Networks and integrating it with ShoreTel’s unified communication and ability offering to create a compelling and differentiated solution.
Fifth, establishing a dedicated channel sales organization to recruit and launch new parts.
Sixth, increasing our sales headcount by over 40% ending the year with 190 quota-carrying sales team members to support our growing customer base and channel partners.
Seventh, earnings for the second year in a row Gartner’s highest strong positive rating in the 2011 MarketScope for Unified Communication for the North America SMB market reflecting solutions for 20-500 line market.
Eighth, growing our revenues 35% from fiscal 2010 despite small market growth of the past couple of quarters.
Ninth, growing our international revenues in excess of 50% from the prior year and perhaps most importantly returning to non-GAAP profitability for the year. With that I will turn the call over to Mike. Mike
Thanks Peter. I am pleased to review another great quarter for ShoreTel. In the fourth quarter, ShoreTel delivered 10% sequential revenue to $56.5 million. Total non-GAAP gross margins were 66.3% and product gross margins were 66.5%. Non-GAAP operating expenses of $36 million were modestly up from the prior quarter. Therefore we have a non-GAAP net income of $1.3 million or $0.03 per share.
Some of the key metrics for the quarter include solid product revenue growth of 10% sequentially in Q4 and 35% year-over-year to $45.3 million. Service and support revenues were up 9% in Q4 to $11.2 million and represented 20% of total revenue in Q4. International revenues were $6.7 million for the quarter, up 13% from the third quarter and represented 12% of our overall business.
Within our vertical markets, we saw excellent sequential growth in education communication and professional services with financial vertical still being our largest.
Business from our major accounts program was strong in the quarter with the sequential increase of 20% quarter-over-quarter. And as we have seen within our past two fiscal fourth quarters, business from our US service providers which include AT&T, Qwest, Verizon and now Windstream was down seasonally 6% to approximately $6 million or 10% of our total business.
We did run a very successful promotion and added a record 1150 new customers in Q4 bringing our total customers sold to over 18,000. We sold a 131,000 end user licenses in the quarter compared with a 115,000 in the March quarter, an increase of nearly 14%.
Non-GAAP gross margins for the quarter were 66.3% approximately 230 basis points lower than Q3. A majority of the quarterly decline was driven by few factors some of which are unique in Q4.
The most significant impact on gross margins was a Q4 promotion to attract new customers which was very successful, but did result in higher discounting in Q4. Also impacting gross margins but to a lesser extent were few other items including support and services margins which declined 65.5% due to the hiring of support personnel and additional training activities.
The product mix shift in Q4 towards phones which have a lower gross margins and finally as expected our transition to two tier distribution during the quarter did have a small negative impact on gross margins. Non-GAAP operating expenses increased by $791,000 or only 2% from the third quarter to $36 million.
Given this modest increase in spending and solid revenue improvement, we were able to demonstrate leverage in the P&L as non-GAAP operating expenses dropped to 64% of revenue, down from 68% to 69% the last few quarters. As a quick note, our Q4 quota-carrying headcount increase of 6 was a little bit lower than our original expectations for the quarter. As of today we have more than doubled our hiring from Q4 and that we have hired or have firm start dates or approximately 14 additional sales people. As you would expect given the small sales headcount additions, most of our sales productivity numbers improved in Q4. Our Q4 non-GAAP net income of $1.3 million included $140,000 loss for other income and expense, most of which is due to foreign exchange losses on our assets and liability denominated in other currency. Our GAAP net loss of $1.7 million or $0.04 per share included 2.9 million stock compensation and other charges as well as related tax adjustments.
Now let me review some of the balance sheet highlights. Cash and short-term investments were up 3.1 million to 105.8 million. For the quarter, we used approximately $660,000 in cash flow from operations mostly due to 2.2 increase in inventory. For the year ended June 30, we generated 1.3 million in cash flow from operations.
Accounts receivable increased 6.7 million on higher sales in the quarter. Day sales outstanding were 37 days, up slightly from last quarter but still one of the best DSOs in the industry.
Inventory increased by $2.2 million to 19.1, mostly due to an intentional buildup in order to avoid any supply issues related to the March earthquake in Japan as well as a buildup of inventory at a value-added distributors ScanSource and Westcon.
Deferred revenue increased substantially by 14% to $37.7 million, driven by an increase in support renewals and increased revenue deferrals from our value-added distributors.
Capital expenditures were approximately 0.7 million and depreciation and amortization was approximately $1.4 million. We ended the year with 634 employees, which represented a 32% increase in headcounts for the year. Approximately 85% of these headcount growth came in the sales, engineering and support departments.
In terms of revenue specifics for fiscal year 2011, our revenue from service providers was up 30% year-over-year driven by large percentage gain from Qwest and Verizon. Our major accounts program also showed strong year-over-year growth of over 50%. Service support revenue grew 29% to $40.4 million on the strength of a growing customer base. For the year service and support revenue was 20% of total revenue.
International revenue for the year was $23 million or 12% of our total business. And for the year we saw a 29% increase in customer count and our percentage of business from new customers was 47% for 2011.
Next, I will discuss our outlook for the September 2011 quarter. Based on our backlog and business book-to-date we expect revenue to be in the range of $53 million to $57 million, which represents a 20% to 29% increase over Q1 of fiscal year 2011 and it was consistent with our overall annual revenue guidance of at least 20%.
This guidance reflects that our bookings volume has some seasonality in our December and June quarters, which are usually stronger than our September and March quarters. Moving forward, we do expect to see continued seasonality in our business.
In addition, as Peter mentioned our transition to two-tier distribution is going well in the U.S. We are however applying some level of caution to our revenue guidance in that we want to acknowledge the chance of slight delay in revenue recognition at the end of the quarter and a large percentage of our partners will now be purchasing from ScanSource and Westcon for the first time.
And finally we are cautious given the ongoing concerns regarding the overall macro economic instability both in the U.S. and overseas. For the September 2011 quarter we expect non-GAAP gross margins to be in the range of 66%-67%. GAAP gross margins are expected to be approximately 100 basis points lower due to the inclusion of $500,000 in stock-based compensation and other charges.
As we have conveyed in the past, we expect non-GAAP operating expenses to grow in the September quarter as we continue to invest in strategic activities especially in the mobility and sales areas. We also have seasonal expenses in Q1 related to our July product offerings, which is approximately 1.5 million and to a lesser extent, our year-end audit of [stocks] and tax fees. Therefore, we expect our Q1 non-GAAP operating expenses to be in the range of $37.5 million $38.5 million.
We expect GAAP operating expenses to be in the range of 40.5 million to 41.5 million, including approximately 3 million stock-based compensation and other expenses.
With that, let me turn it back to Peter for closing remarks.
Thank you, Mike. ShoreTel’s momentum is strong as evidenced by the growth in this quarter and for the fiscal year. This year was a year of tremendous change as we built a solid foundation to enable us to take the company to the next level. The ShoreTel team, both employees and partners alike took this changes in stride and delivered significant growth and world class customer satisfaction.
Most of our competitors faced a variety of distractions, which provides an opportunity for a focused challenger like ShoreTel to step in and win market share, which clearly we have been doing.
We expect our momentum to continue, driven by new revenue streams, product simplicity, quality and clear brand value. In short, our brilliant simplicity is working.
With a strategic view to complete our attention is focused and we know we need to do to maintain our growth and solidify our position is one of the top three contenders in unified communication market.
I want to reiterate that we will remain committed to at least 20% revenue growth and low single-digit non-GAAP operating margin percentage for our fiscal 2012. I am very confident that we are on the right track. I hope all of you are as excited as I am about the great opportunities ahead. I would like to take this opportunity to thank the ShoreTel team for their hard work this year and to thank you for your time, support and interest in the company.
With that, I will turn over to the operator for a question-and-answer session. Operator?
Thank you (Operator Instructions) We’ll take our first question from Troy Jensen with Piper Jaffray.
Troy Jensen - Piper Jaffray
Yeah, maybe so with Mike here; Mike I think you mentioned seasonality and you talked about guidance; but that looks like in each of the past five September quarters you have been up sequentially? So how much of the guidance here and midpoint reflects down 30 is really a seasonal concerns or is it just really don’t matter?
I’ll start and I’ll let Peter add, Troy it’s really a combination of a couple of things, you know there is certainly some macro concerns in the market these days, so that’s one of them. Two, we have this transition to two-tier in the quarter going on and so we are just cautious at the end of the quarter, some things may just not get pushed through redirect in time for us to recognize so that may happen.
And then finally there is from a bookings perspective, usually a little tougher in this quarter than our fourth quarter from a bookings perspective and our backlog is easily somewhat consistent quarter-over-quarter. And frankly, so as our numbers get bigger that backlog that carries over from one quarter to next is enabled to mitigate some of that seasonality. So we are starting to see more seasonality in the final numbers because of that backlog carryover.
Let me add Troy, the seasonality is driven by two calendar events. At the end of calendar quarter four, it’s the end of the calendar year where people typically have budgets they need to spend and the halfway to there and our end of June that’s the end of our fiscal year, so a quarter four much relentless companies is the robust scorer. So it’s a very natural seasonality; we are not making a deal of it but just want everybody to highlight it and we remain confident in our ability to deliver the whole of 2012.
Troy Jensen - Piper Jaffray
Okay. And then follow-up for Mike here, you hit on the gross margins I think I missed part of it over there, service gross margins were down primarily to the investments in support, but why were these products gross margins sounding in?
Well Troy, there is a couple of things right. First and foremost the largest piece again was this promotion we ran in Q4 within promotion design to get new customer which was very successful and that we gathered another 1,150 new customers. And I think as I mentioned last quarter, usually we discount a little bit heavier on new customers than we do existing customers.
So this quarter with a higher percentage of business coming from new customers by yield of 48% that usually has a negative impact on gross margins. So that was the biggest piece; if anytime our new business percentage goes up, it usually has a negative impact on gross margins. We had the opposite effect last quarter.
And then there is little bits and pieces, the rest. We actually had a very big increase in our phone unit sales and our phones have been at lower margins than our switches and software. So that had a gross margin impact and then just the movement two-tier distribution has a little bit of gross margin impact not very much volume this quarter. That will go up as we transition more partners. So that had a little impact.
And then finally service and support margins as you know that were down a little bit through investments and we did a little more training this quarter than we have in the past. So that brought the service and support gross margins down a little bit there. They had a little impact on the overall company margins.
Troy Jensen - Piper Jaffray
The last question then I’ll leave the floor. Yeah that answer it perfectly thank you. The last question would be on the OpEx guidance, you know I understand $1.5 million of kind of one-time expense from the channel partner confidence. If we think about the December quarter and I know you don't want to give guidance there, but should we think about expense flat to balance slightly as some of these expenses roll-off or are you just kind of reinvest that in other areas?
Yeah I wouldn't, it all depends on how the market is going and what our revenue looks like naturally, a lot of its dependent on hiring and what we’re going to do in our hiring. Certainly, our plans to continue to hire along all the revenue metrics are going in the right way and we are hitting our internal revenue plans. So I would expect that to start. We did a very little branding in Q1 to help fund the partner confidence. We are going to start some branding in Q2 that will offset a lot of that that Partner Conference. So I wouldn’t expect a down quarter. We’ll just have to see how the revenue’s looking. Peter, anything you would add.
I think we pointed out to all the investors that we have this one-time event, the Partner Conference is very worthwhile. It builds tremendous momentum, but we have over a 1,000 partner attendees plus obviously ShoreTel and attendees, it will carry a one-time cost. The rest of it Troy, we will manage very sensibly, we want to return that single digit operating profit, we’ve got aggressive plans for revenue, but we’ll plan it quarter-by-quarter.
Yeah, Troy, one other comment I’d make on the gross margins and we talked about this a lot and anytime we can go increase our new customers the way we did this quarter. We’d gladly tradeoff margins to do that, right. So we want to be aggressive and as you know after we get a customer and usually the first order is relatively small and expands two or three times that amount through the life that customer and usually we’re getting much better gross margins after the initial install. So we’ll continue to do promos to gather up and get as many new customers as possible because that’s the biggest part of the cost of acquiring a customer.
Our next question comes from Steve O’Brien with JPMorgan.
Steve O’Brien - JPMorgan
I was just wondering if you have seen anything in terms of the overall environment yet or may be more specifically in the federal, state local or education verticals that you might consider a slowing pipeline or perhaps potential for elongating deal cycles, may be, beyond what you read in newspaper, but what you are hearing from your partners and sales reps?
We have not yet seen any change in the overall environment Steve, we are. watching it carefully like everybody else. But the other general comment I would make is that whenever the overall market dynamics get a little bit tougher, we historically do very well because it plays to our strength of total cost of ownership and I wasn’t here then. But Kevin perhaps you can comment on the last reception, but I believe that our market share did very well despite the 2008 sudden downturn.
In a recessionary market clearly things slow down. The pipeline stretches out, the businesses take longer to make decision. But what they tend to do is to think about two things. One is to consider other alternatives and so as the challenger brand, they look beyond just the market leader to see if there is anybody else that they should be considering. So the slowing down actually helps our consideration rate which is really important.
And the second thing they do is they increase (inaudible) of total cost of ownership in the evaluation criteria. But that tends to help us as well because we have a clear TCO story, it’s a winning story. So it helps to increase our win rate. So the reality is that we like growing stable market with increasing employment to be sure, but during recession we think we can do well to continue capturing market share. And so we will continue to drive forward.
And then your other question, Steve on education. We actually had a very good education quota and on the state local government it was down a little bit which is what we expected?
In federal, very little exposure to because we don’t have too much business in federal government yet.
Steve O’Brien - JPMorgan
And may be on the service provider seasonality this quarter, how much do you think there is an element of service providers potentially favoring a host of services now or looking in that direction potentially enabled by technology that is not ShoreTel?
We haven’t seen that impact. As Mike pointed out in his remarks, for whatever reason, we always see a slightly lower quarter four in services providers than other quarters. So, the last two years have shown that. And also remind everybody that the Qwest-CenturyLink merger, this was their first quarter of the merger. So, that, it obviously had a small impact. But nothing beyond that Steve.
Steve O’Brien - JPMorgan
Got you. And then maybe lastly just one more clarification on the gross margin. You know, versus the expectation going in to the quarter and the promotional activity. I mean was there maybe, you can pry a little more color around, whether that promotional activity targeted competitors or specific systems that might be out there and then with two-tier going to contribute a greater percentage of revenue next quarter and why this gross margin stabilize, I guess.
Hey, this Mike. Let me handle both of those. So, in terms of specific competitors we are going after, I mean we are always going after all of them. So, we are aggressive as we can be against all of them. So I would say we had a competitor specific promo. What we did have is aggressive promo to get new customers in the door and that was the impact of gross margin more than anything else. In terms of your other question, I don’t know if I’d add anything more, Peter anything else.
Nothing much for me on that’s stage.
I would say to the point that which to be clear that ShoreTel does not discount more than our competitors. They think we discount less than our competitors. Our TCO story is what win those business and its overtime when the customer saves money. So we certainly do promos to stimulate the market. Last quarter was a broader promo,. This quarter it’s more focused on larger end deals. So this is much getting kind of channel attention then there is anything else, you shouldn’t take away the impression that we discount heavily. We win business without substantial discount in the market.
Steve O’Brien - JPMorgan
That’s great. Well put, thank you.
I guess Steve the second part question was I avoid this a little bit was the guidance for next quarter it’s up a little bit flat up. From this quarter two-tier will have a bigger impact undoubtedly on our margins next quarter but we expect that to be offset by less promotional discounting and a little bit lower cost structure from our standpoint.
Our next question comes from Edward Parker with Lazard Capital Markets.
Edward Parker - Lazard Capital Markets
Quick maybe just going to Troy question on revenue guidance. I know is a mix of two-tier transition and then also from that macro bit. Can you maybe comment if you change your conversion rate assumption because the macro in terms of factoring your pipeline and maybe if you could quantify the range that you are anticipating in terms of the impact from the future revenue recognition at the end of the quarter?
Yeah. we are not that scientific I guess I would say in terms of the guidance range in the macroeconomic. We will forecast the same way you do every time with the sales field organization. I think this time we’re just applying a little bit more caution to it because of the macroeconomic concerns.
In terms of the two tier and how much could be the delay and that hopefully may just being conservative and that there may be deals that are at the end of the quarter as it doesn’t get pushed through in POS all the way through the value-added distributor and I hopefully I am just being conservative as we move beyond top of those and everything will go through ScanSource quickly. But in terms of how we muck we didn’t qualify, how much was built into our guidance.
We should just probably clarify everybody on the phone. We base revenue recognition through two-tier on the Point of Sale confirmation. So when we doing one tier we obviously have that Point of Sale because we shift directly to the reseller. In two tier shipping to the value-add distributor is the first step in the process and as our volume increases too, that will obviously, we’ve got very good systems recognizing the Point of Sale. we test them to with a very robust, but this is our first quarter of the transition. We will see bulk of the volume so Mike is just being a little bit cautious.
Edward Parker - Lazard Capital Markets
Okay, fair enough. And then may you could just touch quick on your hiring plans. Do you expect it to be in similar rates as this fiscal year and how do you think about it if the macro environment indeed slows down this year and how much would you pull back on hiring?
Well it will depend quarter by quarter. What we want to do is take advantage of this window of opportunity, which I think is very real. Not withstanding any macroeconomic indicators that we are gaining share. We have a winning value proposition, it’s driven by partner recruitment and I’d like to remind you that we had another record number of partners and they are clearly coming from competitors because you don’t find a partner which is brand new to this industry. They always have a competitive product at the moment we are taking it away from the competitors and we need a modest increase in sales people to the service the partners and also help them hunt. But we will be sensible. We want to also deliver that single digit operating profit to the performance of the company while we want to grow as fast as we can and all I can say is let’s take it quarter by quarter and we will build the best plan we can. We want to win in this industry and we are but we are sensible as well.
Edward Parker - Lazard Capital Markets
Okay, and then this last one from me, the share count was up high in the quarter, I guess that's just the function of stock price, how do you expect that to trend this quarter.
You tell me what the stock price is going to do and I will answer.
Edward Parker - Lazard Capital Markets
Well, it’s come down, so I don't know if there is anymore guidance you can give on the share count.
Yeah, I mean usually, the share count is up a little higher side to be sarcastic, but the share count was up a little bit higher. Usually I model 700,000 shares a quarter. If the stock actually goes up a lot you will see more exercises in sales and so it will be above that but I think 500 to 700 of the stock is stable if we could guess if its moving up, should be higher than that.
Our next question comes from Rohit Chopra with Wedbush Securities.
Rohit Chopra -Wedbush Securities
Hi guys. I just want to get a sense, did Polycom or HP help contribute to revenues in the quarter.
HP did not yet. We are just in the process of completing contract negotiations with them. The legal of both sides of just signing off right now. Polycom relationship there is working extremely well. It’s a good partnership but I would say that the revenues are ramping because they attended our partner conference. We just attended this and the sales force of both sides is becoming educated so you will see more impact on that later.
Rohit Chopra -Wedbush Securities
Later, okay. And then you talked a lot about major accounts and some other things in there, but can you give us a sense may be on to metrics but deal sizes and how they trended quarter-over-quarter, year-over-year so way to get some metrics there?
Yeah, I think we gave some of those, but we had a great quarter in what we called our large deal size over 100K. The revenue from those deals was up over 50%, the number of those deals was up significantly I think about 39% or so and so a multitude of large deals, we didn’t have any huge mega deals, $1 million or higher, but certainly a multitude of deals over 100K which really helped the revenue growth of 10% sequentially. Across all verticals right, we did well and education and even some counter governments, professional services, financial services, thank you Troy, other companies.
Rohit Chopra -Wedbush Securities
All right. I was going to come back to the gross margin question real quick and I know Steve was asking about this, but is 66 to 67 a sustainable level given the transition to two-tier and given the on and off promotions that happened I mean last quarter you didn’t have any promotions, this quarter it appears you did it, next quarter you’re saying that it will be off a little bit. Can you give us some color around that? Is that a sustainable level?
Yeah, I think it’s a sustainable level, but there is a number of things that affects our gross margins and we do have promotions every quarter; some are just richer than others and depending how they come. And frankly, I was surprised by the amount of increase we had in our phone unit sales this quarter, it was huge in terms of an increase and then some of our low end following we even had a bigger increase. So the mix in phones and the mix within the phone line had a little impact on gross margin, so all these things come into play.
We are working hard to reduce our costs on our switches and phones to offset some of the transition to two-tier. So net, net I think all of those will kind of offset each other and for now I think certainly guidance where we are at 66-67 for the next quarter is solid as revenue grows, hopefully we can get those back up to higher numbers. But I think you heard me say last quarter the 68 or so we did that was an anomaly and a lot of things came together to help us that quarter.
Rohit Chopra -Wedbush Securities
Okay. And last question, I just want to get a sense of the competitive environment, I think somebody talked a little bit about hosting may be overseas as well, but is that having an impact on the business as a margin, what are the Avaya’s doing out there. We heard from Mytel, but how is the competitive landscape changing?
You know, on the hosting it’s not having an impact on this at the current time. Avaya and Cisco their behavior hasn’t really changed a great deal. Kevin do you have any comment about, but our sales force is not reporting anything really different from three months ago?
Yeah, clearly Cisco and Avaya is the competition. That’s who the market leaders are and that’s who we are driving against and competing against and the value proposition of simple versus complicated is resonating and that’s why we’re winning. And so I think it’s a pretty stable competitive environment.
Our next question comes from Mike Latimore with Northland Capital Markets.
Mike Latimore - Northland Securities
Just I guess the DSO reflect a little bit, but Mike I mean how was the linearity in the quarter you know relative to a typical or your prior fourth quarter?
Linearity, compared to last Q4 was about the same, I think maybe one or two points higher. Let me just check real quick and it certainly was higher than Q3, but not too much different than last year. In fact, it was about the same, certainly up from last quarter in terms of linearity coming in. And as you know, in the September quarter, the first two months July and August a little tough because of the summer holiday season and people away and so you know, you usually have pretty back end loaded September quarter with the momentum grows. Yeah.
Mike Latimore - Northland Securities
And just on the overall environment, I know you are being cautious around the macro information out there, but I guess how maybe I mentioned you haven’t seen a change in the environment yet, it seems maybe could you comment on that sort of regionally U.S. versus Europe is sort of similar patterns in both regions though?
Obviously, there is still a lot of opportunities in Asia and U.S. and Europe, so far we haven’t seen a change to what we normally expect, but we have to watch it everyday. But so far we haven’t seen a change.
Mike Latimore - Northland Securities
And I guess, just in terms of the discounting in the quarter, was there any one or two competitors that were kind of unusually aggressive this quarter at all from a discounting standpoint?
It was the same from the two large ones and as we normally expect, occasionally Mytel does a lot of aggressive service discounting, but it doesn’t affect us that much, so we haven’t really seen a fundamental change.
Mike Latimore - Northland Securities
How many, I think you are off to a strong start in terms of hiring new sales people this quarter but what’s the total amount you would expect to have in the quarter if all goes along?
In terms of quarter carrying that, you know I think we are shooting for 20 and or 40 in the way there 20-25 you know we missed last quarter as you surmise, so I think you know we should be there in terms for the total year you know we added 44% in our sales force this year that was on top of I think 45 the year before. And you know long as everything is going in the right direction there is no big pull back and demand is still there you know we’re going to look to community aggressiveness in the sales hiring area and build out our channel.
Our market penetration although we’re delighted with 9.1% market share, we still have large clients in United States were hopefully under represented either the confidence or sales force so the opportunity is to win once we have the team on the ground is there but we need the team on the ground so that’s what we are trying to do; we’re just trying to be sensible and plan it well, but the opportunity is there.
Mike Latimore - Northland Securities
And then just last question is around having a strategic review I guess one would be, was there any discussion about kind of the long-term operating model still 10% to 15% in kind of timeframe you might that you’re getting there. And second is just on product strategy you know if hosting going to be more or less part of the product strategy going forward?
No, I mean in terms of long-term operating margin yeah we’re still at the 10% to 17% you know we’ll be more specific later on after we get out this year if when we’re going to closer to that so you know this year’s investments have been showing some leverage in managing to that single digit operating margin percentage. You know all that Peter talked about some of the strategy output and focus.
I touched briefly on it, obviously the call is not a lot of time, but the model for the United States is to keep investing sensibly to drive that market penetration and this also has leverage in the United States model that’s allowing us to invest in particularly mobility, where we think there is great upside for our company and good share holder returns over time and then it is internationally we are just going to be very sensible because we get a better return on share holder value by picking a small number of new countries and consolidating the better promising ones now. It is a very straight forward strategy, it was good discussion with the board and we went into operation mode.
Our last question comes from Lynn Um with Barclays Capital.
Lynn Um - Barclays Capital
Hi, everyone. Thanks for greeting me in here. Nice quarter I thin I just want to quickly be touch upon the mobility angle. It sounds like starting to see some [stocks in] and I guess I just want to ask when we can expect to start seeing some material revenues from that and I think I heard R&D would be tripling in that area and can you just give us a sense of is that customer driven or may be you thing it is competition from your peers in that area. Any color there would be helpful. Thanks?
Okay I will give you a general answer to that just reminding that we brought [ZTel], it did not have a big revenue stream just few pilot customers and we then had to train ourselves first and train our partners, which is done we have also recognized that to stay in a very good position in the market we need to increase R&D and put it that in place and improvements going well and then also we added a dedicated sales force and they are going to get just started. The purpose of a dedicated sales force is to hunt opportunities in the Cisco and buyer store base which are quite significant large opportunities with large number of seats.
And we think we can drive good interest, which obviously the partners would fulfill and we are ramping that team. We've got a set of accounts we're targeting. So this will take time. So we are very optimistic and enthusiastic about it but the material revenues well, they happen gradually because these large companies put a pilot in and the CIO is going to turn over the whole mobility to the new solution without testing it very thoroughly. So we are patient, we know the return is there, but it’s going to take a while to ramp the revenues. In the meantime they will be the main revenue drivers to our core business. That's where at least 20% comes from.
Then in terms of investment and mobility Lynn, yeah we are putting a lot of dollars into mobility R&D but overall its still a very small percentage of the R&D spend. So I don't want you to get too worried about R&D is really going to blast off and go up in terms of spending increase.
Absolutely, yeah it’s an important point.
It’s more of a reallocation in R&D.
It’s targeted and we will keep the R&D and the percentage of R&D as a percent of revenues is going down.
And that concludes our Q&A. I would like to turn it back to our presenters for any additional or closing remarks.
I would like to thank everybody once again, we are obviously pleased with the results. We are looking forward to 2012 and thank you again for your support and interest. Let's close the call.
That does conclude today's call. Thank you all for your participation.
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