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ShoreTel, Inc. (NASDAQ:SHOR)

F1Q 2012 Earnings Call

October 27, 2011 5:00 am ET

Executives

Tonya Chin – Director of Investor Relations

Peter Blackmore – President, Chief Executive Officer and Director

Michael E. Healy – Chief Financial Officer and Senior Vice President

Kevin Gavin – Chief Marketing Officer

Analysts

Steve O'Brien – JPMorgan

Edward Parker – Lazard Capital Markets

Greg Burns – Sidoti & Company

Rohit Chopra – Wedbush Securities Inc.

Sanjiv Wadhwani – Stifel Nicolaus & Company,Inc.

Mike Latimore – Northland Capital

Lynn Um – Barclays Capital

Operator

Good day ladies and gentlemen, and welcome to the ShoreTel Q1 Fiscal Year 2012 Earnings Conference Call. Today’s call is being recorded. And now, I’d like to turn the conference over to Tonya Chin. Please go ahead.

Tonya Chin

Hello, and thanks for joining us today as we report our first quarter 2012 financial results.

Joining me on the call today are, ShoreTel’s CEO, Peter Blackmore; and Chief Financial Officer, Mike Healy; Kevin Gavin our Chief Marketing Officer will join us in our question-and-answer session later in the call.

Before we begin, I’ll 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, 2011, and in today’s press release.

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 you to refer to our press release issued today for the reconciliation between these amounts. Our non-GAAP numbers exclude stock-based compensation charges, amortization of intangible assets and the related tax impact.

Now I’ll turn the call over to Peter.

Peter Blackmore

Thank you, Tonya and thanks to all of you for joining us today. For our first fiscal quarter of 2012, ShoreTel generated revenue of $53.9 million, an increase of 22% over the first quarter of fiscal 2011 and in line with our overall revenue guidance of at least 20% for the year.

On a sequential basis, we saw a revenue decrease of 5% as compared to our seasonally strong fourth quarter of fiscal 2011. Non-GAAP gross margins were 66.7%, up slightly from last quarter. We had a non-GAAP operating loss of $711,000 for the quarter, and a net loss of $1.2 million or $0.02 per share, mostly due to lower revenue and approximately $1.2 million in expenses related to our Annual Partner Conference, which took place in July.

The modest sequential decline in ShoreTel’s revenues this quarter is primarily related to three key areas. First, we saw a clear lengthening of the sales cycle, which we believe is driven by the uncertain macro economic environment.

Second, we saw sales from several of our regional partners decline after they had set a record in quarter four.

And finally, quarter one bookings were seasonally down as expected. Despite this, we believe our win rate remained strong during quarter one, and we are encouraged by the very positive reception, our solution continues to get from customers.

As I will detail later in the call, our market share continues to improve and demonstrates our ability to grow faster than our competitors, and the market as a whole. Importantly, we were able to reduce our spending during the quarter to a level below our projections, thereby mitigating the impact of the revenue decline on our bottom line.

We remain confident in ShoreTel strategic positioning within the marketplace, and we continue to believe ShoreTel will grow faster than the overall market, and capture market share based on our brilliantly simple value proposition that is resonating incredibly well with our customers.

I’m happy to report that we had a number of successes during the quarter, including multiple large orders from new education and government customers, strong improvement in our support and services business, excellent growth from our large multi-regional partners, and also good growth in Canada.

These successes were offset by lower performance from many of our U.S. regional partners, which as a group sequentially declined more than our overall business in quarter one. We also maintained flat international revenues compared to our very successful quarter four, reflecting our positive efforts to grow our business outside of the United States.

Additionally, we generated solid gross margins during the quarter and are pleased that we were able to improve them despite having slightly lower revenues than expected, as well as a significantly increase in volume through our U.S. value-added distributors, which have a slightly lower gross margin from the rest of our business.

In terms of the broader market, according to Synergy Research, the U.S. enterprise IP Telephony market declined in the low single-digits in the June quarter. According to the most recent data available, our market share gains enabled us to significantly outpace the overall market in the June 2011 quarter and deliver very robust market share growth. In that quarter, we grew our U.S. pure IP market share from 9.2% to 10.2%, a biggest jump in several quarters.

We also saw a solid growth in our U.S. enterprise IP market share, growing from 6.5% to 7.2% sequentially, further establishing us as the third largest vendor of the United States based on revenue. We had also gained momentum in the worldwide market, growing our worldwide enterprise IP market share by 40 basis points in the June quarter.

With regard to our full year outlook for 2012, I’ll remind you that we first discussed our full-year guidance in May 2011, and our expectations for market growth in our fiscal year 2012 were in the 8% to 10% range. Given the recent declines in the overall IP telephony markets and changing macroeconomic conditions in the U.S. and abroad, we have lowered our own internal expectations for market growth in fiscal 2012.

However, we still believe 20% year-over-year revenue growth is likely, and at these levels of growth we still expect to be able to deliver a profit to fiscal 2012. This continued revenue growth is expected to come from a further expansion of our partner base, the recent refresh of the partner base with new addition of about 200 new channel partners in the last nine months, and expectations for continued share growth and improved sales productivity going forward.

Last quarter, we provided an update on our transition to two-tier distribution, anticipating the completion of our partner transition ScanSource by the end of August. We are pleased to announce we successfully completed this on time. We had a total of 434 partners moved to ScanSource, and these partners were positive in their reaction to the transition.

As of now, 142 of our gold and silver level partners are still purchasing directly through ShoreTel representing a majority of our revenues. Between ScanSource and Westcon, approximately 20% of our total revenue is generated through our U.S. value added distributors of VADs in the quarter, and we expect that percentage to grow again in quarter two.

Couple of weeks ago, we announced that ShoreTel is adding Ingram Micro as preferred VAD in the United States. Ingram Micro is a Fortune 100 company, and the world’s largest technology distributor with annual sales of $34 billion. With over 15,000 employees worldwide, Ingram services over 185,000 resellers in 150 countries.

ScanSource is performing exceptionally well, and we are very pleased with our relationship with them. However, it has always been our intention to have two valued-added distributors to support our U.S. regional partners. Westcon only supports our service providers and therefore we are looking to add a complementary value-added distributor in the United States, which we have found within Ingram Micro.

ShoreTel’s product line is being supported by Ingram’s advanced technology division, which is a new higher value-added group that supports unified communications within Ingram.

The purpose of adding this second word is to expand ShoreTel’s reach to a broader reseller audience in the United States. We are very enthusiastic about the opportunity we have with Ingram and look forward to a fruitful relationship.

In addition, our partner recruitment continues to be very successful. During the first quarter, we signed a total of 73 new partners around the world, 41 of which came to our relationship with ScanSource. A few examples of our larger additions include Cosco National, which is the leading single source provider of the life cycle solutions for retail, voice and data systems, United States. CrossCom is over $100 million in annual revenues and services customers such as Wal-Mart, AutoZone, Walgreens and Office Max.

We also added Sturgeon Electric with multiple offices serving the western United States, this partner has a large three common install base that it is positioning to ShoreTel as a result of this recent relationship. The ShoreTel Mobility specifically, we added Combat Networks, which is headquartered in Ottawa, Canada with offices throughout that country. Combat focuses on selling to the Canadian Federal government.

This quarter, we also signed a new distribution agreement with Tech Data Canada, a company that it is a partner base of over 5,000 technology resellers and solution providers, and offer significant expertise in IP telephony, wireless networking and Voice over IP technologies. We expect this relationship to build upon our recent success in Canada over the coming quarters.

Next, let me provide you with a customer update. We added over 1,000 new customers in our first quarter with revenues from new customers representing 45% of our business. We made strong progress in the social media space winning yet a popular online site to help people find respected local businesses.

With this win opportunities in impressive list of social media customers including LinkedIn, Myspace, [Yala and Groupa]. Our largest win in quarter one was with Pima County, which is the second largest county in the State of Arizona.

The initial award to CenturyLink was close to $1 million, and included 2,000 ShoreTel users. Over the next few years, Pima County plans to rollout an additional 8,000 users. Pima County chose ShoreTel over our competitors because of ShoreTel’s simplicity and low total cost of ownership. We also recently signed PIMCO, a global investment adviser with more than 1,400 dedicated professionals in 10 countries. Our initial installation of PIMCO at a new location for them, included over 200 users with full integration to an existing Nortel PBX.

Furthermore, we were able to customize a streaming solution that captures live TV audio broadcast and delivers it directly to the trader’s ShoreTel desktop phones. Finally, we had a great win with ShoreTel Mobility at the Winnipeg convention center in Canada. ShoreTel Mobility will turn their employee smartphones into a mobile extension of PBX allowing users to make and receive calls wherever they might be just as if they were at their desks.

One of the key factors to choosing ShoreTel is ShoreTel Mobility has heterogeneous platform support enabling them to run ShoreTel Mobility on their existing Nortel PBX.

Next I will take a few minutes to discuss our strategy. The comprehensive review of our strategy that we undertook in June gives us confidence in our direction. Over the next few quarters, we anticipate our growth will be fueled by further market share gains as we continue to focus on improving our consideration rate plus a well-planned expansion of our partner organization, our continued focus on international growth and a further rollout of our ShoreTel Mobility Solution.

We expect Mobility will be a key area of leadership for ShoreTel going forward. To support this initiative, we will continue our investments in mobility product development and a dedicated sales team to support this business and an effective advertising campaign.

Our partners are enthusiastic about this offering and we are training and launching partners as quickly as we can. In fact I’m very pleased to report that Dimension Data one of our key mobility partners has recently purchased ShoreTel Mobility for their own internal use. A benefit for their organization and for us.

In addition, a few weeks ago at the CTIA show in San Diego, AT&T announced the global launch of the solution they’re calling dual mode mobile voice or DMMV, which is their solution based on the ShoreTel Mobility offering. We are pleased that AT&T chose ShoreTel to be the engine behind DMMV and we are happy to see AT&T put such a strong effort to introducing it to the market. To further support customer demands, we recently announced support for the Android and the most recent line of BlackBerry phones. We continue to support Apple iOS devices including the iPhone, iPod Touch and iPad.

We are very pleased with our product advances and we look forward to capitalizing on the opportunities for mobility. We are also extremely pleased with the quality of customers who are interested in our ShoreTel Mobility solution. We are engaged in active discussions with pilots with over a dozen of the Fortune 100 companies. Actually the deal cycle of the companies of the size tends to be quite a bit longer to that of our average non-mobility deals.

On a separate note, we are also pleased that we are seeing significant adoption of ShoreTel in the virtualized environments. With over 1,000 customers running ShoreTel on VMware these tend to be our larger enterprise customers.

As always, we remain focused on profitable growth and maintaining a prudent cost structure. We will keep pursuing operational efficiencies and increase productivity to improve our profitability in order to deliver long-term value to our shareholders.

Now, I will turn the call over to Mike.

Michael E. Healy

Thank you, Peter. First I'm going to use some of the key financial metrics for the quarter. Q1 overall revenue of $53.9 million is segmented as follows. Product revenues were $42.2 million down 7% from our record Q4, 2011. Services and support revenues continuing its steady growth up 4% sequentially to $11.7 million and growing 29% year-over-year. Ethernet support revenues now represent 22% of our total revenue.

Our international revenues were flat with last quarter and represented 12.5% of total revenue. We saw a moderate sequential revenue declines in EMEA and Asia-Pac, while Canada grew exceptionally well at 87% sequentially on the hills of investments made over the past year. Overall our international business grew solid 41% from Q1 last year.

Our U.S. super regional partners led by CBW and Blackhawks did extremely well in the quarter growing 66% quarter-over-quarter. Business from our service providers was also a bright spot posting an increase of 4% sequentially and 28% increase over Q1 last year. As a group service providers represented 11% of business in the quarter. Offsetting these increases was lower revenue from our U.S. regional partners, which is still the majority of our revenue.

In terms of our vertical segments, both the government and education segments were strong in the quarter. Our largest vertical segments continue to be financial, government, education and professional services. With the financial vertical having the largest decline quarter-over-quarter.

About half of our top ten deals this quarter were in the government and education segments, including our largest deal with (inaudible) county as well as two large deals with major university.

In the first quarter we sold 123,000 end user licenses compared to 131,000 in our June quarter. We also added 1,000 new customers bringing our total customer count to over 19,000. Our revenue concentration continues to be well distributed with only two partners between 5% and 10% of revenue for the quarter and no single end customer over 5% of revenue.

Our total non-GAAP gross margins improved slightly to 66.7% in Q1 mostly due to our increase in services and support margins. Our product gross margins were 66.3%, down 20 basis points from Q4 mostly related to increased volume growing through our U.S. Fed, which negatively impacted our product margins by about 40 basis points.

Our non-GAAP services and support gross margins grew 270 basis points to 68.2% due to lower support costs coupled with a 4% increase in revenue. Our non-GAAP operating expenses came in better than expected at $36.6 million as reported in prudent spending constraints primarily slower hiring and plans reduced contractor spending and lower incentive compensation. GAAP operating expenses were $39.7 million included both stock compensation charges and amortization of purchased intangibles. On a non-GAAP basis, our net loss was $1.2 million or a loss of $0.02 per share. This included approximately $440,000 in foreign exchange losses that are included in the other income and expense line, which negatively impacted EPS by $0.01.

Our foreign currency losses were primarily due to the gradual weakening of the U.S. dollar against the British pound, Australian dollar and euro during the month of September. The average decline of the U.S. dollar against those currencies was approximately 6%. This resulted in a $330,000 loss on the revaluation of our cash and accounts receivable, denominated in foreign currencies, and then the additional $110,000 loss associated with translation adjustments of foreign subsidiaries.

We had a GAAP net loss of $4.6 million or a loss of $0.10 per share, which included approximately $3.3 million of stock-based compensation charges and $215,000 in amortization of intangible assets.

Next let me review some highlights from our balance sheet at the close of Q1. Our accounts receivable decreased by $4.3 million to $29.5 million on lower revenue and another good collection in effort. Days sales outstanding were an industry-leading 37 days and consistent with our great performance last quarter. Inventory increased by $1.2 million to $20.2 million mostly due to an increase in our switch inventory as we transition to a new switch vendor in order to lower our cost.

Total deferred revenue increased by $2 million or 5% to $39.6 million, driven by continued sales of maintenance contracts to our growing customer base and an increase in deferred revenue related to our U.S. (inaudible) for buildings that had not sold through by September 30.

Capital expenditures were only $424,000 and depreciation and amortization expenses were approximately $1.7 million for the quarter.

Due mostly to our outstanding efforts in AR, we’ve generated over $4.1 million in cash flow from operations and ended the quarter with cash and short-term investments of $109.2 million. On per share basis that’s approximately $2.30 per share in cash, and we continue to be debt free as well. We ended the quarter with 678 employees, up by 44 from Q4, with the majority of hiring coming in sales and engineering areas, particularly Mobility. We ended the quarter with 201 quota-carrying sales people.

As you can see from our revenue this quarter, our sales rep productivity declined. We believe the key reasons for this decline were the increase in sales cycle times we saw, normal seasonality we expected in Q1, and the continued hiring in our partner recruitments and partner launch sales teams.

We have also recently created a Mobility sales team that’s just beginning to ramp up. While some of these investments have had a short-term negative affect on productivity, we fully expect they will have a positive impact in the future as we pursue expanded distribution; we strive to increase our consideration rate.

Our biggest opportunity continues to be increasing our consideration rate in sales opportunities, and therefore, we see these investments as critical to our long-term success. Given our past sales, hiring rent and assuming our sales reps take four to five quarters to ramp to full productivity, we have the equivalent of approximately 155 fully ramped sales people at the end of Q1.

Next, I’ll discuss our outlook for the December quarter. Based on our backlog entering the quarter, our sales pipeline forecast and business booked to-date, we expect revenue for the second quarter to be in the range of $54 million to $57 million. We expect non-GAAP gross margins to be in the range of 66% to 67%.

GAAP gross margins are expected to be approximately 100 basis points lower to the inclusion of $400,000 in stock-based compensation charges. We expect non-GAAP operating expenses to be in the range of $37 million to $38 million and we expect GAAP operating expenses to be in the range of $40 million to $41 million including approximately $3 million in stock-based compensation expenses.

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

Peter Blackmore

Thanks, Mike. Before we open it up for questions I want to reiterate some of our key lights in quarter one. We saw a good growth from the service providers and from our large multi-regional partners in the United States. We also maintained solid international revenues with good year-over-year growth. We delivered strong gross margins even in the face of lower than anticipated revenues and more revenue going through our U.S. value added distributors.

We added over 1,000 new customers including booking multiple large orders from new education, government and social media customers. We signed 73 new partners in countries around the world and we continue to have world-class customer satisfaction levels.

Everyone at ShoreTel is focused on building on our position as one of the top three vendors in the U.S. Enterprise IP market. We continue to have a very high win rate and our consideration rate is steadily increasing. We believe we have demonstrated our well-developed go-to-market and strategic plans of the past several quarters. We have taken action on discretionary spending in order to improve our short-term profitability and maintain our strong gross margins.

Most importantly team and I are focused on continued execution and delivering the best possible results in quarter two as always positioning ShoreTel the continued success and value creation.

With that, I’ll turn the call over to the operator for questions. Operator, please?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) We’ll go first to Steve O'Brien with JPMorgan.

Steve O’Brien – JPMorgan

Hi, thanks for taking my question. First off, I just wanted to reconfirm the outlook for fiscal ’12, it wasn’t entirely clear to mean what the goal is now, I mean, I think the goal before was 20% growth, and apologies if I just didn't quite get the message, but what is then new goal for fiscal 2012 on and growth basis, our revenue growth basis, and I think I was a little more clear, but I just want to confirm on the operating margin side, on the previous call, it was low single digit operating margin, and now it sounds like the goal is to be profitable, so I guess that sounds less than a low single-digit operating margin, am I correct there?

Peter Blackmore

Thanks, Steve. And it’s good question, and thanks because it’s important to clarify this. So we’re still expecting 20% of revenue growth for the year, and we’ve also said that at 20% revenue growth, we expect to profitable for the year.

Steve O’Brien – JPMorgan

Okay. So then, the next question is, guidance next quarter will have you down, will have ShoreTel down or not down, excuse me, but growing less than 20% growth. So kind of how do you see the company getting to 20% growth starting off the first half of the fiscal year, kind of maybe barely there, and definitely the second quarter trending below that target?

Peter Blackmore

And again, a very good question. So first of all we’re confident, we’ve got a number of things in place due to our strategy, which will help drive revenue in the second half, and I’ll list some of them if I get any of them, Michael help me out.

First of all, we’ve recruited 200 plus deal partners in the last nine months, and we also carried about 100 plus lower performing partners. Those partners will typically want revenues after six to nine month period, so that, that we’ll start to see in the second half of our year.

We’ll also continue to add new partners. We are very pleased with ScanSource, and the majority of the effort in ScanSource and ourselves in this last quarter was to do a good transition of the 434 partners that’s showing them and what we now have is a business plan in place for them to steadily add new partners and they've got access to a huge range of partners. So they are positive about this. They obviously want their revenues with ShoreTel to expand, so they are motivated to add those partners in a disciplined way, so that would be a driver.

The third thing is Ingram Micro, obviously a huge organization, we only just signed them, so we are not anticipating any revenues of substance this quarter, but we fully expect in the second half of the year, back to benefits a great deal. And then we have mobility ramping and we put a lot of effort and resources into mobility and we’re seeing a very good pipeline, so we expect that to ramp. And then lastly, we should have international growth, so there is a lot of positive indicators there, which enable us to have great confidence in the second half of the year.

Michael E. Healy

The only other thing that I would add Steve is, in terms of, the IP telephony market declined a couple of quarters in row through June, one of our assumptions is, it doesn’t get any worse than that to kind of leveled out and it’s more stable, it may not grow a lot into the next two quarters or three quarters, but it doesn’t get any worse.

Steve O’Brien – JPMorgan

Okay. And if you could just follow up on that, the last point I mean, I seem you talked about elongating sales cycle, and as clearly market growth not coming in, and then that seem to have already happened last quarter too, June quarter, but clearly not go in your favor in the September quarter.

I mean what are the signs you’re hearing from customers from CIOs that suggest that voice upgrades are not getting back burnered in a challenging environment, and that there won’t be further of the sales cycle, making the presumption that the market levels out perhaps too optimistic?

Peter Blackmore

Again, a good question. Going back to quarter one, we saw a mixture of two stories, CBW and Black Box knocking it out of the park, you had U.S. service providers doing well, and it was only some of our larger regional partners who had an outstanding quarter four, and frankly it didn’t deliver quite what we’re expecting in quarter one.

So in some sense, the business was there even despite there was a push out, and our pipeline for this coming quarter is very robust, and obviously we have to execute against that, but we are not seeing a decline in the market from a pipeline basis. We have to close that business, and execute against it, but that’s why we’re positive, that we’ll do much better in quarter two and then for the year, the only caveat is, as long as the overall IP telephony market doesn’t deteriorate, we are optimistic about our full year prospect as I said.

Steve O’Brien – JPMorgan

Still the other doubts I'd have just on the general market is, through the various surveys we’ve seen is, you see and VoIP continues to move up the stack in terms of party less per capital spending, in terms of the eyes of the CIO, and I just read, so that was encouraged by the U.S. GDP grow in September and more importantly business and CapEx investment was up significantly I think in the quarter, that gives us a lot more optimism than recessionary times a couple of years ago and CapEx is getting cut and reduced. So I think corporate America is continuing to invest in CapEx, and you know that's where we come in?

Peter Blackmore

And telephony is in the top ten of the sale request and moving up stack. So it’s not been pushed up, not being pushed down, Steve, but it’s staying right up there.

Steve O’Brien – JPMorgan

I guess that you kind of might put it up there, so I will just ask, I mean how has, the quarters are typically back end loaded in September, and was there any – in the month of October it’s pretty much over here, I mean have you seen any change in that environment?

Peter Blackmore

I mean that’s – and obviously are outrageous, we’re obviously back ended so the first month is the first month, but we haven’t seen anything too (inaudible).

Steve O’Brien – JPMorgan

And the September linearity was pretty typical, around 50% of the business came in the month of September, and then certainly how were those last two weeks of September?

Peter Blackmore

Next question.

Operator

We had a call from Piper Jaffray (inaudible).

Steve O’Brien – JPMorgan

Sorry about that, I was on mute. Thanks for taking my question, a quick question on the service gross margin, tick back up to around 68% from 65% last quarter, I'm just wondering going forward, is that a sustainable level, how should we think about that?

Peter Blackmore

Yeah I mean it did trickle up for two reasons right, the revenue grew 4% and more importantly the cost were down just a little bit about 150K, and that's not necessarily a great news other than the gross margin piece of it and the revenue piece, because we are behind in hiring for our support organization and our tech.

So I don't want to go that high unless we’re really getting a good goose on revenue, because that means we’re falling behind in hiring in the support organization. So I think mid-60s is kind of our target for that business, so 68 is a little bit higher than we expected. But I do expect us to catch up little bit hiring this quarter.

Steve O’Brien – JPMorgan

Okay great and then kind of not too delver a point, but going back to the question about 20% growth for fiscal ’12 how much is international growth factored into that?

Peter Blackmore

Certainly, we expect international growth faster than the U.S. business, because it’s coming off of smaller base and we’ve made a lot of investments last year that we’re hoping to pay off. As you would expect the international will grow and not be flat in Q2. And as we said Canada did extremely well, but Asia, far East Asia, we’ve got a number of country just kind of taking off. And then UK and EMEA are little less hopeful on given the macroeconomic conditions there, but the rest of Asia-Pac, we expect pretty good growth.

So certainly, some of that, getting that 20% assumes a good increase in our international numbers as well.

Steve O’Brien – JPMorgan

Okay. And then last question from me. You guys know that some successes in the education and government verticals, and I’m just curious as those were more kind of one-off deals or if you are seeing something that maybe highlight that, that market is actually stronger than what a lot of us are thinking?

Michael E. Healy

I think it’s partly our two CO story, which resonates particularly well with the budgeted constraints, which government organizers are ready. But our pipeline is good, and the government sector for this quarter as well.

Peter Blackmore

Yeah, we tend to do extremely well in the education and government, all the way up to fed to meet our goal, extremely well and with all the budget cuts going on the government, they are looking for ways to save money, get rid of their old system that maybe costing them more, and putting in a new IP system and that's where our TCO comes into play, and helps us win a lot of those city government, and a lot of the major universities.

Steve O’Brien – JPMorgan

That’s it. Well, thank you very much and good luck going forward.

Peter Blackmore

Thanks, Patrick.

Operator

Next we’ll hear form Edward Parker with Lazard.

Edward Parker – Lazard Capital Markets

Hi, guys can you hear me?

Peter Blackmore

Hi Ed, yes, how are you doing?

Edward Parker – Lazard Capital Markets

Good. So I guess going back to the question around the 20% figure, wouldn’t you expect to see linearity in the March quarter, and because given where you’ve guided for the second quarter for December, I mean it seems like you have to expect double digit sequential for the back half, so I guess you are saying that you are seeing your pipeline strong, and why wouldn’t December grow faster considering your customer base will probably see some budget push?

Peter Blackmore

Well, a lot of other indicators because we are expanding consideration rate, we’re expanding our value added distributors, we’ve got a wider channel partner Mobility will ramp, so it’s not exactly inaccurate to draw those comparison there, because we’ve put so many other things in place to help us grow. And we’re factoring in at that end, which I think is appropriate.

Edward Parker – Lazard Capital Markets

And then, with respect to the March quarter, I mean would you expect to see seasonality in your business?

Peter Blackmore

Yeah, I think, Ed, yeah in terms of booking seasonality, it’s only the little bit weaker in the March quarter, and the September quarter. So I agree with you there, and then you always come very strong back in the June quarter, typically in terms of our booking.

So there is some level of seasonality. Certainly, our assumption, I assume some of that’s muted by all the positive things we have going on in new incremental business that Peter has already mentioned.

Edward Parker – Lazard Capital Markets

Okay. And then, you mentioned that AT&T chose the mobility solutions, I guess I didn’t hear all of that, could you walk me through that again and was any of those top 12 pilots that you mentioned a result of AT&T, or is that completely separate?

Peter Blackmore

I’d ask Kevin to do that, because he has helped drive this?

Kevin Gavin

We actually have two separate initiative with AT&T, the first one they have created a solution they call Dual Mode Mobile Voice, and they package together transport with our mobility solution, and they’ve lost and essentially they have ShoreTel Mobility with their transport it’s Dual Mode Mobile Voice. So it's – we’re essentially the engine behind their solutions.

Peter Blackmore

And that really was announced a couple of weeks…

Kevin Gavin

At CTIA, a couple of weeks ago in San Diego they announced the global launch, and that’s how they are taking the market our mobility solution. We had a separate relation with AT&T where they sell our UC solution, and that’s been going on for a while now.

Edward Parker – Lazard Capital Markets

Okay, those top 12 pilots you mentioned that’s separate, and then.

Kevin Gavin

Yes, it was rather separate from AT&T Dual Mode Voice offer.

Edward Parker – Lazard Capital Markets

I guess are any of those pilots, are you expecting us to convert as part of our 20% revenue growth target?

Peter Blackmore

Absolutely.

Edward Parker – Lazard Capital Markets

Okay. And then lastly just from me, what was the number on quota-carrying sales reps again?

Peter Blackmore

201.

Edward Parker – Lazard Capital Markets

201? Okay. Great, thanks guys, good luck.

Peter Blackmore

Thank you, Ed.

Michael E. Healy

Thanks, Ed.

Operator

And next we’ll hear from Greg Burns with Sidoti & Company.

Gregory Burns – Sidoti & Company

Thanks for taking the questions.

Peter Blackmore

Hi, Greg.

Gregory Burns – Sidoti & Company

Just wanted to, I guess, if we look back to – I guess the fourth quarter you were a little bit more promotional and really drove some customer wins. I was wondering why kind of step up the gas, how do you balance, being more promotional on pricing to drive new wins versus profitability?

Peter Blackmore

My step off from gas, you mean hiring?

Gregory Burns – Sidoti & Company

I mean, as far as in terms of promotion, I guess you are a little more aggressive promotionally in the fourth quarter, drove a lot of new customer wins.

Peter Blackmore

Right.

Gregory Burns – Sidoti & Company

Why not follow through with that going forward to just really take additional market share?

Peter Blackmore

That’s a good question, again as they all have been. Our current quarter has a promotion, which is almost exactly the same as the fourth quarter. So it’s a strong promotion, and I should have mentioned that earlier because I think that will be a factor in our performance in quarter two. So thanks for prompting the question.

Gregory Burns – Sidoti & Company

Okay, thanks. And then in terms of the sales additions, I think at the end of the last quarter, you might have had I think 190 quota-carrying, and you had mentioned that you had hired 14 after the quarter closed, so it seems like you’ve now added less than that 14 for this fourth quarter. So first are my number correct, and maybe why do you expect to hire going forward for the balance of the year?

Peter Blackmore

Yeah, your numbers are right, we kind of netted 11 sales people for the quarter, so obviously the math shows, we had a little attrition between August 10 when we announced in the end of the quarter, which is normal. We always have a little bit of attrition in sales force.

So we ended with 201, and then in terms of hiring going forward, we’re kind of in evaluation mode, we’re going to continue to hire, our goal is growth and we’re certainly limiting the hiring in the company, but there is certainly some focus, I said in support of sales, and probably there are two areas you will see some headcount growth in Q2, but certainly our goals to hire much less than the 44 we hired this quarter.

Michael E. Healy

And I should add, the attrition in quarter one is partly driven by us. So obviously at the end of financial year, you take the opportunity to weed out any weaker performance.

Gregory Burns – Sidoti & Company

Okay. And then, lastly the 12 mobility pilots. Can you give us any kind of color on the size of those and have you had any thoughts there eventually on the pilot stage?

Peter Blackmore

Yeah, so we’ve had certainly some few mobility deals closed. Also this third week, they do more voice. We closed one just recently was in Q2, not in Q1. So we got some of them closed. How big they are, it just depends. That usually start relatively small after a pilot closes and then there is rollout process to this Fortune 100 Company that takes time. So it usually start with 100 licenses or something like that, rollout to the IT department if you will and then expand from there. So it’s usually a pretty phased in approach on most mobility deals.

Gregory Burns – Sidoti & Company

Okay. Thank you.

Peter Blackmore

Sure.

Operator

And next we will hear from Rohit Chopra with Wedbush.

Rohit Chopra – Wedbush Securities Inc.

Good. Just a couple of questions, I just wanted to know how you know that competition is an issue everybody on almost every (inaudible) talking about Cisco, Hawaii has been a little bit more aggressive as well, so how do we know that some of that stuff is not related to competition, and then I wanted to ask about the U.S. regionals who are still working with you, what do you do there to try and get them onboard to some of your Catalyst or ScanSource because it seems like they drove some of the weakness this quarter. So what bring down you to address that problem a little bit faster?

Peter Blackmore

I’ll ask Kevin to talk about competition that we do measure a less rate in a very disciplined way. So that’s why we didn’t highlight it during the call, but Kevin will add to that and we’ll now come back and talk about the U.S. regionals.

Kevin Gavin

Yeah, there is no doubt as we capture share, it becomes more competitive and we’re gaining more attention from our competitors. But fundamentally the value proposition continues to win in the market place, that brilliantly simple that really is simpler and that really does mean its lower total cost of ownership and our partners and our sales team is telling us they continue to have a very strong and consistent win rate against the competition.

Rohit Chopra – Wedbush Securities Inc.

Thanks, Kevin.

Peter Blackmore

And then the U.S. regionals, I mean they do perform well for us. I think the lesson I learned is still new to the company is that after a strong quarter four you need to sort of motivate a bit more in quarter one and we’ve got chance to do that next year, which I’ll go into at a future date. And I’ve got calls with every major regional partner in the next few days to check what they’re doing, how we look at the pipeline and they are very motivated to succeed, they are very loyal to us, a lot of them the only business they have is with ShoreTel, so they are motivated to hit their numbers, but I think quarter one, we’ll do a few things differently next year, but that’s history now.

Rohit Chopra – Wedbush Securities Inc.

Can I ask you a follow up on all these resellers who are working with you like ScanSource sells other peoples product, through Catalyst they go through Avaya, how do you work with them to move your product instead of the competition and they all sell everybody’s product, so like what’s being done to move the ShoreTel product line at these vendors?

Peter Blackmore

Not so bad, sorry to interrupt, so the 142 partners that stay with us they probably will not move under ScanSource or Westcon, so they are going to continue to buy from us and that’s still will be the majority of our revenue, they can move under ScanSource, if they choose to, but most probably keep their direct relationship with us.

In terms of your question, how we get ScanSource to pick up and sign other resellers, we obviously have centers in place for ScanSource to do that, financial incentives to recruit in volume numbers. And the best way usually to get partners signed up to be in the marketplace with the ShoreTel solution and then get some more motivated to sell ShoreTel.

So there is a number of activities underway and then we do some promotions with ScanSource through their reseller base, to promote ShoreTel as well and tips to sales people ScanSource people that kind of thing as we see them necessary to drive demand.

Michael E. Healy

I would say two things also maybe is the economics for the reseller depends on their win rate and the total cost of ownership. So as Mike said we effectively compete for resellers and so we do compete effectively for them, but also these bad relationships are new to us, so that’s a one-way flow out of the gate, they've got lots of other partners from Avaya or Cisco and that they don’t have any ShoreTel partners today. So to the extent they are slow from a bad resellers from one vendor to another it's effectively out of the gate and it's all our way and it's part that we are benefiting from as we open up these new brand relationships.

Rohit Chopra – Wedbush Securities Inc.

Thanks, guys.

Peter Blackmore

Thanks, Rob.

Operator

Next we will hear from Sanjiv Wadhwani from Stifel Nicolaus.

Sanjiv Wadhwani – Stifel Nicolaus & Company,Inc.

Thanks so much. Peter at the start of the call you sort of gave three reasons for the slightly higher revenue decline than expected, can you sort of a talked about between those three, what – which was the major factor in terms of the larger than expected decline?

Peter Blackmore

The major factor is the and I think they are connected because the regional pattern decline I think it was partly we had a very strong quarter four and didn't quite perform in quarter one as I’ve said a big part of that was driven by the push-out they have to get a lot of their business in the last two weeks of the (inaudible), so their ability to close was obviously not as good as CBW and Blackhawks ability to play. So I think the business is there, because we didn't lose business, so those were the other two factors, and then we've also been trying to educate all of our investors that we are seasonally stronger in quarter four than quarter one, so we have highlighted that a couple of times. We’d obviously like to see the quarter smaller continue to work, I’m doing that, but we do have some seasonality.

Sanjiv Wadhwani – Stifel Nicolaus & Company,Inc.

Got it. Okay. And then Mike last quarter, I know you had a little of a gross margin issue because of pricing obviously you saw gross margins hit higher this quarter up. Any commentary on the pricing environment overall, discounting in general.

Peter Blackmore

Yeah, I mean, it was – pricing was relatively stable. Our discounting trickled up a little bit, but as you saw, it didn’t have effect on our gross margin. Our product gross margins went down a little bit and that was all mostly due to the business going through the bad – heard us about 40 points and obviously we had some other offset on mix and other things that helped us to just to be down 20 basis point.

So it was relatively consistent and you’re right and kind of where we expected that we guided. So no surprises and I mentioned we’re moving to a new switch vendor. So that will hopefully reduce our switch cost a little bit starting going forward in the September quarter.

Sanjiv Wadhwani – Stifel Nicolaus & Company,Inc.

Got it. Okay. And the last question. As we progress through the fiscal 2012, do you think we might be able to get some revenue metrics in the mobility product or is it something that might be coming the following fiscal year, any color over there?

Kevin Gavin

Yeah, I mean I think when it start to become a material piece of our business and two guys have talk about it and give you an indication, but as we discuss it is the slower ramp, I would say our internal projections are relatively modest for the fiscal year, well I do you think fiscal ’13 that will be a much bigger breakout year for mobility, than it would be in ’12. We’re actively going after our installed base as well as new customers.

Sanjiv Wadhwani – Stifel Nicolaus & Company,Inc.

Got it, all right. Thanks very much guys.

Michael E. Healy

Thanks Andy.

Operator

And from Northland Capital, Mike Latimore. Please go ahead.

Mike Latimore – Northland Capital

Thank you in terms of the 20% outlook for the year, what are you assuming kind of your traditional regional base do you see there flat or they grow a little bit. Any kind of color on that, the regional base in that 20% growth outlook?

Peter Blackmore

Yeah, I mean goal that U.S. regional base has to grow since it’s still the majority of our revenue. So there is no assumption that it declined. So it’s important that that base continues to move up and maybe a turn of the base a little bit, as we mentioned. We will have over 200 new partners and some of the older partners may not do so well, but some of the new partners getting them ramped up in selling ShoreTel is one of our key strategic initiatives going on.

Mike Latimore – Northland Capital

Okay.

Peter Blackmore

There may not all the same.

Mike Latimore – Northland Capital

Okay. And then, on the – sometimes you have a major count either as a percent of revenue or your year-over-year growth or something that along those lines. Do you have any kind of stats around major accounts this quarter?

Peter Blackmore

Yeah, major accounts was up a little bit. So it was better than the overall company, nothing hugely material, but at least the major account program was incrementally up quarter-over-quarter.

Mike Latimore – Northland Capital

Then how did, I know this last quarter, was the first quarter where ScanSource is a big part of revenues, how did the kind of quarter end go in terms of closing deals, working through (inaudible) as expected or any changes there?

Michael E. Healy

Yeah, actually, as you remember I'm a little worried about the transition at the beginning of the quarter and any potential destruction and we work very closer with the ScanSource team, and you remember the bulk of the partners just moved over September 1. So when they had kind of one month to work through everything, but it went, I would say extremely well, in terms of transition knowing where we were at the end of the each day and as we are counting down, so I couldn’t have asked for better performance from ScanSource.

Mike Latimore – Northland Capital

And just a last question on, and on the Telco segment, I think you had some comments in prior quarters that maybe some of your Telco partners are doing little more service by themselves or internally has that trend changed at all?

Michael E. Healy

By Telco I think, you mean the service providers, right?

Mike Latimore – Northland Capital

Service providers, yeah.

Michael E. Healy

So that’s AT&T, Qwest, Verizon and Windstream?

Mike Latimore – Northland Capital

Right.

Michael E. Healy

Yeah, some of them are certainly doing more of their own support installation work in support of customers than having us directly. So that is muting the revenue a little bit because they’re taking on more of that challenge. And that has…

Mike Latimore – Northland Capital

Thank you.

Michael E. Healy

Thank you, Mike.

Mike Latimore – Northland Capital

Thanks a lot.

Operator

And next we’ll hear from Lynn Um with Barclays Capital.

Lynn Um – Barclays Capital

Hi, everyone.

Michael E. Healy

Hi, Lynn.

Lynn Um – Barclays Capital

I guess, I just want to touch on the guidance once again for the December quarter, are you assuming any sort of full year end budget cuts that you might see during the quarter?

Michael E. Healy

It’s tough to – it’s impossible to measure that, all right, in terms of companies doing budget flush, and I think as a public company CFO, I don’t buy under that too much, either as a product you do or not do and don’t spend it or lose your mentality, I don’t think too many public company’s CFOs buy under that too much anymore.

But there certainly is – we always see an uptick in the December quarter because its end of the calendar quarter, and fiscal quarter, fiscal year end for a lot of companies. So I do think there is – some of that built into our pipeline, which is – we have a pretty strong pipeline for the quarter, it’s just a matter on how much of that will convert. But to give you a certain percentage of assumption based on that, I just can't do.

Lynn Um – Barclays Capital

Okay. And then on OpEx, you’ve a focus there, and they thought obviously of keeping that under control. I guess if you sort of see the market growth rates fund again that this quarter I guess where would the leverage be in the model, it seems like R&D came down a bit, with the cumulative hiring or us, sales and marketing or how can we think about that?

Michael E. Healy

We said if the market declines a little bit.

Lynn Um – Barclays Capital

If the growth expectation, I think you said last quarter the expectations for the markets go 8% to 10% and you're expecting the market to be a) little bit slower than that but for yourself just well it’s taking 20% growth, would there be leverage there in terms of the OpEx line? If you were to see another downtick in kind of the market growth rates?

Michael E. Healy

Yeah, certainly there is some leverage, and the hiring is what drives a big bulk of our spending, obviously, and as I indicated, we are slowing down on hiring in Q2 a little bit than we did in Q1. There is incentive compensation certainly based on hitting certain internal goals that will fluctuate depending on what we do internally versus our final achievement.

And then, we don’t have too much other variable spending and we just did roll out a mobility brand in advertising campaign that’s just hitting, which – it’s not something you would start and stop. So we want to keep the momentum growing there on mobility. So I would most of leverage would be in headcount hiring more than anywhere else.

Lynn Um – Barclays Capital

Okay. That’s all from me. Thank you.

Peter Blackmore

Thanks, Lin.

Operator

Ladies and gentlemen, that does conclude today’s question portion and our call. We thank you for joining. Have a great day.

Peter Blackmore

Thank you very much everybody. I appreciate you taking the call. I appreciate your interest in the company. Thank you.

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