The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the condensed consolidated financial statements and related notes included elsewhere in this document. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those discussed below. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section entitled “Risk Factors.”
ShoreTel is a leading provider of brilliantly simple business communication solutions, comprised of integrated voice, video, data and mobile applications based on Internet Protocol ("IP") technologies. We focus on the small and medium sized businesses (less than 5,000 users), with a Unified Communications ("UC") platform so that they can communicate anytime, anyplace, and through any device that they chose. Our strategy is to provide customers with a flexible choice of deployment options: either operating our ShoreTel solution in their own premise-based data centers, subscribing to our cloud-based ShoreTel Sky communication services or a hybrid combination of both.
We are headquartered in Sunnyvale, California and have offices located throughout the United States, the United Kingdom, India, Canada, Singapore and Australia. Additionally, our ShoreTel Sky services are provided primarily from our data center in Texas. While most of our customers are located in the United States, we have remained fairly consistent in revenue from international sales, which accounted for approximately 8% and 9% of our total revenue for the three months ended September 30, 2014 and 2013, respectively. We expect sales to customers in the United States will continue to comprise the majority of our sales in the foreseeable future.
In the three months ended September 30, 2014, we continued to grow our market share of the IP telephony market, both in the United States and worldwide. Our total revenue increased to $90.4 million for the three months ended September 30, 2014 from $84.3 million in the three months ended September 30, 2013, driven by sales and services delivered to new customers and add-on sales from existing customers.
Key Business Metrics
We monitor a number of key metrics to help forecast growth, establish budgets, measure the effectiveness of sales and marketing efforts and measure operational effectiveness.
Deferred revenue. Deferred revenue relates to the timing of revenue recognition for specific transactions based on delivery of service, support, specific commitments, product and services delivered to our value-added distributors that have not been delivered or sold through to resellers, and other factors. Deferred revenue primarily consists of billings or payments received in advance of revenue recognition from our transactions and are recognized as the revenue recognition criteria are met. Nearly all of our premise system sales include the purchase of post-contractual support contracts with terms of up to five years, and our renewal rates on these contracts have been high historically. We recognize support revenue on a ratable basis over the term of the support contract. Since we receive payment for support in advance of recognizing the related revenue, we carry a deferred revenue balance on our consolidated balance sheet. Almost all of our hosted services are billed a month in advance. Billings that are collected before the service is delivered are included in the deferred revenue balance on our consolidated balance sheet. These amounts are recognized as revenue as the services are delivered. Our deferred revenue balance at September 30, 2014 was $67.2 million, of which $49.6 million is expected to be recognized within one year.
Gross margin. Our gross margins for products are primarily affected by our ability to reduce hardware costs faster than the decline in average overall system sales prices. We strive to increase our product gross margin by reducing hardware costs through product redesign and volume discount pricing from our suppliers. In general, product gross margin on our switches is greater than product gross margin on our IP phones. We consider our ability to monitor and manage these factors to be a key aspect of maintaining product gross margins and increasing our profitability.
Gross margin for support and services is impacted primarily by labor-related expenses. The primary goal of our support and services function is to ensure a high level of customer satisfaction and our investments in support personnel and infrastructure are made with this goal in mind. We expect that as our installed enterprise customer base grows, we may be able to slightly improve gross margin for support and services through economies of scale. However, the timing of additional investments in our support and services infrastructure could materially affect our cost of support and services revenue, both in absolute dollars and as a percentage of support and services revenue and total revenue, in any particular period.
Gross margin for hosted and related services is lower than the gross margins for support and services and product and is impacted primarily by the reselling of broadband costs to customers, employee-related expense, data communication cost, carrier cost, telecom taxes, and intangible asset amortization expense. We expect that with the growth in customer base, the gross margins may reflect improvement due to synergies and other cost reductions in our service delivery platform.
Operating expense. Our operating expenses are comprised primarily of compensation and benefits for our employees. Accordingly, increases in operating expenses historically have been primarily related to increases in our headcount. We intend to expand our workforce as we grow, and therefore, our ability to forecast revenue is critical to managing our operating expenses.
Average revenue per user. We calculate the monthly average service revenue per user (“ARPU”) for our hosted and related services revenue as the average monthly recurring revenue per customer divided by the average number of seats per customer. The average monthly recurring revenue per customer is calculated as the monthly recurring service revenue from customers in the period, divided by the simple average number of business customers during the period. Our ARPU includes telecommunication internet circuits that we resell that could, as a percentage of our business, decline over time as our average customer size increases and therefore they are more likely to have their own networks already established. Our monthly ARPU for the three months ended September 30, 2014 was approximately $45 as compared to $47 for the three months ended September 30, 2013. The decrease in ARPU was primarily due to a greater number of volume discounts related to increased sales to larger enterprise customers and a decrease in the resale of internet circuits to new customers as compared to the existing customer base.
Revenue churn. Revenue churn for our hosted and related services revenue is calculated by dividing the monthly recurring revenue from customers that have terminated during a period by the simple average of the total monthly recurring revenue from all customers in a given period. The effective management of the revenue churn is critical to our ability to maximize revenue growth and to maintain and improve margins. Our annualized revenue churn for customers that have terminated services for the three months ended September 30, 2014 was approximately 2% as compared to 4% for the three months ended September 30, 2013.
Basis of Presentation
Revenue. We derive our revenue from sales of our premise IP telecommunications systems and related support and services as well as hosted services.
Product revenue. Product revenue consists of sales of our business communication systems. Our typical system includes a combination of IP phones, switches and software applications primarily for our premise-based solutions. We sell our products through channel partners that include resellers and value-added distributors. Prices to a given channel partner for hardware and software products depend on that channel partner's volume and other criteria, as well as our own strategic considerations. Product revenue has accounted for 53% and 56% of our total revenue for the three months ended September 30, 2014 and 2013, respectively.
Support and services revenue. Support and services revenue primarily consists of post-contractual support, and to a lesser extent revenue from training services, professional services and installations that we perform. Post-contractual support includes software updates which grant rights to unspecified software license upgrades and maintenance releases issued during the support period. Post-contractual support also includes both Internet- and phone-based technical support. Revenue from post-contractual support is recognized ratably over the contractual service period. Support and services revenues accounted for 20% and 19% of our total revenue for the three months ended September 30, 2014 and 2013, respectively.
Hosted and related services revenue. Hosted and related services and solutions consist primarily of our proprietary hosted VoIP Unified Communications system as well as other services such as foreign and domestic calling plans, certain UC applications, internet service provisioning, training and other professional services. Our hosted and related services are sold through indirect channel resellers and a direct sales force. Our customers typically enter into 12 month service agreements whereby they are billed for such services on a monthly basis. Revenue from our hosted and related services is recognized on a monthly basis as services are delivered. Revenue associated with various calling plans and internet services are recognized as such services are provided. Hosted and related services revenues accounted for 27% and 25% of our total revenue for the three months ended September 30, 2014 and 2013, respectively.
Cost of revenue. Cost of product revenue consists primarily of hardware costs, royalties and license fees for third-party software included in our systems, salary and related overhead costs of operations personnel, freight, warranty costs and provision for excess inventory. The majority of these costs vary with the unit volumes of products sold. Cost of support and services revenue consists of salary and related overhead costs of personnel engaged in support and service activities including our technical assistance center ("TAC"). Cost of hosted and related services revenue consists of personnel and related costs of the hosted services, data center costs, data communication cost, carrier cost and amortization of intangible assets.
Research and development expenses. Research and development expenses primarily include personnel costs, outside engineering costs, professional services, prototype costs, test equipment, software usage fees and facilities expenses. Research and development expenses are recognized when incurred. We have capitalized software development costs incurred during the period from the date of determination of technological feasibility through the date of general release of the product to customers. We are devoting substantial resources to the development of additional functionality for existing products and the development of new products and related software applications. We intend to continue to make investments in our research and development efforts because we believe they are essential to maintaining and improving our competitive position.
Sales and marketing expenses. Sales and marketing expenses primarily include personnel costs, sales commissions, travel, marketing promotional and lead generation programs, branding and advertising, trade shows, sales demonstration equipment, professional services fees, amortization of intangible assets, and facilities expenses. We plan to continue to invest in development of our distribution channel by increasing the size of our field sales force to enable us to expand into new geographies and further increase our sales to enterprise customers. We plan to continue investing in our domestic and international marketing activities to help build brand awareness and create sales leads for our channel partners. We expect that sales and marketing expenses will be our largest operating expense category.
General and administrative expenses. General and administrative expenses primarily relate to our executive, finance, human resources, legal and information technology organizations. General and administrative expenses primarily consist of personnel costs, professional fees for legal, board of directors' costs, accounting, tax, compliance and information systems, travel, recruiting expense, depreciation expense and facilities expenses. We expect that our general and administrative expense will increase during the second fiscal quarter as we have incurred additional professional services fees in connection with an unsolicited acquisition proposal.
Interest expense. Interest expense primarily consists of interest expense on our debt as well as other miscellaneous items affecting our operating results.
Interest income and other (expense). Interest income and other (expense) primarily consists of interest earned on cash, cash equivalents and short-term investments, gains and losses on foreign currency translations and transactions as other miscellaneous items affecting our operating results.
Provision for (benefit from) income taxes. Provision for (benefit from) income taxes includes federal, state and foreign tax on our income as well as any adjustments made to our valuation allowance for deferred tax assets. Since our inception, we have accumulated substantial net operating loss and tax credit carryforwards. We account for income taxes under an asset and liability approach. Deferred income taxes reflect the impact of temporary differences between assets and liabilities recognized for financial reporting purposes and such amounts recognized for income tax reporting purposes, net operating loss carryforwards and other tax credits measured by applying current enacted tax laws. Valuation allowances are provided when necessary to reduce deferred tax assets to an amount that is more likely than not to be realized.
Critical Accounting Policies and Estimates
The preparation of our financial statements and related disclosures in conformity with generally accepted accounting principles in the United States of America, or GAAP, requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. These estimates and assumptions are based on historical experience and various other factors that we believe are reasonable under the circumstances. We consider our accounting policies related to revenue recognition, stock-based compensation, goodwill and purchased-intangible assets and accounting for income taxes to be critical accounting policies. A number of significant estimates, assumptions, and judgments are inherent in our determination of when to recognize revenue, how to estimate the best evidence of selling price for revenue recognition, the calculation of stock-based compensation expense, evaluation of the potential impairment of goodwill and purchased-intangible assets and the income tax related balances. We base our estimates and judgments on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ materially from these estimates. Management believes there have been no significant changes during the three months ended September 30, 2014 to the items that we disclosed as our critical accounting policies and estimates in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our 2014 Annual Report on Form 10-K filed with the Securities and Exchange Commission. For a description of those accounting policies, please refer to our 2014 Annual Report on Form 10-K.
Results of Operations
The following table sets forth unaudited selected condensed consolidated statements of operations data for the three months ended September 30, 2014 and 2013 (in thousands, except per share amounts):
| | | Three Months Ended September 30, | |
| | | 2014 | | | 2013 | |
| Revenue: | | | | | | |
| Product | | $ | 47,707 | | | $ | 47,682 | |
| Hosted and related services | | | 24,891 | | | | 20,739 | |
| Support and services | | | 17,833 | | | | 15,866 | |
| Total revenue | | | 90,431 | | | | 84,287 | |
| Cost of revenue: | | | | | | | | |
| Product | | | 16,779 | | | | 16,296 | |
| Hosted and related services | | | 15,593 | | | | 12,533 | |
| Support and services | | | 4,281 | | | | 4,282 | |
| Total cost of revenue | | | 36,653 | | | | 33,111 | |
| Gross profit | | | 53,778 | | | | 51,176 | |
| Operating expenses: | | | | | | | | |
| Research and development | | | 13,661 | | | | 13,280 | |
| Sales and marketing | | | 29,016 | | | | 27,666 | |
| General and administrative | | | 9,991 | | | | 10,629 | |
| Total operating expenses | | | 52,668 | | | | 51,575 | |
| Income (loss) from operations | | | 1,110 | | | | (399 | ) |
| Other income (expense): | | | | | | | | |
| Interest expense | | | (152 | ) | | | (287 | ) |
| Interest income and other (expense), net | | | (214 | ) | | | (140 | ) |
| Total other expense | | | (366 | ) | | | (427 | ) |
| Income (loss) before provision for income tax | | | 744 | | | | (826 | ) |
| Provision for income tax | | | 378 | | | | 209 | |
| Net income (loss) | | $ | 366 | | | $ | (1,035 | ) |
| Net income (loss) per share - basic | | $ | 0.01 | | | $ | (0.02 | ) |
| Net income (loss) per share - diluted | | $ | 0.01 | | | $ | (0.02 | ) |
| Shares used in computing net income (loss) per share - basic | | | 62,967 | | | | 59,543 | |
| Shares used in computing net income (loss) per share - diluted | | | 64,571 | | | | 59,543 | |
The following table sets forth selected condensed consolidated statements of operations data as a percentage of total revenue for each of the periods indicated.
| | | Three Months Ended September 30, | |
| | | 2014 | | | 2013 | |
| Revenue: | | | | | | |
| Product | | | 53 | % | | | 56 | % |
| Hosted and related services | | | 27 | % | | | 25 | % |
| Support and services | | | 20 | % | | | 19 | % |
| Total revenue | | | 100 | % | | | 100 | % |
| Cost of revenue: | | | | | | | | |
| Product | | | 19 | % | | | 19 | % |
| Hosted and related services | | | 17 | % | | | 15 | % |
| Support and services | | | 5 | % | | | 5 | % |
| Total cost of revenue | | | 41 | % | | | 39 | % |
| Gross profit | | | 59 | % | | | 61 | % |
| Operating expenses: | | | | | | | | |
| Research and development | | | 15 | % | | | 16 | % |
| Sales and marketing | | | 32 | % | | | 33 | % |
| General and administrative | | | 11 | % | | | 12 | % |
| Total operating expenses | | | 58 | % | | | 61 | % |
| Income (loss) from operations | | | 1 | % | | | - | |
| Other income (expense): | | | | | | | | |
| Interest expense | | | - | | | | (1 | %) |
| Interest income and other (expense), net | | | - | | | | - | |
| Total other expense | | | - | | | | (1 | %) |
| Income (Loss) before provision for income tax | | | 1 | % | | | (1 | %) |
| Provision for income tax | | | - | | | | - | |
| Net income (loss) | | | 1 | % | | | (1 | %) |
Comparison of the three months ended September 30, 2014 and September 30, 2013
Revenue.
| | | Three Months Ended September 30, | |
| | | 2014 | | | 2013 | | | Change $ | | | Change % | |
| (in thousands, except percentages) | | | | | | | | | | | | |
| Product revenue | | $ | 47,707 | | | $ | 47,682 | | | $ | 25 | | | | - | |
| Hosted and related services revenue | | | 24,891 | | | | 20,739 | | | | 4,152 | | | | 20 | % |
| Support and services revenue | | | 17,833 | | | | 15,866 | | | | 1,967 | | | | 12 | % |
| Total revenue | | $ | 90,431 | | | $ | 84,287 | | | $ | 6,144 | | | | 7 | % |
Total revenue increased by $6.1 million or 7% in the three months ended September 30, 2014 as compared to the three months ended September 30, 2013.
Product revenue
Product revenue remained consistent at $47.7 million during both the three months ended September 30, 2014 and 2013.
Hosted and related services revenue
Hosted and related services revenue increased by $4.2 million or 20% in the three months ended September 30, 2014 as compared to the same period in the prior year. The increase in hosted and related services revenue was primarily due to continued growth in our customer and partner base, increase in our non-recurring revenue such as installation fees and usage based telecommunications charges as well as additional increases in the use of our services from existing customers.
Support and services revenue
Support and services revenue increased by $2.0 million or 12% in the three months ended September 30, 2014 as compared to the same period in the prior year. The increase in support and services revenue was primarily due to high renewal rates on maintenance contracts, increases in professional services revenue as well, as the continued expansion of our customer base resulting from sales to new customers who entered into post-contractual support agreements.
Cost of revenue and gross profit.
| | | Three Months Ended September 30, | |
| | | 2014 | | | 2013 | | | Change $ | | | Change % | |
| (in thousands, except percentages) | | | | | | | | | | | | |
| Product cost of revenue | | $ | 16,779 | | | $ | 16,296 | | | $ | 483 | | | | 3 | % |
| Hosted and related services cost of revenue | | | 15,593 | | | | 12,533 | | | | 3,060 | | | | 24 | % |
| Support and services cost of revenue | | | 4,281 | | | | 4,282 | | | | (1 | ) | | | 0 | % |
| Total cost of revenue | | $ | 36,653 | | | $ | 33,111 | | | $ | 3,542 | | | | 11 | % |
| | | | | | | | | | | | | | | | | |
| Product gross profit | | $ | 30,928 | | | $ | 31,386 | | | $ | (458 | ) | | | (1 | %) |
| Hosted and related services gross profit | | | 9,298 | | | | 8,206 | | | | 1,092 | | | | 13 | % |
| Support and services gross profit | | | 13,552 | | | | 11,584 | | | | 1,968 | | | | 17 | % |
| Total gross profit | | $ | 53,778 | | | $ | 51,176 | | | $ | 2,602 | | | | 5 | % |
| | | | | | | | | | | | | | | | | |
| Product gross margin | | | 65 | % | | | 66 | % | | | n/ | a | | | (1 | %) |
| Hosted and related services gross margin | | | 37 | % | | | 40 | % | | | n/ | a | | | (2 | %) |
| Support and services gross margin | | | 76 | % | | | 73 | % | | | n/ | a | | | 3 | % |
| Total gross margin | | | 59 | % | | | 61 | % | | | n/ | a | | | (2 | %) |
The overall gross margin was 59% for the three months ended September 30, 2014 compared to 61% for the same period in the prior year.
Product Gross Margin
Product gross margins remained fairly consistent at 65% in the three months ended September 30, 2014 as compared to 66% in the same period in the prior year
Hosted and Related Services Gross Margin
Hosted and related service gross margin decreased to 37% in the three months ended September 30, 2014 as compared to 40% in the same period in the prior year primarily due to increased regulatory fees and increased redundant facility costs as part of the consolidation and relocation of our data centers. As the related hosted business continues to expand and grow, we anticipate that we will realize improvements in our gross margins as we achieve synergies and other cost reductions in our service delivery platform.
Our hosted business service offering includes cost elements that are unique to the hosted service offering which in turn, impacts the overall hosted service and related services gross margins. Specifically, as part of our hosted service offering, we provide our customers unlimited domestic calling plans and internet service plans. To provide calling services, we purchase and resell minutes and calling plans from various national and regional telecommunication carriers. Additionally, we purchase and resell telecommunications circuits from various local and national internet service providers as a service to our customers. As a result of reselling calling plans, telecommunications circuits and providing internet data plans to our customers, we incur various regulatory charges. In addition, the hosted gross margin is impacted by the amortization of intangible assets related to the acquisition of M5 Networks.
Upon completion of our acquisition of M5 Networks, we have undertaken and plan to undertake several initiatives to create greater efficiencies in the delivery of our hosted services. These initiatives include:
| · | Consolidation of data centers; |
| · | Integration to common IP phones; |
| · | Integration of our customer support services teams; |
| · | Development of our next generation products. |
While we believe that through the execution of these initiatives we will improve our gross margins over time, due to the nature of the unique costs identified above and the overall timing to execute our gross margin improvement initiatives, we do not anticipate that gross margins for our hosted and related services will be commensurate with that of premise business in the short term.
Support and Services Gross Margin
Support and services gross margins increased to 76% in the three months ended September 30, 2014 as compared to 73% in the same period in the prior year. This increase was driven by synergies achieved by existing headcount which allowed lower personnel costs to support a larger customer base and generate a higher revenue amount from the same period in the prior year.
Operating expenses.
| | | Three Months Ended September 30, | |
| | | 2014 | | | 2013 | | | Change $ | | | Change % | |
| (in thousands, except percentages) | | | | | | | | | | | | |
| Research and development | | $ | 13,661 | | | $ | 13,280 | | | $ | 381 | | | | 3 | % |
| Sales and marketing | | | 29,016 | | | | 27,666 | | | | 1,350 | | | | 5 | % |
| General and administration | | | 9,991 | | | | 10,629 | | | | (638 | ) | | | (6 | %) |
Research and development. Research and development expenses increased by $0.4 million, or 3%, during the three months ended September 30, 2014 as compared to the same period in the prior year. The increase in research and development expenses from the prior period is primarily due to an increase in equipment related costs of $0.2 million.
Sales and marketing. Sales and marketing expenses increased by $1.4 million, or 5%, in the three months ended September 30, 2014 as compared to the same period in the prior year. This increase in sales and marketing expenses is primarily due to an increase in personnel related costs including benefits, bonus and commissions of $1.2 million due to an increase in headcount and an increase in marketing event expenses of $0.5 million.
General and administrative. General and administrative expenses decreased by $0.6 million, or 6%, in the three months ended September 30, 2014 as compared to the same period in the prior year. The decrease in general and administrative expenses from the prior period is primarily due to a decrease in personnel related costs of $0.9 million, a decrease in sales tax expense of $0.4 million and a decrease in equipment related costs of $0.3 million, partially offset by an increase in the professional fees of $1.0 million.
Other income (expense), net.
| | | Three Months Ended September 30, | |
| | | 2014 | | | 2013 | | | Change $ | | | Change % | |
| (in thousands, except percentages) | | | | | | | | | | | | |
| Interest expense | | | (152 | ) | | | (287 | ) | | | (135 | ) | | | (47 | %) |
| Interest income and other (expense), net | | | (214 | ) | | | (140 | ) | | | 74 | | | | 53 | % |
Interest expense. Interest expense decreased by $0.1 million or 47% in the three months ended September 30, 2014 as compared to the same period in the prior year primarily due to lower outstanding borrowings under our line of credit agreement during the three months ended September 30, 2014 as compared to the three months ended September 30 2013.
Interest income and other (expense), net. Interest income and other (expense), net, increased by $0.1 million or 53% in the three months ended September 30, 2014 compared to the same period in the prior year primarily as a result of an increase in our foreign exchange loss due to the weakening of certain foreign currencies in which we transact against the US dollar.
Provision for income tax.
| | | Three Months Ended September 30, | |
| | | 2014 | | | 2013 | | | Change $ | | | Change % | |
| (in thousands, except percentages) | | | | | | | | | | | | |
| Provision for income tax | | $ | 378 | | | $ | 209 | | | $ | 169 | | | | 81 | % |
Provision for income tax. The provision for income taxes for the three months ended September 30, 2014 and 2013 is primarily related to federal Alternative Minimum Tax, state and foreign income tax expense.
Liquidity and Capital Resources
Balance Sheet and Cash Flows
The following table summarizes our cash, cash equivalents and short-term investments (in thousands):
| | | September 30, 2014 | | | June 30, 2014 | | | Increase/ (Decrease) | |
| Cash and cash equivalents | | $ | 57,283 | | | $ | 53,472 | | | $ | 3,811 | |
| Short-term investments | | | 5,399 | | | | 2,673 | | | | 2,726 | |
| Total | | $ | 62,682 | | | $ | 56,145 | | | $ | 6,537 | |
As of September 30, 2014, our principal sources of liquidity consisted of cash, cash equivalents and short-term investments of $62.7 million, accounts receivable of $27.6 million and the balance of $50.0 million available for borrowing under our Credit Facility.
On March 15, 2012, we entered into a secured credit agreement (the “Credit Facility”). The Credit Facility was amended on December 4, 2012 and again on June 2, 2014. The Credit Facility includes a revolving loan facility for an aggregate principal amount not exceeding $50.0 million. The Credit Facility matures on the fifth anniversary of its closing (March 15, 2017) and is payable in full upon maturity. As of September 30, 2014, no amounts were outstanding under the Credit Facility.
On October 22, 2014, we entered into an Amended and Restated Credit Agreement (“New Credit Facility”) which provides for a revolving loan facility for an aggregate principal amount not exceeding $100.0 million. The New Credit Facility amended and restated the prior Credit Facility. The New Credit Facility matures on the fifth anniversary of its closing (October 22, 2019) and is payable in full upon maturity. The amounts borrowed and repaid under the New Credit Facility are available for future borrowings. The Credit Facility contains customary representations and warranties and affirmative and negative covenants.
The borrowings under the New Credit Facility accrue interest either (at our election) at (i) the London interbank offered rate then in effect, plus a margin of between 1.50% and 2.25%, which is based on our consolidated EBITDA (as defined in the Credit Facility), or (ii) the higher of (a) the bank’s publicly-announced prime rate then in effect and (b) the federal funds rate plus 0.50%, in each case of (a) or (b), plus a margin of between 0.00% and 0.50%, which will be based upon our consolidated EBITDA. We also pay annual commitment fees during the term of the New Credit Facility which varies depending on our consolidated EBITDA. The New Credit Facility is secured by substantially all of our assets.
Historically, our principal uses of cash have consisted of the purchase of finished goods inventory from our contract manufacturers, payroll and other operating expenses related to the development and marketing of our new products, purchases of property and equipment and acquisitions.
Our future capital requirements will depend on many factors, including our rate of revenue growth, the expansion of our sales and marketing activities, the addition of new business initiatives, the timing and extent of our expansion into new territories, the timing of introductions of new products and enhancements to existing products, the continuing market acceptance of our products and acquisition and licensing activities. We may enter into agreements relating to potential investments in, or acquisitions of, complementary businesses or technologies in the future, which could also require us to seek additional equity or debt financing. If needed, additional funds may not be available on terms favorable to us or at all. We believe that the available amounts under the line of credit together with our cash flows from our operations will be sufficient to fund our operating requirements for at least the next twelve months.
The following table shows our cash flows from operating activities, investing activities and financing activities for the stated periods (in thousands):
| | | Three Months Ended September 30, | |
| | | 2014 | | | 2013 | |
| Cash provided by operating activities | | $ | 11,110 | | | $ | 14,238 | |
| Cash provided by (used in) investing activities | | | (6,574 | ) | | | 314 | |
| Cash used in financing activities | | | (725 | ) | | | (8,472 | ) |
| Net increase in cash and cash equivalents | | $ | 3,811 | | | $ | 6,080 | |
Cash flows from operating activities
Net income (loss) during the three months ended September 30, 2014 and 2013 included non-cash charges of $2.5 million and $2.1 million in stock-based compensation expense, respectively, and depreciation and amortization of $5.0 million and $4.3 million, respectively.
Cash provided by operating activities of $11.1 million during the three months ended September 30, 2014 reflects net changes in operating assets and liabilities, which provided $3.2 million of cash consisting primarily of a decrease in accounts receivable of $6.1 million due to improved collections, a decrease in inventories of $2.3 million, an increase in deferred revenue of $2.7 million and an increase in accrue and other liabilities of $1.7 million. These cash inflows were partially offset by an increase in prepaid expenses and other current assets of $2.8 million, a decrease in accounts payable of $3.2 million, a decrease in accrued employee compensation of $2.8 million and a decrease in accrued and taxes and surcharges of $0.8 million.
Cash provided by operating activities of $14.3 million during the three months ended September 30, 2013 also reflects net changes in operating assets and liabilities, which provided $8.4 million of cash consisting primarily of a decrease in accounts receivable of $6.0 million due to improved collections, a decrease in inventory of $1.1 million, an increase in accounts payable of $3.2 million and an increase in deferred revenue of $2.4 million. These cash inflows were partially offset by an increase in indemnification asset of $0.3 million, a decrease in accrued and other liabilities of $2.1 million, a decrease in accrued employee compensation of $1.2 million and a decrease in accrued taxes and surcharges of $0.7 million.
Cash flows from investing activities
We have classified our investment portfolio as “available for sale,” and our investments are made with a policy of capital preservation and liquidity as the primary objectives. We may hold investments to maturity; however, we may sell an investment at any time if the quality rating of the investment declines, the yield on the investment is no longer attractive or we are in need of cash.
Net cash used in investing activities was $6.6 million during the three months ended September 30, 2014 primarily related to the purchase of short-term investments of $4.2 million, the purchase of property and equipment of $3.3 million and the purchases of patents, technology and internally developed software of $0.6 million, offset by $1.5 million in proceeds from maturities of our short term investments.
Net cash provided by investing activities was $0.3 million during the three months ended September 30, 2013 primarily related to the maturities of short-term investments of $1.4 million, offset by purchase of property and equipment of $1.0 million.
Cash flows from financing activities
Net cash used in financing activities was $0.7 million for the three months ended September 30, 2014. In the three months ended September 30, 2014, we paid $0.8 million associated with employee tax obligations on the vesting of restricted stock units and paid $0.2 million in relation to our capital leases, offset by the receipt of $0.3 million from the exercise of stock options.
Net cash used in financing activities was $8.5 million for the three months ended September 30, 2013. In the three months ended September 30, 2013, we made repayments of $11.0 million under our Credit Facility, paid $0.4 million associated with employee tax obligations on the vesting of restricted stock units, paid $0.4 million in relation to our capital leases, offset by the receipt of $3.3 million from the exercise of stock options.
Off-Balance Sheet Arrangements
We do not have any material off-balance sheet arrangements (other than those disclosed below within the Contractual obligations and commitments section) nor do we have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which are established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
Contractual obligations and commitments
The following table summarizes our contractual obligations as of September 30, 2014 and the effect that such obligations are expected to have on our liquidity and cash flows in future periods:
| | | Payments Due by Period | |
| (In thousands) | | Total | | | Less Than 1 Year | | | 1-3 Years | | | 3-5 Years | | | Thereafter | |
| Operating lease obligations | | $ | 29,694 | | | $ | 5,828 | | | $ | 11,493 | | | $ | 10,258 | | | $ | 2,115 | |
| Capital lease obligations | | | 235 | | | | 191 | | | | 44 | | | | - | | | | - | |
| Line of credit | | | - | | | | - | | | | - | | | | - | | | | - | |
| Non-cancellable purchase commitments (inventory and software licenses) | | | 16,593 | | | | 16,230 | | | | 363 | | | | - | | | | - | |
| Outstanding letters of credit | | | 635 | | | | 635 | | | | - | | | | - | | | | - | |
| Total | | $ | 47,157 | | | $ | 22,884 | | | $ | 11,900 | | | $ | 10,258 | | | $ | 2,115 | |
| ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
In the normal course of our business, we are exposed to foreign currency exchange rate risk inherent in conducting business globally in foreign currencies. We are primarily exposed to foreign currency fluctuations related to collections from accounts receivable balances and cash in banks that are denominated in the Australian dollar, British pound and the Euro. We use relatively short-term foreign currency forward contracts to minimize the risk associated with the foreign exchange effects of the losses and gains of the related foreign currency denominated exposures. We recognize the gains and losses on foreign currency forward contracts in the same period as the losses and gains of the related foreign currency denominated exposures. The gains and losses on foreign exchange contracts mitigate the effect of currency movements on our cash and accounts receivable balances. As of September 30, 2014, a 10% change in the applicable foreign exchange rates would result in an increase or decrease in our pretax earnings of approximately $0.6 million.
We do not have any material changes in the market risk and the interest rate risk disclosure included in the “Quantitative and Qualitative Disclosures About Market Risk” in Item 7A of Part II of our Annual Report on Form 10-K, for the fiscal year ended June 30, 2014.
| ITEM 4. | CONTROLS AND PROCEDURES |
Disclosure Controls and Procedures. Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, our disclosure controls and procedures were effective.
Internal Control Over Financial Reporting. There have not been any changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II: OTHER INFORMATION
See Note 12 to the Financial Statements.
There were no material changes in our risk factors as described in “Part I, Item 1A. Risk Factors” of our Annual Report on Form 10-K, for the fiscal year ended June 30, 2014.
| ITEM 2. | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS |
None.
| ITEM 3. | DEFAULTS UPON SENIOR SECURITIES |
None.
| ITEM 4. | MINE SAFETY DISCLOSURES |
Not applicable.
Not applicable.
See Index to Exhibits following the signature page to this Form 10-Q, which is incorporated by reference herein.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Date: November 7, 2014
| | ShoreTel, Inc. |
| | | |
| | By: | /s/ MICHAEL E. HEALY |
| | | Michael E. Healy Chief Financial Officer (Principal Accounting and Financial Officer) |
Exhibit Number | Exhibit Title |
| | |
| 3.1 | Fourth Amended and Restated Bylaws of the Company (incorporated by reference to the Company’s Form 8-K filed on September 15, 2014). |
| | |
| Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer. |
| | |
| Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer. |
| | |
| Section 1350 Certification of Chief Executive Officer. |
| | |
| Section 1350 Certification of Chief Financial Officer. |
| | |
101.INS | XBRL Instance Document |
| | |
| 101.SCH | XBRL Taxonomy Extension Schema |
| | |
| 101.CAL | XBRL Taxonomy Extension Calculation Linkbase |
| | |
101.DEF | XBRL Taxonomy Extension Definition Linkbase |
| | |
| 101.LAB | XBRL Taxonomy Extension Label Linkbase |
| | |
| 101.PRE | XBRL Taxonomy Extension Presentation Linkbase |
| + | Management Compensatory Plan or Arrangement |
| (1) | This certification accompanying this report pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 is not deemed filed with the Securities and Exchange Commission and is not to be incorporated by reference into any filing of the Company under the Securities Act of 1933 or the Securities Exchange Act of 1934 (whether made before or after the date of the Report), irrespective of any general incorporation language contained in such filing. |
