ShoreTel, Inc.
ShoreTel Inc (Form: 10-K, Received: 09/12/2011 17:04:34)


UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Form 10-K
 
 
þ
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the year ended June 30, 2011
 
or
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
Commission file number: 001-33506
 
SHORETEL, INC.
 
(Exact name of Registrant as specified in its charter)
 
Delaware
3661
77-0443568
(State or other jurisdiction of
(Primary standard
(I.R.S. employer
incorporation or organization)
industrial code number)
identification no.)
 
960 Stewart Drive
Sunnyvale, CA 94085-3913
(408) 331-3300
(Address, including zip code, and telephone number, including area code, of Registrant’s principal executive offices)
 
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, $0.001 par value.
Securities registered pursuant to Section 12(g) of the Act:
None
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o No þ
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ
 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-Kor any amendment to this Form 10-K/A. þ
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act (Check one):
 
 
Large accelerated filer o
Accelerated Filer þ
 
Non-accelerated filer o
Smaller reporting company o
 
(do not check if a smaller reporting company)
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No þ
 
The aggregate market value of the voting stock held by non-affiliates of the registrant as of December 31, 2010 was approximately $182.7 million (based on the last reported sale price of $7.87 on December 31, 2010 on The NASDAQ Global Select Market). This calculation does not reflect a determination that persons are affiliates for any other purposes. Shares of stock held by ten percent stockholders have been excluded from this calculation as they may be deemed affiliates.
 
The number of shares outstanding of the registrant’s common stock as of September 1, 2011 was 47,592,489.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
Part III incorporates by reference certain information from the Registrant’s definitive proxy statement (the “2011 Proxy Statement”) for the 2011 Annual Meeting of Stockholders.



 
 

 

TABLE OF CONTEN TS
 
   
Page
     
PART I
     
Item 1
  3
Item 1A
  12
Item 1B
  27
Item 2
  27
Item 3
  27
Item 4 Reserved   27
Item 5
  27
     
PART II
     
Item 6
  31
Item 7
  32
Item 7A
  47
Item 8
  48
Item 9
  71
Item 9A
  72
Item 9B
  74
     
PART III
Item 10
  74
Item 11
  74
Item 12
  74
Item 13
  74
Item 14
  74
     
PART IV
Item 15
  74
    75

 
- 1 -


TRADEMARKS
 
The ShoreTel logo, ShoreTel, ShoreCare, ShoreGear, ShorePhone, ShoreWare, Brilliantly Simple, Brilliantly Simple Communication,   Agito Networks, Dual Persona and RoamAnywhere are trademarks or registered trademarks of ShoreTel, Inc. in the United States and/or other countries. All other trademarks, trade names and service marks herein are the property of their respective owners.
 
AVAILABLE INFORMATION
 
Our Internet address is www.shoretel.com. On our Internet website, we make publicly available free of charge our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission.
 
In addition, the public may read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at http://www.sec.gov.
 
The charters of our Audit Committee, our Compensation Committee and our Corporate Governance and Nominating Committee, as well as our Code of Business Conduct and Ethics, are available on the Investor Relations section of our website under “Corporate Governance.” This information is also available by writing to us at the address on the cover of this Annual Report on Form 10-K.
 
 
 
- 2 -


This report contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements relate to expectations concerning matters that are not historical facts. Words such as “projects,” “believes,” “anticipates,” “plans,” “expects,” “intends” and similar words and expressions are intended to identify forward-looking statements. While we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot assure you that those expectations will prove to be correct. Important factors that could cause our actual results to differ materially from those expectations are disclosed in this report, including, without limitation, in the “Risk Factors” described in Part I, Item 1A. All forward-looking statements are expressly qualified in their entirety by these factors and all related cautionary statements. We do not undertake any obligation to update any forward-looking statements.
 
ITEM 1.
BUSIN ES S
 
Overview
 
We are a leading provider of brilliantly simple business communication solutions. Our Unified Communications (UC) and Contact Center solutions are based on our award-winning Internet Protocol (IP) business phone system (IP-PBX). We offer organizations of all sizes integrated voice, video, data and mobile communications on an open, distributed IP architecture and switch-based hardware platform which enable multi-site enterprises to be served by a single system. Our solutions enable a single point of management, easy installation and a high degree of scalability and reliability.  They also provide end-users with a consistent, full suite of features across the enterprise, regardless of location, which helps IT management meet growing demands for powerful communication capabilities. As a result, we believe our solutions enable enhanced end-user productivity and provide lower total cost of ownership and higher customer satisfaction than alternative systems.
 
Our business communication solutions are comprised of hardware and software components including ShoreTel Voice Switches, ShoreTel IP Phones, ShoreTel Appliances and ShoreTel Software Applications for system management and user interfaces. The mobility component of our UC solution is comprised of an appliance coupled with system management and end-user software.  Our mobility offering is platform agnostic in that it works with the ShoreTel IP-PBX but also works across several leading IP-PBXs and UC systems on the market today, including Cisco, Avaya, Mitel, and Microsoft Lync. Our mobility enterprise customers include multi-site Fortune 500 companies. As of June 30, 2011, we had sold our IP phone system with integrated unified communications and contact center capabilities to approximately 18,000 enterprise customers. We sell our solutions through our extensive network of over 900 distributors and resellers.
 
We have achieved broad industry recognition for our technology and high customer satisfaction. We have won the “best overall” CustomerSat Achievement award (ACE) for three years in a row. For the last eight years, IT executives surveyed by Nemertes Research, an independent research firm, have rated ShoreTel the Best IP Telephony Provider.
 
We were originally incorporated in California in September 1996, and reincorporated in Delaware in June 2007. ShoreTel is based in Sunnyvale, California, and has regional offices in Austin, Texas; Maidenhead, United Kingdom; Sydney, Australia; and Singapore.
 
Products
 
We provide business communication solutions for the enterprise. Our solutions are based on our distributed software architecture and appliance-based hardware platform that enable a single system to serve multi-site enterprises. This architecture provides high network reliability and allows for a single view for management and administration across all sites of a multi-site enterprise. System administrators can make changes anywhere throughout the system through a Web-browser interface that presents a user-friendly view of the system’s configuration. Our architecture also provides end-users with a consistent and full set of features across an enterprise, regardless of location.
 
We introduced our first suite of products in 1998 and have continued to add features and functionality since then. We offer an IP phone system with integrated unified communications (including mobility) and contact center capabilities. We also offer the mobility component of our UC solution on a stand-alone basis to businesses without a ShoreTel IP-PBX platform. Our solutions are composed of hardware and software components including ShoreTel Voice Switches, ShoreTel IP Phones, ShoreTel Software applications encompassing system management and end-user applications. As new software versions of our solutions have been released, existing enterprise customers have been able to upgrade their switches, phones and applications, allowing them to preserve their ShoreTel investment.
 
 
IP Phone System
 
The ShoreTel IP Phone system provides call routing, voice processing, messaging, voice conferencing, and other core voice services for business communications. Our solution contains several advanced UC features that we include without additional cost, including a desktop client and unified messaging features.
 
 
·
ShoreTel IP Phones : We offer a range of innovative, high performance phones to meet the needs of the different types of end-users across the enterprise. Our phones are designed to provide a superior combination of ergonomics, sound quality and appearance. We offer a variety of phones that vary by user interface style and size, sound quality, line capacity and Gigabit Ethernet support.  A large color touch screen graphical user interface with haptic feedback is available to provide a rich user experience and high functionality.  Beam forming microphones are used to provide enhanced speakerphone sound quality. ShoreTel IP Phones are designed to function without any configuration, simplifying installation. Remote workers can also utilize ShoreTel IP Phones using an integrated Virtual Private Network (VPN) feature and mobile workers can select Wi-Fi phones that work with the open interfaces of the system.
 
 
·
ShoreTel Voice Switches:   We offer a range of switches of varying capabilities to meet the needs of enterprises of all sizes. The modular nature of our switches allows our enterprise customers to easily expand their system capacity by deploying additional switches across their network. Our switches provide call management functionality.  Each switch in the system is capable of independently establishing and terminating calls without relying on a centralized call control server. As a result, enterprise unified communications can survive a variety of LAN, WAN and hardware failures. The high reliability of our switches is enhanced by two key design features:  (i) the use of flash memory instead of disk drives and (ii) running an embedded operating system optimized for real-time processing, such as call management. Unlike disk drives, flash memory does not rely on mechanical movement, and therefore is less likely to break down and cause our systems to fail. Furthermore, our embedded operating system enables a higher performing and more reliable software platform relative to server-centric IP systems because it is optimized for real-time processing. The reliability of the system can be further improved by adding an additional switch to the headquarters  location to create “n+1” redundancy, rather than requiring a dedicated back-up switch for each primary switch to improve reliability as needed by alternative systems. In addition, our switches connect to the public telephone network through one of several interfaces, including high-density T1 and E1 interfaces.
 
 
·
ShoreTel Director: ShoreTel Director provides enterprises with a single point of system management, enabling IT administrators to view and manage the entire system of the enterprise from any location using a single application. A new end user’s extension, mailbox and automated attendant profile can be added from a single management screen, avoiding the additional work required with most Private Branch Exchanges (PBXs), voice mail systems and automated attendants.
 
 
·
Unified Messaging: Our Unified Messaging solution integrates our voicemail application with Microsoft Outlook. This enables end users to receive, send, be notified of and play voice mail messages through their Microsoft Outlook email.
 
 
·
Automated Attendant:   Our Automated Attendant solution provides end users with a 24-hour automated call answering and routing capability that enables the enterprise to direct callers to appropriate individuals, workgroups or messages
 
 
·
Small Business Edition: Our Small Business Edition (SBE) solution is targeted for smaller enterprises who are in their early stages or are currently operating on a relatively smaller scale than our enterprise customers.  The solution is a bundled solution consisting limited user licenses, voice switches, server, and feature licenses.  This solution allows our customers to economically scale our products and solutions as their organizations begin to grow and expand.
 
Unified Communications
 
ShoreTel Unified Communications provide advanced communications to business including voice calling, instant messaging, unified messaging, device agnostic mobility capability, desktop collaboration and video. The solution includes voice telephones, switching infrastructure, end-user interfaces, and platform software.
 
 
 
·
ShoreTel Communicator : ShoreTel Communicator is a powerful UC application for users across an organization, whether an operator, a contact center agent, a knowledge worker or a road warrior. Available on multiple operating systems, ShoreTel Communicator makes it easy for people to communicate any way they choose: by video, voice (wired or wireless), instant messaging (IM), and more. One single interface makes training simple and reduces the IT workload because there is just a single application to support, and no additional servers to deploy and maintain.
 
 
·
ShoreTel Conferencing Bridge: ShoreTel Conferencing Bridge enables enterprises to conduct large audio conferences and provides collaboration tools for application sharing, desktop sharing, instant messaging and end-user presence information.
 
 
·
Microsoft Integration™ : For customers seeking to leverage their investment in Microsoft’s Unified Communications portfolio, ShoreTel offers a range of integration options. Users can leverage their Microsoft Exchange messaging platform and Microsoft Office™.
 
Contact Center
 
ShoreTel Contact Center includes a range of options including agent phones, switching infrastructure, end-user interfaces, and platform software. The solution features call handling, self-service, multi-media, and reporting capabilities.
 
Contact Center applications provide a range of features to satisfy the needs of all sizes of organizations, from basic call center capabilities to sophisticated distributed multimedia contact center capabilities. Contact Center enables organizations to route incoming contacts to the most appropriate agent in a multisite contact center, regardless of location.
 
 
·
Workgroups: Workgroups is a licensing option for our contact center solution used for basic contact center needs.
 
Enterprise Mobility
 
ShoreTel Mobility extends the capabilities of a desk phone and unified communications capabilities to leading smartphones and allows the user to communicate from any location, including office, home or through hotspots, enabling access to any cellular or WiFi network, simply and cost effectively.
 
 
·
ShoreTel Mobility Router: The ShoreTel Mobility Router is a scalable network appliance that fuses enterprise wireless LANs, carrier cellular networks, IP telephony and location technology to extend voice and UC to mobile devices. The router allows users to make and receive calls from both the enterprise and personal mobile phone numbers and automatically selects the best network (Wi-Fi or cellular) with fast and automatic network handover, to optimize cost, call quality and battery life.
 
 
·
ShoreTel RoamAnywhere Client: ShoreTel Mobility’s RoamAnywhere Client for mobile devices is designed to extend UC applications with location technology information to single- and dual-mode (WiFi and cellular) mobile handsets. End users can use enterprise deskphone features such as extension dialing, call transfer and directory query on their smartphones. Additionally, they can make and receive calls from both enterprise and personal cellular numbers while the best network (Wi-Fi or cellular) is automatically selected. Seamless and automatic network handover helps call continuity across networks, and moves calls to Wi-Fi when available, thereby reducing mobile costs.
 
Business Integration
 
We offer businesses the option to enhance their communications by enabling the integration of best in breed business applications including several customer relationship management (CRM) solutions, such as Salesforce.com, Microsoft Dynamics, Netsuite and RightNow, as well as cost recovery applications, including Equitrak, Copitrak, and Lexis/Nexis Time Matters. These integrations are designed to improve the productivity of end users that use these applications by seamlessly integrating communications capabilities into their data-driven workflow. Customers or partners can create additional business integrations using the open interfaces of the system available for developers through the ShoreTel Innovation Network.
 
ShoreTel Global Services
 
 
We complement our product offerings with a broad range of services to help us maintain and expand our relationships with enterprise customers and distribution partners. Our product support contracts provide us with recurring revenue. Typically, our resellers provide many of these services, with ShoreTel providing manufacturer and escalation support as needed, or if requested by the enterprise customer, we provide these services directly.
 
ShoreTel Global Services include support, training, system design and installation, and professional services including:
 
 
·
Our support services include Web-based access support services and tools, access to technical support engineers, hardware replacement and software updates. These services are offered under support contracts with terms of up to five years.
 
 
·
Training services include certification programs for resellers, training programs at enterprise customer or reseller locations and self-paced, computer-based desktop training programs.
 
 
·
System design and installation services include the assessment of unified communications, contact center and mobility requirements of a particular enterprise, the configuration of systems to meet customer specifications and maximize operating efficiencies, management of the installation, and the subsequent testing and implementation of our systems.
 
 
·
Professional services include catalogue and custom software development to extend system capabilities, enable UC integration with other enterprise applications, streamline business processes and address enterprise customer-specific business opportunities and collaborate with third party developers through ShoreTel’s SDK program, the ShoreTel Innovation Network.
 
Technology
 
Our systems are based on a combination of our proprietary software, industry-standard interfaces and protocols, and customized and off-the-shelf hardware components. We have developed proprietary technologies that are critical to the operation of the servers and ShoreTel Voice Switches within our systems and provide our systems with the properties that distinguish them from alternative IP systems.
 
The key elements of our distributed software architecture include software that:
 
 
allows a geographically-distributed system to operate and be managed as a single system;
 
 
enables calling between ShoreTel Voice Switches and allows calls to be distributed among Voice Switches instead of using a single centralized call control server;
 
 
enables  ShoreTel Voice Switches to obtain call routing information;
 
 
monitors the bandwidth consumed on each WAN segment and prevents the system from exceeding bandwidth limitations;
 
 
monitors all call activity on Voice Switches, and enables integration of ShoreTel and third-party applications;
 
 
coordinates the functions of all servers and Voice Switches on the system, allowing them to perform as a single, virtual server;
 
 
enables remote ShoreTel and third-party applications to access and modify our systems;
 
 
enables the Voice Switches to communicate with the application server, and receive system configuration information;
 
 
allows each Voice Switch to maintain a comprehensive view of the system;
 
 
provides a graphical user interface for our phones;
 
 
allows the system to scale from small to large simply by adding additional components; and
 
 
- 6 -

 
 
allows centralized monitoring and management of the system independent of the geographical location of the users or system components.
 
Our switch-based software also uses industry-standard Session Initiation Protocol, or SIP, and Media Gateway Control Protocol, or MGCP, for setting up calls.
 
ShoreTel Voice Switches are comprised of off-the-shelf, embedded microprocessors and networking components, such as ethernet controllers, and customized integrated circuits. These Voice Switches run on an embedded operating system, and use random access memory and flash memory as well as our switch call management software for application processing. ShoreTel IP phones are comprised of enterprise IP phone semiconductors using customized LCD displays, microphones, speaker circuitry and custom software providing plug and play installation and management, ease of use and a rich feature set.
 
ShoreTel provides client and server-side application software for control and management of IP phones for individuals, workgroups such as contact centers, as well as the system manager.  Client applications are available for personal computers, mobile phones and web browsers.
 
Enterprise Customers
 
Our enterprise customers include small, medium and large companies and public institutions in a wide range of vertical markets, including professional services, financial services, government, education, health care, manufacturing, non-profit organizations, and technology industries. As of June 30, 2011, we had sold our IP unified communications systems to approximately 18,000 enterprise customers.
 
We believe that maintaining the highest possible levels of customer satisfaction is critical to our ability to retain existing and gain new enterprise customers. We believe that satisfied enterprise customers will purchase more of our products and serve as advocates for our systems, and we work closely with them as they deploy and use our systems. We follow implementations with a formal review with the enterprise customer that involves contacts with our internal staff and third-party technical personnel. We take prompt action to resolve any issues that might have been identified. We also have frequent follow-up contacts with our enterprise customers to promptly resolve issues and ensure that they are fully satisfied with their system. We also survey enterprise customers that use our technical support services to ensure that high-quality support services are being provided. Through this process, we gain valuable insights into the existing and future requirements of our enterprise customers’ activities and this helps us develop product enhancements that address the evolving requirements of enterprises.
 
Additionally, to promote high-quality support throughout our services organization, we measure key performance indicators and operational metrics of our services organization, including call answer times, call abandon rates, customer satisfaction with technical support, time to issue resolution, call interaction quality, as well as customer satisfaction with system implementation, training services and technical support, and use the results to direct the management of our services organization.
 
We also monitor our enterprise customers’ satisfaction with our channel partners by surveying our enterprise customers after the system is installed. We actively encourage our channel partners to maintain and improve our enterprise customers’ levels of satisfaction. We also monitor our channel partners’ satisfaction with ShoreTel, as their satisfaction with and advocacy of ShoreTel is also very important to our success.
 
Sales and Marketing
 
We sell our products and services primarily through an extensive network of channel partners, including distributors. As of June 30, 2011, we had over 900 channel partners in our network. These channel partners range in size from single-site, regional firms with specialized products and services to multi-national firms that provide a full range of IT products and services including the top three U.S. telecommunication carriers: AT&T, Verizon and Qwest/CenturyLink. Our channel partners market and sell our products into both the large and small-to-medium enterprise markets.
 
We maintain a sales organization that recruits, qualifies and trains new channel partners, participates in sales presentations to potential enterprise customers and assesses customer feedback to assist in developing product roadmaps. As part of our increased focus on sales to large accounts, we also have a major accounts program whereby sales personnel assist our channel partners in selling to and providing support for large enterprise customer accounts. No single channel partner or value-added distributor accounted for ten percent or more of our total revenue in fiscal 2011.
 
We believe our channel partner network allows us to effectively sell our systems without the need to build large dedicated in-house sales and service capabilities. We continue to work with existing channel partners to expand their sales of our systems and to recruit new channel partners with a focus on increasing market coverage.
 
Our internal marketing team focuses on increasing our “Brilliantly Simple” brand awareness, communicating product advantages and generating qualified leads for our sales force and channel partners. In addition to providing marketing materials, we communicate product and service offerings through email and direct mail campaigns, print and Web-based advertising, press releases and Web-based demonstrations.
 
Backlog
 
Our backlog at June 30, 2011, 2010 and 2009 was approximately $6.1 million, $9.1 million and $5.7 million respectively. Our backlog consists of orders received from value-added resellers but not shipped before the end of the quarter in which the order was received, and excludes orders from distributors, as we recognize product revenue on sales made through distributors upon sell-through to our value-added resellers. Although we believe that the orders included in the backlog are firm, all orders are subject to possible rescheduling by customers and some orders may be cancelled by customers, and we may elect to allow such cancellations without penalty to the customer. Therefore, we do not believe that our backlog, as of any particular date, is necessarily indicative of actual revenue for any future period.
 
Research and Development
 
We believe that our ability to enhance our current products, develop and introduce new products on a timely basis, maintain technological competitiveness and meet enterprise customer requirements is essential to our success. To this end, we have assembled a team of engineers with expertise in various fields, including voice and IP communications, unified communications network design, data networking and software engineering. Our principal research and development activities are conducted in Sunnyvale, California and Austin, Texas. We have invested significant time and financial resources into the development of our architecture, including our switches and related software. We intend to continue to expand our product offerings, improve the features available on our products and integrate our systems with third-party enterprise applications. Research and development expenses were $45.5 million, $33.6 million, and $30.7 million in fiscal years 2011, 2010 and 2009, respectively.
 
Manufacturing and Suppliers
 
We outsource the manufacturing of our hardware products. This outsourcing allows us to:
 
 
avoid costly capital expenditures for the establishment of manufacturing operations;
 
 
focus on the design, development, sales and support of our hardware products; and
 
 
leverage the scale, expertise and purchasing power of specialized contract manufacturers.
 
Currently, we have arrangements for the production of our switches with a contract manufacturer in the United States and for the production of our phones with contract manufacturers located in China. Our reliance on contract manufacturers involves a number of potential risks, including the absence of adequate capacity, ownership of certain elements of electronic designs, and reduced control over delivery schedules. Our contract manufacturers provide us with a range of operational and manufacturing services, including component procurement and performing final testing and assembly of our products. We typically depend on our contract manufacturers to procure components and to maintain adequate manufacturing capacity. We typically fulfill product orders out of our Fremont, California location or United Kingdom and Australia warehouses.
 
We regularly provide forecasts for orders, and we order products from our contract manufacturers based on our projected sales levels, which is well in advance of receiving customer orders. However, enterprise customers may generally cancel or reschedule orders without penalty, and delivery schedules requested by enterprise customers in these orders frequently vary based upon each enterprise customer’s particular needs.
 
We also rely on sole or limited numbers of suppliers for several key components utilized in the assembly of our products. For example, our contract manufacturers purchase semiconductors that are essential to the production of our phones from a single source supplier, and we have not identified any alternative suppliers for these components. This reliance is amplified by the fact that our contract manufacturers maintain relatively low inventories and acquire components only as needed. As a result, our ability to respond to enterprise customer orders efficiently may be constrained by the then-current availability or terms and pricing of these components. Constraints on our ability to respond efficiently is partially offset by build-up of levels of safety stock inventory which lets us respond to our enterprise customer orders in a timely manner. We cannot assure you that we will be able to obtain a sufficient quantity of these components in a timely manner to meet the demands of our enterprise customers or that prices of these components will not increase. In addition, we cannot assure you that our suppliers continue to offer components that we need.  Any delays or any disruption of the supply of these components could also materially and adversely affect our operating results.
 
Financial Information about Geographic Areas
 
For financial information about geographic areas, refer to Note 10 to the Consolidated Financial Statements in Item 8 of this report.
 
Competition
 
The market for business communication solutions is quickly evolving, highly competitive and subject to rapid technological change. As a result of the convergence of voice, video, messaging, mobility and data networking technologies that characterize IP enterprise unified communications solutions, we compete with providers of enterprise unified communications solutions, such as:
 
 
Providers of pure IP communication systems, including Cisco Systems and Interactive Intelligence
 
 
Providers of Open Source IP communication systems, including Digium
 
 
Providers of hybrid IP/TDM communication systems, including Aastra, Avaya, Alcatel-Lucent, Mitel Networks, NEC, and Siemens
 
 
Providers of Unified Communications software applications providers, including Microsoft
 
 
Providers of Hosted PBX services from service providers, including incumbent local exchange carriers, or ILECs, and competitive local exchange carriers, or CLECs, and
 
 
Providers of mobile communication systems, including Research in Motion
 
In addition, because the market for our products is subject to rapid technological change as the market evolves, we may face competition in the future from companies that do not currently compete in the enterprise unified communications market, including companies that currently compete in other sectors of the information technology, communications and software industries or communications companies that serve consumer rather than enterprise customers.
 
We may also face competition from internet portal-focused providers who extend their portfolio to include business communications solutions, such as Skype/Microsoft, Google and Yahoo.
 
In particular, as more enterprises converge their voice and data networks, the business information technology and communication applications deployed on converged networks become more integrated. We may face increased competition from current leaders in information technology infrastructure, information technology, personal and business applications and the software that connects the network infrastructure to those applications. This could include network systems providers such as Brocade, Hewlett-Packard, and Juniper Networks.
 
We could also face competition from new market entrants, whether from new ventures or from established companies moving into the market. Competition from these and other potential market entrants may take many forms, including offering products and applications similar to those we offer as part of a larger, bundled offering or as a “cloud”-based services offering. In addition, technological developments and consolidation within the communications industry result in frequent changes to our group of competitors.
 
Many of our current and potential competitors are substantially larger than we are and have higher brand familiarity with buyers, and significantly greater financial, sales, marketing, and distribution, technical, manufacturing and other resources. We believe that we currently compete favorably with regard to the principal competitive factors applicable to our products, which include:
 
 
Lower selling costs for resellers and distributors with greater ease of implementation
 
 
Lowest total cost of ownership over a multi-year period compared to competitor’s IP and hybrid system, based on independent data from third parties such as Alinean Research and Nemertes Research
 
 
Highest ratings in customer satisfaction, as reported by an independent third party, Nemertes Research, for the last eight years in a row
 
 
Superior product scalability, without forklift upgrades, supporting from 10 to 20,000 users in a single image configuration
 
 
World-class customer service and support from technicians and support centers located around the world
 
 
Greater ease of management for system administrators
 
 
Intuitive productivity tools for employees with integrated unified communications capabilities, and
 
 
Highest system availability and reliability with our N+1 distributed switch architecture
 
For more information concerning competition, please see “Risk Factors - Risks Related To Our Business and Industry – “The market in which we operate is intensely competitive, and many of our competitors are larger, more established and better capitalized than we are” and – “As voice, video, messaging and data networks converge, we are likely to face increased competition from Microsoft and other companies in the information technology, personal and business applications and software industries.”
 
Intellectual Property
 
A factor of our success as a company is our ability to protect our core technology and intellectual property. To accomplish this, we rely on a combination of intellectual property rights, including patents, trade secrets, copyrights and trademarks, as well as customary contractual protections.
 
As of June 30, 2011, we have 33 patents issued in the United States, and have 61 patent applications in the United States. Our patents have a range of expiration dates. The earliest patent to expire will do so in 2016, and the last to expire will do so in 2026.
 
The steps we have taken to protect our intellectual property rights may not be adequate. Third parties may infringe or misappropriate our intellectual property rights and may challenge our issued patents. In addition, other parties may independently develop similar or competing technologies designed around any patents that are or may be issued to us. We intend to enforce our intellectual property rights vigorously, and from time to time, we may initiate claims against third parties that we believe are infringing on our intellectual property rights if we are unable to resolve matters satisfactorily through negotiation. If we fail to protect our proprietary rights adequately, our competitors could offer similar products, potentially significantly harming our competitive position and decreasing our revenue.
 
Employees
 
As of June 30, 2011, we had 634 employees in North America, Europe, Asia and Australia, of which 264 were in sales and marketing, 208 were in research and development, 100 were in global support services, and 62 were in general and administrative functions.  None of our employees are represented by labor unions and we consider current employee relations to be good.
 
 None of our employees are represented by labor unions and we consider current employee relations to be good.
 
Executive Officers
 
The following table sets forth information about our executive officers as of September 1, 2011:
 
Name
 
Age
 
Position
         
Peter Blackmore
 
63
 
President and Chief Executive Officer
Donald J. Girskis
 
51
 
Senior Vice President, Worldwide Sales
Michael E. Healy
 
50
 
Senior Vice President and Chief Financial Officer
Edwin J. Basart
 
62
 
Founder, Chief Technology Officer and Director
Pedro E. Rump
 
55
 
Senior Vice President, Engineering and Operations
Ava M. Hahn
 
38
 
Vice President, General Counsel and Secretary
 
 
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Peter Blackmore has served as our President and Chief Executive Officer since December 2010.  From July 2008 to September 2009 Mr. Blackmore served as President, Chief Executive Officer and a member of the Board of Directors of UTStarcom, Inc., a provider of Internet protocol-based network solutions, and served as President and Chief Operating Officer of UTStarcom from July 2007 to June 2008. From 2005 until he joined UTStarcom, Mr.     Blackmore served as Executive Vice President in charge of world-wide sales, marketing and technology at Unisys Corporation. Prior to joining Unisys in 2005, Mr. Blackmore served as Executive Vice President of the Customer Solutions Group at Hewlett-Packard Company from 2004 and as Executive Vice President of the Enterprise Systems Group from 2002 through 2004. From 1991 until its acquisition by Hewlett-Packard in 2002, Mr.     Blackmore served in a number of senior management positions with Compaq Computer Corporation, most recently as its Executive Vice President of worldwide sales and services from 2000 through 2002. Mr.     Blackmore serves on the board of directors of MEMC Electronic Materials     Inc. Mr.     Blackmore holds an M.A. in Economics from Trinity College, Cambridge, U.K.
 
Donald J. Girskis has served as our Senior Vice President of Worldwide Sales since February 2008. Mr. Girskis served as interim Chief Executive Officer from October to December 2010.  From 1993 to 2008, Mr. Girskis held a variety of executive positions at Sprint-Nextel, a telecommunications company, most recently as the Senior Vice President and General Manager of Boost Mobile, a subsidiary of Sprint-Nextel. At Nextel, Mr. Girskis held the position of Area Vice President of Sales, Area Vice President of Marketing, Vice President of Engineering, and General Manager. Prior to Sprint-Nextel, Mr. Girskis held sales management positions with Businessland, and Los Angeles Cellular Telephone Company. Mr. Girskis holds a B.A. in business administration from California State University at Fullerton.
 
Michael E. Healy has served as our Senior Vice President and Chief Financial Officer since May 2007. From February 2004 to May 2007, he served as Chief Financial Officer and Senior Vice President of Finance of Genesis Microchip Inc., a supplier of display image processors. From November 2002 to February 2004, Mr. Healy served as Chief Financial Officer of Jamcracker, Inc., a software and application service provider. From September 1997 to June 2002, Mr. Healy held senior level finance positions at Exodus Communications, Inc., an Internet infrastructure outsourcing services provider (Exodus Communications sold substantially all of its assets in January 2002 and changed its name to EXDS, Inc. in February 2002), including as Senior Vice President of Finance prior to February 2002, and as its Chief Financial Officer and Corporate Treasurer from February 2002 to June 2002. From 1987 to 1997, Mr. Healy held various financial management positions at Apple Computer, Inc., and was an auditor at Deloitte & Touche LLP from 1983 to 1987. Mr. Healy holds a B.S. in accounting from Santa Clara University and is a Certified Public Accountant. Mr. Healy is a member of the American Institute of Certified Public Accountants and the California Society of Certified Public Accountants.
 
Edwin J. Basart co-founded ShoreTel in 1996 and has served as our Chief Technology Officer and as a director since inception. Mr. Basart will serve as Special Advisor to the Board upon the expiration of his term as a director in November 2011, and will also continue to serve as our Chief Technology Officer.  Prior to co-founding ShoreTel, Mr. Basart co-founded Network Computing Devices, Inc., a provider of thin client computing hardware and software, where he served as Vice President of Engineering, and Ridge Computers, Inc. where he served as Vice President of Software. Mr. Basart began his career as a software engineer at Hewlett Packard. Mr. Basart holds a B.S. in English from Iowa State University and an M.S. in electrical engineering from Stanford University.
 
Pedro E. Rump has served as our Senior Vice President of Engineering and Operations since January 2011.  Prior to then, he served as our Vice President of Engineering and Operations since 2006. From July 2004 to January 2006, Mr. Rump served as Vice President of Engineering and Operations at Dust Networks, Inc., a developer of embedded wireless sensor networking products. From January 2004 to July 2004, Mr. Rump served as Vice President of Engineering at Sonim Technologies, Inc., a provider of voice over IP applications. From January 2003 to January 2004, Mr. Rump served as Vice President of Engineering at Littlefeet Inc. From January 2002 to October 2002, Mr. Rump served as Vice President of Inviso, a developer of signal transport and display solutions for television and telecommunications. Mr. Rump holds a B.S. and M.S. in electrical engineering from the Swiss Federal Institute of Technology.
 
Ava M. Hahn has served as our Vice President, General Counsel and Secretary since May 2009. Ms. Hahn joined ShoreTel in June 2007 serving in the position of General Counsel and Secretary. From August 2002 to May 2007, Ms. Hahn served as General Counsel, Assistant General Counsel and Secretary for Genesis Microchip, Inc., a supplier of display image processors. From August 2000 to August 2002, Ms. Hahn served as Director, Legal Affairs for LuxN, Inc., a provider of optical access equipment. Prior to then, Ms. Hahn was in private practice at Wilson Sonsini Goodrich & Rosati, P.C. Ms. Hahn holds a J.D. from Columbia Law School and a B.A. from the University of California, Berkeley.
 
 
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ITEM 1A.
RISK FACTO RS
 
Risks Related to Our Business and Industry
 
Current uncertainty in global economic conditions makes it particularly difficult to predict demand for our products and forecast revenues, and makes it more likely that our actual results could differ materially from expectations.
 
Our operations and performance depend on worldwide economic conditions, which have been volatile in the United States and other countries, and may remain volatile or depressed for the foreseeable future. These conditions make it difficult for our customers and potential customers to accurately forecast and plan future business activities, and have caused our customers and potential customers to slow or reduce spending on capital equipment such as our products. These economic conditions could also cause our competitors to drastically reduce prices or take unusual actions to gain a competitive edge, which could force us to provide similar discounts and thereby reduce our profitability. These factors make it difficult for us to forecast demand for our products and provide revenue guidance.  We cannot predict the timing, strength or duration of the current economic slowdown or subsequent economic recovery, worldwide, in the United States, or in our industry. In addition, these factors could have a material adverse effect on demand for our products and services, and on our financial condition, including profitability and operating results.
 
 Our business could be harmed by adverse economic conditions in our target markets, reduced spending on information technology and telecommunication products by customers and potential customers, and the tightening of the credit markets.
 
Our business depends on the overall demand for information technology, and in particular for telecommunications systems. The market we serve is emerging and the purchase of our products involves significant upfront expenditures. In addition, the purchase of our products can be discretionary and may involve a significant commitment of capital and other resources. In many cases, our resellers and/or end customers procure our products and services on credit. If credit is not available to them, it may be difficult or impossible for our resellers and/or end customers to purchase our products. Weak economic conditions in our target markets, or a reduction in information technology or telecommunications spending even if economic conditions improve, would likely adversely impact our business, operating results and financial condition in a number of ways, including longer sales cycles, lower prices for our products and reduced unit sales.
 
We may not be able to achieve our strategic initiatives and grow our business as anticipated.
 
While we currently intend to grow our business by pursuing strategic initiatives to increase our sales capacity by expanding our sales team and our channel partnerships, enhance our product offerings and increase awareness of our company and our products among existing and prospective customers, we cannot assure you that we will be able to achieve these initiatives. Our success depends on our ability to appropriately manage our expenses as we grow our organization, identify or acquire companies or assets at attractive valuations, enter into beneficial channel relationships, develop new products, and successfully execute our marketing and sales strategies. If we are not able to execute on these actions, our business may not grow as we anticipated, and our operating results could be adversely affected.
 
The market in which we operate is intensely competitive, and many of our competitors are larger, more established and better capitalized than we are.
 
The market for IP telecommunications and other telecommunications systems is extremely competitive. Our competitors include companies that offer IP systems, such as Cisco Systems, Inc. and that offer hybrid systems, such as Alcatel-Lucent, Avaya and Mitel Networks Corporation. In addition, we compete with much larger companies such as Microsoft in the unified communications market. Several of the companies that offer hybrid systems also offer IP telecommunications systems. Many of our competitors are substantially larger and have greater financial, technical, research and development, sales and marketing, manufacturing, distribution and other resources. We could also face competition from new market entrants, whether from new ventures or from established companies moving in to the market. These competitors have various other advantages over us, including:
 
                   
 
greater market presence, name recognition and brand reputation;
 
 
larger distribution channels;
 
 
a larger installed base of telecommunications and networking systems with enterprise customers;
 
 
larger and more geographically distributed services and support organizations and capabilities;
 
 
a broader offering of telecommunications and networking products, applications and services;
 
 
 
a more established international presence to address the needs of global enterprises;
 
 
larger patent and intellectual property portfolios;
 
 
longer operating histories;
 
 
a longer history of implementing large-scale telecommunications or networking systems;
 
 
more established relationships with industry participants, customers, suppliers, distributors and other technology companies;
 
 
the ability to acquire technologies or consolidate with other companies in the industry to compete more effectively; and
 
 
the ability to bundle a broader offering of telecom and networking equipment and services into an IP PBX offering, and offer these products as part of a hosted services offering.
 
Given their capital resources, many of these competitors are in a better position to withstand any significant reduction in capital spending by enterprise customers on telecommunications equipment and are not as susceptible to downturns in a particular market. This risk is enhanced because we focus our business solely on the enterprise IP telecommunications market and do not have a diversified portfolio of products that are applicable to other market segments.
 
We compete primarily on the basis of price, feature set, reliability, scalability, usability, total cost of ownership, customer satisfaction and service. Because our competitors have greater financial strength than we do and are able to offer a more diversified bundle of products and services, they have offered and in the future may offer telecommunications products at lower prices than we do. These larger competitors can also bundle products with other services, such as hosted or managed services, effectively reducing the price of their products. In order to remain competitive from a cost perspective, we have in the past reduced the prices of our products, and we may be required to do so in the future, in order to gain enterprise customers. Price reductions could have a negative effect on our gross margins.
 
Our competitors may also be able to devote more resources to developing new or enhanced products, including products that may be based on new technologies or standards. If our competitors’ products become more accepted than our products, our competitive position will be impaired and we may not be able to increase our revenue or may experience decreased gross margins. If any of our competitors’ products or technologies become the industry standard, if they are successful in bringing their products to market earlier, or if their products are more technologically capable than ours, then our sales could be materially adversely affected. We may not be able to maintain or improve our competitive position against our current or future competitors, and our failure to do so could materially and adversely affect our business.
 
The gross margins on our products may decrease due to competitive pressures or otherwise, which could negatively impact our profitability.
 
It is possible that the gross margins on our products will decrease in the future in response to competitive pricing pressures, new product introductions by us or our competitors, changes in the costs of components, manufacturing issues,  the shift in our channel distribution model towards more value-added distributors, royalties we need to pay to use certain intellectual property, the introduction of our managed solution offering, growth of our international business, or other factors. If we experience decreased gross margins and we are unable to respond in a timely manner by introducing and selling new, higher-margin products successfully and continually reducing our product costs, our gross margins may decline, which will harm our business and results of operations.
 
As voice and data networks converge, we are likely to face increased competition from Microsoft and other companies in the information technology, personal and business applications and software industries.
 
The convergence of voice and data networks and their wider deployment by enterprises has led information technology and communication applications deployed on converged networks to become more integrated. This integration has created an opportunity for the leaders in information technology, personal and business applications and the software that connects the network infrastructure to those applications, to enter the telecommunications market and offer products that compete with our systems, commonly referred to as Unified Communications. Competition from these potential market entrants may take many forms, and they may offer products and applications similar to those we offer. For example, Microsoft Corporation has announced its Lync server, which Microsoft states is a single platform that can enhance, extend, and even replace traditional and IP PBX systems. This system competes with our ShoreTel Communicator application. Microsoft and other leaders in the information technology, personal and business applications and software industries, have substantial financial and other resources that they could devote to this market.
 
 
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If Microsoft continues to move into the telecommunications market or if other new competitors from the information technology, personal and business applications or software industries enter the telecommunications market, the market for IP telecommunications systems will become increasingly competitive. If the solutions offered by Microsoft or other new competitors achieve substantial market penetration, or if we cannot integrate our products with Microsoft, we may not be able to maintain or improve our market position, and our failure to do so could materially and adversely affect our business and results of operations.
 
  If we fail to respond to technological changes and evolving industry standards, our products could become obsolete or less competitive in the future.
 
The telecommunications industry is highly competitive and characterized by rapidly changing technologies and standards, frequent product introductions and short product life cycles. For example, mobile telephones have experienced rapid adoption and may eventually replace desktop telephones.  Accordingly, our operating results depend upon, among other things, our ability to develop and introduce new products and our ability to reduce production costs of existing products. Our long-term success will depend on our ability to stay head of these changes and avoid obsolescence of our products.
 
The process of developing new technologies and products is complex, and if we are unable to develop enhancements to, and new features for, our existing products or acceptable new products that keep pace with technological developments or industry standards, our products may become obsolete, less marketable and less competitive and our business will be harmed.
 
In addition, as industry standards evolve, it is possible that one standard becomes predominant in the market. This could facilitate the entry into the market for competing products, which could result in significant pricing pressure. Additionally, if one standard becomes predominant and we adopt that standard, enterprises may be able to create a unified, integrated system by using phones, switches, servers, applications, or other telecommunications products produced by different companies. Therefore, we may be unable to sell complete systems to enterprise customers because the enterprise customers elect to purchase portions of their telecommunications systems from our competitors. For example, if a single industry standard is adopted, customers may elect to purchase our switches, but could purchase software applications and phones from other vendors. This could reduce our revenue and gross margins if enterprise customers instead purchase primarily lower-margin products from us. Conversely, if one standard becomes predominant, and we do not adopt it, potential enterprise customers may choose to buy a competing system that is based on that standard.
 
We rely on third-party resellers to sell our products, and disruptions to, or our failure to develop and manage our distribution channels could adversely affect our business.
 
Substantially all of our total revenue is generated through indirect channel sales. These indirect sales channels consist of third-party resellers that market and sell telecommunications systems and other products and services to customers. We expect indirect channel sales will continue to generate a substantial majority of our total revenue in the future. Therefore, our success is highly dependent upon establishing and maintaining successful relationships with third-party resellers, and the financial health of these resellers.
 
Many of the resellers we recruit never generate significant revenues for us. Recruiting, launching and retaining qualified channel partners and training them in our technology and products requires significant time and resources. In order to develop and expand our distribution channel, we must continue to recruit larger and more productive channel partners. We must also scale and improve our processes and procedures that support our channel, including investment in personnel, systems and training, and those processes and procedures may become increasingly complex and difficult to manage.
 
We have no long-term contracts or minimum purchase commitments with any of our channel partners, and our contracts with these channel partners do not prohibit them from offering products or services that compete with ours. Our competitors may be effective in providing incentives to existing and potential channel partners to favor their products or to prevent or reduce sales of our products. Our channel partners may choose not to offer our products exclusively or at all. Our failure to establish and maintain successful relationships with channel partners would likely materially adversely affect our business, operating results and financial condition.
 
Our success in expanding our customer base to larger enterprises will depend in part on our ability to expand our channel to partners that serve those larger enterprises. In addition, we rely on these entities to provide many of the installation, implementation and support services for our products. Accordingly, our success depends in large part on the effective performance of these channel partners. If a partner’s performance is ineffective, it may reflect poorly upon ShoreTel or negatively impact our business. For example, if one of these resellers experiences a work stoppage due to a labor union dispute, installation of our phone systems could be delayed and our sales and reputation could suffer. By relying on channel partners, we may in some cases have little or no contact with the ultimate users of our products, thereby making it more difficult for us to establish brand awareness, ensure proper delivery and installation of our products, service ongoing enterprise customer requirements and respond to evolving enterprise customer needs. This difficulty is more pronounced where enterprise customers purchase our systems from a channel partner that purchased through a distributor. Additionally, some of our channel partners are smaller companies that may not have the same financial resources as other of our larger channel partners, which exposes us to collections risks.
 
 
We are embarking on a new distribution strategy, which could be disruptive to our business.
 
 We have recently announced that we will now sell our products through value-added distributors as well as resellers in the United States.  As a result, we have contracted with value-added distributors who will purchase our products, add value such as other products and services, and then distribute our products through resellers. This new strategy is intended to increase our distribution channel and enable our revenue growth, but it could also disrupt our existing established reseller channels and reduce our gross margins.
 
We have no long-term contracts or minimum purchase commitments with our distributors, and our contracts with these distributors do not prohibit them from offering products or services that compete with ours. Our competitors may be effective in providing incentives to existing and potential distributors to favor their products or to prevent or reduce sales of our products. Our distributors may choose not to offer our products exclusively or at all. Our failure to establish and maintain successful relationships with our distributors could materially adversely affect our business, operating results and financial condition.
 
In addition, a significant portion of our product orders are usually received in the last month of each fiscal quarter, with a concentration of such orders in the final two weeks of the quarter. Orders received by our distributors during the final days of a quarter may not be recognizable as revenue to us until after the end of the quarter,  which could cause us to fall short of our expectations, and the expectations of our analysts and investors.
 
We have had significant executive management turnover, and may not be able to retain or attract the executives we need to succeed.
 
 In fiscal 2011, a new Chief Executive Officer and Vice President of Global Support joined us due to turnover in our executive team. We cannot assure you that we will be able to retain other key employees, including senior management and executive positions. If we cannot attract and retain these executives and key employees, our business would be harmed, particularly if the departure of any executive or key employee results in a business interruption, or if we are not successful in preserving material knowledge of our departing employees.
 
Our future success depends on our ability to attract, integrate and retain key personnel, and our failure to do so could harm our ability to grow our business.
 
Our company strategy and future success will depend, to a significant extent, on our ability to attract, integrate and retain our key personnel, namely our management team and experienced sales and engineering personnel. We may experience difficulty assimilating our newly hired personnel, which may adversely affect our business. In addition, we must retain and motivate high quality personnel, and we must also attract and assimilate other highly qualified employees. Competition for qualified management, sales, technical and other personnel can be intense, and we may not be successful in attracting and retaining such personnel. In addition, even if we succeed in hiring additional sales personnel, it may take some period of time before they become productive. Competitors have in the past and may in the future attempt to recruit our employees, and our management and key employees are not bound by agreements that could prevent them from terminating their employment at any time. If we fail to attract, integrate and retain key employees, our ability to manage and grow our business could be harmed.
 
 If we fail to manage our growth effectively, our business could be harmed.
 
We plan to further expand our operations, particularly in sales headcount, channel partnerships, and the number and size of enterprise customers implementing our systems. We will need to increase our operating expenses in order to fund this expansion and support larger customers. This growth will place a significant strain on our management, administrative, operational and financial infrastructure. Our success will depend upon our ability to manage this growth effectively. If we do not increase our revenues commensurate to our increased spending, we will not be profitable. To manage the expected growth of our operations and personnel, we will need to continue to improve our operational, financial and management controls and our reporting systems and procedures. Failure to effectively manage growth could result in difficulty in filling enterprise customer orders, declines in product quality or customer satisfaction, increases in costs, production and distribution difficulties, and any of these difficulties could adversely impact our business performance and results of operations.
 
 
            If we fail to increase our consideration rate, our business could suffer.
 
We estimate that we compete for only a fraction of the potential customers in our market due to our smaller size and lower brand recognition as compared to our much larger competitors. Many of our potential customers purchase their communications systems without ever having considered ShoreTel. We have launched a brand recognition campaign in an effort to increase our rate of consideration by prospective customers. If we do not increase our brand recognition and public awareness of our products, we may not be able to enter the sales process for many potential customers and therefore not increase sales and revenues commensurate with our increased operating expenses, which would have a negative financial impact on our business.
 
Our business may be harmed if our contract manufacturers are not able to provide us with adequate supplies.
 
We outsource the manufacturing of our products. Currently, we have arrangements for the production of our products with a contract manufacturer in the United States and contract manufacturers located in China. Our reliance on contract manufacturers involves a number of potential risks, including the absence of adequate capacity, financial viability, ownership of certain elements of electronic designs, the ongoing viability of those contract manufacturers, and reduced control over delivery schedules.
 
 We depend on our contract manufacturers to finance the production of goods ordered and to maintain adequate manufacturing capacity. Global economic conditions could adversely impact the financial condition of our contract manufacturers and their suppliers that could impact our contract manufacturer’s ability to procure components or otherwise manufacture our products. Additionally, as a result of the current economic downturn, the businesses of our contract manufacturers and other suppliers could be adversely affected and they may be required to slow or curtail operations. We do not exert direct control over our contract manufacturers or suppliers of our contract manufacturers, so we may be unable to procure timely delivery of acceptable products to our enterprise customers or incur substantially higher product costs if we move production to other contract manufacturers.
 
If sales of our products continue to grow, our contract manufacturers may not have sufficient capacity to enable it to increase production to meet the demand for our products. Moreover, our contract manufacturers could have manufacturing engagements with companies that are much larger than we are and whose production needs are much greater than ours. As a result, our contract manufacturers may choose to reallocate resources to the production of products other than ours if capacity is limited.
 
In addition, our contract manufacturers do not have any written contractual obligation to accept any purchase order that we submit for the manufacture of any of our products nor do we have any assurance that our contract manufacturers will agree to manufacture and supply any or all of our requirements for our products. Furthermore, our contract manufacturers may unilaterally terminate their relationship with us at any time upon 180 days’ notice with respect to the contract manufacturers of our switches and 90 days’ notice with respect to the contract manufacturer of our phones or seek to increase the prices they charge us. As a result, we are not assured that our current manufacturers will continue to provide us with an uninterrupted supply of products of at an acceptable price in the future.
 
Even if our contract manufacturers accept and fulfill our orders, it is possible that the products may not meet our specifications. Because we do not control the final assembly and quality assurance of our products, there is a possibility that these products may contain defects or otherwise not meet our quality standards, which could result in warranty claims against us that could adversely affect our operating results and future sales.
 
If our contract manufacturers are unable or unwilling to continue manufacturing our products in required volumes and to meet our quality specifications, or if they significantly increase their prices, whether caused by uncertain global economic conditions, tightening of the credit markets, their weak financial condition or otherwise, we will have to procure components on their behalf in the short term and identify one or more acceptable alternative contract manufacturers. The process of identifying and qualifying a new contract manufacturer can be time consuming, and we may not be able to substitute suitable alternative contract manufacturers in a timely manner or at acceptable prices. Additionally, transitioning to new contract manufacturers may cause delays in supply if the new contract manufacturers have difficulty manufacturing products to our specifications or quality standards and may result in unexpected costs to our business. Furthermore, we do not own the electronic design for our IP phones, hence it may be more difficult or costly for us to change the contract manufacturer of our phones or to arrange for an alternate of or a replacement for these products in a timely manner should a transition be required. This could also subject us to the risk that our competitors could obtain phones containing technology that is the same as or similar to the technology in our phones.
 
 
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Any disruption in the supply of products from our contract manufacturers may harm our business and could result in a loss of sales, an increase in lead times on inventory orders and an increase in production costs resulting in lower gross product margins, which could adversely affect our business and results of operations.
 
  If the emerging market for enterprise IP telecommunications systems does not continue to grow and if we do not increase our market share, our future business would be harmed.
 
The market for enterprise IP telecommunications systems is evolving rapidly and is characterized by an increasing number of market entrants. As is typical of a new and rapidly evolving industry, the demand for and market acceptance of, enterprise IP telecommunications systems products and services are uncertain. We cannot assure you that enterprise telecommunications systems that operate on IP networks will become widespread. In particular, enterprises that have already invested substantial resources in other means of communicating information may be reluctant or slow to implement an IP telecommunications system that can require significant initial capital expenditures as compared to a hybrid system that might require a lower initial capital expenditure despite higher potential total expenditures over the long term. If the market for enterprise IP telecommunications systems fails to develop or develops more slowly than we anticipate, our products could fail to achieve market acceptance, which in turn could significantly harm our business. This growth may be inhibited by a number of factors, such as:
 
                   
 
  
initial costs of implementation for a new system;
 
 
  
quality of infrastructure;
 
 
  
security concerns;
 
 
  
equipment, software or other technology failures;
 
 
  
regulatory encroachments;
 
 
  
inconsistent quality of service;
 
 
  
perceived unreliability or poor voice quality over IP networks as compared to circuit-switched networks; and
 
 
  
lack of availability of cost-effective, high-speed network capacity.
 
Moreover, as IP-based data communications and telecommunications usage grow, the infrastructure used to support these services, whether public or private, may not be able to support the demands placed on them and their performance or reliability may decline.
 
Even if enterprise IP telecommunications systems become more widespread in the future, we cannot assure you that our products will attain broad market acceptance. We estimate that our sales represent a very small percentage of the total available market for enterprise IP telecommunications systems. We must increase our market penetration in order to maintain and expand our business.
 
Our sales cycle can be lengthy and unpredictable, which makes it difficult to forecast the amount of our sales and operating expenses in any particular period.
 
The sales cycle for our products typically ranges from six to twelve months, or longer. Part of our strategy is to increasingly target our sales efforts on larger enterprises. Because the sales cycle for large enterprises is generally longer than for smaller enterprises, our sales cycle in the future may be even longer than it has been historically. As a result, we may have limited ability to forecast whether or in which period a sale will occur. The success of our product sales process is subject to many factors, some of which we have little or no control over, including:
 
 
  
the timing of enterprise customers’ budget cycles and approval processes;
 
 
  
a technical evaluation or trial by potential enterprise customers;
 
 
 
  
our ability to introduce new products, features or functionality in a manner that suits the needs of a particular enterprise customer;
 
 
  
the announcement or introduction of competing products; and
 
 
  
the strength of existing relationships between our competitors and potential enterprise customers.
 
We may expend substantial time, effort and money educating our current and prospective enterprise customers as to the value of, and benefits delivered by, our products, and ultimately fail to produce a sale. If we are unsuccessful in closing sales after expending significant resources, our operating results will be adversely affected. Furthermore, if sales forecasted for a particular period do not occur in such period, our operating results for that period could be substantially lower than anticipated and the market price of our common stock could decline.
 
  Our products incorporate some sole sourced components and the inability of these sole source suppliers to provide adequate supplies of these components may prevent us from selling our products for a significant period of time or limit our ability to deliver sufficient amounts of our products.
 
We rely on sole or limited numbers of suppliers for several key components utilized in the assembly of our products. For example, we source semiconductors that are essential to the operation of our phones from separate single suppliers, and we have not identified or qualified any alternative suppliers for these components. We do not have supply agreements with our sole source suppliers, and the components for our products are typically procured by our contract manufacturers. If we lose access to these components we may not be able to sell our products for a significant period of time, and we could incur significant costs to redesign our products or to qualify alternative suppliers. This reliance on a sole source or limited number of suppliers involves several additional risks, including:
                   
 
 
  
supplier capacity constraints;
 
 
  
price increases;
 
 
  
purchasing lead times;
 
 
  
inventory buildup;
 
 
  
timely delivery; and
 
 
  
component quality.
 
This reliance is exacerbated by the fact that we maintain a relatively small amount of inventory and our contract manufacturers typically acquire components only as needed. As a result, our ability to respond to enterprise customer orders efficiently may be constrained by the then-current availability or the terms and pricing of these components. Disruption or termination of the supply of these components could delay shipments of our products and could materially and adversely affect our relationships with current and prospective enterprise customers. Also, from time to time we have experienced component quality issues with products obtained from our contract manufacturers. In addition, any increase in the price of these components could reduce our gross margin and adversely impact our profitability. We may not be able to obtain a sufficient quantity of these components to meet the demands of enterprise customers in a timely manner or prices of these components may increase. In addition, problems with respect to yield and quality of these components and timeliness of deliveries could occur. These delays could also materially and adversely affect our operating results.
 
If we fail to offer high quality customer support and services, our business would suffer.
 
Once our telephone systems are deployed within our end customers’ sites, our customers depend on our support organization and/or our channel partners to resolve any issues relating to our products. A high level of customer support and services is important for the successful marketing and sale of our products. If we or our channel partners do not help our customers quickly resolve post-deployment issues and provide effective ongoing support, our ability to sell our products to existing customers would suffer and our reputation with potential customers would be harmed. Many of our channel partners offer primary support for the products they sell to customers. If the channel partners fail to provide timely and effective services, our business could be harmed. As we expand our sales, we will be required to hire and train additional support personnel. In addition, as we expand our operations internationally, our support organization will face additional challenges including those associated with delivering support, training and documentation in languages other than English. If we fail to maintain high quality customer support or to grow our support organization to match any future sales growth, our business will suffer.
 
       
 
  If we fail to forecast demand for our products accurately, we may have excess or insufficient inventory, which may increase our operating costs, decrease our revenues and harm our business.
 
We generate forecasts of future demand for our products several months prior to the scheduled delivery to our prospective customers and typically prior to receiving a purchase order from our customers. We therefore make significant investments before our resellers or customers place orders to purchase our products and before we know if corresponding shipment forecasts will be changed. Our resellers and customers are not contractually bound by the forecasts they provide us until they sign a purchase order, and the orders we ultimately receive often differ from original forecasts. If we underestimate demand for our products, we will have inadequate inventory, which could result in delays in shipments, loss of orders and reduced revenues. This is exacerbated by the fact that lead times for materials and components that we need can vary significantly and depend on factors such as the specific supplier, contract terms and demand for each component at a given time. On the other hand, if we overestimate demand for our products and increase our inventory in anticipation of customer orders that do not materialize, we will have excess inventory and we will face a risk of significant inventory write-downs. Our failure to forecast demand accurately on a timely basis could result in a decrease in our revenues and gross margins.
 
       
We may acquire other companies or technologies, which could divert our management’s attention, result in additional dilution to our stockholders, increase expenses, and otherwise disrupt our operations and harm our operating results.
 
We may acquire or invest in other businesses, products or technologies that we believe could complement or expand our capabilities or otherwise offer growth opportunities.  The pursuit of potential acquisitions may divert the attention of management and cause us to incur various expenses in identifying, investigating, and pursuing suitable acquisitions, whether or not they are consummated.  We may not realize the anticipated benefits of these acquisitions.
 
There are inherent risks in integrating and managing corporate acquisitions, and we have limited experience with acquisitions.  If we acquire additional businesses, we may not be able to integrate the acquired personnel, operations and technologies successfully, or effectively manage the combined business following the acquisition. We also may not achieve the anticipated benefits from the acquired business due to a number of factors, including:
 
·  
unanticipated costs or liabilities associated with the acquisition;

·  
diversion of management’s attention from other business concerns;

·  
harm to our existing business relationships with business partners and customers as a result of the acquisition;

·  
the potential loss of key employees;

·  
use of resources that are need in other parts of our business; and

·  
use of substantial portions of our available cash or equity to consummate the acquisition.
 
In addition, a significant portion of the purchase price of companies we acquire may be allocated to goodwill and other indefinite lived intangible assets, which must be assessed for impairment at least annually.  In the future, if our acquisitions do not yield expected returns, we may be required to take charges to our operating results based on this impairment assessment process, which could harm our results of operations. Also, contingent considerations related to the acquisitions will be re-measured to fair value at each reporting period, with any changes in the value recorded as income or expense.
 
Future acquisitions could result in dilutive issuances of equity securities or the incurrence of debt, which could adversely affect our operating results. In addition, if an acquired business fails to meet our expectations, our operating results, business and financial condition may suffer.
 
If we fail to develop and introduce new products and features in a timely manner, or if we fail to manage product transitions, we could experience decreased revenue or decreased selling prices in the future.
 
Our future growth depends on our ability to develop and introduce new products successfully. Due to the complexity of the type of products we produce, there are significant technical risks that may affect our ability to introduce new products and features successfully. For example, our future success will depend in part on our ability to introduce new applications such as contact center systems, which are based on complex software, and our ability to integrate our products with other business applications, such as Microsoft Office. As another example, we believe there is increasing demand for communications as a managed service, either on mobile phones or desk phones, whether ours or another vendors’.
 
 
In addition, we must commit significant resources to developing new products and features before knowing whether our investments will result in products that are accepted by the market. The success of new products depends on many factors, including:
 
                
 
the ability of our products to compete with the products and solutions offered by our competitors;
 
 
the cost of our products;
 
 
the reliability of our products;
 
 
the timeliness of the introduction and delivery of our products; and
 
 
the market acceptance of our products.
 
If we are unable to develop and introduce new products in a timely manner or in response to changing market conditions or enterprise customer requirements, or if these products do not achieve market acceptance, our operating results could be materially and adversely affected.
 
Product introductions by us in future periods may also reduce demand for, or cause price declines with respect to, our existing products. As new or enhanced products are introduced, we must successfully manage the transition from older products, avoid excessive levels of older product inventories and ensure that sufficient supplies of new products can be delivered to meet enterprise customer demand. Our failure to do so could adversely affect our revenue, gross margins and other operating results.
 
Our products are highly complex and may contain undetected software or hardware errors, which could harm our reputation and future product sales.
 
Because our enterprise customers rely on our products for telecommunications, an application that is critical to their business, any failure to provide high quality and reliable products, whether caused by our own failure or failures by our contract manufacturer or suppliers, could damage our reputation and reduce demand for our products. Our products have in the past contained, and may in the future contain, undetected errors or defects. Some errors in our products may only be discovered after a product has been installed and used by enterprise customers. Any errors or defects discovered in our products after commercial release could result in loss of revenue, loss of enterprise customers and increased service and warranty costs, any of which could adversely affect our business. In addition, we could face claims for product liability, tort or breach of warranty. Our purchase orders contain provisions relating to warranty disclaimers and liability limitations, which may not be upheld. Defending a lawsuit, regardless of its merit, is costly and may divert management’s attention and adversely affect the market’s perception of us and our products. In addition, if our business liability insurance coverage proves inadequate or future coverage is unavailable on acceptable terms or at all, our business, operating results and financial condition could be adversely affected.
 
       
We intend to expand our international operations, which could expose us to significant risks.
 
To date we have limited international operations and have had low amounts of revenue from international enterprise customers. The future success of our business will depend, in part, on our ability to expand our operations and enterprise customer base successfully worldwide. Operating in international markets requires significant resources and management attention and will subject us to regulatory, economic and political risks that are different from those in the United States. Because of our limited experience with international operations, our international expansion efforts may not be successful. In addition, we will face risks in doing business internationally that could adversely affect our business, including:
 
                
 
  
our ability to comply with differing technical and environmental standards and certification requirements outside the United States;
 
 
  
difficulties and costs associated with staffing and managing foreign operations;
 
 
 
  
lower gross margins due to higher discounting;
 
 
  
greater difficulty collecting accounts receivable and longer payment cycles;
 
 
  
the need to adapt our products for specific countries;
 
 
  
availability of reliable broadband connectivity and wide area networks in targeted areas for expansion;
 
 
  
unexpected changes in regulatory requirements;
 
 
  
difficulties in understanding and complying with local laws, regulations and customs in foreign jurisdictions;
 
 
  
tariffs, export controls and other non-tariff barriers such as quotas and local content rules;
 
 
  
more limited protection for intellectual property rights in some countries;
 
 
  
adverse tax consequences;
 
 
  
fluctuations in currency exchange rates, which could increase the price of our products outside of the United States, increase the expenses of our international operations and expose us to foreign currency exchange rate risk;
 
 
  
restrictions on the transfer of funds;
 
 
  
new and different sources of competition;
 
 
  
less access to the end customer due to our use of two-tier distribution internationally.
 
Our failure to manage any of these risks successfully could harm our future international operations and our overall business.
 
We are subject to environmental and other health and safety regulations that may increase our costs of operations or limit our activities.
 
We are subject to environmental and other health and safety regulations relating to matters such as reductions in the use of harmful substances, the use of lead-free soldering and the recycling of products and packaging materials. For example, the European Parliament and the Counsel of the European Union have published directives on waste electrical and electronic equipment and on the restriction of the use of certain hazardous substances in electrical and electronic equipment. These directives generally require electronics producers to bear the cost of collection, treatment, recovery and safe disposal of past and future products from end users and to ensure that new electrical and electronic equipment does not contain specified hazardous substances. While the cost of these directives to us cannot be determined before regulations are adopted in individual member states of the European Union, it may be substantial and may divert resources, which could detract from our ability to develop new products or operate our business, particularly if we increase international operations. We may not be able to comply in all cases with applicable environmental and other regulations, and if we do not, we may incur remediation costs or we may not be able to offer our products for sale in certain countries, which could adversely affect our results.
       
 
Some of our competitors could design their products to prevent or impair the interoperability of our products with enterprise customers’ networks, which could cause installations to be delayed or cancelled.
 
Our products must interface with enterprise customer software, equipment and systems in their networks, each of which may have different specifications. To the extent our competitors supply network software, equipment or systems to our enterprise customers; it is possible these competitors could design their technologies to be closed or proprietary systems that are incompatible with our products or to work less effectively with our products than their own. As a result, enterprise customers would be incentivized to purchase products that are compatible with the products and technologies of our competitors over our products. A lack of interoperability may result in significant redesign costs and harm relations with our enterprise customers. If our products do not interoperate with our enterprise customers’ networks, installations could be delayed or orders for our products could be cancelled, which would result in losses of revenue and enterprise customers that could significantly harm our business.
 
       
 
Our products require reliable broadband connections, and we may be unable to sell our products in markets where broadband connections are not yet widely available.
 
End users of our products must have reliable access to an enterprise customer’s wide area network in order for our products to perform properly. Accordingly, it is not likely that there will be demand for our products in geographic areas that do not have a sufficiently reliable infrastructure of broadband connections. Many geographic locations do not have reliable infrastructure for broadband connections, particularly in some international markets. Our future growth could be limited if broadband connections are not or do not become widely available in markets that we target.
 
If our enterprise customers experience inadequate performance with their wide area networks, even if unrelated to our systems, our product performance could be adversely affected, which could harm our relationships with current enterprise customers and make it more difficult to attract new enterprise customers.
 
Our products depend on the reliable performance of the wide area networks of enterprise customers. If enterprise customers experience inadequate performance with their wide area networks, whether due to outages, component failures, or otherwise, our product performance would be adversely affected. As a result, when these types of problems occur with these networks, our enterprise customers may not be able to immediately identify the source of the problem, and may conclude that the problem is related to our products. This could harm our relationships with our current enterprise customers and make it more difficult to attract new enterprise customers, which could harm our business.
 
We might require additional capital to support our business in the future, and this capital might not be available on acceptable terms, or at all.
 
Although we anticipate that our current cash, cash equivalents and short-term investments on hand will be sufficient to meet our currently anticipated cash needs, if our cash and cash equivalents balances are not sufficient to meet our future cash requirements, we will need to seek additional capital, potentially through debt or equity financings, to fund our operations. We may also need to raise additional capital to take advantage of new business or acquisition opportunities. We may seek to raise capital by, among other things:
                   
 
 
  
issuing additional common stock or other equity securities;
 
 
  
issuing debt securities; or
 
 
  
borrowing funds under a credit facility.
 
We may not be able to raise needed cash on terms acceptable to us or at all. Financings, if available, may be on terms that are dilutive or potentially dilutive to our stockholders. The holders of new securities may also receive rights, preferences or privileges that are senior to those of existing holders of common stock. In addition, if we were to raise cash through a debt financing, such debt may impose conditions or restrictions on our operations, which could adversely affect our business. If new sources of financing are required but are insufficient or unavailable, we would be required to modify our operating plans to the extent of available funding, which would harm our ability to maintain or grow our business.
 
We are exposed to fluctuations in the market value of our money market funds and investments and financial pressure on investment institutions managing our investments may lead to restrictions on access to our investments which could harm our financial condition.
 
We maintain an investment portfolio of various holdings and maturity dates. These securities are recorded on our consolidated balance sheets at fair value. This portfolio includes money market funds, U.S. Government agency securities, corporate notes and commercial paper of various issuers. If the debt of these issuers is downgraded, the carrying value of these investments could be impaired. We could face default risk from some of these issuers, which could also cause the carrying value to be impaired.
 
In addition, although a downgrade in credit ratings is not unprecedented, the impact of a downgrade of the U.S. credit rating is uncertain.  This downgrade could materially affect global and domestic financial markets and economic conditions, which may affect our financial condition and liquidity.
 
Our products include third-party technology and intellectual property, which could present additional risks.
 
We incorporate certain third-party technologies, such as our contact center, conference bridge and network monitoring software, into our products, and intend to utilize additional third-party technologies in the future. However, licenses to relevant third-party technology or updates to those technologies may not continue to be available to us on commercially reasonable terms, or at all. Furthermore, we do not own the electronic design for our phones, so it may be difficult for us to arrange for an alternate of or a replacement for these products in a timely manner. Therefore, we could face delays in product releases until equivalent technology can be identified, licensed or developed, and integrated into our current products. These delays, if they occur, could materially adversely affect our business.
 
 
Failure to protect our intellectual property could substantially harm our business.
 
Our success and ability to compete are substantially dependent upon our intellectual property. We rely on patent, trademark and copyright law, trade secret protection and confidentiality or license agreements with our employees, enterprise customers, strategic partners and others to protect our intellectual proprietary rights. However, the steps we take to protect our intellectual property rights may be inadequate. We currently have 33 issued U.S. patents and 61patent applications pending in the U.S. and outside the U.S. We cannot assure you that any additional patents will be issued. Even if patents are issued, they may not adequately protect our intellectual property rights or our products against competitors, and third-parties may challenge the scope, validity and/or enforceability of our issued patents. In addition, other parties may independently develop similar or competing technologies designed around any patents that may be issued to us.
 
In order to protect our intellectual property rights, we may be required to spend significant resources to monitor and protect such rights. We may not be able to detect infringement, and may lose our competitive position in the market before we are able to do so. In the event that we detect any infringement of our intellectual property rights, we intend to enforce such rights vigorously, and from time to time we may initiate claims against third parties that we believe are infringing on our intellectual property rights if we are unable to resolve matters satisfactorily through negotiation. Litigation brought to protect and enforce our intellectual property rights could be costly, time-consuming and distracting to management and could result in the impairment or loss of portions of our intellectual property. Furthermore, our efforts to enforce our intellectual property rights may be met with defenses, counterclaims and countersuits attacking the validity and enforceability of our intellectual property rights. Our failure to secure, protect and enforce our intellectual property rights could harm our brand and adversely impact our business, financial condition and results of operations.
 
If a third party asserts that we are infringing on its intellectual property, whether successful or not, it could subject us to costly and time-consuming litigation or expensive licenses, which could harm our business.
 
There is considerable patent and other intellectual property development activity in our industry. Our success depends, in part, upon our not infringing upon the intellectual property rights of others. Our competitors, as well as a number of other “non-practicing entities” and individuals, own or claim to own intellectual property relating to our industry and may have substantially larger and broader patent portfolios than we do. From time to time, third parties may claim that we are infringing upon their intellectual property rights, and we may be found to be infringing upon such rights. Third parties have in the past sent us correspondence regarding their intellectual property and have filed litigation against us, and in the future we may receive claims that our products infringe or violate their intellectual property rights. In this regard, in 2007, Mitel Networks Corporation, one of our competitors, filed a lawsuit against us, which was subsequently settled. Furthermore, we may be unaware of the intellectual property rights of others that may cover some or all of our technology or products. Any claims or litigation could cause us to incur significant expenses and, if successfully asserted against us, could require that we pay substantial damages or ongoing royalty payments, prevent us from selling our products, damage our reputation, or require that we comply with other unfavorable terms, any of which could materially harm our business. In addition, we may decide to pay substantial settlement costs in connection with any claim or litigation, whether or not successfully asserted against us. Even if we were to prevail, any litigation regarding our intellectual property could be costly and time-consuming and divert the attention of our management and key personnel from our business operations.
 
Litigation with respect to intellectual property rights in the telecommunications industries is not uncommon and can often involve patent holding companies who have little or no product revenue and against whom our own patents may provide little or no deterrence. We may also be obligated to indemnify our enterprise customers or business partners in connection with any such litigation, which could further exhaust our resources. Furthermore, as a result of an intellectual property challenge, we may be required to enter into royalty, license or other agreements. We may not be able to obtain these agreements on terms acceptable to us or at all. We may have to incur substantial cost in re-designing our products to avoid infringement claims. In addition, disputes regarding our intellectual property rights may deter distributors from selling our products and dissuade potential enterprise customers from purchasing such products. As such, third-party claims with respect to intellectual property may increase our cost of goods sold or reduce the sales of our products, and may have a material and adverse effect on our business.
 
If we fail to establish and maintain proper and effective internal control over financial reporting, our operating results and our ability to operate our business could be harmed.
 
 
- 23 -

 
The Sarbanes-Oxley Act of 2002 requires, among other things, that we establish and maintain internal control over financial reporting and disclosure controls and procedures. In particular, under the current rules of the SEC, we must perform system and process evaluation and testing of our internal control over financial reporting to allow management to report on the effectiveness of our internal control over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act. Our independent registered public accounting firm is also required to report on our internal control over financing reporting. Our and our auditor’s testing may reveal deficiencies in our internal control over financial reporting that are deemed to be material weaknesses and render our internal control over financial reporting ineffective. We have incurred and we expect to continue to incur substantial accounting and auditing expense and expend significant management time in complying with the requirements of Section 404. If we are not able to comply with the requirements of Section 404 in a timely manner, or if we and our independent registered public accounting firm identify deficiencies in our internal control over financial reporting that are deemed to be material weaknesses, the market price of our stock could decline and we could be subject to investigations or sanctions by the SEC, The NASDAQ Stock Market, or NASDAQ, or other regulatory authorities or subject to litigation. To the extent any material weaknesses in our internal control over financial reporting are identified in the future, we could be required to expend significant management time and financial resources to correct such material weaknesses or to respond to any resulting regulatory investigations or proceedings.
 
Changes in regulatory compliance obligations of critical suppliers may adversely impact our operations.
 
The Dodd-Frank Wall Street Reform and Consumer Protection Act, (Dodd-Frank Act), signed into law on July 21, 2010, includes Section 1502, which requires the Securities and Exchange Commission (SEC), to adopt additional disclosure requirements related to certain minerals sourced from the Democratic Republic of Congo and surrounding countries, or conflict minerals, for which such conflict minerals are necessary to the functionality of a product manufactured, or contracted to be manufactured, by an SEC reporting company. The metals covered by the proposed rules, promulgated on December 15, 2010, are commonly referred to as “3TG” and include tin, tantalum, tungsten and gold. Our suppliers may use these materials in the production processes. If the rules are adopted as proposed, in order to be able to accurately report our compliance with Section 1502, we will have to perform supply chain due diligence, third-party verification and possibly private sector audits on the sources of these metals all the way down to the mine of origin. Global supply chains are complicated, with multiple layers and suppliers between the mine and the final product. Accordingly, we could incur significant cost related to the compliance process. While the impact of Section 1502 on our business is uncertain at this time, we could potentially have difficulty in procuring needed materials from conflict-free sources and in satisfying the associated disclosure requirements when finalized by the SEC.
 
Our principal offices and the facilities of our contract manufacturers are located near known earthquake fault zones, and the occurrence of an earthquake or other catastrophic disaster could damage our facilities or the facilities of our contract manufacturers, which could cause us to curtail our operations.
 
Our principal offices, our disaster recovery site, and the facilities of one of our contract manufacturers are located in California near known earthquake fault zones and, therefore, are vulnerable to damage from earthquakes. We and our contract manufacturers are also vulnerable to damage from other types of disasters, such as power loss, fire, floods and similar events. If any disaster were to occur, our ability to operate our business could be seriously impaired. In addition, we may not have adequate insurance to cover our losses resulting from disasters or other similar significant business interruptions. Any significant losses that are not recoverable under our insurance policies could seriously impair our business and financial condition.
 
Risks Related to Ownership of Our Common Stock
 
Our stock price in the past has been volatile, and may continue to be volatile or may decline regardless of our operating performance, and investors may not be able to resell shares at or above the price at which they purchased the shares.
 
Since our stock began trading in July 2007, our stock price has fluctuated significantly, from a low of approximately $3 per share to a high of approximately $18 per share. At times the stock price has changed very quickly. For example, in January 2008, our stock price dropped from approximately $13 per share to approximately $6 per share, and as a result, we were subject to securities lawsuits which have since been settled. If investors purchase shares of our common stock, they may not be able to resell those shares at or above the price at which they purchased them. The market price of our common stock may fluctuate significantly in response to numerous factors, many of which are beyond our control, including:
 
 
                   
 
  
fluctuations in the overall stock market;
 
 
  
the financial projections we may provide to the public, any changes in these projections or our failure to meet these projections;
 
 
  
actual or anticipated fluctuations in our operating results;
 
 
  
changes in operating performance and stock market valuations of other technology companies generally, or those that sell enterprise communication products in particular;
 
 
  
changes in financial estimates by any securities analysts who follow our company, our failure to meet these estimates or failure of those analysts to initiate or maintain coverage of our stock;
 
 
  
ratings downgrades by any securities analysts who follow our company;
 
 
  
the public’s response to our press releases or other public announcements, including our filings with the SEC;
 
 
  
announcements by us or our competitors of significant technical innovations, customer wins or losses, acquisitions, strategic partnerships, joint ventures or capital commitments;
 
 
  
introduction of technologies or product enhancements that reduce the need for our products;
 
 
  
market conditions or trends in our industry or the economy as a whole;
 
 
  
lawsuits threatened or filed against us and the outcome of such lawsuits;
 
 
  
shareholder activism;
 
 
  
future sales of our common stock by our officers, directors and significant stockholders; and
 
 
  
other events or factors, including those resulting from war, incidents of terrorism or responses to these events.
 
In addition, the stock markets, and in particular the Nasdaq Global Select Market, have experienced extreme price and volume fluctuations that have affected and continue to affect the market prices of equity securities of many technology companies. Stock prices of many technology companies have fluctuated in a manner unrelated or disproportionate to the operating performance of those companies. In the past, stockholders have initiated securities class action litigation following declines in stock prices of technology companies. Our current litigation is, and any future litigation may, subject us to substantial costs, divert resources and the attention of management from our business, which could harm our business and operating results.
 
Our operating results may fluctuate in the future, which could cause our stock price to decline.
 
Our historical revenues and operating results have varied from quarter to quarter. Moreover, our actual or projected operating results for some quarters may not meet our own expectations, or the expectations of stock market analysts and investors, which may cause our stock price to decline. In addition to the factors discussed elsewhere in this “Risk Factors” section, a number of factors may cause our revenue to fall short of our expectations or cause fluctuations in our operating results, including:
 
                           
 
  
adverse conditions specific to the IP telecommunications market, including decreased demand due to overall economic conditions or reduced discretionary spending by enterprises, rates of adoption of IP telecommunications systems and introduction of new standards;
 
 
  
our ability to attract and retain larger and more productive channel partners;
 
 
  
the purchasing and budgeting cycles of enterprise customers, in particular, the tendency of some customers to wait until the end of a quarter in the hopes of obtaining a better price;
 
 
  
the timing and volume of shipments of our products during a quarter, particularly as we experience an increased level of sales occurring towards the end of a quarter;
 
 
 
  
delays in purchasing decisions by our customers from one quarter to the next, or later;
 
 
  
seasonality in our target markets;
 
 
  
our ability to attract new channel partners, retain existing channel partners, and their ability to generate revenues;
 
 
  
changes in accounting rules;
 
 
  
the timing of recognition of revenue from sales to our customers;
 
 
  
changes in the mix of our products and services sold during a particular period;
 
 
  
our ability to control costs, including third-party manufacturing costs and costs of components;
 
 
  
our ability to maintain sufficient production volumes for our products from our contract manufacturers;
 
 
  
volatility in our stock price, which may lead to higher stock-based compensation expenses
 
 
  
volatility and fluctuation in foreign currency exchange rates;
 
 
  
the timing of costs related to the development or acquisition of technologies or businesses;
 
 
  
our ability to successfully expand our international operations;
 
 
  
general economic conditions or economic recession;
 
 
  
decline in interest rates on our investments; and
 
 
  
publicly-announced litigation, and the impact of such litigation on our operating results.
 
Because our operating expenses are largely fixed in the short-term, any shortfalls in revenue in a given period would have a direct and adverse effect on our operating results in that period. We believe that our quarterly and annual revenue and results of operations may vary significantly in the future and that period-to-period comparisons of our operating results may not be meaningful. You should not rely on the results of one period as an indication of future performance.
 
A substantial portion of our product orders are usually received in the last month of each fiscal quarter, with a concentration of such orders in the final two weeks of the quarter. While we typically ship products shortly after the receipt of an order, we may have orders that have not shipped at the end of any given quarter. Because the amount of such product orders may vary, the amount, if any, of such orders at the end of a particular quarter is not a reliable predictor of our future performance.
 
Because it is difficult for us to predict our quarterly operating results, period-to-period comparisons of our operating results may not be a good indication of our future performance. If, as a result of these difficulties, our revenues and operating results do not meet the expectations of our investors or securities analysts or fall below guidance we may provide to the market, the price of our common stock may decline.
 
Future sales of outstanding shares of our common stock into the market in the future could cause the market price of our common stock to drop significantly, even if our business is doing well.
 
Approximately 10% of our outstanding shares are currently held by one investor. If this investor or any existing stockholders sell or distribute a large number of shares of our common stock or the public market perceives that these sales may occur, the market price of our common stock could decline. All of our outstanding shares are freely tradable without restriction or further registration under the federal securities laws, subject in some cases to the volume, manner of sale and other limitations under Rule 144. In addition, pursuant to our investor rights agreement, some of our early investors may require us to register their shares for public sale which could result in a substantial volume of shares being sold in a short period of time. Due to these factors, sales of a substantial number of shares of our common stock in the public market could occur at any time. These sales, or the perception in the market that the holders of a large number of shares intend to sell shares, could reduce the market price of our common stock.
 
 
Our charter documents and Delaware law may inhibit a takeover that stockholders consider favorable and could also limit the market price of our stock.
 
Our restated certificate of incorporation and bylaws and applicable provisions of Delaware law may make it more difficult for or prevent a third party from acquiring control of us without the approval of our board of directors. These provisions:
 
               
 
  
prohibit stockholder action by written consent, thereby requiring all stockholder actions to be taken at a meeting of our stockholders;
 
 
  
limit who may call a special meeting of stockholders;
 
 
  
established a classified board of directors, so that not all members of our board of directors may be elected at one time;
 
 
  
provide our board of directors with the ability to designate the terms of and issue a new series of preferred stock without stockholder approval;
 
 
  
require the approval of two-thirds of the shares entitled to vote at an election of directors to adopt, amend or repeal our bylaws or repeal certain provisions of our certificate of incorporation;
 
 
  
allow a majority of the authorized number of directors to adopt, amend or repeal our bylaws without stockholder approval;
 
 
  
do not permit cumulative voting in the election of our directors, which would otherwise permit less than a majority of stockholders to elect directors; and
 
 
  
set limitations on the removal of directors.
 
In addition, Section 203 of the Delaware General Corporation Law generally limits our ability to engage in any business combination with certain persons who own 15% or more of our outstanding voting stock or any of our associates or affiliates who at any time in the past three years have owned 15% or more of our outstanding voting stock. These provisions may have the effect of entrenching our management team and may deprive you of the opportunity to sell your shares to potential acquirers at a premium over prevailing prices. This potential inability to obtain a control premium could reduce the price of our common stock.
 
ITEM 1B.
UNRESOLVED STAFF COMMEN TS
 
None.
 
ITEM 2. 
PROPERTI ES
 
Our headquarters, which is located in Sunnyvale, California is a 63,781 square foot leased facility.  This lease expires in September 2014.  We also occupy leased facilities in Austin, Texas, and in Europe and Australia.
  
We maintain a shipping and warehouse facility in Fremont, California for our inventory and we rent space as needed at third-party warehouses. Our inventory is expected to be kept at our facility and at the third party facilities.
 
We believe that our current facilities are suitable and adequate to meet our current needs, and we intend to add new facilities or expand existing facilities as we add employees. We believe that suitable additional or substitute space will be available on commercially reasonable terms as needed to accommodate our operations.
 
ITEM 3.
LEGAL PROCEE DINGS
 
Information with respect to this item may be found in Note 9 to the Consolidated Financial Statements in Item 8,  which is incorporated herein by reference.
 
ITEM 4.
RESERVE D
 
ITEM 5.
MARKET FOR OUR COMMON STOCK AND RELATED STOCKHOLDER MAT TERS
 
 
- 27 -

 
Market Information
 
Our common stock has been traded on The NASDAQ Global Select Market under the symbol “SHOR” since July 3, 2007.  Prior to that time, there was no public market for our common stock. The following table sets forth for the periods indicated the high and low sale prices of our common stock, as reported by The NASDAQ Global Select Market.
 
Year Ended June 30, 2011
 
High
   
Low
 
First Quarter
  $ 6.02     $ 4.36  
Second Quarter
    7.96       4.90  
Third Quarter
    8.99       6.50  
Fourth Quarter
    12.00       8.09  
                 
Year Ended June 30, 2010
 
High
   
Low
 
First Quarter
  $ 9.22     $ 5.86  
Second Quarter
    8.14       5.06  
Third Quarter
    6.96       5.22  
Fourth Quarter
    6.79       4.47  
 
In the past, technology stocks have experienced high levels of volatility. The trading price of our common stock may fluctuate substantially. These fluctuations could cause you to lose all or part of your investment in our common stock. Factors that could cause fluctuations in the trading price of our common stock include the following:
 
 
price and volume fluctuations in the overall stock market from time to time;
 
 
significant volatility in the market price and trading volume of technology companies;
 
 
actual or anticipated changes in our results of operations or fluctuations in our operating results;
 
 
actual or anticipated changes in the expectations of investors or securities analysts;
 
 
actual or anticipated developments in our competitors’ businesses or the competitive landscape generally;
 
 
litigation involving us, our industry or both;
 
 
regulatory developments in the United States, foreign countries or both;
 
 
economic conditions and trends in our industry;
 
 
major catastrophic events;
 
 
sales of large blocks of our stock;
 
 
stock buyback programs; or
 
 
departures of key personnel.
 
In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation has often been brought against that company. If our stock price is volatile, we may become the target of securities litigation. Securities litigation could result in substantial costs and divert our management’s attention and resources from our business.
 
On September 1, 2011, the last reported sales price of our common stock on the Nasdaq Global Select Market was $6.54 per share.
 
Holders of Record
 
As of September 1, 2011, there were 108 stockholders of record of our common stock, although we believe there are approximately 1,900 beneficial owners since many brokers and other institutions hold our common stock on behalf of stockholders.
 
Dividend Policy
 
We have never declared or paid dividends on our common stock. We intend to retain any future earnings for use in our business and therefore we do not anticipate declaring or paying any cash dividends in the foreseeable future.
 
 
Sales of Unregistered Securities
 
None.
 
Use of Proceeds from Public Offering of Common Stock
 
The effective date of the registration statement for our initial public offering was July 2, 2007 (Registration No. 333-140630). The proceeds from our initial public offering were primarily invested in cash, cash equivalents and short term investments and the acquisition of Agito Networks, Inc.. None of the use of the proceeds was made, directly or indirectly, to our directors, officers, or persons owning 10% or more of our common stock.
 
Stock Performance Graphs and Cumulative Total Return   (1)
 
The following graph shows the cumulative total stockholder return of an investment of $100 in cash on July 3, 2007, the date our common stock first started trading on the NASDAQ Global Select Market through June 30, 2011, for (i) our common stock, (ii) the S&P Small Cap 500 Index and (iii) the NASDAQ Telecommunications Index. Pursuant to applicable SEC rules, all values assume reinvestment of the full amount of all dividends, however no dividends have been declared on our common stock to date. The stockholder return shown on the graph below is not necessarily indicative of future performance, and we do not make or endorse any predictions as to future stockholder returns.
 
This performance graph shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or the “Exchange Act,” or incorporated by reference into any filing of ours under the Securities Act of 1933, as amended, or the Exchange Act, except as shall be expressly set forth by specific reference in such filing.

 
$100 invested on 7/3/08 in stock or index.  Fiscal year ending June 30,
 
 
7/3/2007
2008
2009
2010
2011
ShoreTel, Inc.
100
36.38
65.84
38.19
83.95
S&P Small Cap 500 Index
100
83.94
61.94
70.87
92.63
NASDAQ Telecommunications Index
100
71.62
52.08
69.02
102.15
 
 

 
(1) This Section is not “soliciting material,” is not deemed “filed” with the SEC and is not to be incorporated by reference in any filing of ShoreTel, Inc. under the 1933 Act or the 1934 Act whether made before or after the date hereof and irrespective of any general incorporation language in any such filing.
 
 
 
- 29 -


Equity Compensation Plan Information
 
The following table summarizes information about our equity compensation plans as of June 30, 2011. All outstanding awards relate to our common stock.
 
Plan Category
 
Number of
Securities to be
Issued upon
Exercise of
Outstanding
Options,
Warrants and
Rights
   
Weighted
Average
Exercise
Price of
Outstanding
Options,
Warrants and
Rights
   
Number of
Securities
Remaining
Available for
Future Issuances
under Equity
Compensation
Plans (Excluding)
Securities Column 
(a)
 
   
(a)
   
(b)(2)
   
(c)
 
Equity compensation plans approved by security holders(1)
    9,127,000     $ 4.74       5,010,000  
Equity compensation plans not approved by security holders
                 
Total
    9,127,000     $ 4.74       5,010,000  
 
(1)   
The number of securities remaining available for future issuance in column (c) includes 5,010,000 shares of common stock authorized and available for issuance under our 2007 Employee Stock Purchase Plan (ESPP) and our 2007 Equity Incentive Plan (2007 Plan). The number of shares authorized for issuance under the ESPP is subject to an annual increase equal to 1% of the outstanding shares on the date of the annual increase or an amount determined by the Board of Directors and the number of shares authorized for issuance under the 2007 Plan is subject to an annual increase equal to 5% of the outstanding shares on the date of the annual increase or an amount determined by the Board of Directors. The number of securities to be issued to participants in column (a) does not include shares of common stock to be issued to participants in consideration of aggregate participant contributions under the ESPP as of June 30, 2011.
 
(2)  
The weighted average exercise price does not reflect shares subject to restricted stock awards.

 
 
- 30 -


PART II.
 
ITEM 6.
SELECTED CONSOLIDATED FINANCIAL DATA
 
The following selected consolidated financial data should be read in connection with our consolidated financial statements and notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this Annual Report on Form 10-K. Our historical results are not necessarily indicative of the results to be expected in any future period.
 
   
Year Ended June 30,
 
       
   
2011
   
2010
   
2009
   
2008
   
2007
 
      (In thousands)  
Revenue:      
Product
  $ 159,693     $ 117,138     $ 109,555     $ 110,496     $ 87,095  
Support and services
    40,419       31,326       25,267       18,233       10,732  
Total revenue
    200,112       148,464       134,822       128,729       97,827  
Cost of revenue:
                                       
Product(1)
    52,957       40,471       38,149       37,466       29,753  
Support and services(1)
    13,688       11,580       11,048       10,036       6,847  
Total cost of revenue
    66,645       52,051       49,197       47,502       36,600  
Gross profit
    133,467       96,413       85,625       81,227       61,227  
Operating expenses:
                                       
Research and development(1)
    45,548       33,596       30,724       26,811       17,260  
Sales and marketing(1)
    74,859       55,973       44,652       37,869       26,174  
General and administrative(1)
    25,230       19,888       19,596       17,645       11,674  
Litigation settlement
    -       -       4,110       -       -  
Total operating expenses
    145,637       109,457       99,082       82,325       55,108  
Operating income (loss)
    (12,170 )     (13,044 )     (13,457 )     (1,098 )     6,119  
Other income – net
    640       84       1,141       4,101       273  
Income (loss) before income tax benefit (provision)
    (11,530 )     (12,960 )     (12,316 )     3,003       6,392  
Income tax benefit (provision)
    67       156       (343 )     (861 )     (408 )
Net income (loss)
    (11,463 )     (12,804 )     (12,659 )     2,142       5,984  
Accretion of preferred stock
    -       -       -       -       (50 )
Net  income (loss) available to common stockholders
  $ (11,463 )   $ (12,804 )   $ (12,659 )   $ 2,142     $ 5,934  
Net  income (loss) per common share available to common stockholders(2):
                                       
Basic
  $ (0.25 )   $ (0.29 )   $ (0.29 )   $ 0.05     $ 0.69  
Diluted
  $ (0.25 )   $ (0.29 )   $ (0.29 )   $ 0.05     $ 0.17  
Shares used in computing net  income (loss)  per share available to common stockholders:
                                       
Basic
    46,177       44,804       43,714       42,413       8,565  
Diluted
    46,177       44,804       43,714       44,861       35,581  
 

 (1)   Includes stock-based compensation expense as follows:
 
 
      Year Ended June 30,  
   
2011
   
2010
   
2009
   
2008
   
2007
 
 
   
(In thousands)
 
Cost of product revenue
  $ 123     $ 139     $ 113     $ 74     $ 14  
Cost of support and services revenue
    678       838       799       545       109  
Research and development
    3,497       3,064       2,829       2,005       420  
Sales and marketing
    3,140       3,400       3,468       2,447       581  
General and administrative
    3,741       3,213       2,549       2,360       1,659  
Total stock-based compensation expense
  $ 11,179     $ 10,654     $ 9,758     $ 7,431     $ 2,783  
 
(2)  
See Note 5 to the Consolidated Financial Statements in Item 8 for a description of the method used to compute basic and diluted net income (loss) per share available to common stockholders.
 
    As of June 30,  
   
2011
   
2010
   
2009
   
2008
   
2007
 
   
(In thousands)
 
Consolidated balance sheet data:
                             
Cash and cash equivalents and short-term investments
  $ 105,752     $ 115,801     $ 107,666     $ 102,811     $ 17,326  
Working capital
    109,855       112,836       111,617       111,993       23,018  
Total assets
    187,101       170,721       155,624       147,797       53,034  
Redeemable convertible preferred stock
                            56,341  
Total stockholders’ equity (deficit)
    121,424       114,466       113,772       113,213       (31,829 )
 
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPER ATIONS
 
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the 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 above in the section entitled “Risk Factors.” We report results on a fiscal year ending June 30. For ease of reference within this section, 2011 refers to the fiscal year ended June 30, 2011, 2010 refers to the fiscal year ended June 30, 2010, and 2009 refers to the fiscal year ended June 30, 2009.
 
Overview
 
We are a leading provider of IP telecommunications solutions for enterprises. Our solution is comprised of our switches, IP phones and software applications. We were founded in September 1996 and shipped our first system in 1998. Since that time, we have continued to develop and enhance our product line. Our acquisition of Agito Networks, Inc. (“Agito”) , a leader in platform-agnostic enterprise mobility, in the second quarter of fiscal 2011, expands our existing mobile solution with the vision of allowing users to communicate on any device, such as a desk phone, mobile phone, or computer, at any location using any cellular or Wi-Fi network  simply and cost effectively.

 Our phone and switch products are manufactured by contract manufacturers located in United States and in China. Our contract manufacturers provide us with a range of operational and manufacturing services, including component procurement, final testing and assembly of our products, which allows us to scale our business without the significant capital investment and on-going expenses required to establish and maintain a manufacturing operation.
 
We sell our products primarily through channel partners that market and sell our systems to enterprises across all industries, including small, medium and large companies and public institutions. We believe our channel strategy allows us to reach a larger number of prospective enterprise customers more effectively than if we were to sell directly. The number of our authorized channel partners grew to over 900 as of June 30, 2011, representing approximately 13% year-over-year growth. Our c hannel partners typically purchase products directly from us or from our value-added distributors. Our internal sales and marketing personnel support these channel partners in their selling efforts. In some circumstances, the enterprise customer will purchase products directly from us, but in these situations we typically compensate the channel partner for its sales efforts. At the request of the channel partner, we often ship our products directly to the enterprise customer.
 
 
- 32 -

 
Most channel partners perform installation and implementation services for the enterprises that use our systems. Generally, our channel partners provide the post-contractual support to the enterprise customer by providing first-level support services and purchasing additional services from us under a post-contractual support contract. For channel partners without support capabilities or that do not desire to provide support, we offer full support contracts to provide all of the support to enterprise customers. Our channel partners may provide managed services offerings to the enterprise customer under which the channel partner may purchase our products and services and, in turn, charge the enterprise customer a monthly subscription fee to access those products and services. In addition, we have begun to engage some of our channel partners to purchase our products and services from us under a monthly managed services model.
 
During the second quarter of fiscal 2011, we entered into arrangements with two major value-added distributors to distribute our comprehensive line of business communication solutions to channel partners in the United States in what we refer to as a “two-tier” distribution model.  We believe that the two-tier distribution model allows us to better serve our existing channel partners, to reach a larger number of prospective enterprise customers more effectively and to position us to continue to build momentum and capture increased market share in the IP telephony, mobility and UC markets.  Furthermore, the two-tier distribution model allows us to scale our business operations without making significant investments in product distribution facilities, thus allowing us to manage our cost structure.  We plan to seek relationships with additional value-added distributors in the future.
 
Although, we have historically sold our systems primarily to small and medium sized enterprises, in recent years, we have been expanding our sales and marketing activities to increase our focus on larger enterprise customers, including the creation of a major accounts program whereby our sales personnel assist our channel partners to sell to large enterprise accounts. As of June 30, 2011, we had sold our products to approximately 18,000 enterprise customers, representing close to a 30% year-over-year growth.  To the extent, we continue to successfully acquire larger enterprise customers in the United States and worldwide, we expect our sales cycle to increase, and the demands on our sales and support infrastructure to increase.
 
We are headquartered in Sunnyvale, California and have sales, customer support, general and administrative and engineering functions in Austin, Texas. The majority of our personnel work at these locations. Sales, engineering, and support personnel are also located throughout the United States and, to a lesser extent, in Canada, the United Kingdom, Ireland, Germany, Belgium, Spain, Hong Kong, Singapore and Australia. While most of our customers are located in the United States, we have continued to achieve growth in revenue from international sales, which accounted for approximately 13% of our total revenue for fiscal 2011 compared with 10% and 7% in fiscal 2010 and 2009, respectively.  We expect sales to customers in the United States will continue to comprise the majority of our sales in the foreseeable future.
 
In fiscal 2011, we continued to grow our market share of the IP telephony market, both in the United States and worldwide. Our total revenue increased to $200.1 million in fiscal 2011 from $148.5 million in fiscal 2010, primarily driven by sales to new customers. Our operating expenses increased to $145.6 million in fiscal 2011 from $109.5 million in fiscal 2010, primarily due to increases in compensation expenses related to growth in headcount (including stock-based based compensation).  In fiscal 2011, we increased our headcount by 32%, with most of the growth in headcount coming from additions to our sales, product development and support workforce to support efforts to grow our sales channel and to enhance our product development activities, among other things.  The acquisition of Agito also contributed to the increase in operating expenses primarily due to increases in compensation expense associated with employees hired from Agito, as well as non-recurring acquisition related expenses.
 
Key Business Metrics
 
We monitor a number of key metrics to help forecast growth, establish budgets, measure the effectiveness of our sales and marketing efforts and to measure operational effectiveness.
 
Initial and repeat sales orders. Our goal is to attract a significant number of new enterprise customers and to encourage existing enterprise customers to purchase additional products and support. Many enterprise customers make an initial purchase and deploy additional sites at a later date, and also purchase additional products and support as their businesses expand. As our installed enterprise customer base has grown, a larger portion of orders has come from existing enterprise customers. In fiscal year 2011, order volume from existing enterprise customers represented approximately 53% of total order volume compared with 56% and 54% in fiscal 2010 and 2009, respectively.
 
 
- 33 -

 
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 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 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. This deferred revenue helps provide predictability to our future support and services revenue. Our deferred revenue balance at June 30, 2011 was $37.7 million, of which $26.4 million is expected to be recognized within one year.
 
Gross margin. Our gross margin for products is 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. As the prices and costs of our hardware components have decreased over time, our software components, which have lower costs than our hardware components, have represented a greater percentage of our overall margin on system sales. 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 slightly lower than gross margin for products, and 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.
 
Operating expense management. 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 to support our anticipated growth, and therefore, our ability to forecast revenue is critical to managing our operating expenses.
 
Basis of Presentation
 
Revenue. We derive our revenue from sales of our IP telecommunications systems and related support and services. Our typical system includes a combination of IP phones, switches and software applications. Channel partners buy our products directly from us or from our value-added distributors. Prices to a given channel partner for hardware and software products depend on that channel partner’s volume and customer satisfaction levels, as well as our own strategic considerations. In circumstances where we sell directly to the enterprise customer in transactions that have been assisted by channel partners, we report our revenue net of any associated payment to the channel partners that assisted in such sales. This results in recognized revenue from a direct sale approximating the revenue that would have been recognized from a sale of a comparable system through a channel partner. Product revenue has accounted for 80%, 79%, and 81% of our total revenue for 2011, 2010 and 2009, respectively.
 
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.
 
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.
 
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 capitalize development costs incurred from determination of technological feasibility through 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 significant investments in our research and development efforts because we believe they are essential to maintaining and improving our competitive position. Accordingly, we expect research and development expenses to continue to increase in absolute dollars.
 
 
- 34 -

 
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 and allocated 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 large 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 increase in absolute dollars and remain 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, accounting, tax, compliance and information systems, travel, recruiting expense, software amortization costs, depreciation expense and facilities expenses. As we expand our business, we expect general and administrative expenses to increase in absolute dollars.
 
Other income (expense). Other income (expense) primarily consists of interest earned on cash, cash equivalents and short-term investments, gains and losses on foreign currency translations and transactions, as well as other miscellaneous items affecting our operating results.
 
Income tax benefit (provision). Income tax benefit (provision) includes federal, state and foreign tax on our income. 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.
 
Use of Non-GAAP Financial Measures
 
We believe that evaluating our ongoing operating results may limit the reader’s understanding if limited to reviewing only generally accepted accounting principles (GAAP) financial measures. Many investors and analysts have requested that, in addition to reporting financial information in accordance with GAAP that we also disclose certain non-GAAP information because it is useful in understanding our performance as it excludes non-cash and other non-recurring charges or credits that many investors and management feel may obscure our true operating performance. Likewise, we use these non-GAAP financial measures to manage and assess the profitability of the business and determine a portion of our employee compensation. We do not consider stock-based compensation expenses, amortization of acquisition-related intangible assets and other special charges and their related tax adjustments in managing the core operations. These measures are not based on any standardized methodology prescribed by GAAP and are not necessarily comparable to similar measures presented by other companies. Non-GAAP net income (loss) is calculated by adjusting GAAP net income (loss) for stock-based compensation expense, amortization of acquisition-related intangible assets, special charges and their related tax effect. Non-GAAP net income (loss) per share per share is calculated by dividing Non-GAAP net income (loss) by the weighted average number of basic and diluted shares outstanding for the period. These measures should not be considered in isolation or as a substitute for measures prepared in accordance with GAAP, and because these amounts are not determined in accordance with GAAP, they should not be used exclusively in evaluating our business and operations. We have provided a reconciliation of non-GAAP financial measures in the following table:
 
 
RECONCILIATION OF GAAP TO NON-GAAP FINANCIAL MEASURES
(Amounts in thousands, except per share amounts)
 
   
Year Ended June 30, 2011
   
Year Ended June 30, 2010
 
                 
(Unaudited)
                 
(Unaudited)
 
Revenue:
 
GAAP
   
Excludes
     
Non-GAAP
   
GAAP
   
Excludes
     
Non-GAAP
 
Product
  $ 159,693     $ -       $ 159,693     $ 117,138     $ -       $ 117,138  
Support and services
    40,419       -         40,419       31,326       -         31,326  
Total revenues
    200,112       -         200,112       148,464       -         148,464  
Cost of revenue
                                                   
Product
    52,957       (614 )
(a),(c)
    52,343       40,471       (139 )
(a)
    40,332  
Support and services
    13,688       (678 )
(a)
    13,010       11,580       (838 )
(a)
    10,742  
Total cost of revenue
    66,645       (1,292 )       65,353       52,051       (977 )       51,074  
Gross profit
    133,467       1,292         134,759       96,413       977         97,390  
Gross margin
    66.7 %               67.3 %     64.9 %               65.6 %
                                                     
Operating expenses:
                                                   
Research and development
    45,548       (3,497 )
(a)
    42,051       33,596       (3,064 )
(a)
    30,532  
Sales and marketing
    74,859       (3,170 )
(a),(c)
    71,689       55,973       (3,373 )
(a),(b)
    52,600  
General and administrative
    25,230       (4,266 )
(a),(b)
    20,964       19,888       (3,213 )
(a)
    16,675  
Total operating expenses
    145,637       (10,933 )       134,704       109,457       (9,650 )       99,807  
Income (loss) from operations
    (12,170 )     12,225         55       (13,044 )     10,627         (2,417 )
Other income, net
    640       -         640       84       -         84  
Income (loss) before benefit (provision) for income taxes
    (11,530 )     12,225         695       (12,960 )     10,627         (2,333 )
Income tax benefit (provision)
    67       (81 )
(d)
    (14 )     156       (195 )
(c)
    (39 )
Net income (loss)
  $ (11,463 )   $ 12,144       $ 681     $ (12,804 )   $ 10,432       $ (2,372 )
Net income (loss) per share:
                                                   
Basic
  $ (0.25 )   $ 0.26       $ 0.01     $ (0.29 )   $ 0.24       $ (0.05 )
Diluted (e)
  $ (0.25 )   $ 0.26  
 
  $ 0.01     $ (0.29 )   $ 0.24  
 
  $ (0.05 )
                                                     
Shares used in computing net loss per share:
                                                   
Basic
    46,177                 46,177       44,804                 44,804  
Diluted
    46,177                 47,900       44,804                 44,804  
 
(a)
Excludes stock-based compensation as follows:
                         
 
Cost of product revenue
  $ 123                       $ 139  
 
Cost of support and services revenue
    678                                838  
 
Research and development
    3,497                         3,064  
 
Sales and marketing
    3,140                         3,400  
 
General and administrative
    3,741                         3,213  
      $ 11,179                       $ 10,654  
                                     
(b)
Excludes severance for former Chief Executive Officer:
                           
 
General and administration
  $ 525                            
      $ 525                            
                                     
(c)
Excludes amortization of acquisition-related intangibles:
                                 
 
Cost of product revenue
  $ 491                            
 
Sales and marketing
    30                       $ (27 )
      $ 521                       $ (27 )
                                     
(d)
Excludes the tax impact of the items which are excluded in (a) to (c) above.
                                 
 
 
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Results of Operations
 
The following table sets forth selected consolidated statements of operations data as a percentage of total revenue for each of the periods indicated.
 
   
Year Ended June 30,
 
   
2011
   
2010
   
2009
 
Revenue:
                 
Product
    80 %     79 %     81 %
Support and services
    20 %     21 %     19 %
Total revenue
    100 %     100 %     100 %
Cost of revenue:
                       
Product
    26 %     27 %     28 %
Support and services
    7 %     8 %     8 %
Total cost of revenue
    33 %     35 %     36 %
Gross profit
    67 %     65 %     64 %
Operating expenses:
                       
Research and development
    23 %     23 %     23 %
Sales and marketing
    37 %     38 %     33 %
General and administrative
    13 %     13 %     14 %
Litigation settlement
                3 %
Total operating expenses
    73 %     74 %     73 %
Operating loss
    (6 )%     (9 )%     (9 )%
Other income, net
                1 %
Loss before benefit from (provision for) income tax
    (6 )%     (9 )%     (8 )%
Income tax benefit (provision)
                (1 )%
Net loss
    (6 )%     (9 )%     (9 )%
 
Fiscal 2011 compared to Fiscal 2010
 
Revenue
 
   
Year ended
   
Change
 
   
June 30,
   
June 30,
             
   
2011
   
2010
      $       %  
   
(in thousands, except percentages)
 
Revenue
  $ 200,112     $ 148,464     $ 51,648       35 %
 
Revenue
 
Total revenue increased by $51.6 million or 35% in fiscal 2011, reflecting increases in revenues across substantially all of our IP phone systems, switches and software applications, as well as increases in revenues from support and services. Product revenue increased to $160.0 million in fiscal 2011 from $117.1 million in fiscal 2010, primarily due to higher sales volume. The increase in sales volume was primarily driven by a 29% year-over-year increase in our enterprise customer base.  We also experienced increases in sales volume and revenue from our existing enterprise customers, primarily driven by add-on sales of IP phones, switches, and software applications. The Agito acquisition, which expanded our existing mobility solution, did not significantly contribute to the growth in product revenue in fiscal 2011. However, as we continue to ramp-up our mobility efforts, we expect mobility revenue to increase in the future.
 
 
- 37 -

 
Support and services revenue increased to $40.4 million in fiscal 2011 from $31.3 million in fiscal 2010. Revenue from post-contractual support increased by approximately $8.0 million in fiscal 2011, primarily due to growth in our installed base of our customers and their contract renewals, growth in new enterprise customers, and increased add-on sales to our existing customers. These factors resulted in higher post-contractual support revenues from both the amortization of existing support contracts initiated in prior years and from renewal and new support contracts initiated in fiscal 2011. In addition, the growth in new customers contributed to a combined increase of $1.1 million in revenues from training, professional services, and installation, as these services are generally purchased in connection with the initial sale of our products to new customers.

Revenue from customers in the United States accounted for approximately 87%, 90% and 93% of total revenue for years ended June 30, 2011, 2010 and 2009, respectively.

Gross margin
 
   
Year ended
   
Change
 
   
June 30,
   
June 30,
             
   
2011
   
2010
      $       %  
   
(in thousands, except percentages)
 
Cost of revenue
  $ 66,645     $ 52,051     $ 14,594       28 %
Gross profit
  $ 133,467     $ 96,413     $ 37,054       38 %
Gross margin
    67 %     65 %     n/a       2 %
 
Gross margin increased to 67% in fiscal 2011compared with 65% in fiscal 2010. Product gross margin improved to 67% from 65% in 2010, primarily attributable to the overall increase in revenue, favorable product mix and lower unit manufacturing costs, primarily due to overall decrease in product costs as a result of achieving product design efficiencies.  These factors were offset by amortization expenses related to purchased-intangible assets.
 
Support and services gross margin improved to 66% from 63%, primarily due to productivity gains, as the increase in support and services revenues outpaced the rate of increase in the associated costs, which largely consist of employee-related costs.
 
Operating expenses
 
   
Year ended
   
Change
 
   
June 30,
   
June 30,
             
   
2011
   
2010
    $       %  
   
(in thousands, except percentages)
 
Other income, net
  $ 640     $ 84     $ 556       662 %
Research and development
  $ 45,548     $ 33,596     $ 11,952       36 %
Sales and marketing
  $ 74,859     $ 55,973     $ 18,886       34 %
General and administrative
  $ 25,230     $ 19,888     $ 5,342       27 %
 
Research and development . Research and development expenses increased by $12.0 million or 36% in fiscal 2011 compared with fiscal 2010. The increase in research and development expenses was primarily due to an increase of $8.4 million in employee-related costs, primarily due to headcount additions to our research and development workforce, including the addition of research and development employees from Agito. In fiscal 2011, we had higher spending on various product development costs as we continued to expand our product roadmap, including an increase of $1.5 million in consulting fees and an increase of $0.4 million in both equipment expenses related to prototype development and software license expenses, partially offset by a decrease of $0.3 million in non-recurring engineering expenses. Other increases in research and development expenses were due to increases of $0.9 million in allocated facilities costs and $0.3 million in travel expenses.
 
Sales and marketing. Sales and marketing expenses increased by $18.9 million or 34% in fiscal 2011 compared with fiscal 2010, primarily due to an increase of $12.4 million in employee-related costs. In fiscal 2011, we increased our salesforce by 46% as part of our strategic focus to expand our enterprise customer base. The growth in our salesforce, coupled with the increase in total revenue in fiscal 2011, resulted in a $1.9 million or 18% increase in commission expense, which is reflected in the increase in compensation expenses. Also contributing to the increase in sales and marketing expenses were increases of $2.2 million in marketing expenses related to demand generation, channel marketing and branding activities, $2.1 million in travel-related expenses, $0.9 million in channel partner co-marketing expenses, and a combined $1.6 million increase in facilities, equipment and supplies expenses.
 
 
- 38 -

 
General and administrative . General and administrative expenses increased by $5.3 million or 27% in fiscal 2011 compared with fiscal 2010. The increase in general and administrative expenses was primarily due to an increase of $3.3 million in employee-related costs, primarily due to headcount additions to our finance and information technology workforce. In addition, we incurred approximately $0.5 million of severance costs related to our former CEO in the first quarter of 2011.  Other increases in general and administrative expenses were due to an  increase of $1.0 million in consulting and acquisition-related costs, and an  increase of $0.8 million in software license expenses, partially offset by $0.3 million decrease in other expenses.
 
Other income, net
 
   
Year ended
   
Change
 
   
June 30,
   
June 30,
             
   
2011
   
2010
      $       %  
   
(in thousands, except percentages)
 
Other income, net
  $ 640     $ 84     $ 556       662 %
 
Other income, net increased by $0.6 million in fiscal 2011 compared with fiscal 2010,  primarily due to an increase of approximately $0.1 million in interest income, and an  increase of approximately $0.5 million in net realized and unrealized foreign exchange gains related to accounts receivable and accounts payable denominated in foreign currencies.
 
Income tax benefit (provision)
 
   
Year ended
   
Change
 
   
June 30,
   
June 30,
             
   
2011
   
2010
      $       %  
   
(in thousands, except percentages)
 
Income tax benefit (provision)
  $ 67     $ 156     $ (89 )     (57 )%
 
Income tax benefit . Income tax benefit decreased by approximately $0.1 million or 57 % in fiscal 2011 compared with fiscal 2010 ,   primarily due to increases in the state and foreign income tax provisions. The state tax provision was higher in fiscal 2011 due to increases in measurable tax base for certain states that determine tax liabilities based on factors other than income.  The foreign tax provision was higher in fiscal 2011 due to higher revenue and pretax earnings by certain of our foreign subsidiaries.

Fiscal 2010 compared to Fiscal 2009
 
Revenue
   
Year ended
   
Change
 
   
June 30,
   
June 30,
             
   
2010
   
2009
    $     %  
   
(in thousands, except percentages)
 
Revenue
  $ 148,464     $ 134,822     $ 13,642       10 %
 
Revenue . The increase in total revenue in fiscal 2010 was due to increases in both product revenue and support and services revenue.  Product revenue was $117.1 million in fiscal 2010, an increase of $7.5 million or 7%, from $109.6 million in fiscal 2009, as a result of higher sales volumes of $12.5 million primarily from our U.S. telecom carrier resellers, partially offset by a slight decline in average selling prices.  Support and services revenue was $31.3 million in 2010, an increase of $6.0 million, or 24%, from $25.3 million in 2009, as a result of a $4.5 million increase in revenue associated with post-contractual support contracts, an increase of $0.5 million in professional services, $0.3 million increase in installations revenue and a $0.7 million increase in training revenue.
 
 
- 39 -

 
  Gross margin
 
   
Year ended
   
Change
 
   
June 30,
   
June 30,
             
   
2010
   
2009
      $       %  
   
(in thousands, except percentages)
 
Cost of revenue
  $ 52,051     $ 49,197     $ 2,854       6 %
Gross profit
  $ 96,413     $ 85,625     $ 10,788       13 %
Gross margin