ShoreTel, Inc.
ShoreTel Inc (Form: 10-K, Received: 09/13/2012 16:49:32)


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, 2012
 
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  incorporation or organization)
(Primary standard  industrial code number)
(I.R.S. employer  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 website, 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 þ 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. o
 
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, 2011 was approximately $236.4 million (based on the last reported sale price of $6.38 on December 31, 2011 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 August 30, 2012 was 58,315,627.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
Part III incorporates by reference certain information from the Registrant’s definitive proxy statement (the “2012 Proxy Statement”) for the 2012 Annual Meeting of Stockholders.



 
 

 
 
  TABLE OF CONTENTS
 
   
Page
     
PART I
Item 1
4
Item 1A
14
Item 1B
30
Item 2
30
Item 3
30
Item 4
30
     
PART II
Item 5
30
Item 6
33
Item 7
34
Item 7A
50
Item 8
52
Item 9
80
Item 9A
80
Item 9B
82
     
PART III
Item 10
82
Item 11
82
Item 12
82
Item 13
82
Item 14
83
     
PART IV
Item 15
83
 
84

 
2


TRADEMARKS
 
The ShoreTel logo, ShoreTel, ShoreCare, ShoreWare, ShoreTel Sky, Brilliantly Simple, Agito Networks, the Agito Networks logo, M5, Callfinity, 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.
 
 
3

 
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.
 
PART I

ITEM 1.
 
Overview
 
ShoreTel is a leading provider of brilliantly simple business communication solutions, comprised of integrated voice, video, data and mobile applications based on Internet Protocol (IP) technologies. We provide customers with a choice to operate our solution in their own premise-based data centers, or to subscribe to our cloud-based hosted communication service which we refer to as ShoreTel Sky. Our distributed Internet Protocol (“IP”) architecture enables multi-site enterprises to be served by a single integrated communication system. These 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.
 
We sell our solutions through our extensive network of over 1,000 authorized resellers served either by national distributors or by ShoreTel directly. ShoreTel solutions are also sold by strategic partners under their brand names, such as AT&T and HP for our mobility services.

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 North America, Europe, Asia and Australia.
 

 
Business Communication Products and Services
 
History

ShoreTel introduced its first suite of premise products in 1998.  We believe our unique focus and approach has resulted in high customer satisfaction and low total cost of ownership.

In order to meet the customer’s evolving requirements for alternative forms of communications, such as instant messaging, desktop sharing and collaboration, we extended our portfolio of IP telephony solutions by developing integrated Unified Communications (UC) capabilities and applications. We maintain our same approach of making UC brilliantly simple, resulting in a high adoption rate for these new emerging solutions.

With the increasing adoption of smart phones and tablets and with more employees requesting the support of devices they bring to work for communication purposes, we extended our mobility service offering of our UC solution in 2010 by acquiring Agito Networks, a provider of mobility solutions supported on IP based Private Branch Exchanges (PBXs). We anticipate more customers will enable their employees to use the most appropriate device for communications for each user no matter whether they are located at the office, home, airport or around the world. Our strategy is to provide a complete portfolio of IP-based desk phones, and software applications for smartphones, tablets and computers to ensure customers have the most flexibility with their communication needs.

Over time, we observed an increasing number of customers embracing cloud-based services and hosted applications. We made a strategic decision in 2012 to acquire M5 Networks, Inc. (“M5” or “M5 Networks”). M5’s technology, service experience, execution in service delivery, and reputation for excellence in customer service provides the foundation to provide hosted services, and we now offer integrated hosted services to our premise customers. We have expanded M5’s existing solutions to create the ShoreTel Sky offering, which includes hosted UC services for a mobile device. We are developing and planning the introduction of new ShoreTel Sky services which will also become available to our existing and new premise customers.

 
We believe we have a unique opportunity to leverage our customer satisfaction and experience in delivering a world class service to customers in premise solutions, within the hosted ShoreTel Sky services organization. We now have an opportunity to offer customers a choice of a premise or a hosted platform from which to access Unified Communications applications.

Business Communication Solutions

ShoreTel provides a diverse set of applications for both premise and ShoreTel Sky customers, consisting of IP Telephony, Unified Communications, Contact Center, Conferencing, Video, Enterprise Mobility and professional services.

IP Telephony

ShoreTel offers a broad range of IP telephony solutions that provide business features commonly offered in existing legacy Time Division Multiplexing (TDM) PBXs, but with lower cost and lesser complexity for system administrators or users. Complex star codes on phone key pads are replaced by intuitive user interfaces. We replaced complex administration historically required for system management by highly skilled system administrators with extensive training with intuitive web application interfaces, which results in significantly lower cost of ownership to the customer.

 
IP Phones : We offer a range of innovative, high performance designed business phones to meet the needs of the different types of end-users across the enterprise. Our phones are designed to provide superior 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. Our products use beam forming microphones to provide enhanced speakerphone sound quality. ShoreTel IP Phones are designed to function with minimal 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. We also support a variety of third party phones from leading manufacturers such as Polycom, Ascom and Cisco Systems for our ShoreTel Sky customer deployments.

 
Unified Messaging: Unified Messaging solutions enable users to obtain voice mail messages from a variety of devices, including desktop phones, and various third party tablets and smart phones. In addition, our technology is integrated with Microsoft Outlook, enabling end users to receive, send, be notified of and play voice mail messages through their laptops.

 
Automated Attendant:   Our Automated Attendant software provides end users with an automated call answering and routing capability that enables the enterprise to direct callers to appropriate individuals, groups or messages.

Unified Communications

ShoreTel Unified Communications enables the integration of IP telephony solutions with instant messaging, desktop collaboration and video.

 
PC Clients : ShoreTel Communicator is designed for users across an organization, whether an operator, a contact center agent, a knowledge worker or a mobile worker. 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.

 
Conferencing and Collaboration: ShoreTel enables enterprises to conduct large audio conferences and provides collaboration tools for application sharing, desktop sharing, and 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

Contact Center enables organizations to route incoming contacts to the most appropriate agent in a multisite contact center, regardless of location. 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.

 
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 Wi-Fi hotspots, enabling access to any cellular or Wi-Fi network, simply and cost effectively. ShoreTel Mobility solutions for smartphone users consist of a ShoreTel appliance coupled with system management and end-user software. Our mobility offering also works across several leading IP-PBXs and UC systems on the market today, including Cisco, Avaya, and Microsoft Lync. Mobility solutions are available both as part of our premise solution and also offered as a separate service as part of ShoreTel Sky.

 
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 their 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 usage costs.

 
ShoreTel Mobility Router: The ShoreTel Mobility Router is a scalable network appliance that integrates 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 of the mobile phone.

Application Development Professional Services

ShoreTel offers custom application development, integration and implementation services for businesses with unique communication requirements. We offer businesses the option to enhance their communications solution 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 integrated applications using the open interfaces of the system available for developers through the ShoreTel Innovation Network. ShoreTel Innovation Network is where other third-party companies can offer solutions that complement our product offerings, such as video technology, wireless phones, contact center call recording, and networking equipment.

ShoreTel’s Unique Distributed Architecture for Premise Customers

ShoreTel provides a unique modern hardware and software architecture for premise customers, which offers the high availability and reliability needed for mission critical communications previously served by TDM technologies. Our premise business communication solutions are comprised of hardware and software components including ShoreTel Voice Switches, ShoreTel IP Phones, ShoreTel Service Appliances and ShoreTel Client and Server Software Applications. 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.   Our systems are based on a combination of our proprietary software, industry-standard interfaces and protocols, and customized and off-the-shelf hardware components.

 
ShoreTel Voice Switches:   We offer a range of ShoreTel designed 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. 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. 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 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. 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 Service Appliances: We offer a range of ShoreTel designed appliances for specific applications, such as conferencing and collaboration. The administration of these service appliances is functionally integrated with the IP Telephony Web Administration. Appliances are automatically recognized by the ShoreTel Director software and user functions are seamlessly integrated with the user management application, eliminating the complexity found with other systems.
 
 
 
ShoreTel Director: ShoreTel Director provides enterprises with a single point of system management, enabling IT administrators to view and manage the entire system 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 PBXs, voice mail systems and automated attendants.

 
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 of system software, user licenses and voice switches. This solution allows our customers to economically scale our products and solutions as their organizations begin to grow and expand. Customers that grow beyond the capacity of the SBE solution may expand their investment by adding additional switches and licenses, while preserving their original investment and avoiding costly upgrades.

 
ShoreTel IP Phones: ShoreTel IP phones are comprised of enterprise IP phone semiconductors using customized LCD displays, microphones, speaker circuitry and custom software providing single installation and management, ease of use and a rich feature set.

Our distributed software architecture for premise customer includes 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; and

 
allows the system to scale from small to large simply by adding additional components.

ShoreTel Global Services

We complement our premise product offerings with a broad range of services to help us maintain and expand our relationships with our 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 provides 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, software updates and monitoring capabilities. 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 network capabilities used in 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 standard 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.

ShoreTelSky Architecture and Services for Hosted Customers

Our ShoreTel Sky services offer a secure and managed business communications solution to an organization with minimal capital investment. The heart of the ShoreTel Sky service is our Call Conductor core technology, a ShoreTel designed and developed modular software architecture operating on an industry standard platform, which makes it easy to add capabilities in response to a customer’s evolving needs and enables it to integrate readily with leading business applications. This was specifically designed to meet the unique requirements of the hosted communications market, offering a full portfolio of services to customers, including soft-switch services for IP telephony, integrated software modules for Unified Communications, Contact Center, Mobility, Conferencing and Collaboration, Business Intelligence Analytics and Reporting. By incorporating a multi-tenant software foundation, multiple customers can be served simultaneously by servers located in data centers. ShoreTel Sky technologies are complemented by a series of services modules that enable billing, diagnostics, system monitoring, CALEA regulatory compliance, E911 routing and other relation operational services. A variety of customer selectable network services are also available, including local and long distance network services, toll free numbers, number porting and other value-added network services.
 
ShoreTel Sky Operations
 
We have a centrally managed platform consisting of data management, monitoring, control and billing systems that support our ShoreTel Sky services. This platform consists of a customer quotation portal, customer provisioning, customer access, fraud control, network security, call routing, call monitoring, media processing and normalization, call reliability, and call record storage and billing. Our platform monitors our process of digitizing and compressing voice and video into packets and transmitting these packets over data networks around the world. We maintain a call switching platform in software that manages call control, and routes calls to an appropriate destination or customer premise equipment. Our billing and back office systems manage and enroll customers and bill calls as they originate and terminate on the service.
 
Network Operations Center
 
We maintain network operations centers in New York and provide voice and data operations support 24 hours a day, 7 days per week. We use various tools to monitor and manage all elements of our network in real-time. We also monitor the network elements of some of our larger customers. Additionally, our network operations center provides technical support to troubleshoot equipment and network problems. We also rely upon the network operations centers and resources of our telecommunications carrier partners to augment our monitoring and response efforts.
 
Customer and Technical Support
 
We maintain a call center in New York that provides customer service and technical support to our ShoreTel Sky customers. In addition, we have outsourced some customer support activities to third parties. Customers who access our services directly through our website receive customer service and technical support through multilingual telephone communication, web-based sessions, "chat" sessions, and e-mail support.
 
ShoreTel Sky Professional Services

ShoreTel provides consultation and professional services for integrating other hosted services with the ShoreTel Sky offering, such as Salesforce.com integration and other Customer Relationship Management Applications integration. This includes application specification gathering, design services, implementation services and operational consultation services.

ShoreTel Sky Data Centers

ShoreTel operates multiple data centers in the United States, which are co-located in service facilities operated by third party operators. These data centers have specific guidelines for providing world class service for customers including sufficient physical building security, network operations and resiliency services and backup power generation. These operations centers house the application servers and proprietary technologies used to provide services to customers.

 
The key elements of our ShoreTel Sky applications and services include:

 
ShoreTel designed modular software architecture and service creation environment for rapid design;

 
development and introduction of new services;

 
demonstrated excellence in customer service, with high customer satisfaction rating;

 
experience in customer implementations;

 
complete portfolio of operational services for billing, system management, and other requirements; and

 
support for industry standard interfaces, enabling support for third party devices from other vendors such as Cisco and Polycom.

Industry Recognition

We have achieved broad industry recognition for our technology and high customer and channel partner satisfaction. (Our channel partners include resellers as well as value-added distributors who in turn sell to the resellers.) We have won the “best overall” CustomerSat Achievement award (ACE) for three years in a row. ShoreTel received Gartner’s highest possible rating of Strong Positive 1 in their most recent 2012 Unified Communications MarketScope Report for SMB Businesses in North America.
 
Customers

As of June 30, 2012, we have sold our solutions to more than 24,000 businesses in 50 countries. We serve a wide range of vertical markets, including professional services, financial services, government, education, health care, manufacturing, non-profit organizations, and technology industries.

ShoreTel has been selected by industry leaders that place our communication solutions at the heart of their organizations for serving their employees and customers, such as The San Francisco Giants, Miami Marlins, Verizon Center, Cleveland Clinic, City of Arlington, GreenBay Public Schools, CNet, Brita, Brunswick, Wedbush Securities, First Republic Bank, US Army Corp of Engineers, USDA, Cummins, Fujitsu, Girl Scouts of America, HayGroup, Robert Half, Gensler, Twitter, LinkedIn, Good Samaritan Society, Maxim, and Randstad.

Focus on Customer Satisfaction  
 
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 and our knowledge base system users to ensure that high-quality support services are being provided, using industry-recognized Net Promoter Score customer loyalty metric. 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 performance indicators 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 premise products and services primarily through an extensive network of channel partners that include resellers and value-added distributors. Our hosted services are sold through indirect channel resellers and a direct sales force. As of June 30, 2012, we had over 1,000 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. They also include the top U.S. telecommunication carriers: AT&T, WindStream and Qwest/CenturyLink. Our channel partners market and sell our products into both the large and small-to-medium enterprise markets.
 
1 Gartner, “MarketScope for Unified Communications for the SMB Market, North America”, August 2010. The Gartner Report described herein represents data, research opinion or viewpoints published, as part of a syndicated subscription service, by Gartner, Inc. ("Gartner"), and are not representations of fact. Each Gartner Report speaks as of its original publication date (and not as of the date of this Filing) and the opinions expressed in the Gartner Report are subject to change without notice. Gartner does not endorse any vendor, product or service depicted in its research publications, and does not advise technology users to select only those vendors with the highest ratings. Gartner research publications consist of the opinions of Gartner's research organization and should not be construed as statements of fact. Gartner disclaims all warranties, expressed or implied, with respect to this research, including any warranties of merchantability or fitness for a particular purpose.
 
 
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.
 
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 e-mail and direct mail campaigns, print and web-based advertising, press releases and web-based demonstrations.
 
Backlog
 
Our backlog at June 30, 2012, 2011 and 2010 was approximately $4.6 million, $6.1 million and $9.1 million, respectively. Our backlog consists of orders received from our resellers but not shipped before the end of the quarter in which the order was received, and excludes orders from our value-added distributors, as we recognize product revenue on sales made through distributors upon sell-through to our 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 and services, develop and introduce new products and services 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 research and development activities are conducted in Sunnyvale, California, Austin, Texas and Rochester, New York. We have invested significant time and financial resources into the development of our architecture, including our switches, routers and related software. We intend to continue to expand our product and service offerings, improve the features available on our products and services and integrate our systems with third-party enterprise applications. Research and development expenses were $51.9 million, $45.5 million and $33.6 million in fiscal years 2012, 2011 and 2010, respectively.
 
Manufacturing and Suppliers
 
We outsource the manufacturing of our premise 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 and mobility routers 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 California, New York, United Kingdom or 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 for these orders frequently vary based upon each enterprise customer’s particular needs.
 
 
We also rely on a sole or limited number of suppliers for several key components utilized in the assembly of our premise 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 will 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 13 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 against vendors of premise-based solutions, hosted solutions, some of which have solutions in both markets.
 
 
Providers of premise-based business communication solutions, including Alcatel-Lucent, Aastra, Avaya, Cisco, Digium, Interactive Intelligence, Mitel, NEC and Siemens
 
 
Providers of Unified Communications software applications providers, including Alcatel Lucent, Aastra, Avaya, Cisco Systems, Huawei, IBM, Interactive Intelligence, Siemens Enterprise Communications, Microsoft, Mitel, NEC and Toshiba
 
 
 
Providers of hosted communication service providers including Tier 1 operators such as AT&T, British Telecom, Verizon, incumbent local exchange carriers, and competitive local exchange carriers, and independent providers such as 8x8, Broadsoft, Cisco Systems, West IP Communications, Google, Microsoft, Siemens Enterprise Networks, RingCentral,Thinking Phones, and Smoothstone/West IP.
 
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 increased 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 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 or hosted 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, distribution, technical, manufacturing and other resources. We believe that we currently compete favorably with regard to the principal competitive factors applicable to our products and services, which include price, feature set, reliability, scalability, usability, total cost of ownership, customer satisfaction and service.
 
 
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 .”
 
Regulatory
 
Voice over IP (VoIP) communication services, like ours, have been subject to less regulation at the state and federal levels than traditional telecommunications services. Providers of traditional telecommunications services are subject to the highest degree of regulation, while providers of information services are largely exempt from most federal and state regulations governing traditional common carriers. The Federal Communications Commission (FCC) has subjected VoIP service providers to a smaller subset of regulations that apply to traditional telecommunications service providers and have not yet classified VoIP services as either telecommunications or information. However, the FCC is currently examining the status of VoIP service providers and the services they provide in multiple open proceedings and may increase regulations that apply to ShoreTel Sky services.
 
The effect of any future laws, regulations and orders on the ShoreTel Sky offering is unknown at this time. But as a general matter, increased regulation and the imposition of additional funding obligations increases service costs that may or may not be recoverable from our customers. This increased regulation could result in making our services less competitive with traditional telecommunications services if we increase our retail prices or decreasing our profit margins if we attempt to absorb such costs.
 
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, 2012, we have 53 patents issued in the United States, and have 72 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 2031.
 
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, 2012, we had 933 employees in North America, Europe, Asia and Australia, of which 342 were in sales and marketing, 275 were in research and development, 227 were in global support services, and 89 were in general and administrative functions.  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, 2012:
 
Name
 
Age
 
Position
Peter Blackmore
 
64
 
President, Chief Executive Officer and Director
Michael E. Healy
 
51
 
Senior Vice President and Chief Financial Officer
Edwin J. Basart
 
63
 
Founder and Chief Technology Officer
Ava M. Hahn
 
39
 
Vice President, Corporate Development, General Counsel and Secretary
Dan Hoffman
 
43
 
President and General Manager of the Cloud Division
Don Joos
 
42
 
Senior Vice President, Business Operations
David Petts
 
49
 
Senior Vice President, Worldwide Sales
Pedro E. Rump
 
56
 
Senior Vice President, Engineering and Operations
 
 
Peter Blackmore has served as our President and Chief Executive Officer and a director 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 IP-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.
 
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 also served as a director from 1996 to November 2011 and has served as Special Advisor to the Board since 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.

Ava M. Hahn has served as our Vice President, General Counsel and Secretary since May 2009 and added Corporate Development to her responsibilities in April 2012. 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. in history from the University of California, Berkeley.
 
Dan Hoffman has served as our President and General Manager of Cloud Division since March 2012. Before ShoreTel, Mr. Hoffman served as Chief Executive Officer of M5 Networks, Inc. since May 2001. Prior to M5 Networks, Inc., Mr. Hoffman co-founded Global Internet Group where he served as President, from July 1998 to January 1999, before selling the company to Asia Online, an ISP holding company based in Hong Kong. Mr. Hoffman served as Managing Director from January 1999 to January 2001. Mr. Hoffman holds a M.B.A. from the Wharton School of Business, a M.A. in international studies from the University of Pennsylvania and a A.B. Magna Cum Laude in Slavic language and literature from Harvard.

Don Joos has served as our Senior Vice President of Business Operations since July 2012. Mr. Joos joined ShoreTel in April 2011 as our Vice President of Global Services. Prior to joining ShoreTel, from December 2001 to April 2011, Mr. Joos served in senior management roles at Avaya, most recently as Vice President Channel Transformation. Prior to then, Mr. Joos held a variety of operational roles, including Vice President, Integration and Global Customer Satisfaction, Vice President, North America Services, Vice President, Implementation Services, and Vice President, Global Customer Care Centers. Mr. Joos also held service and operational roles at Williams Communication Solutions, Nortel Communication Solutions and Marshalls Inc. Mr. Joos holds a B.A. in sports management from Springfield College in Massachusetts.

David Petts has served as our Senior Vice President of Worldwide Sales since July 2012. Before ShoreTel, Mr. Petts served in several sales leadership roles at Nokia from June 2005 to July 2012. Prior to Nokia, Mr. Petts held a number of executive management roles with Hewlett Packard and Compaq both in the United States and the United Kingdom. Mr. Petts holds a B.S. in economics and quantitative studies from Queen Mary College, London 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 VoIP 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.  
 
 
ITEM 1A.
 
Risks Related to Our Business and Industry
 
We may not be able to achieve our strategic initiatives and grow our business as anticipated.
 
We have recently embarked on strategic initiatives to (a) offer hosted Unified Communications applications, and (b) enable the mobile device to be fully integrated with the enterprise PBX and enjoy the same or better features as a desk phone. 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 invest in these initiatives, enter into beneficial channel relationships, develop new products and service offerings 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, we could spend monies on developing products that never reach commercial success and thus our operating results could be adversely affected.

We have made acquisitions in the past and expect to 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 acquired Agito Networks in October 2010 and acquired M5 Networks, Inc. ("M5") in March 2012, in a cash and stock transaction valued up to approximately $160 million. We may acquire or invest in other businesses, products or technologies that we believe could complement or expand our product line, enhance our technical capabilities or otherwise offer growth opportunities. The acquisition of M5 and other 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 cannot assure you that we will 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 any other additional businesses, we may not be able to integrate the acquired personnel, operations, product lines 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;

 
incurrence of acquisition-related direct and indirect costs;

 
diversion of management's attention from other business concerns;

 
risks related to entering into new markets;

 
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 needed in other parts of our business;

 
risks associated with unknown liabilities for sales, use, telecom, utility and other taxes;

 
use of substantial portions of our available cash to consummate the acquisition; and

 
risks and costs associated with the incurrence of debt financing sufficient to have available the cash needed to consummate the acquisition.
 
In addition, a significant portion of the purchase price of the other companies that we acquire may be allocated to goodwill and other indefinite lived intangible assets, which must be assessed for impairment. Also, contingent consideration related to the acquisitions may be remeasured to fair value at each reporting period, with any changes in the value recorded as income or expense. 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.
 
Acquisitions could also 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.
 
 
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 both premise and hosted Unified Communications is extremely competitive. Our premise competitors include Cisco Systems, Inc., Avaya and Mitel Networks Corporation. Our hosted competitors include 8x8, Broadsoft, Smoothstone and RingCentral. In addition, our ShoreTel Sky customers are not subject to long-term contractual commitments to purchase our services and can terminate our service and switch to competitors' offerings on short notice.

We also compete with much larger companies such as Microsoft in the unified communications market. 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. Some competitors have 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 primarily on the enterprise IP telecommunications market.
 
We compete primarily on the basis of price, feature set, reliability, scalability, usability, total cost of ownership, customer satisfaction and service. Because some of 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. 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 impact of the current economic climate and adverse credit markets may impact customer demand for our premise solution and our ShoreTel Sky services.
 
Our business depends on the overall demand for information technology, and in particular for IP-based telecommunications systems. Many of our existing and target customers are in the small and medium business sector. Although we believe our products and services have the lowest total cost of ownership of our competitors, our target customers may be more likely to be significantly affected by economic downturns than larger, more established businesses. Additionally, these customers often have limited discretionary funds which they may choose to spend on items other than our products and services. The purchase of our premise solution involves significant upfront expenditures. If credit is not available to them, it may be difficult or impossible for our resellers and/or end customers to purchase our products. If small and medium businesses continue to experience economic hardship, this could negatively affect the overall demand for our products and services, delay and lengthen sales cycles and lead to slower growth or even a decline in our revenue, increase in net loss and cash flows.
 
If we fail to manage our growth effectively, our business could be harmed.
 
We plan to further expand our operations, particularly in developing a more sophisticated billing and operating support system to support the growth of our ShoreTel Sky business. We will need to increase our spending in order to fund this development. 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.
 
The gross margins on our premise products and ShoreTel Sky offering may decrease due to competitive pressures or otherwise, which could negatively impact our profitability.
 
It is possible that the gross margins on our premise products or ShoreTel Sky solution 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 or telecommunications costs, manufacturing issues, the shift in our channel distribution model towards more value-added distributors, royalties we need to pay to use certain intellectual property, growth of our international business, or other factors. The margins on our ShoreTel Sky solution are also impacted by the fact that we sell the broadband connection, which is typically a lower-margin business, as well as the hosted telephony service. We sell the broadband connection because we believe it helps us provide better quality of service to our customers. 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, 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.
 
The convergence of voice, video, messaging 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.
 
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’s solutions, 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 and value-added distributors to sell our premise products, and disruptions to, or our failure to develop and manage our distribution channels could adversely affect our business.
 
Substantially all of our premise revenue is generated through indirect channel sales. These indirect sales channels consist of third-party resellers and value-added distributors 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 premise 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.

Our success depends in part on the growth and public acceptance of wireless local area networks.

We have placed strategic importance on the mobile device, such as a smartphone or tablet, becoming an endpoint of choice for our users. Our ShoreTel Mobility solution is software that integrates the mobile device into our platform so that a wireless mobile device can be used like a wired desk phone. ShoreTel Mobility relies on wireless local area networks (WLAN) and cellular telephone coverage in order to operate. Slow or limited adoption of WLANs could adversely affect the growth of our ShoreTel Mobility base and revenues. In addition, WLANs must improve quality of service for real-time communications, managing effects such as packet jitter, packet loss, and unreliable bandwidth, so that toll-quality service can be consistently provided. Mobile devices must achieve a similar level of reliability that users of the public switched telephone network (PSTN) have come to expect from their telephone service. We must devote substantial resources to educate customers and end users about the benefits of wireless telephony solutions, in general, and our solutions in particular. Substantial, ongoing interaction with our customers in order to train and assist them with the deployment and use of our solutions over these networks is sometimes required. If any or all of these factors fail to occur, our business may be affected adversely.

 
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.
              
Our business may be harmed if our contract manufacturers are not able to provide us with adequate supplies.
 
We outsource the manufacturing of our telephones and switches for our premise business. Currently, we have arrangements for the production of our products with contract manufacturers in the United States and 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.
 
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 and hosted 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 and hosted 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 and hosted 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 and hosted 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. 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 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 Unified Communications 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 accurately forecast demand for our premise business hardware products, 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 premise customers and typically prior to receiving a purchase order from our premise 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.

 
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. Software products may contain defects, and as such 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.
   
The agreement governing our loan imposes restrictions on our business that may limit our business opportunities and hinder our ability to execute our business strategy.
 
On March 15, 2012, we entered into a Senior Secured Credit Facilities Credit Agreement (the “Credit Agreement”) with Silicon Valley Bank. The Credit Agreement contains, and other agreements we may enter into in the future may contain, covenants imposing restrictions on our business, and requires us to maintain certain financial covenants. These restrictions and covenants may affect our ability to operate our business and may limit our ability to take advantage of potential business opportunities as they arise. These covenants place restrictions on our ability to, among other things, incur additional debt, create liens, consolidate or merge, dispose of any property, redeem common stock or make other distributions to stockholders, make investments or enter into transactions with affiliates.
 
Although we believe we were in compliance with all of our non-financial and financial covenants under the Credit Agreement, our future ability to comply with these covenants may be affected by events beyond our control, including prevailing economic, financial, and industry conditions. In the event of our default under the Credit Agreement, our lender could declare all amounts borrowed to be due and payable, together with accrued and unpaid interest. If we were unable to repay any debt owed, the lender could proceed against the collateral securing that debt.
 
We might require additional capital or debt to support our business in the future, and this financing might not be available on acceptable terms, or at all.
 
Although we anticipate that our current cash, cash equivalents, short-term investments and the available balance on the existing line of credit arrangement 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 additional 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 have had significant executive management turnover, and may not be able to retain or attract the executives we need to succeed.
 
 In July 2012, we hired a new Senior Vice President of Worldwide Sales. We also made other changes to our senior management 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 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 53 issued U.S. patents and 72 patent applications pending in 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.

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 Securities and Exchange Commission (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, or if we or 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 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 and our disaster recovery site are located in California near known earthquake fault zones and, therefore, are vulnerable to damage from earthquakes. We 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.
 
 
Additional Risks Related to Our ShoreTel Sky Business
 
Success of ShoreTel Sky is dependent on the growth and public acceptance of hosted communications.

Our future success depends on our ability to significantly increase revenues generated from ShoreTel Sky, our hosted Unified Communications solution. Because the use of a hosted solution requires that the user be a subscriber of a broadband Internet service, slow or limited adoption of broadband Internet service could adversely affect the growth of our subscriber base and revenues. Although the number of broadband subscribers worldwide has grown significantly over the last five years, VoIP service has not yet been adopted by a majority of prospective business customers. To increase the deployment of broadband Internet services from broadband Internet service providers, telephone companies and cable companies must continue to invest in the deployment of high speed broadband networks to residential and business customers, over which we have no control.

In addition, VoIP networks must improve quality of service for real-time communications, managing effects such as packet jitter, packet loss, and unreliable bandwidth, so that toll-quality service can be consistently provided. VoIP telephony equipment and services must achieve a similar level of reliability that users of the PSTN have come to expect from their telephone service, and the cost and feature benefits of VoIP must be sufficient to cause customers to switch away from traditional telephony service providers. We must devote substantial resources to educate customers and end users about the benefits of VoIP telephony solutions, in general, and our solutions in particular. Substantial, ongoing interaction with our customers in order to train and assist them with the deployment and use of our solutions over these networks is sometimes required. If any or all of these factors fail to occur, our business may be affected adversely.
 
A higher rate of customer terminations associated with our ShoreTel Sky business would negatively affect our business by reducing our revenue or requiring us to spend more money to grow our customer base.
 
Our rate of customer terminations, or annualized customer churn was 4% for the quarter ended June 30, 2012. Our churn rate could increase in the future if customers are not satisfied with our service. Other factors, including increased competition from other VoIP providers, alternative technologies, and adverse business conditions also influence our churn rate.
 
Because of churn, we have to acquire new customers on an ongoing basis or sell additional services to existing customers just to maintain our existing level of customers and revenues. As a result, marketing expenditures are an ongoing requirement of our business. If our churn rate increases, we will have to acquire even more new customers in order to maintain our existing revenues. We incur significant costs to acquire new customers, and those costs are an important factor in determining our net profitability. Therefore, if we are unsuccessful in retaining customers or are required to spend significant amounts to acquire new customers beyond those budgeted, our revenue could decrease and our net income could decrease.
 
Any failure in our physical infrastructure for our ShoreTel Sky services could lead to significant costs and disruptions and could reduce our revenue, harm our business reputation and have a material adverse effect on our financial results.
 
Our leased network and data centers are subject to various points of failure. Problems with cooling equipment, generators, uninterruptible power supply, routers, switches, or other equipment, whether or not within our control, could result in service interruptions for our customers as well as equipment damage. Because our services do not require geographic proximity of our data centers to our customers, our infrastructure is consolidated into a few large facilities. Any failure or downtime in one of our data center facilities could affect a significant percentage of our customers. The total destruction or severe impairment of any of our data center facilities could result in significant downtime of our services and the loss of customer data. Because our ability to attract and retain customers depends on our ability to provide customers with highly reliable service, even minor interruptions in our service could harm our reputation. Additionally, in connection with the expansion or consolidation of our existing data center facilities from time to time, there is an increased risk that service interruptions may occur as a result of server relocation or other unforeseen construction-related issues.
 
We have experienced interruptions in service in the past. While we have not experienced a material increase in customer attrition following these events, the harm to our reputation is difficult to assess. We have taken and continue to take steps to improve our infrastructure to prevent service interruptions, including upgrading our electrical and mechanical infrastructure. However, service interruptions continue to be a significant risk for us and could materially impact our business.
 
Any future service interruptions could:
 
 
·
cause our customers to seek damages for losses incurred;

 
·
require us to replace existing equipment or add redundant facilities;
 
 
 
·
affect our reputation as a reliable provider of hosting services;

 
·
cause existing customers to cancel or elect to not renew their contracts; or

 
·
make it more difficult for us to attract new customers.
 
Any of these events could materially increase our expenses or reduce our revenue, which would have a material adverse effect on our operating results.
 
Our success also depends on our ability to handle a large number of simultaneous calls, which our network may not be able to accommodate.
 
We expect the volume of simultaneous calls to increase significantly as the ShoreTel Sky subscriber base grows. Our network hardware and software may not be strained by heavy volume. If we fail to maintain an appropriate level of operating performance, or if our service is disrupted, our reputation could be hurt and we could lose customers or have to issues credits or refunds, all of which could have a material adverse effect on our business, financial condition or operating results.
 
Our ShoreTel Sky services must comply with industry standards, FCC regulations, state and local regulations, and compliance may be costly and/or require us to modify existing services.
 
Our ShoreTel Sky service relies on communication standards such as SIP, MGCP and network standards such as TCP/IP and UDP to interoperate with other vendors' equipment. There is currently a lack of agreement among industry leaders about which standard should be used for a particular application, and about the definition of the standards themselves. As standards evolve, we may be required to modify our existing products or develop and support new versions of our services.
 
We must also comply with certain federal, state and local requirements regarding how we interact with our customers, including marketing practices, consumer protection, privacy, law enforcement and billing issues, the provision of 9-1-1 emergency service and the quality of service we provide to our customers. The failure of our services to comply, or delays in compliance, with various existing and evolving regulations could delay or interrupt the sales of our services, subject us to fines or other imposed penalties, or harm the perception and adoption rates of our service, any of which would have a material adverse effect on our business, financial condition or operating results.
 
Increased taxes on our service will increase our customers' cost of using our service and/or reduce our profit margins (to the extent the costs are not passed through to our customers) and we may be subject to liabilities for past sales and additional taxes, surcharges and fees.
 
We have reviewed ShoreTel Sky’s state and municipal tax filing history, such as sales, excise, and ad valorem taxes, fees or surcharges and found that there may be jurisdictions for which ShoreTel Sky has an obligation to collect and remit such taxes due on the charges to our customers for our services, but has yet to do so. Additionally, in jurisdictions where ShoreTel Sky does file these returns, its interpretation and application of the tax laws and regulations applicable to these services may be in conflict with the interpretation held by the states and municipalities where we do business. Although we have consistently maintained that these taxes, fees or surcharges do not apply to our service for a variety of reasons depending on the statute or rule that establishes such obligations, some states have changed their statutes as part of streamlined sales tax initiatives and therefore we may have an obligation to collect and remit sales taxes in those states. The collection of these taxes, fees or surcharges may have the effect of decreasing any price advantage we may have over other providers who have historically paid these taxes and fees. Our compliance with these tax initiatives will also make us less competitive with those competitors who choose not to comply with these tax initiatives. As of June 30, 2012, there has been no change in the status of the assessment. We have accrued for taxes that we believe are required to be remitted. If our ultimate liability exceeds the accrued amount, it could result in a material adverse effect on our earnings.
 
Our emergency and e-911 calling services are different from those offered by traditional wireline telephone companies and may expose us to significant liability. There may be risks associated with limitations associated with e-911 emergency dialing with the ShoreTel Sky service.
 
Both our emergency calling service and our e-911 calling service differ from the emergency calling services offered by traditional wireline telephone companies. In each case, the differences may cause significant delays, or even failures, in callers' receipt of the emergency assistance they need.
 
We are offering e-911 service that is similar to the emergency calling services provided to customers of traditional wireline telephone companies in the same area. We route 911 calls to a 911 service aggregation vendor, who in turn routes the calls to the local Public Safety Answering Point, or PSAP. The PSAP should have automatic access to the customer's telephone number and registered location information. If the number is not associated with an address in a 911 call, then the call is routed by the vendor to an emergency response center where a live answer takes place and the address is determined for routing to the correct PSAP.  If a customer moves their ShoreTel Sky service to a new location, the customer's registered location information must be updated and verified by the customer. Until that takes place, the customer will have to verbally advise the emergency dispatcher of his or her actual location at the time of an emergency 911 call. This can lead to delays in the delivery of emergency services.
 
 
In addition, in the event that a customer experiences a broadband or power outage, or if a network failure were to occur, the customer will not be able to reach an emergency services provider using our services. Delays our customers may encounter when making emergency services calls and any inability of the answering point to automatically recognize the caller's location or telephone number can result in life threatening consequences. Customers may, in the future, attempt to hold us responsible for any loss, damage, personal injury or death suffered as a result of any failure of our e-911 services. In July 2008, the President signed into law the "New and Emerging Technologies 911 Improvement Act of 2008." The law provides public safety, interconnected VoIP providers and others involved in handling 911 calls the same liability protections when handling 911 calls from interconnected VoIP users as from mobile or wired telephone service users. The applicability of the liability protections to our business is unclear at the present time.
 
There may be risks associated with our ability to comply with the requirements of federal law enforcement agencies.
 
The FCC requires all interconnected VoIP providers to comply with the Communications Assistance for Law Enforcement Act (CALEA). The FCC allows VoIP providers to comply with CALEA through the use of a solution provided by a trusted third party with the ability to extract call content and call-identifying information from a VoIP provider's network. While the FCC permits companies like us to use the services provided by these third parties to comply with CALEA, we are ultimately responsible for ensuring the timely delivery of call content and call-identifying information to law enforcement, and for protecting subscriber privacy. While we believe we are currently CALEA compliant, we could be subject to an enforcement action by the FCC or law enforcement agencies for any delays related to meeting, or if we fail to comply with, any current or future CALEA obligations.

Reform of federal and state Universal Service Fund programs could increase the cost of our service to our customers diminishing or eliminating our pricing advantage.

The FCC and a number of states are considering reform or other modifications to Universal Service Fund programs. The way we calculate our contribution may change if the FCC or certain states engage in reform or adopt other modifications. In April, 2012, the FCC released a Further Notice of Proposed Rulemaking to consider reforms to the manner in which companies, like us, contribute to the federal Universal Service Fund program. In general, the Further Notice of Proposed Rulemaking is considering questions like: what companies should contribute, how contributions should be assessed, and methods to improve the administration of the system. We cannot predict the outcome of this proceeding nor its impact on our business at this time.

Should the FCC or certain states adopt new contribution mechanisms or otherwise modify contribution obligations that increase our contribution burden, we will either need to raise the amount we currently collect from our customers to cover this obligation or absorb the costs, which would reduce our profit margins. Furthermore, the FCC has ruled that states can require us to contribute to state Universal Service Fund programs. A number of states already require us to contribute, while others are actively considering extending their programs to include the services we provide. We currently pass-through Universal Service Fund contributions to our customers which may result in our services becoming less competitive as compared to those provided by others.

We rely on third party network service providers to originate and terminate substantially all of our public switched telephone network calls.

We leverage the infrastructure of third party network service providers to provide telephone numbers, PSTN call termination and origination services, and local number portability for our customers rather than deploying our own network throughout the United States. This decision has resulted in lower capital and operating costs for our business in the short term but has reduced our operating flexibility and ability to make timely service changes. If any of these network service providers cease operations or otherwise terminate the services that we depend on, the delay in switching our technology to another network service provider, if available, and qualifying this new service could have a material adverse effect on our business, financial condition or operating results.

While we believe that relations with our current service providers are good, and we have contracts in place, there can be no assurance that these service providers will be able or willing to supply cost-effective services to us in the future or that we will be successful in signing up alternative or additional providers. Although we could replace our current providers, if necessary, our ability to provide service to our subscribers could be impacted during this timeframe and this could have an adverse effect on our business, financial condition or results of operations. The loss of access to, or requirement to change, the telephone numbers we provide to our customers also could have a material adverse effect on our business, financial condition or operating results.
 
 
Due to our reliance on these service providers, when problems occur in a network, it may be difficult to identify the source of the problem. The occurrence of hardware and software errors, whether caused by our service or another vendor's products, may result in the delay or loss of market acceptance of our products and any necessary revisions may force us to incur significant expenses. The occurrence of some of these types of problems may seriously harm our business, financial condition or operating results.

 
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, from July 2011 to June 2012, our stock price dropped from approximately $11 per share to approximately $4 per share. 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 could, 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.
 
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.

None.
 
ITEM 2. 
 
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, New York City and Rochester, New York, Chicago, Illinois, and in Europe, Asia and Australia.
  
We maintain a shipping and warehouse facility in Newark, 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.
 
Information with respect to this item may be found in Note 12 to the Consolidated Financial Statements in Item 8, which is incorporated herein by reference.
 
ITEM 4.
 
Not applicable.

PART II.

ITEM 5.

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, 2012
High
 
Low
 
First Quarter
  $ 10.70     $ 4.76  
Second Quarter
    6.88       4.70  
Third Quarter
    7.13       5.15  
Fourth Quarter
    5.75       3.82  
                 
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  
 
On August 30, 2012, the last reported sales price of our common stock on the NASDAQ Global Select Market was $3.98 per share.
 
Holders of Record
 
As of August 30, 2012, there were 133 stockholders of record of our common stock, although we believe there are approximately 2,500 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.
 
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, 2012, 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.
 
 

(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.
 
 

 
$100 invested on 7/3/07 in stock or index.  Fiscal year ending June 30,
 
   
7/3/2007
   
2008
   
2009
   
2010
   
2011
   
2012
 
ShoreTel, Inc.
  $ 100.00     $ 36.38     $ 65.84     $ 38.19     $ 83.95     $ 36.05  
S&P Small Cap 500 Index
    100.00       83.94       61.94       70.87       92.63       97.67  
NASDAQ Telecommunications Index
    100.00       71.62       52.08       69.02       102.15       91.16  
 
Equity Compensation Plan Information
 
The following table summarizes information about our equity compensation plans as of June 30, 2012. 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)
   
(c)
 
Equity compensation plans approved by security holders(1)
    10,586,000     $ 4.78       5,335,000  
Equity compensation plans not approved by security holders
                 
Total
    10,586,000     $ 4.78       5,335,000  


(1)   
The number of securities remaining available for future issuance in column (c) includes 5,335,000 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, 2012.

 
ITEM 6.
 
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,  
   
2012 (a)
   
2011 (b)
   
2010
   
2009
   
2008
 
   
(In thousands, except per share amounts)
 
Revenue:
                                       
Product
  $ 182,009     $ 159,693     $ 117,138     $ 109,555     $ 110,496  
Hosted and related services
    15,547       -       -       -       -  
Support and services
    49,076       40,419       31,326       25,267       18,233  
Total revenue
    246,632       200,112       148,464       134,822       128,729  
Cost of revenue:
                                       
Product(1)
    61,884       52,957       40,471       38,149       37,466  
Hosted and related services (1)
    9,804       -       -       -       -  
Support and services(1)
    16,465       13,688       11,580       11,048       10,036  
Total cost of revenue
    88,153       66,645       52,051       49,197       47,502  
Gross profit
    158,479       133,467       96,413       85,625       81,227  
Operating expenses:
                                       
Research and development(1)
    51,909       45,548       33,596       30,724       26,811  
Sales and marketing(1)
    94,797       74,859       55,973       44,652       37,869  
General and administrative(1)
    27,468       24,890       19,888       19,596       17,645  
Acquisition-related costs
    4,524       340       -       -       -  
Litigation settlement
    -       -       -       4,110       -  
Total operating expenses
    178,698       145,637       109,457       99,082       82,325  
Loss from operations
    (20,219 )     (12,170 )     (13,044 )     (13,457 )     (1,098 )
Other income (expense) – net
    (1,465 )     640       84       1,141       4,101  
Income (loss) before provision for (benefit from) income taxes
    (21,684 )     (11,530 )     (12,960 )     (12,316 )     3,003  
Provision for (benefit from) income taxes
    (947 )     (67 )     (156 )     343       861  
Net income (loss)
  $ (20,737 )   $ (11,463 )   $ (12,804 )   $ (12,659 )   $ 2,142  
Net (loss) per common share (2):
                                       
Basic
  $ (0.41 )   $ (0.25 )   $ (0.29 )   $ (0.29 )   $ 0.05  
Diluted
  $ (0.41 )   $ (0.25 )   $ (0.29 )   $ (0.29 )   $ 0.05  
Shares used in computing net loss per share:
                                       
Basic
    50,591       46,177       44,804       43,714       42,413  
Diluted
    50,591       46,177       44,804       43,714       44,861  
 
 
(a)
The fiscal year ended June 30, 2012 includes the impact of the acquisition of M5 Networks, Inc., which was completed in the third fiscal quarter.

 
(b)
The fiscal year ended June 30, 2011 includes the impact of the acquisition of Agito Networks, Inc., which was completed in the second fiscal quarter.
 
 
(1)           Includes stock-based compensation expense as follows:

      Year Ended June 30,  
   
2012
   
2011
   
2010
   
2009
   
2008
 
     
(In thousands)
 
Cost of product revenue
  $ 132     $ 123     $ 139     $ 113     $ 74  
Cost of hosted and related services
    37       -       -       -       -  
Cost of support and services revenue
    836       678       838       799       545  
Research and development
    3,614       3,497       3,064       2,829       2,005  
Sales and marketing
    4,031       3,140       3,400       3,468       2,447  
General and administrative
    3,993       3,741       3,213       2,549       2,360  
Total stock-based compensation expense
  $ 12,643     $ 11,179     $ 10,654     $ 9,758     $ 7,431  

(2)             See Note 8 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.

    As of June 30,  
   
2012
   
2011
   
2010
   
2009
   
2008
 
   
(In thousands)
 
Consolidated balance sheet data:
                             
Cash, cash equivalents and short-term investments
  $ 55,495     $ 105,752     $ 115,801     $ 107,666     $ 102,811  
Working capital
    30,961       109,855       112,836       111,617       111,993  
Total assets
    295,432       187,101       170,721       155,624       147,797  
Line of credit, net of issuance costs
    19,946                          
Total stockholders’ equity
    170,232       121,424       114,466       113,772       113,213  
 
  ITEM 7.
 
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, 2012 refers to the fiscal year ended June 30, 2012, 2011 refers to the fiscal year ended June 30, 2011, and 2010 refers to the fiscal year ended June 30, 2010.
 
Overview
 
We are a leading provider of IP telecommunications solutions for enterprises. 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 M5 Networks, Inc. (“M5”), a leader in providing hosted unified communication solutions in the third quarter of fiscal 2012, expanded our products and service offerings to now include hosted solutions. Our acquisition of Agito Networks, Inc. (“Agito”) , a leader in platform-agnostic enterprise mobility, in the second quarter of fiscal 2011, expanded 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 solutions are available for businesses to operate in their own premise data centers or on a hosted, cloud-based platform. Solutions within our premise segment are comprised of our switches, IP phones and software application which work with our unique IP architecture to provide a brilliantly integrated communication system. Our ShoreTel Sky solutions are sold within our hosted segment (formerly known as our Cloud segment) and are comprised of M5’s unique software delivered to the customer using our routers and IP phones.

 
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 premise 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. Our channel partners include resellers as well as value-added distributors who in turn sell to the resellers. 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 1,000 as of June 30, 2012, representing approximately 9% year-over-year growth. 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.

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.
 
During the second quarter of fiscal 2011, we entered into arrangements with two major value-added distributors to distribute our comprehensive line of premise business communication solutions to resellers within the United States in what we refer to as a “two-tier” distribution model. During fiscal 2012, we have expanded our two-tier network and added more value-added distributors to the network. 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. 
 
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 customers. As of June 30, 2012, we had sold our products to approximately 24,000 enterprise customers, representing approximately 36% 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. After the acquisition of M5, our ShoreTel Sky services are provided from our offices in New York City and Rochester, New York and Chicago, Illinois. 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, 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 12% of our total revenue for fiscal 2012 as compared with 13% and 10% in fiscal 2011 and 2010, 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 2012, we continued to grow our market share of the IP telephony market, both in the United States and worldwide. Our total revenue increased to $246.6 million in fiscal 2012 from $200.1 million in fiscal 2011, driven by sales to new customers, add-on sales from existing customers and the addition of ShoreTel Sky services revenue after the M5 acquisition. Our operating expenses increased to $178.7 million in fiscal 2012 from $145.6 million in fiscal 2011, primarily due to increases in compensation expenses related to growth in headcount (including stock-based based compensation), the addition of expenses from the M5 operations and the incurrence of non-recurring acquisition related costs.  In fiscal 2012, we increased our headcount by 47%, with most of the growth in headcount coming from the employees assumed and retained in connection with our acquisition of M5, 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.  
 
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 large portion of orders has come from existing enterprise customers. In fiscal year 2012, premise billings from existing enterprise customers represented approximately 54% of total billings compared with 53% and 56% in fiscal 2011 and 2010, respectively.
 
Deferred revenue. Deferred revenue relates to the timing of revenue recognition for specific transactions based on delivery of service, support, specific commitments, product and services delivered to our value-added distributors that have not been delivered or sold through to resellers, and other factors. Deferred revenue primarily consists of billings or payments received in advance of revenue recognition from our transactions and are recognized as the revenue recognition criteria are met. Nearly all of our premise system sales include the purchase of post-contractual support contracts with terms of up to five years, and our renewal rates on these contracts have been high historically. We recognize support revenue on a ratable basis over the term of the support contract. Since we receive payment for support in advance of recognizing the related revenue, we carry a deferred revenue balance on our consolidated balance sheet. This deferred revenue helps provide predictability to our future support and services revenue. Almost all of our hosted services are billed a month in advance. Billings that are collected before the service is delivered are included in the deferred revenue balance on our consolidated balance sheet. These amounts are recognized as revenue as the services are delivered. Our deferred revenue balance at June 30, 2012 was $49.5 million, of which $35.8 million is expected to be recognized within one year.
 
Gross margin. Our gross margin for premise segment 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 premise segment 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.

Gross margin for the hosted segment services is lower than the gross margins for the premise segment and is impacted primarily by the reselling of broadband costs to customers, employee-related expense, data communication cost, carrier cost, telecom taxes, and intangible asset amortization expense. We expect that with the growth in customer base, the gross margins may reflect improvement.
 
Operating expense. Our operating expenses are comprised primarily of compensation and benefits for our employees. Accordingly, increases in operating expenses historically have been primarily related to increases in our headcount. We intend to expand our workforce to support our anticipated growth, and therefore, our ability to forecast revenue is critical to managing our operating expenses.

Average revenue per user . We calculate the monthly average service revenue per user (ARPU) for our hosted segment as the average monthly recurring revenue per customer divided by the average number of seats per customer. The average monthly recurring revenue per customer is calculated as the monthly recurring service revenue from customers in the period, divided by the simple average number of business customers during the period. Our ARPU includes telco circuits that we resell that could, as a percentage of our business, decline over time as our average customer size increases and therefore they are more apt to have their own networks already established. Our monthly ARPU for the three month period ended June 30, 2012 is $62.

Customer churn . Customer churn for our hosted segment is calculated by dividing the monthly recurring revenue from customers that have terminated during a period by the simple average of the total monthly recurring revenue from all customers in a given period. The effective management of subscriber churn is critical to our ability to maximize revenue growth and to maintain and improve margins. Our annualized customer churn as of June 30, 2012 is 4%.
 
Basis of Presentation
 
Revenue. We derive our revenue from sales of our premise IP telecommunications systems and related support and services as well as hosted services.

 
Premise Revenue . Our typical system includes a combination of IP phones, switches and software applications primarily for our premise business. We sell our products through channel partners that include resellers and value-added distributors. Prices to a given channel partner for hardware and software products depend on that channel partner’s volume and 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 74%, 80%, and 79% of our total revenue for fiscal years 2012, 2011 and 2010, respectively.
 
Premise 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. Premise support and services revenues accounted for 20%, 20% and 21% of our total revenue for fiscal 2012, 2011 and 2010, respectively.

Hosted Revenue. Hosted services and solutions consist primarily of our proprietary hosted VoIP Unified Communications system as well as other services such as foreign and domestic calling plans, certain UC applications, internet service provisioning, training and other professional services. Additionally, we offer our customers the ability to purchases phones systems from us directly or rent such systems as part of their service agreements. Our hosted services are sold through indirect channel resellers and a direct sales force. Our customers typically enter into 12 month service agreements whereby they are billed for such services on a monthly basis. Revenue from our hosted services is recognized on a monthly basis as services are delivered. Revenue associated with various calling plans and Internet services are recognized as such services are provided. Hosted revenues accounted for 6% of our total revenues for fiscal 2012. There was no hosted or related services revenue in any of the fiscal years prior to 2012.
 
Cost of revenue. Cost of premise 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 premise support and services revenue consists of salary and related overhead costs of personnel engaged in support and service activities. Cost of hosted services revenue consists of personnel and related costs of the hosted operation, data center costs, data communication cost, carrier cost and amortization of intangible assets
 
Research and development expenses. Research and development expenses primarily include personnel costs, outside engineering costs, professional services, prototype costs, test equipment, software usage fees and facilities expenses. Research and development expenses are recognized when incurred. We 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.

Sales and marketing expenses. Sales and marketing expenses primarily include personnel costs, sales commissions, travel, marketing promotional and lead generation programs, branding and advertising, trade shows, sales demonstration equipment, professional services fees, amortization of intangible assets, and facilities expenses.  We plan to continue to invest in development of our distribution channel by increasing the size of our field sales force to enable us to expand into new geographies and further increase our sales to 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, interest expense on our debt as well as other miscellaneous items affecting our operating results.
 
 
Benefit from income taxes. Benefit from income taxes includes federal, state and foreign tax on our income as well as any adjustments made to our valuation allowance for deferred tax assets. Since our inception, we have accumulated substantial net operating loss and tax credit carryforwards. We account for income taxes under an asset and liability approach.  Deferred income taxes reflect the impact of temporary differences between assets and liabilities recognized for financial reporting purposes and such amounts recognized for income tax reporting purposes, net operating loss carryforwards and other tax credits measured by applying current enacted tax laws.  Valuation allowances are provided when necessary to reduce deferred tax assets to an amount that is more likely than not to be realized.
 
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 charges, amortization of purchased intangibles, acquisition-related costs, severance charges, litigation settlement costs, interest charge from change in fair value of contingent consideration and related tax adjustments (non-GAAP 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 non-GAAP adjustments. 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, 2012
   
Year Ended
 June 30, 2011
 
   
GAAP
   
Excludes
       
Non-GAAP
   
GAAP
   
Excludes
       
Non-GAAP
 
Revenue:
                                           
Product
  $ 182,009     $ -         $ 182,009     $ 159,693     $ -         $ 159,693  
Hosted and related services
    15,547       -           15,547       -       -           -  
Support and services
    49,076       -           49,076       40,419       -           40,419  
Total revenues
    246,632       -           246,632       200,112       -           200,112  
Cost of revenue:
                                                       
Product
    61,884       (1,022 )  
(a),(b)
    60,862       52,957       (614 )  
(a), (b)
    52,343  
Hosted and related services
    9,804       (850 )  
(a),(b)
    8,954       -       -           -  
Support and services
    16,465       (836 )  
(a)
    15,629       13,688       (678 )  
(a)
    13,010  
Total cost of revenue
    88,153       (2,708 )         85,445       66,645       (1,292 )         65,353  
Gross profit
    158,479       2,708           161,187       133,467       1,292           134,759  
Gross profit %
    64.3 %                 65.4 %     66.7 %                 67.3 %
                                                         
Operating expenses:
                                                       
Research and development
    51,909       (3,614 )  
(a)
    48,295       45,548       (3,497 )  
(a)
    42,051  
Sales and marketing
    94,797       (5,043 )  
(a),(b)
    89,754       74,859       (3,170 )  
(a), (b)
    71,689  
General and administrative
    27,468       (4,534 )  
(a),(b) ,(c)
    22,934       24,890       (4,266 )  
(a), (f)
    20,624  
Acquisition-related costs
    4,524       (4,524 )  
(d)
    -       340       -           340  
Total operating expenses
    178,698       (17,715 )         160,983       145,637       (10,933 )         134,704  
Income (loss) from operations
    (20,219 )     20,423           204       (12,170 )     12,225           55  
Other income (expense) - net
    (1,465 )     203    
(e)
    (1,262 )     640       -           640  
Income (loss) before provision for income tax
    (21,684 )     20,626           (1,058 )     (11,530 )     12,225           695  
Provision for (benefit from) income tax
    (947 )     1,315    
(g)
    368       (67 )     81    
(g)
    14  
Net income (loss)
  $ (20,737 )   $ 19,311         $ (1,426 )   $ (11,463 )   $ 12,144         $ 681  
Net income (loss) per share:
                                                       
Basic
  $ (0.41 )   $ 0.38         $ (0.03 )   $ (0.25 )   $ 0.26         $ 0.01  
Diluted (h)
  $ (0.41 )   $ 0.38         $ (0.03 )   $ (0.25 )   $ 0.26         $ 0.01  
                                                         
Shares used in computing net income (loss) per share:
                                                       
Basic
    50,591                   50,591       46,177                   46,177  
Diluted (h)
    50,591                   50,591       46,177                   47,900  
                                                         
(a) Excludes stock-based compensation included in:
                                                       
Cost of product revenue
          $ 132                         $ 123              
Cost of hosted and related services
            37                           -              
Cost of support and services revenue
            836                           678              
Research and development
            3,614                           3,497              
Sales and marketing
            4,031                           3,140              
General and administrative
            3,993                           3,741              
            $ 12,643                         $ 11,179