ShoreTel, Inc.
ShoreTel Inc (Form: 10-K, Received: 09/10/2010 17:04:37)

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-K



 

 

x

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the year ended June 30, 2010

or

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number: 001-33506

SHORETEL, INC.
(Exact name of Registrant as specified in its charter)

 

 

 

Delaware

3661

77-0443568

(State or other jurisdiction of

(Primary standard

(I.R.S. employer

incorporation or organization)

industrial code number)

identification no.)

960 Stewart Drive
Sunnyvale, CA 94085-3913
(408) 331-3300

(Address, including zip code, and telephone number, including area code, of Registrant’s principal executive offices)
Securities registered pursuant to Section 12(b) of the Act:
None.

Securities registered pursuant to Section 12(g) of the Act:
Shares of Common Stock, $0.001 par value

          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 x

          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 x

          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 x No o

          Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

          Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K/A. x

          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 x

 

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 x

          The aggregate market value of the voting stock held by non-affiliates of the registrant as of December 31, 2009 was approximately $116.3 million (based on the last reported sale price of $5.78 on December 31, 2009 on The NASDAQ Global Select Market). This calculation does not reflect a determination that persons are affiliates for any other purposes. Shares of stock held by ten percent stockholders have been excluded from this calculation as they may be deemed affiliates.

          The number of shares outstanding of the registrant’s common stock as of September 1, 2010 was 45,490,124.

DOCUMENTS INCORPORATED BY REFERENCE

          Part III incorporates by reference certain information from the Registrant’s definitive proxy statement (the “2010 Proxy Statement”) for the 2010 Annual Meeting of Stockholders.



TABLE OF CONTENTS

 

 

 

 

 

 

 

Page

 

 

 


 

 

 

 

 

PART I

 

 

 

 

 

 

Item 1

Business

 

3

Item 1A

Risk Factors

 

10

Item 1B

Unresolved Staff Comments

 

24

Item 2

Properties

 

24

Item 3

Legal Proceedings

 

24

Item 4

Reserved

 

24

Item 5

Market for Our Common Stock and Related Stockholder Matters and Issuer Purchases of Equity Securities

 

24

 

 

 

 

 

PART II

 

 

 

 

 

 

Item 6

Selected Consolidated Financial Data

 

29

Item 7

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

30

Item 7A

Quantitative and Qualitative Disclosures About Market Risk

 

44

Item 8

Financial Statements and Supplementary Data

 

45

Item 9

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

68

Item 9A

Controls and Procedures

 

68

Item 9B

Other Information

 

71

 

 

 

 

 

PART III

 

 

Item 10

Directors and Executive Officers of the Registrant and Corporate Governance

 

71

Item 11

Executive Compensation

 

71

Item 12

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

71

Item 13

Certain Relationships and Related Transactions, Director Independence

 

71

Item 14

Principal Accounting Fees and Services

 

71

 

 

 

 

 

PART IV

 

 

Item 15

Exhibits and Financial Statement Schedules

 

71

Signatures

 

 

72



TRADEMARKS

          The ShoreTel logo, ShoreTel, ShoreCare, ShoreGear, ShorePhone, and ShoreWare are registered trademarks of ShoreTel, Inc. in the United States and/or other countries. Brilliantly Simple and Brilliantly Simple Communication are 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 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.

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          This report contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements relate to expectations concerning matters that are not historical facts. Words such as “projects,” “believes,” “anticipates,” “plans,” “expects,” “intends” and similar words and expressions are intended to identify forward-looking statements. While we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot assure you that those expectations will prove to be correct. Important factors that could cause our actual results to differ materially from those expectations are disclosed in this report, including, without limitation, in the “Risk Factors” described in Part I, Item 1A. All forward-looking statements are expressly qualified in their entirety by these factors and all related cautionary statements. We do not undertake any obligation to update any forward-looking statements.

 

 

ITEM 1.

B USINESS

Overview

          We are a leading provider of Internet Protocol, or IP, unified communications systems for enterprises. Our systems are based on our distributed software architecture and switch-based hardware platform which enable multi-site enterprises to be served by a single system. Our systems enable a single point of management, easy installation and a high degree of scalability and reliability, and provide end users with a consistent, full suite of features across the enterprise, regardless of location. As a result, we believe our systems enable enhanced end user productivity and provide lower total cost of ownership and higher customer satisfaction than alternative systems.

          Our solution is comprised of ShoreTel Voice Switches, ShoreTel IP Phones and ShoreTel Software applications. We provide our systems to enterprises across all industries, including small, medium and large companies and public institutions. Our enterprise customers include multi-site Fortune 500 companies. As of June 30, 2010, we had sold our IP unified communications systems to approximately 14,000 enterprise customers. We sell our systems through our extensive network of over 800 channel partners.

          We have achieved broad industry recognition for our technology and high customer satisfaction. We have won the “best overall” CustomerSat Acheivement award (ACE) for three years in a row. For the last six years, IT executives surveyed by Nemertes Research, an independent research firm, have rated ShoreTel highest in customer satisfaction among leading enterprise unified communications systems providers.

          We were originally incorporated in California in September 1996, and reincorporated in Delaware in June 2007.

Products

          We provide a switch-based business communications systems for the enterprise. Our solutions are based on our distributed software architecture and appliance-based hardware platform that enable a single system to serve multi-site enterprises. This architecture provides high network reliability and allows for a single view of management and administration across all sites of a multi-site enterprise. System administrators can make changes anywhere throughout the system through a web browser interface that presents a user-friendly view of the system’s configuration. Our architecture also provides end users with a consistent and full set of features across an enterprise, regardless of location.

          We introduced our first suite of products in 1998 and have continued to add features and functionality throughout our history. Our bundled solution is comprised of ShoreTel Voice Switches, ShoreTel IP Phones and ShoreTel System Software applications. As new software versions of our solution have been released, existing enterprise customers have been able to upgrade their switches, phones and applications, allowing them to preserve their ShoreTel investment.

          ShoreTel Voice Switches. Our switches provide call management functionality, and each switch in the system is capable of independently establishing and terminating calls without relying on a centralized call control server. As a result, enterprise unified communications can survive a variety of LAN, WAN and hardware failures. The high reliability of our switches is enhanced by two key design features: the use of flash memory in lieu of disk drives and running an embedded operating system optimized for real-time processing, such as call management. Unlike disk drives, flash memory does not rely on mechanical movement, and therefore is less likely to break down and cause our systems to fail. Furthermore, our embedded operating system enables a higher performing and more reliable software platform relative to server-centric IP systems because it is optimized for real-time processing. The reliability of the system can be further improved by adding an additional switch to the headquarters location to create “n+1” redundancy, rather than requiring a dedicated back-up switch for each primary switch to improve reliability as needed by alternative systems. In addition, our switches connect to the public telephone network via one of several interfaces, including high-density T1 and E1 interfaces. We offer a range of switches of varying capabilities to meet the needs of enterprises of all sizes. The modular nature of our switches allows our enterprise customers to easily expand their system capacity by deploying additional switches across their network.

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          ShoreTel IP Phones . We offer a range of innovative, high performance phones to meet the needs of the different types of end users across the enterprise. Our phones are designed to provide a superior combination of ergonomics, sound quality and appearance. We offer a variety of phones that vary by size, display features, line capacity and Gigabit Ethernet support. ShoreTel IP phones are designed to function without any configuration, simplifying installation. Remote workers can also utilize ShoreTel IP telephones using an integrated Virtual Private Network (VPN) feature and mobile workers can select Wi-Fi phones that work with the open interfaces of the system.

          ShoreTel Software applications. Our software features a number of applications that facilitate the end user experience and enterprise system management. In addition, we offer additional business applications that integrate with core business processes to provide enhanced end user productivity. An industry standard server is used to support these applications, as opposed to the call management functions of our systems, which run on switches. Our software consists of our proprietary software as well as third-party applications and includes:

 

 

 

 

ShoreTel Communicator . ShoreTel Communicator is a powerful unified communications (UC) application for users across an organization, whether an operator, a contact center agent, a knowledge worker or a road warrior. Available on multiple operating systems, ShoreTel Communicator makes it easy for people to communicate any way they choose: by video, voice (wired or wireless), instant messaging (IM), and more. One single interface makes training simple and reduces the IT workload because there is just a single application to support, and no additional servers to deploy and maintain.

 

 

 

 

Office Anywhere. The Office Anywhere feature enables end users outside the office to manage calls with ShoreTel Communicator and to enjoy the same call handling productivity benefits as their office-based colleagues. Calls directed to the end user’s office phone are forwarded to the end user’s location, and the end user’s outbound calls appear to the called party as if they originated in the end user’s office. Using Office Anywhere, end users have the same call management and unified messaging features and functionality at remote locations as they have in their offices.

 

 

 

 

Unified Messaging. Unified Messaging integrates our voicemail application with Microsoft Outlook. This enables end users to receive, send, be notified of and play voice mail messages through their Microsoft Outlook email.

 

 

 

 

Automated Attendant. Automated Attendant provides end users with a 24-hour automated call answering and routing capability that enables the enterprise to direct callers to appropriate individuals, workgroups or messages.

 

 

 

 

ShoreTel Contact Center. Contact Center applications provide a range of features to satisfy the needs of all organizations, from basic call center capabilities to sophisticated distributed multimedia contact center capabilities. The virtual contact center is now a reality as Contact Center enables organizations to route incoming contacts to the most appropriate agent in a multisite contact center, regardless of location.

 

 

 

 

Converged Conferencing. ShoreTel Converged Conferencing enables enterprises to conduct large audio conferences and provides collaboration tools for application sharing, desktop sharing, instant messaging and end user presence information.

 

 

 

 

Microsoft Integration . For customers seeking to leverage their investment in Microsoft’s Unified Communications portfolio, ShoreTel offers a range of integration options. Users can leverage their Microsoft Exchange messaging platform and Microsoft Office Communications Server installation with the ShoreTel solution as well as control their ShoreTel IP telephony using the Microsoft Office Communicator.

 

 

 

 

System management. Our browser-based system management applications consist of ShoreTel Director.

 

 

 

 

ShoreTel Director. Director provides enterprises with a single point of system management, enabling IT administrators to view and manage the entire system of the enterprise from any location using a single application. A new end user’s extension, mailbox and automated attendant

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profile can be added from a single management screen, avoiding the additional work required with most Private Branch Exchanges (PBXs), voice mail systems and automated attendants.

 

 

 

 

Business integration. We offer businesses the option to enhance their communication, enable their business applications pre-built solutions that integration with several customer relationship management (CRM) solutions (Salesforce.com, Microsoft Dynamics, Netsuite and RightNow) as well as cost recovery applications (Equitrak, Copitrak, and Lexis/Nexis Time Matters). These integrations are designed to improve the productivity of end users that use these applications by seamlessly integrating communications capabilities into their data-driven workflow. Customers or partners can create additional business integrations using the open interfaces of the system available for developers through ShoreTel’s Developer Network.

     ShoreTel Global Services

          We complement our product offerings with a broad range of services that help us maintain and expand our relationships with enterprise customers and channel partners and, in the case of post-contractual support, provide us with recurring revenue. Typically, our channel partners provide many of these services, although we provide back up and escalation support as needed, or if requested by the enterprise customer, we provide these services directly.

          The ShoreTel Global Services include post-contractual support, training, system design and installation, and professional services as follows:

 

 

 

 

Post-contractual support services include web-based access support services and tools, access to technical support engineers, hardware replacement and software updates. These services are typically offered under support contracts with terms of up to five years.

 

 

 

 

Training services include certification programs for channel partners, training programs at enterprise customer or channel partner locations and self-paced, desktop training programs.

 

 

 

 

System design and installation services include the assessment of the unified communications requirements of a particular enterprise, the configuration of a system to maximize its efficiency, the management of the installation, and the subsequent testing and implementation of our systems.

 

 

 

 

Professional services include software development to improve system performance, enable integration of our systems with third party applications or legacy systems, streamline business processes and address enterprise customer-specific business opportunities.

      Technology

          Our systems are based on a combination of our proprietary software, industry-standard interfaces and protocols, and customized and off-the-shelf hardware components. We have developed proprietary technologies that are critical to the operation of the servers and ShoreTel Voice Switches within our systems and provide our systems with the properties that distinguish them from alternative IP systems.

          The key elements of our distributed software architecture are:

 

 

 

 

software that allows a geographically-distributed system to operate and be managed as a single system;

 

 

 

 

software that enables calling between ShoreTel Voice Switches and allows calls to be distributed among Voice Switches instead of using a single centralized call control server;

 

 

 

 

software that enables ShoreTel Voice Switches to obtain call routing information;

 

 

 

 

software that monitors the bandwidth consumed on each WAN segment and prevents the system from exceeding bandwidth limitations;

 

 

 

 

software that monitors all call activity on Voice Switches, and enables integration of ShoreTel and third-party applications;

 

 

 

 

software that coordinates the functions of all servers and Voice Switches on the system, allowing them to perform as a single, virtual server;

 

 

 

 

software that enables remote ShoreTel and third-party applications to access and modify our systems;

 

 

 

 

software that enables the Voices Switches to communicate with the application server, and receive system configuration information;

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software that allows each Voice Switch to maintain a comprehensive view of the system;

 

 

 

 

software that provides a graphical user interface for our phones;

 

 

 

 

software that allows the system to scale from small to large simply by adding additional components; and

 

 

 

 

software that allows centralized monitoring and management of the system independent of the geographical location of the users or system components

          Our switch-based software also uses industry-standard Session Initiation Protocol, or SIP, and Media Gateway Control Protocol, or MGCP, for setting up calls.

          ShoreTel Voice Switches are comprised of off-the-shelf, embedded microprocessors and networking components, such as ethernet controllers, and customized integrated circuits. These Voice Switches run on an embedded operating system, and use random access memory and flash memory and our switch call management software for application processing. ShoreTel IP phones are comprised of enterprise IP phone chips manufactured by Broadcom Corporation using customized LCD displays, microphones speaker circuitry and custom software providing plug and play installation and management, ease of use and a rich feature set.

          ShoreTel provides client and server-side application software for control and management of IP phones for individuals, workgroups such as contact centers, as well as the system manager. Client applications are available for personal computers, mobile phones and web browsers.

      Enterprise Customers

          Our enterprise customers include small, medium and large companies and public institutions in a wide range of vertical markets, including professional services, financial services, government, education, health care, manufacturing, non-profit organizations, and technology industries. As of June 30, 2010, we had sold our IP unified communications systems to approximately 14,000 enterprise customers. Our broad enterprise customer base reflects our historical strength in the small and medium-sized business and public institution sectors.

          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 implementation with a formal review with the enterprise customer that involves contacts with our internal staff and third-party technical personnel, and 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 to ensure that they are fully satisfied with their system. We also survey enterprise customers that use technical support services to ensure that high-quality support services are being provided. Through this process, we gain valuable insights into the existing and future requirements of our enterprise customers’ activities and this helps us develop product enhancements that address the evolving requirements of enterprises.

          Additionally, to promote high-quality support throughout our services organization, we measure key performance indicators and operational metrics of our services organization, including call answer times, call abandon rates, customer satisfaction with technical support, time to issue resolution, call interaction quality, as well as customer satisfaction with system implementation, training services and technical support, and use the results to direct the management of our services organization.

          We also monitor our enterprise customers’ satisfaction with our channel partners by surveying our enterprise customers after the system is installed. We actively encourage our channel partners to maintain and improve our enterprise customers’ levels of satisfaction. We also monitor our channel partners’ satisfaction with ShoreTel, as their satisfaction with and advocacy of ShoreTel is also very important to our success.

      Sales and Marketing

          We sell our products and services primarily through an extensive network of channel partners, including distributors in most international markets. As of June 30, 2010, we had over 800 channel partners in our network. These channel partners range in size from single-site, regional firms with specialized products and services to multi-national firms that provide a full range of IT products and services including the top three US telecommunication carriers: AT&T, Verizon and Qwest. Our channel partners market and sell our products into both the large enterprise and small-to-medium enterprise markets.

          We maintain a sales organization that recruits, qualifies and trains new channel partners, participates in sales presentations to potential enterprise customers and assesses customer feedback to assist in developing product roadmaps. As part of our increased focus on sales to large accounts, we also have a major accounts program whereby sales personnel assist

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our channel partners in selling to and providing support for large enterprise customer accounts. No single channel partner accounted for 10 percent or more of our total revenue in fiscal 2010.

          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 brand awareness highlighting that the ShoreTel solution is Brilliantly Simple compared to competitive alternatives, 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 our installed-base newsletters, e-mail and direct mail campaigns, print and web-based advertising, press releases and web-based demonstrations.

      Research and Development

          We believe that our ability to enhance our current products, develop and introduce new products on a timely basis, maintain technological competitiveness and meet enterprise customer requirements is essential to our success. To this end, we have assembled a team of engineers with expertise in various fields, including voice and IP communications, unified communications network design, data networking and software engineering. Our principal research and development activities are conducted in Sunnyvale, California and Austin, Texas. We have invested significant time and financial resources into the development of our architecture, including our switches and related software. We intend to continue to expand our product offerings, improve the features available on our products and integrate our systems with third-party enterprise applications. Research and development expenses were $33.6 million, $30.7 million, and $26.8 million in fiscal 2010, 2009 and 2008, respectively.

      Manufacturing and Suppliers

          We outsource the manufacturing of our hardware products. This outsourcing allows us to:

 

 

 

 

avoid costly capital expenditures for the establishment of manufacturing operations;

 

 

 

 

focus on the design, development, sales and support of our hardware products; and

 

 

 

 

leverage the scale, expertise and purchasing power of specialized contract manufacturers.

          Currently, we have arrangements for the production of our switches with a contract manufacturer in California and for the production of our phones with contract manufacturers located in China. Our reliance on contract manufacturers involves a number of potential risks, including the absence of adequate capacity, ownership of certain elements of electronic designs, and reduced control over delivery schedules. Our contract manufacturers provide us with a range of operational and manufacturing services, including component procurement and performing final testing and assembly of our products. We typically depend on our contract manufacturers to procure components and to maintain adequate manufacturing capacity. We typically fulfill product orders out of our Fremont, California location or United Kingdom and Australia warehouses.

          We regularly provide forecasts for orders, and we order products from our contract manufacturers based on our projected sales levels, which is well in advance of receiving customer orders. However, enterprise customers may generally cancel or reschedule orders without penalty, and delivery schedules requested by enterprise customers in these orders frequently vary based upon each enterprise customer’s particular needs.

          We also rely on sole or limited numbers of suppliers for several key components utilized in the assembly of our products. For example, our contract manufacturers purchase semiconductors that are essential to the production of our phones from a single source supplier, and we have not identified any alternative suppliers for these components. This reliance is amplified by the fact that our contract manufacturers maintain relatively low inventories and acquire components only as needed. As a result, our ability to respond to enterprise customer orders efficiently may be constrained by the then-current availability or terms and pricing of these components. Constraints on our ability to respond efficiently is partially offset by build-up of levels of safety stock inventory which lets us respond to our enterprise customer orders in a timely manner. We cannot assure you that we will be able to obtain a sufficient quantity of these components in a timely manner to meet the demands of our enterprise customers or that prices of these components will not increase. In addition, we cannot assure you that our suppliers continue to offer components that we need. Any delays or any disruption of the supply of these components could also materially and adversely affect our operating results.

      Financial Information about Geographic Areas

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     For financial information about geographic areas, refer to Note 10 of the notes to the Consolidated Financial Statements in Item 8 of this report.

Competition

          The market for enterprise IP unified communications systems is quickly evolving, highly competitive and subject to rapid technological change. As a result of the convergence of voice, video, messaging and data networking technologies that characterize IP enterprise unified communications systems, we compete with providers of enterprise unified communications systems, such as:

 

 

 

 

 

 

Providers of IP systems, including Cisco Systems

 

 

 

 

 

 

Providers of hybrid IP/TDM communication systems, including Aastra, Avaya, Alcatel-Lucent, Mitel Networks, NEC, Nortel Networks and Siemens

 

 

 

 

 

 

Providers of Unified Communications software applications providers, including Microsoft

 

 

 

 

 

 

Providers of Hosted PBX services from service providers, including ILECs and CLECs

 

 

 

 

 

 

Providers of Computer Server technologies bundles with telephony applications, including Hewlett-Packard.

          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 residential rather than enterprise customers.

          We may face competition from internet portal focused providers extend their portfolio to include business communications solutions, such and Google and Yahoo.

          In particular, as more enterprises converge their voice and data networks, the business information technology and communication applications deployed on converged networks become more integrated. We may face increased competition from current leaders in information technology infrastructure, information technology, personal and business applications and the software that connects the network infrastructure to those applications. This could include network systems providers such as Brocade, Hewlett-Packard, and Juniper.

          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. In addition, technological developments and consolidation within the communications industry result in frequent changes to our group of competitors. Many of our current and potential competitors are substantially larger than we are and have higher brand familiarity with buyers, and significantly greater financial, sales, marketing, and distribution, technical, manufacturing and other resources. We believe that we currently compete favorably with regard to the principal competitive factors applicable to our products, which include:

 

 

 

 

 

 

Lower selling costs for resellers and distributors with ease of implementation

 

 

 

 

 

 

Lowest total cost of ownership over a multi-year period compared to competitor’s IP and hybrid system backed by independent data from third parties such as Alinean Research and Nemertes Research

 

 

 

 

 

 

Highest rating in customer satisfaction, as reported by an independent third party, Nemertes Research for the last six years in a row

 

 

 

 

 

 

Superior product scalability without forklift upgrades from 10 to 10,000 users in a single image configuration

 

 

 

 

 

 

World class customer service and support from technicians and support centers located around the world

 

 

 

 

 

 

Greater ease of management for system administrators

 

 

 

 

 

 

Intuitive productivity tools for employees with integrated unified communications capabilities

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Highest system availability and reliability with our N+1 distributed switch architecture

          For more information concerning competition, please see Risk Factors - Risks Related To Our Business and Industry – “The market in which we operate is intensely competitive, and many of our competitors are larger, more established and better capitalized than we are” and – “As voice, video, messaging and data networks converge, we are likely to face increased competition from Microsoft and other companies in the information technology, personal and business applications and software industries.”

     Intellectual Property

          A factor to our success as a company depends upon 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.

          We have 16 patents issued in the United States, and have 41 patent applications in the United States. We also have five foreign patents and four patent applications relating to our United States patents.

          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, 2010, we had 479 employees in North America, Europe, Asia and Australia, of which 158 were in sales and marketing, 168 were in engineering, 81 were in global support services, 47 were in general and administrative functions and 25 were in operations. 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, 2010:

 

 

 

 

 

 

 

Name

 

Age

 

Position

 


 


 


 

 

 

 

 

John W. Combs

 

63

 

President and Chief Executive Officer

 

Donald J. Girskis

 

50

 

Senior Vice President, Worldwide Sales

 

Michael E. Healy

 

49

 

Chief Financial Officer

 

Edwin J. Basart

 

61

 

Founder, Chief Technology Officer and Director

 

Pedro E. Rump

 

54

 

Vice President, Engineering and Operations

 

Ava M. Hahn

 

37

 

Vice President, General Counsel and Secretary

          John W. Combs has served as our President and Chief Executive Officer and as a director since July 2004. In addition, Mr. Combs served as our Chairman from February 2007 to July 2010. From July 2002 to May 2004, Mr. Combs served as Chairman and Chief Executive Officer of Littlefeet Inc., a wireless infrastructure supplier. From September 1999 to July 2002, Mr. Combs served as Chief Executive Officer of InternetConnect Inc., a broadband networking solutions provider. Mr. Combs has also held senior management positions at Nextel Communications, Inc., a wireless digital communications system provider, L.A. Cellular, a wireless network operator, Mitel Inc., a manufacturer of private branch exchanges and Fujitsu Business Communication Systems, Inc., a provider of telecommunications products. Mr. Combs holds a B.S. in engineering from California Polytechnic State University, San Luis Obispo. Mr. Combs will be leaving our company as President and Chief Executive Officer as of September 30, 2010 and will not be standing for reelection as a Board member.

          Donald J. Girskis has served as our Senior Vice President of Worldwide Sales since February 2008. Mr. Girskis has been appointed interim Chief Executive Officer, effective October 1, 2010. From 1993 to 2008, Mr. Girskis held a variety of executive positions at Sprint-Nextel, a telecommunications company, most recently as the Senior Vice President and General Manager of Boost Mobile, a subsidiary of Sprint-Nextel. At Nextel, Mr. Girskis held the position of Area Vice President of

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Sales, Area Vice President of Marketing, Vice President of Engineering, and General Manager. Prior to Sprint-Nextel, Mr. Girskis held sales management positions with Businessland, and Los Angeles Cellular Telephone Company. Mr. Girskis holds a B.A. in business administration from California State University at Fullerton.

          Michael E. Healy has served as our 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. Prior to co-founding ShoreTel, Mr. Basart co-founded Network Computing Devices, Inc., a provider of thin client computing hardware and software, where he served as Vice President of Engineering, and Ridge Computers, Inc. where he served as Vice President of Software. Mr. Basart began his career as a software engineer at Hewlett Packard. Mr. Basart holds a B.S. in English from Iowa State University and an M.S. in electrical engineering from Stanford University.

          Pedro E. Rump has served as our Vice President of Engineering and Operations since January 2006. From July 2004 to January 2006, Mr. Rump served as Vice President of Engineering and Operations at Dust Networks, Inc., a developer of embedded wireless sensor networking products. From January 2004 to July 2004, Mr. Rump served as Vice President of Engineering at Sonim Technologies, Inc., a provider of voice over IP applications. From January 2003 to January 2004, Mr. Rump served as Vice President of Engineering at Littlefeet Inc. From January 2002 to October 2002, Mr. Rump served as Vice President of Inviso, a developer of signal transport and display solutions for television and telecommunications. Mr. Rump holds a B.S. and M.S. in electrical engineering from the Swiss Federal Institute of Technology.

          Ava M. Hahn has served as our Vice President, General Counsel and Secretary since May 2009. Ms. Hahn joined ShoreTel in June 2007 serving in the position of General Counsel and Secretary. From August 2002 to May 2007, Ms. Hahn served as General Counsel, Assistant General Counsel and Secretary for Genesis Microchip, Inc., a supplier of display image processors. From August 2000 to August 2002, Ms. Hahn served as Director, Legal Affairs for LuxN, Inc., a provider of optical access equipment. Prior to then, Ms. Hahn was in private practice at Wilson Sonsini Goodrich & Rosati, P.C. Ms. Hahn holds a J.D. from Columbia Law School and a B.A. from the University of California, Berkeley.

 

 

I TEM 1A.

RISK FACTORS

Risks Related to Our Business and Industry

          We may not be able to return to profitability.

          We were not profitable on a GAAP basis in the fiscal years ended June 30, 2010 and 2009, and we had an accumulated deficit of $108.2 million as of June 30, 2010. If we are not able to grow our revenues or maintain our operating expenses at appropriate levels based on those revenues, we may not succeed in achieving or maintaining profitability in future periods. We also incur significant operating expenses and have recently announced that we plan to increase operating expenses in order to fund our growth. If our gross profit does not increase to offset these expected increases in operating expenses, our operating results will be negatively affected. You should not consider our historic annual revenue growth rates as indicative of our future growth particularly in light of the current economic environment. Accordingly, we cannot assure you that we will be able to return to significant revenue growth or profitability in the future.

          Current uncertainty in global economic conditions makes it particularly difficult to predict demand for our products, and makes it more likely that our actual results could differ materially from expectations.

          Our operations and performance depend on worldwide economic conditions, which have been depressed in the United States and other countries, and may remain depressed for the foreseeable future. These conditions make it difficult for our customers and potential customers to accurately forecast and plan future business activities, and have caused our customers and potential customers to slow or reduce spending on capital equipment such as our products. These economic conditions could also cause our competitors to drastically reduce prices or take unusual actions to gain a competitive edge, which could force us to provide similar discounts and thereby reduce our profitability. We cannot predict the timing, strength or duration of the current economic slowdown or subsequent economic recovery, worldwide, in the United States, or in our

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industry. These and other economic factors could have a material adverse effect on demand for our products and services, and on our financial condition, including profitability and operating results.

          Our business could be harmed by adverse economic conditions in our target markets, reduced spending on information technology and telecommunication products by customers and potential customers, and the tightening of the credit markets.

          Our business depends on the overall demand for information technology, and in particular for telecommunications systems. The market we serve is emerging and the purchase of our products involves significant upfront expenditures. In addition, the purchase of our products can be discretionary and may involve a significant commitment of capital and other resources. In many cases, our resellers and/or end customers procure our products and services on credit. If credit is not available to them, it may be difficult or impossible for our resellers and/or end customers to purchase our products. Weak economic conditions in our target markets, or a reduction in information technology or telecommunications spending even if economic conditions improve, would likely adversely impact our business, operating results and financial condition in a number of ways, including longer sales cycles, lower prices for our products and reduced unit sales.

          We have had significant executive management turnover, and may not be able to retain or attract the executives we need to succeed.

          We have had significant turnover in our executive team. Our Chief Executive Officer John W. Combs, resigned in July 2010 and will continue to serve as our CEO until September 30, 2010. Though we have commenced a search for his successor, we cannot predict how long such a search will take. Our Vice President of Global Services, Walter Weisner, also recently left the company and we have not yet hired his replacement.

          We cannot assure you that we will be able to attract executives to replace Mr. Combs or Mr. Weisner in a timely manner, or that we will be able to retain them. We also cannot assure you that we will be able to retain other key employees, including senior management and executive positions. If we cannot attract and retain these executives and key employees, our business would be harmed, particularly if the departure of any executive or key employee results in a business interruption, or if we are not successful in preserving material knowledge of our departing employees.

          Our future success depends on our ability to attract, integrate and retain key personnel, and our failure to do so could harm our ability to grow our business.

          Our company strategy and future success will depend, to a significant extent, on our ability to attract, integrate and retain our key personnel, namely our management team and experienced sales and engineering personnel. We may experience difficulty assimilating our newly hired personnel, which may adversely affect our business. In addition, we must retain and motivate high quality personnel, and we must also attract and assimilate other highly qualified employees. Competition for qualified management, sales, technical and other personnel can be intense, and we may not be successful in attracting and retaining such personnel. In addition, even if we succeed in hiring additional sales personnel, it may take some period of time before they become productive. Competitors have in the past and may in the future attempt to recruit our employees, and our management and key employees are not bound by agreements that could prevent them from terminating their employment at any time. If we fail to attract, integrate and retain key employees, our ability to manage and grow our business could be harmed.

          We rely on third-party resellers to sell our products, and disruptions to, or our failure to develop and manage our distribution channels could adversely affect our business.

          Substantially all of our total revenue is generated through indirect channel sales. These indirect sales channels consist of third-party resellers that market and sell telecommunications systems and other products and services to customers. We expect indirect channel sales will continue to generate a substantial majority of our total revenue in the future. Therefore, our success is highly dependent upon establishing and maintaining successful relationships with third-party resellers, and the financial health of these resellers.

          Many of the resellers we recruit never generate significant revenues for us. Recruiting, launching and retaining qualified channel partners and training them in our technology and products requires significant time and resources. In order to develop and expand our distribution channel, we must continue to recruit larger and more productive channel partners. We must also scale and improve our processes and procedures that support our channel, including investment in personnel, systems and training, and those processes and procedures may become increasingly complex and difficult to manage.

          We have no long-term contracts or minimum purchase commitments with any of our channel partners, and our contracts with these channel partners do not prohibit them from offering products or services that compete with ours. Our competitors may be effective in providing incentives to existing and potential channel partners to favor their products or to

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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 badly 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 could be more pronounced in international markets, where we expect that enterprise customers will 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.

          As a result of the ongoing credit contraction in the credit markets, our channel partners may have their credit lines withdrawn or may not be able to procure financing necessary to purchase our products, or maintain their business. Additionally, as a result of the current economic downturn, the businesses of our channel partners are being adversely affected. Our channel partners could be unable to devote the same level of resources to selling and marketing our systems, or worse, they could discontinue operations. In such event, we must find another channel partner to support the failed partner’s customers, or take on support of those customers ourselves, even if we have not been paid to do so. If our resellers cannot continue to purchase our products, or if they cease operations, our ability to collect receivables, our operating results and our financial condition will be materially adversely affected.

     If we fail to manage our growth effectively, our business could be harmed.

     We plan to further expand our operations, particularly in sales headcount, channel partnerships, and the number and size of enterprise customers implementing our systems. We will need to increase our operating expenses in order to fund this expansion and support larger customers. This growth will place a significant strain on our management, administrative, operational and financial infrastructure. Our success will depend upon our ability to manage this growth effectively. If we do not increase our revenues commensurate to our increased spending, we will not be profitable. To manage the expected growth of our operations and personnel, we will need to continue to improve our operational, financial and management controls and our reporting systems and procedures. Failure to effectively manage growth could result in difficulty in filling enterprise customer orders, declines in product quality or customer satisfaction, increases in costs, production and distribution difficulties, and any of these difficulties could adversely impact our business performance and results of operations.

          If we fail to increase our consideration rate, our business could suffer.

          We estimate that we compete for only a fraction of the potential customers in our market due to our smaller size and lower brand recognition as compared to our much larger competitors. Many of our potential customers purchase their communications systems without ever having considered ShoreTel. We have recently launched a brand recognition campaign in an effort to increase our rate of consideration by prospective customers. If we do not increase our brand recognition and public awareness of our products, we may not be able to enter the sales process for many potential customers and therefore not increase sales and revenues commensurate with our increased operating expenses, which would have a negative financial impact on our business.

          Our business may be harmed if our contract manufacturers are not able to provide us with adequate supplies.

          We outsource the manufacturing of our products. Currently, we have arrangements for the production of our products with a contract manufacturer in California and contract manufacturers located in China. Our reliance on contract manufacturers involves a number of potential risks, including the absence of adequate capacity, financial viability, ownership of certain elements of electronic designs, the ongoing viability of those contract manufacturers, and reduced control over delivery schedules.

          We depend on our contract manufacturers to finance the production of goods ordered and to maintain adequate manufacturing capacity. Global economic conditions could adversely impact the financial condition of our contract manufacturers and their suppliers that could impact our contract manufacturer’s ability to procure components or otherwise manufacture our products. Additionally, as a result of the current economic downturn, the businesses of our contract manufacturers and other suppliers could be adversely affected and they may be required to slow or curtail operations. We do

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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 and an increase in production costs resulting in lower gross product margins, which could adversely affect our business and results of operations.

     The market in which we operate is intensely competitive, and many of our competitors are larger, more established and better capitalized than we are.

          The market for IP telecommunications and other telecommunications systems is extremely competitive. Our competitors include companies that offer IP systems, such as Cisco Systems, Inc. and that offer hybrid systems, such as Alcatel-Lucent, Avaya and Mitel Networks Corporation. In addition, we compete with much larger companies such as Microsoft in the unified communications market. Several of the companies that offer hybrid systems are beginning to also offer IP telecommunications systems. Many of our competitors are substantially larger and have greater financial, technical, research and development, sales and marketing, manufacturing, distribution and other resources. We could also face competition from new market entrants, whether from new ventures or from established companies moving in to the market. These competitors have various other advantages over us, including:

 

 

 

 

greater market presence, name recognition and brand reputation;

 

 

 

 

larger distribution channels;

 

 

 

 

a larger installed base of telecommunications and networking systems with enterprise customers;

 

 

 

 

larger and more geographically distributed services and support organizations and capabilities;

 

 

 

 

a broader offering of telecommunications and networking products, applications and services;

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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.

          Given their capital resources, many of these competitors are in a better position to withstand any significant reduction in capital spending by enterprise customers on telecommunications equipment and are not as susceptible to downturns in a particular market. This risk is enhanced because we focus our business solely on the enterprise IP telecommunications market and do not have a diversified portfolio of products that are applicable to other market segments.

          We compete primarily on the basis of price, feature set, reliability, scalability, usability, total cost of ownership, customer satisfaction and service. Because our competitors have greater financial strength than we do and are able to offer a more diversified bundle of products and services, they have offered and in the future may offer telecommunications products at lower prices than we do. These larger competitors can also bundle products with other services, such as hosted or managed services, effectively reducing the price of their products. In order to remain competitive from a cost perspective, we have in the past reduced the prices of our products, and we may be required to do so in the future, in order to gain enterprise customers. Price reductions could have a negative effect on our gross margins.

          Our competitors may also be able to devote more resources to developing new or enhanced products, including products that may be based on new technologies or standards. If our competitors’ products become more accepted than our products, our competitive position will be impaired and we may not be able to increase our revenue or may experience decreased gross margins. If any of our competitors’ products or technologies become the industry standard, if they are successful in bringing their products to market earlier, or if their products are more technologically capable than ours, then our sales could be materially adversely affected. We may not be able to maintain or improve our competitive position against our current or future competitors, and our failure to do so could materially and adversely affect our business.

           The gross margins on our products may decrease due to competitive pressures or otherwise, which could negatively impact our profitability.

          It is possible that the gross margins on our products will decrease in the future in response to competitive pricing pressures, new product introductions by us or our competitors, changes in the costs of components, manufacturing issues, royalties we need to pay to use certain intellectual property, the introduction of our managed solution offering, growth of our international business, or other factors. If we experience decreased gross margins and we are unable to respond in a timely manner by introducing and selling new, higher-margin products successfully and continually reducing our product costs, our gross margins may decline, which will harm our business and results of operations.

 

 

 

As voice and data networks converge, we are likely to face increased competition from Microsoft and other companies in the information technology, personal and business applications and software industries.

          The convergence of voice and data networks and their wider deployment by enterprises has led information technology and communication applications deployed on converged networks to become more integrated. This integration has created an opportunity for the leaders in information technology, personal and business applications and the software that connects the network infrastructure to those applications, to enter the telecommunications market and offer products that compete with our systems, commonly referred to as Unified Communications. Competition from these potential market entrants may take many forms, and they may offer products and applications similar to those we offer. For example, Microsoft Corporation has announced its unified communications product roadmap. This includes Office Communicator 2007, which Microsoft states allows end users to control communications, including voice over IP, through the Office Communicator application on their PC, which provides functionality that competes with our ShoreTel Communicator application. Microsoft has also introduced Office Communications Server 2007, a product that offers competing unified messaging capabilities. Microsoft has also developed an IP phone and has licensed the rights to produce such phones to third

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parties. 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, 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 the emerging market for enterprise IP telecommunications systems does not continue to grow and if we do not increase our market share, our future business would be harmed.

          The market for enterprise IP telecommunications systems is evolving rapidly and is characterized by an increasing number of market entrants. As is typical of a new and rapidly evolving industry, the demand for and market acceptance of, enterprise IP telecommunications systems products and services are uncertain. We cannot assure you that enterprise telecommunications systems that operate on IP networks will become widespread. In particular, enterprises that have already invested substantial resources in other means of communicating information may be reluctant or slow to implement an IP telecommunications system that can require significant initial capital expenditures as compared to a hybrid system that might require a lower initial capital expenditure despite higher potential total expenditures over the long term. If the market for enterprise IP telecommunications systems fails to develop or develops more slowly than we anticipate, our products could fail to achieve market acceptance, which in turn could significantly harm our business. This growth may be inhibited by a number of factors, such as:

 

 

 

 

initial costs of implementation for a new system;

 

 

 

 

quality of infrastructure;

 

 

 

 

security concerns;

 

 

 

 

equipment, software or other technology failures;

 

 

 

 

regulatory encroachments;

 

 

 

 

inconsistent quality of service;

 

 

 

 

perceived unreliability or poor voice quality over IP networks as compared to circuit-switched networks; and

 

 

 

 

lack of availability of cost-effective, high-speed network capacity.

          Moreover, as IP-based data communications and telecommunications usage grow, the infrastructure used to support these services, whether public or private, may not be able to support the demands placed on them and their performance or reliability may decline.

          Even if enterprise IP telecommunications systems become more widespread in the future, we cannot assure you that our products will attain broad market acceptance. We estimate that our sales represent a very small percentage of the total available market for enterprise IP telecommunications systems. We must increase our market penetration in order to maintain and expand our business.

 

 

 

Our sales cycle can be lengthy and unpredictable, which makes it difficult to forecast the amount of our sales and operating expenses in any particular period.

          The sales cycle for our products typically ranges from six to twelve months, or longer. Part of our strategy is to increasingly target our sales efforts on larger enterprises. Because the sales cycle for large enterprises is generally longer than for smaller enterprises, our sales cycle in the future may be even longer than it has been historically. As a result, we may have limited ability to forecast whether or in which period a sale will occur. The success of our product sales process is subject to many factors, some of which we have little or no control over, including:

 

 

 

 

the timing of enterprise customers’ budget cycles and approval processes;

 

 

 

 

a technical evaluation or trial by potential enterprise customers;

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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;

 

 

 

 

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 that prices of these components may increase. In addition, problems with respect to yield and quality of these components and timeliness of deliveries could occur. These delays could also materially and adversely affect our operating results.

 

 

 

If we fail to offer high quality customer support and services, our business would suffer.

          Once our telephone systems are deployed within our end customers’ sites, our customers depend on our support organization and/or our channel partners to resolve any issues relating to our products. A high level of customer support and services is important for the successful marketing and sale of our products. If we or our channel partners do not help our customers quickly resolve post-deployment issues and provide effective ongoing support, our ability to sell our products to existing customers would suffer and our reputation with potential customers would be harmed. Many of our channel partners offer primary support for the products they sell to customers. If the channel partners fail to provide timely and effective services, our business could be harmed. As we expand our sales, we will be required to hire and train additional support personnel. In addition, as we expand our operations internationally, our support organization will face additional challenges including those associated with delivering support, training and documentation in languages other than English. If we fail to maintain high quality customer support or to grow our support organization to match any future sales growth, our business will suffer.

 

 

 

If we fail to forecast demand for our products accurately, we may have excess or insufficient inventory, which may increase our operating costs, decrease our revenues and harm our business.

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          We generate forecasts of future demand for our products several months prior to the scheduled delivery to our prospective customers and typically prior to receiving a purchase order from our customers. We therefore make significant investments before our resellers or customers place orders to purchase our products and before we know if corresponding shipment forecasts will be changed. Our resellers and customers are not contractually bound by the forecasts they provide us until they sign a purchase order, and the orders we ultimately receive often differ from original forecasts. If we underestimate demand for our products, we will have inadequate inventory, which could result in delays in shipments, loss of orders and reduced revenues. This is exacerbated by the fact that lead times for materials and components that we need can vary significantly and depend on factors such as the specific supplier, contract terms and demand for each component at a given time. On the other hand, if we overestimate demand for our products and increase our inventory in anticipation of customer orders that do not materialize, we will have excess inventory and we will face a risk of significant inventory write-downs. Our failure to forecast demand accurately on a timely basis could result in a decrease in our revenues and gross margins.

 

 

 

If we fail to develop and introduce new products and features in a timely manner, or if we fail to manage product transitions, we could experience decreased revenue or decreased selling prices in the future.

          Our future growth depends on our ability to develop and introduce new products successfully. Due to the complexity of the type of products we produce, there are significant technical risks that may affect our ability to introduce new products and features successfully. For example, our future success will depend in part on our ability to introduce new applications such as contact center systems, which are based on complex software, and our ability to integrate our products with other business applications, such as Microsoft Office. As another example, we believe there is increasing demand for communications as a managed service, either on mobile phones or desk phones, whether ours or another vendors’.

          In addition, we must commit significant resources to developing new products and features before knowing whether our investments will result in products that are accepted by the market. The success of new products depends on many factors, including:

 

 

 

 

the ability of our products to compete with the products and solutions offered by our competitors;

 

 

 

 

the cost of our products;

 

 

 

 

the reliability of our products;

 

 

 

 

the timeliness of the introduction and delivery of our products; and

 

 

 

 

the market acceptance of our products.

          If we are unable to develop and introduce new products in a timely manner or in response to changing market conditions or enterprise customer requirements, or if these products do not achieve market acceptance, our operating results could be materially and adversely affected.

          Product introductions by us in future periods may also reduce demand for, or cause price declines with respect to, our existing products. As new or enhanced products are introduced, we must successfully manage the transition from older products, avoid excessive levels of older product inventories and ensure that sufficient supplies of new products can be delivered to meet enterprise customer demand. Our failure to do so could adversely affect our revenue, gross margins and other operating results.

 

 

 

Our products are highly complex and may contain undetected software or hardware errors, which could harm our reputation and future product sales.

          Because our enterprise customers rely on our products for telecommunications, an application that is critical to their business, any failure to provide high quality and reliable products, whether caused by our own failure or failures by our contract manufacturer or suppliers, could damage our reputation and reduce demand for our products. Our products have in the past contained, and may in the future contain, undetected errors or defects. Some errors in our products may only be discovered after a product has been installed and used by enterprise customers. Any errors or defects discovered in our products after commercial release could result in loss of revenue, loss of enterprise customers and increased service and warranty costs, any of which could adversely affect our business. In addition, we could face claims for product liability, tort or breach of warranty. Our purchase orders contain provisions relating to warranty disclaimers and liability limitations, which may not be upheld. Defending a lawsuit, regardless of its merit, is costly and may divert management’s attention and adversely affect the market’s perception of us and our products. In addition, if our business liability insurance coverage proves inadequate or future coverage is unavailable on acceptable terms or at all, our business, operating results and financial condition could be adversely affected.

- 17 -


 

 

 

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. 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. 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 of 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 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.

- 18 -


          Our failure to manage any of these risks successfully could harm our future international operations and our overall business.

 

 

 

We are subject to environmental and other health and safety regulations that may increase our costs of operations or limit our activities.

          We are subject to environmental and other health and safety regulations relating to matters such as reductions in the use of harmful substances, the use of lead-free soldering and the recycling of products and packaging materials. For example, the European Parliament and the Counsel of the European Union have published directives on waste electrical and electronic equipment and on the restriction of the use of certain hazardous substances in electrical and electronic equipment. These directives generally require electronics producers to bear the cost of collection, treatment, recovery and safe disposal of past and future products from end users and to ensure that new electrical and electronic equipment does not contain specified hazardous substances. While the cost of these directives to us cannot be determined before regulations are adopted in individual member states of the European Union, it may be substantial and may divert resources, which could detract from our ability to develop new products or operate our business, particularly if we increase international operations. We may not be able to comply in all cases with applicable environmental and other regulations, and if we do not, we may incur remediation costs or we may not be able to offer our products for sale in certain countries, which could adversely affect our results.

 

 

 

Some of our competitors could design their products to prevent or impair the interoperability of our products with enterprise customers’ networks, which could cause installations to be delayed or cancelled.

          Our products must interface with enterprise customer software, equipment and systems in their networks, each of which may have different specifications. To the extent our competitors supply network software, equipment or systems to our enterprise customers; it is possible these competitors could design their technologies to be closed or proprietary systems that are incompatible with our products or to work less effectively with our products than their own. As a result, enterprise customers would be incentivized to purchase products that are compatible with the products and technologies of our competitors over our products. A lack of interoperability may result in significant redesign costs and harm relations with our enterprise customers. If our products do not interoperate with our enterprise customers’ networks, installations could be delayed or orders for our products could be cancelled, which would result in losses of revenue and enterprise customers that could significantly harm our business.

 

 

 

Our products require reliable broadband connections, and we may be unable to sell our products in markets where broadband connections are not yet widely available.

          End users of our products must have reliable access to an enterprise customer’s wide area network in order for our products to perform properly. Accordingly, it is not likely that there will be demand for our products in geographic areas that do not have a sufficiently reliable infrastructure of broadband connections. Many geographic locations do not have reliable infrastructure for broadband connections, particularly in some international markets. Our future growth could be limited if broadband connections are not or do not become widely available in markets that we target.

 

 

 

If our enterprise customers experience inadequate performance with their wide area networks, even if unrelated to our systems, our product performance could be adversely affected, which could harm our relationships with current enterprise customers and make it more difficult to attract new enterprise customers.

          Our products depend on the reliable performance of the wide area networks of enterprise customers. If enterprise customers experience inadequate performance with their wide area networks, whether due to outages, component failures, or otherwise, our product performance would be adversely affected. As a result, when these types of problems occur with these networks, our enterprise customers may not be able to immediately identify the source of the problem, and may conclude that the problem is related to our products. This could harm our relationships with our current enterprise customers and make it more difficult to attract new enterprise customers, which could harm our business.

 

 

 

We might require additional capital to support our business in the future, and this capital might not be available on acceptable terms, or at all.

          Although we anticipate that our current cash, cash equivalents and short-term investments on hand will be sufficient to meet our currently anticipated cash needs, if our cash and cash equivalents balances are not sufficient to meet our future cash requirements, we will need to seek additional capital, potentially through debt or equity financings, to fund our operations. We may also need to raise additional capital to take advantage of new business or acquisition opportunities. We may seek to raise capital by, among other things:

 

 

 

 

issuing additional common stock or other equity securities;

 

 

 

 

issuing debt securities; or

 

 

 

 

borrowing funds under a credit facility.

- 19 -


          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, and the prices at which new investors would be willing to purchase our securities may be lower than the initial public offering price. The holders of new securities may also receive rights, preferences or privileges that are senior to those of existing holders of common stock. In addition, if we were to raise cash through a debt financing, such debt may impose conditions or restrictions on our operations, which could adversely affect our business. If new sources of financing are required but are insufficient or unavailable, we would be required to modify our operating plans to the extent of available funding, which would harm our ability to maintain or grow our business.

We are exposed to fluctuations in the market value of our money market funds and investments and financial pressure on investment institutions managing our investments may lead to restrictions on access to our investments which could harm our financial condition.

          We maintain an investment portfolio of various holdings and maturities. These securities are recorded on our consolidated balance sheets at fair value. This portfolio includes money market funds, bonds and commercial paper of various issuers. If the debt of these issuers is downgraded, the carrying value of these investments could be impaired. In addition, we could also face default risk from some of these issuers, which could also cause the carrying value to be impaired.

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 16 issued U.S. patents and a 41 patent applications pending in the U.S. and outside the U.S. We cannot assure you that any additional patents will be issued. Even if patents are issued, they may not adequately protect our intellectual property rights or our products against competitors, and third-parties may challenge the scope, validity and/or enforceability of our issued patents. In addition, other parties may independently develop similar or competing technologies designed around any patents that may be issued to us.

          In order to protect our intellectual property rights, we may be required to spend significant resources to monitor and protect such rights. We may not be able to detect infringement, and may lose our competitive position in the market before we are able to do so. In the event that we detect any infringement of our intellectual property rights, we intend to enforce such rights vigorously, and from time to time we may initiate claims against third parties that we believe are infringing on our intellectual property rights if we are unable to resolve matters satisfactorily through negotiation. Litigation brought to protect and enforce our intellectual property rights could be costly, time-consuming and distracting to management and could result in the impairment or loss of portions of our intellectual property. Furthermore, our efforts to enforce our intellectual property rights may be met with defenses, counterclaims and countersuits attacking the validity and enforceability of our intellectual property rights. Our failure to secure, protect and enforce our intellectual property rights could harm our brand and adversely impact our business, financial condition and results of operations.

If a third party asserts that we are infringing on its intellectual property, whether successful or not, it could subject us to costly and time-consuming litigation or expensive licenses, which could harm our business.

          There is considerable patent and other intellectual property development activity in our industry. Our success depends, in part, upon our not infringing upon the intellectual property rights of others. Our competitors, as well as a number of other 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

- 20 -


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 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. For example, as a result of an error in the computation of the forfeiture rate used in computing our stock-based compensation expense, we determined that we had a material weakness in our internal control over financial reporting as of June 30, 2009. We have remediated this material weakness as of June 30, 2010. We have incurred and we expect to continue to incur substantial accounting and auditing expense and expend significant management time in complying with the requirements of Section 404. If we are not able to comply with the requirements of Section 404 in a timely manner, or if we and our independent registered public accounting firm identify deficiencies in our internal control over financial reporting that are deemed to be material weaknesses, the market price of our stock could decline and we could be subject to investigations or sanctions by the SEC, The NASDAQ Stock Market, or NASDAQ, or other regulatory authorities or subject to litigation. To the extent any material weaknesses in our internal control over financial reporting are identified in the future, we could be required to expend significant management time and financial resources to correct such material weaknesses or to respond to any resulting regulatory investigations or proceedings.

Our principal offices and the facilities of our contract manufacturers are located near known earthquake fault zones, and the occurrence of an earthquake or other catastrophic disaster could damage our facilities or the facilities of our contract manufacturers, which could cause us to curtail our operations.

          Our principal offices, our disaster recovery site, and the facilities of one of our contract manufacturers are located in California near known earthquake fault zones and, therefore, are vulnerable to damage from earthquakes. We and our contract manufacturers are also vulnerable to damage from other types of disasters, such as power loss, fire, floods and similar events. If any disaster were to occur, our ability to operate our business could be seriously impaired. In addition, we may not have adequate insurance to cover our losses resulting from disasters or other similar significant business interruptions. Any significant losses that are not recoverable under our insurance policies could seriously impair our business and financial condition.

- 21 -


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.

          Our stock has been publicly traded for a relatively short period of time, having first begun trading in July 2007. During that time our stock price has fluctuated significantly, from a low of approximately $3 per share to a high of approximately $18 per share. At times the stock price has changed very quickly. For example, in January 2008, our stock price dropped from approximately $13 per share to approximately $6 per share, and as a result, we were named in the lawsuits described in Item 3. 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;

 

 

 

 

the loss of one or more key customers;

 

 

 

 

the loss of key personnel;

 

 

 

 

the development and sustainability of an active trading market for our common stock;

 

 

 

 

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 Market, have experienced extreme price and volume fluctuations that have affected and continue to affect the market prices of equity securities of many technology companies. Stock prices of many technology companies have fluctuated in a manner unrelated or disproportionate to the operating performance of those companies. In the past, stockholders have initiated securities class action litigation following declines in stock prices of technology companies. Our current litigation is, and any future litigation may, subject us to substantial costs, divert resources and the attention of management from our business, which could harm our business and operating results.

- 22 -


           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 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;

 

 

 

 

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 resellers, retain existing resellers, and their ability to generate revenues;

 

 

 

 

the amount and timing of operating costs related to the maintenance and expansion of our business operations and infrastructure;

 

 

 

 

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.

Future sales of outstanding shares of our common stock into the market in the future could cause the market price of our common stock to drop significantly, even if our business is doing well.

          Currently, more than 40% of our outstanding shares are held by venture capital investors. If these investors or any existing stockholders sell or distribute a large number of shares of our common stock or the public market perceives that these sales may occur, the market price of our common stock could decline. All of our outstanding shares are freely tradable without restriction or further registration under the federal securities laws, subject in some cases to the volume, manner of sale and other limitations under Rule 144. In addition, pursuant to our investor rights agreement, some of our early investors may require us to register their shares for public sale which could result in a substantial volume of shares being sold in a short period of time. Due to these factors, sales of a substantial number

- 23 -


of shares of our common stock in the public market could occur at any time. These sales, or the perception in the market that the holders of a large number of shares intend to sell shares, could reduce the market price of our common stock.

Our charter documents and Delaware law may inhibit a takeover that stockholders consider favorable and could also limit the market price of our stock.

          Our restated certificate of incorporation and bylaws and applicable provisions of Delaware law may make it more difficult for or prevent a third party from acquiring control of us without the approval of our board of directors. These provisions:

 

 

 

 

prohibit stockholder action by written consent, thereby requiring all stockholder actions to be taken at a meeting of our stockholders;

 

 

 

 

limit who may call a special meeting of stockholders;

 

 

 

 

established a classified board of directors, so that not all members of our board of directors may be elected at one time;

 

 

 

 

provide our board of directors with the ability to designate the terms of and issue a new series of preferred stock without stockholder approval;

 

 

 

 

require the approval of two-thirds of the shares entitled to vote at an election of directors to adopt, amend or repeal our bylaws or repeal certain provisions of our certificate of incorporation;

 

 

 

 

allow a majority of the authorized number of directors to adopt, amend or repeal our bylaws without stockholder approval;

 

 

 

 

do not permit cumulative voting in the election of our directors, which would otherwise permit less than a majority of stockholders to elect directors; and

 

 

 

 

set limitations on the removal of directors.

          In addition, Section 203 of the Delaware General Corporation Law generally limits our ability to engage in any business combination with certain persons who own 15% or more of our outstanding voting stock or any of our associates or affiliates who at any time in the past three years have owned 15% or more of our outstanding voting stock. These provisions may have the effect of entrenching our management team and may deprive you of the opportunity to sell your shares to potential acquirers at a premium over prevailing prices. This potential inability to obtain a control premium could reduce the price of our common stock.

 

 

ITEM 1B.

UNRESOLVED STAFF COMMENTS

          None.

 

 

ITEM 2.

PROPERTIES

          Our headquarters, which is located in Sunnyvale, California is a 63,781 square foot leased facility. This lease expires in September 2014. We also occupy leased facilities in Austin, Texas, and in Europe and Australia.

          We maintain a shipping and warehouse facility in Fremont, California for our inventory and we rent space as needed at third-party warehouses. Our inventory is expected to be kept at our facility and at the third party facilities.

          We believe that our current facilities are suitable and adequate to meet our current needs, and we intend to add new facilities or expand existing facilities as we add employees. We believe that suitable additional or substitute space will be available on commercially reasonable terms as needed to accommodate our operations.

 

 

ITEM 3.

LEGAL PROCEEDINGS

          Information with respect to this item may be found in Note 9 to the Consolidated Financial Statements in Item 8, is which is incorporated herein by reference.

 

 

ITEM 4.

RESERVED


I TEM 5.


MARKET FOR OUR COMMON STOCK AND RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

- 24 -


Market Information

          Our common stock has been traded on The NASDAQ Global Market under the symbol “SHOR” since July 3, 2007. Prior to then, 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 Market.

 

 

 

 

 

 

 

 

Year Ended June 30, 2010

 

High

 

Low

 

 

 


 


 

First Quarter

 

$

9.22

 

$

5.86

 

Second Quarter

 

 

8.14

 

 

5.06

 

Third Quarter

 

 

6.96

 

 

5.22

 

Fourth Quarter

 

 

6.79

 

 

4.47

 

 

 

 

 

 

 

 

 

Year Ended June 30, 2009

 

High

 

Low

 

 

 


 


 

First Quarter

 

$

6.50

 

$

3.87

 

Second Quarter

 

 

5.87

 

 

2.61

 

Third Quarter

 

 

5.18

 

 

3.63

 

Fourth Quarter

 

 

8.52

 

 

4.17

 

          In the past, technology stocks have experienced high levels of volatility. The trading price of our common stock may fluctuate substantially. These fluctuations could cause you to lose all or part of your investment in our common stock. Factors that could cause fluctuations in the trading price of our common stock include the following:

 

 

 

 

price and volume fluctuations in the overall stock market from time to time;

 

 

 

 

significant volatility in the market price and trading volume of technology companies;

 

 

 

 

actual or anticipated changes in our results of operations or fluctuations in our operating results;

 

 

 

 

actual or anticipated changes in the expectations of investors or securities analysts;

 

 

 

 

actual or anticipated developments in our competitors’ businesses or the competitive landscape generally;

 

 

 

 

litigation involving us, our industry or both;

 

 

 

 

regulatory developments in the United States, foreign countries or both;

 

 

 

 

economic conditions and trends in our industry;

 

 

 

 

major catastrophic events;

 

 

 

 

sales of large blocks of our stock;

 

 

 

 

stock buyback programs; or

 

 

 

 

departures of key personnel.

          In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation has often been brought against that company. If our stock price is volatile, we may become the target of securities litigation. Securities litigation could result in substantial costs and divert our management’s attention and resources from our business.

          On September 1, 2010, the last reported sales price of our common stock on the Nasdaq Global Market was $4.98 per share.

Holders of Record

          As of September 1, 2010, there were 151 stockholders of record of our common stock, although we believe there are approximately 2,000 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.

- 25 -


Sales of Unregistered Securities

          None.

Use of Proceeds from Public Offering of Common Stock

          The effective date of the registration statement for our initial public offering was July 2, 2007 (Registration No. 333-140630). As of June 30, 2010, the proceeds from our initial public offering were primarily invested in cash, cash equivalents and short term investments. None of the use of the proceeds was made, directly or indirectly, to our directors, officers, or persons owning 10% or more of our common stock.

- 26 -


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 National Market through June 30, 2010, 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.

(LINE GRAPH)

$100 invested on 7/3/08 in stock or index. Fiscal year ending June 30,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

7/3/2007

 

2008

 

2009

 

2010

 

 

 


 


 


 


 

 

 

 

 

 

 

 

 

 

 

ShoreTel, Inc.

 

100.00

 

 

36.38

 

 

65.84

 

 

38.19

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

S&P Small Cap 500 Index

 

100.00

 

 

83.94

 

 

61.94

 

 

70.87

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

NASDAQ Telecommunications Index

 

100.00

 

 

71.62

 

 

52.08

 

 

69.02

 

 


 

 


 

(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.

- 27 -


Equity Compensation Plan Information

          The following table summarizes information about our equity compensation plans as of June 30, 2010. All outstanding awards relate to our common stock.

 

 

 

 

 

 

 

 

 

 

 

Plan Category

 

Number of
Securities to
be Issued
upon
Exercise of
Outstanding
Options,
Warrants
and Rights
(a)

 

Weighted
Average
Exercise
Price of
Outstanding
Options,
Warrants
and Rights
(b)(2)

 

Number of
Securities
Remaining
Available for
Future
Issuances
under Equity
Compensation
Plans
(Excluding
Securities
Reflected in
Column (a))
(c)

 


 


 


 


 

Equity compensation plans approved by security holders(1)

 

 

8,303,000

 

$

4.14

 

 

5,152,000

 

Equity compensation plans not approved by security holders

 

 

 

 

 

 

 

 

 



 

 

 

 



 

Total

 

 

8,303,000

 

$

4.14

 

 

5,152,000

 

 

 



 

 

 

 



 


 

 

 

 


 

 

(1)

The number of securities remaining available for future issuance in column (c) includes 5,152,000 shares of common stock authorized and available for issuance under our 2007 Employee Stock Purchase Plan (“ESPP”) and our 2007 Equity Incentive Plan (the “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, 2010.

 

 

 

 

 

(2)

The weighted average exercise price does not reflect shares subject to restricted stock awards.

- 28 -


          P ART II.

 

 

I TEM 6.

SELECTED CONSOLIDATED FINANCIAL DATA

          The following selected 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,

 

 

 


 

 

 

 

 

 

 

2010

 

2009

 

2008

 

2007

 

2006

 

 

 


 


 


 


 


 

 

 

 

 

 

 

(In thousands, except per share amounts)

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Product

 

$

117,138

 

$

109,555

 

$

110,496

 

$

87,095

 

$

55,300

 

Support and services

 

 

31,326

 

 

25,267

 

 

18,233

 

 

10,732

 

 

6,308

 

 

 



 



 



 



 



 

Total revenue

 

 

148,464

 

 

134,822

 

 

128,729

 

 

97,827

 

 

61,608

 

Cost of revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Product(1)

 

 

40,471

 

 

38,149

 

 

37,466

 

 

29,753

 

 

21,855

 

Support and services(1)

 

 

11,580

 

 

11,048

 

 

10,036

 

 

6,847

 

 

5,425

 

 

 



 



 



 



 



 

Total cost of revenue

 

 

52,051

 

 

49,197

 

 

47,502

 

 

36,600

 

 

27,280

 

 

 



 



 



 



 



 

Gross profit

 

 

96,413

 

 

85,625

 

 

81,227

 

 

61,227

 

 

34,328

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Research and development(1)

 

 

33,596

 

 

30,724

 

 

26,811

 

 

17,260

 

 

9,720

 

Sales and marketing(1)

 

 

55,973

 

 

44,652

 

 

37,869

 

 

26,174

 

 

15,699

 

General and administrative(1)

 

 

19,888

 

 

19,596

 

 

17,645

 

 

11,674

 

 

4,936

 

Litigation settlement

 

 

 

 

4,110

 

 

 

 

 

 

 

 

 



 



 



 



 



 

Total operating expenses

 

 

109,457

 

 

99,082

 

 

82,325

 

 

55,108

 

 

30,355

 

 

 



 



 



 



 



 

Operating income (loss)

 

 

(13,044

)

 

(13,457

)

 

(1,098

)

 

6,119

 

 

3,973

 

Other income – net

 

 

84

 

 

1,141

 

 

4,101

 

 

273

 

 

248

 

 

 



 



 



 



 



 

Income (loss) before income tax benefit (provision)

 

 

(12,960

)

 

(12,316

)

 

3,003

 

 

6,392

 

 

4,221

 

Income tax benefit (provision)

 

 

156

 

 

(343

)

 

(861

)

 

(408

)

 

(219

)

 

 



 



 



 



 



 

Net income (loss)

 

 

(12,804

)

 

(12,659

)

 

2,142

 

 

5,984

 

 

4,002

 

Accretion of preferred stock

 

 

 

 

 

 

 

 

(50

)

 

(51

)

 

 



 



 



 



 



 

Net income (loss) available to common stockholders

 

$

(12,804

)

$

(12,659

)

$

2,142

 

$

5,934

 

$

3,951

 

 

 



 



 



 



 



 

Net income (loss) per common share available to common stockholders(2):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

(0.29

)

$

(0.29

)

$

0.05

 

$

0.69

 

$

0.60

 

 

 



 



 



 



 



 

Diluted

 

$

(0.29

)

$

(0.29

)

$

0.05

 

$

0.17

 

$

0.12

 

 

 



 



 



 



 



 

Shares used in computing net income (loss) per share available to common stockholders:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

44,804

 

 

43,714

 

 

42,413

 

 

8,565

 

 

6,609

 

Diluted

 

 

44,804

 

 

43,714

 

 

44,861

 

 

35,581

 

 

33,431

 


 

 

 


(1)

Includes stock-based compensation expense as follows:


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended June 30,

 

 

 


 

 

 

2010

 

2009

 

2008

 

2007

 

2006

 

 

 


 


 


 


 


 

 

 

 

 

 

 

(In thousands)

 

Cost of product revenue

 

$

139

 

$

113

 

$

74

 

$

14

 

$

 

Cost of support and services revenue

 

 

838

 

 

799

 

 

545

 

 

109

 

 

16

 

Research and development

 

 

3,064

 

 

2,829

 

 

2,005

 

 

420

 

 

14

 

Sales and marketing

 

 

3,400

 

 

3,468

 

 

2,447

 

 

581

 

 

7

 

General and administrative

 

 

3,213

 

 

2,549

 

 

2,360

 

 

1,659

 

 

45

 

 

 



 



 



 



 



 

Total stock-based compensation expense

 

$

10,654

 

$

9,758

 

$

7,431

 

$

2,783

 

$

82

 

 

 



 



 



 



 



 


 

 

(2)

See Note 5 to our consolidated financial statements for a description of the method used to compute basic and diluted net income (loss) per share available to common stockholders.

- 29 -


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of June 30,

 

 

 


 

 

 

2010

 

2009

 

2008

 

2007

 

2006

 

 

 


 


 


 


 


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(In thousands)

 

Consolidated balance sheet data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents and short-term investments

 

$

115,801

 

$

107,666

 

$

102,811

 

$

17,326

 

$

12,333

 

Working capital

 

 

112,836

 

 

111,617

 

 

111,993

 

 

23,018

 

 

16,208

 

Total assets

 

 

170,721

 

 

155,624

 

 

147,797

 

 

53,034

 

 

30,885

 

Redeemable convertible preferred stock

 

 

 

 

 

 

 

 

56,341

 

 

56,332

 

Total stockholders’ equity (deficit)

 

 

114,466

 

 

113,772

 

 

113,213

 

 

(31,829

)

 

(41,168

)


 

 

I TEM 7.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

          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, 2010 refers to the fiscal year ended June 30, 2010, 2009 refers to the fiscal year ended June 30, 2009, and 2008 refers to the fiscal year ended June 30, 2008.

Overview

          We are a leading provider of IP telecommunications solutions for enterprises. Our solution is comprised of our ShoreGear switches, ShorePhone IP phones and ShoreWare software applications. We were founded in September 1996 and shipped our first system in 1998. We have continued to develop and enhance our product line since that time. We currently offer a variety of models of our switches and IP phones.

          We sell our products primarily through channel partners that market and sell our systems to enterprises across all industries, including to small, medium and large companies and public institutions. We believe our channel strategy allows us to reach a larger number of prospective enterprise customers more effectively than if we were to sell directly. The number of our authorized channel partners has more than doubled since June 30, 2004 to over 800 as of June 30, 2010. Channel partners typically purchase our products directly from us. 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 generally perform installation and implementation services for the enterprises that use our systems. In most cases, 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.

          We outsource the manufacturing of our products to contract manufacturers. Our outsourced manufacturing model allows us to scale our business without the significant capital investment and on-going expenses required to establish and maintain a manufacturing operation. Our phone and switch products are manufactured by contract manufacturers located in California 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. We work closely with our contract manufacturers to manage the cost of components, since our total manufacturing costs are directly tied to component costs. We regularly provide forecasts to our contract manufacturers, and we order products from our contract manufacturers based on our projected sales levels well in advance of receiving actual orders from our enterprise customers. We seek to maintain

- 30 -


sufficient levels of finished goods inventory to meet our forecasted product sales with limited levels of inventory to compensate for unanticipated shifts in sales volume and product mix.

          Although we have historically sold our systems primarily to small and medium sized enterprises, we expanded our sales and marketing activities to increase our focus on larger enterprise customers. Accordingly, we have a major accounts program whereby our sales personnel assist our channel partners to sell to large enterprise accounts, and we coordinate with our channel partners to enable them to better serve large multi-site enterprises. To the extent we are successful in penetrating larger enterprise customers, we expect that the sales cycle for our products will increase, and that the demands on our sales and support infrastructure will also increase.

          We are headquartered in Sunnyvale, California and have a customer support, finance and engineering office in Austin, Texas. The majority of our personnel work at these two locations. Sales and support personnel are located throughout the United States and, to a lesser extent, in the United Kingdom, Germany, Belgium, Spain, Hong Kong, Singapore and Australia. Most of our enterprise customers are located in the United States. Revenue from international sales was approximately 10% of our total revenue for 2010 and approximately 7% for 2009 and 2008, respectively. Although we intend to focus on increasing international sales, we expect that sales to enterprise customers in the United States will continue to comprise the significant majority of our sales.

          We have experienced some growth despite the economic recession and contraction in the IT telephony market, with our total revenue growing to $148.5 million for 2010 from $134.8 million for 2009. This growth in revenue has been driven by increased revenue from both support and services and product revenue. Our operating expenses have increased significantly to $109.5 million for 2010 from $99.1 million for 2009. This increase in operating expenses is primarily a result of increases in compensation expenses related to growth in headcount, increases in advertising and promotion expense, facilities expenses, and research and development expenses. Compensation expense included increases in stock-based compensation and commissions. We increased headcount from 375 at June 30, 2009 to 479 at June 30, 2010, with the growth driven by the Company’s strategic investment plan focused on growing our sales channel, enhancing our product and increasing our branding activities. We expect to continue to add personnel primarily in our sales, engineering, and customer support areas.

Key Business Metrics

          We monitor a number of key metrics to help forecast growth, establish budgets, measure the effectiveness of sales and marketing efforts and measure operational effectiveness.

          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 buy additional products and support as their businesses expand. As our installed enterprise customer base has grown we have experienced an increase in orders attributable to existing enterprise customers, which currently represents a significant portion of our total revenue. For fiscal year 2010 order volume from existing enterprise customers represented approximately 56% of total order volume, while in fiscal year 2009 and 2008 it has been approximately 54% and 50%, respectively.

          Deferred revenue. Deferred revenue relates to the timing of revenue recognition for specific transactions based on service, support, specific commitments and other factors. Deferred revenue primarily consists of billings or payments received in advance of revenue recognition from our transactions described above and are recognized as the revenue recognition criteria are met. Nearly all system sales include the purchase of post-contractual support contracts with terms of up to five years, and our renewal rates on these contracts have been high historically. We recognize support revenue on a ratable basis over the term of the support contract. Since we receive payment for support in advance of our 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. Accordingly, the level of purchases of post-contractual support with our product sales is an important metric for us along with the renewal rates for these services. Our deferred revenue balance at June 30, 2010 was $28.7 million, of which $19.5 million is expected to be recognized within one year.

          Gross margin. Our gross margin for products is primarily affected by our ability to reduce hardware costs faster than the decline in average overall system prices. We strive to increase our product gross margin by reducing hardware costs through product redesign and volume discount pricing from our suppliers. In general, product gross margin on our switches is greater than product gross margin on our IP phones. As the prices and costs of our hardware components have decreased over time, our software components, which have lower costs than our hardware components, have represented a greater percentage of our overall margin on system sales. We consider our ability to monitor and manage these factors to be a key aspect of maintaining product gross margins and increasing our profitability.

          Gross margin for support and services is slightly lower than gross margin for products, and is impacted primarily by personnel costs and labor related expenses. The primary goal of our support and services function is to ensure a high level of

- 31 -


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 will be able to improve gross margin for support and services through economies of scale. However, the timing of additional investments in our support and services infrastructure could materially affect our cost of support and services revenue, both in absolute dollars and as a percentage of support and services revenue and total revenue, in any particular period.

          Operating expense management. Our operating expenses are comprised primarily of compensation and benefits for our employees and, therefore, the increase in operating expenses has been primarily related to increase in our headcount. We intend to expand our workforce to support our anticipated growth, and therefore our ability to forecast revenue is critical to managing our operating expenses.

Basis of Presentation

          Revenue. We derive our revenue from sales of our IP telecommunications systems and related support and services. Our typical system includes a combination of IP phones, switches and software applications. Channel partners buy our products directly from us. 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 79%, 81%, and 86% of our total revenue for 2010, 2009 and 2008, respectively.

          Support and services revenue primarily consists of post-contractual support, and to a lesser extent revenue from training services, professional services and installations that we perform. Post-contractual support includes software updates which grant rights to unspecified software license upgrades and maintenance releases issued during the support period. Post-contractual support also includes both Internet- and phone-based technical support. Post-contractual support revenue is recognized ratably over the contractual service period.

          Cost of revenue. Cost of product revenue consists primarily of hardware costs, royalties and license fees for third-party software included in our systems, salary and related overhead costs of operations personnel, freight, warranty costs and provision for excess inventory. The majority of these costs vary with the unit volumes of product sold. Cost of support and services revenue consists of salary and related overhead costs of personnel engaged in support and services.

          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 software development costs incurred from determination of technological feasibility through general release of the product to customers. Software development costs capitalized and shown under other assets was $0.7 million, $0.5 million and zero in fiscal 2010, 2009, and 2008, respectively.

          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, demo equipment, professional services fees and facilities expenses. We plan to continue to invest in development of our distribution channel by increasing the size of our field sales force and the number of our channel partners to enable us to expand into new geographies, including Europe and Asia Pacific, and further increase our sales to large enterprises. In conjunction with channel growth, we plan to increase the investment in our training and support of channel partners to enable them to more effectively sell our products. We also 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 relate to our executive, finance, human resources, legal and information technology organizations. Expenses primarily include personnel costs, professional fees for legal, accounting, tax, compliance and information systems, travel, recruiting expense, software amortization costs, depreciation expense and facilities expenses. In addition, as we expand our business, we expect to increase our general and administrative expenses.

          Other income (expense). Other income (expense) primarily consists of interest earned on cash and short-term investments, gains and losses on foreign currency transactions, and other miscellaneous income (expenses).

          Income tax benefit (provision). Income tax benefit (provision) includes federal, state and foreign tax on our income. From inception through 2005, we accumulated substantial net operating loss and tax credit carryforwards. We account for

- 32 -


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 carry-forwards 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.

We believe we have had multiple ownership changes, as defined under Section 382 of the Internal Revenue Code, due to significant stock transactions in previous years, which had limited the realization of our net operating losses and tax credit carryforwards under Section 382 of the Internal Revenue Code in future periods. During fiscal 2010, the Company received a favorable tax ruling from the Internal Revenue Service related to Section 382. As a result of the ruling, at least $25 million of net operating losses that were previously limited by Section 382 of the Internal Revenue Code are now available to the Company to offset future taxable income and to recapture previously paid taxes. The increase in the deferred tax assets associated with this ruling was offset by an increase in valuation allowance. As a result, in the fourth quarter of fiscal 2010, the Company filed an amended fiscal 2008 federal income tax return utilizing the available net operating losses to request a tax refund for approximately $1.7 million, which the Company has not received as of June 30, 2010.

SHORETEL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands, except per share amounts)

 

 

 

 

 

 

 

 

 

 

 

 

(Unaudited)

 

 

 

 

Year Ended
June 30,

 

 

 

 


 

 

 

 

 

 

 

 

 

 

 

 

 

2010

 

2009

 

 

 

 


 


 

 

 

 

 

 

 

 

 

 

Revenue:

 

 

 

 

 

 

 

Product

 

$

117,138

 

$

109,555

 

Support and services

 

 

31,326

 

 

25,267

 

 

 



 



 

Total revenues

 

 

148,464

 

 

134,822

 

Cost of revenue

 

 

 

 

 

 

 

Product (1)

 

 

40,471

 

 

38,149

 

Support and services (1)

 

 

11,580

 

 

11,048

 

 

 



 



 

Total cost of revenue

 

 

52,051

 

 

49,197

 

 

 



 



 

Gross profit

 

 

96,413

 

 

85,625

 

Gross profit %

 

 

64.9

%

 

63.5

%

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

Research and development (1,2)

 

 

33,596

 

 

30,724

 

Sales and marketing (1,2)

 

 

55,973

 

 

44,652

 

General and administrative (1,2)

 

 

19,888

 

 

19,596

 

Litigation Settlement

 

 

 

 

4,110

 

 

 



 



 

Total operating expenses

 

 

109,457

 

 

99,082

 

 

 



 



 

Loss from operations

 

 

(13,044

)

 

(13,457

)

Other income (expense), net

 

 

84

 

 

1,141

 

 

 



 



 

Loss before provision for income taxes

 

 

(12,960

)

 

(12,316

)

Benefit from (provision for) income taxes

 

 

156

 

 

(343

)

 

 



 



 

Net loss

 

$

(12,804

)

$

(12,659

)

 

 



 



 

Net loss per share available to common stockholders:

 

 

 

 

 

 

 

Basic

 

$

(0.29

)

$

(0.29

)

Diluted (3)

 

$

(0.29

)

$

(0.29

)

 

 

 

 

 

 

 

 

Shares used in computing net loss per share available to common stockholders:

 

 

 

 

 

 

 

Basic

 

 

44,804

 

 

43,714

 

Diluted (3)

 

 

44,804

 

 

43,714

 

 

 

 

 

 

 

 

 

 

(1)  

Includes stock-based compensation as follows:

 

 

 

 

 

 

 

 

Cost of product revenue

 

$

139

 

$

113

 

 

Cost of support and services revenue

 

 

838

 

 

799

 

 

Research and development

 

 

3,064

 

 

2,829

 

 

Sales and marketing

 

 

3,400

 

 

3,468

 

 

General and administrative

 

 

3,213

 

 

2,549

 

 

 

 



 



 

 

 

 

$

10,654

 

$

9,758

 

 

 

 



 



 

 

 

 

 

 

 

 

 

 

(2)  

Includes restructuring charge as follows:

 

 

 

 

 

 

 

 

Research and development

 

 

 

 

98

 

 

Sales and marketing

 

 

(27

)

 

235

 

 

General and administrative

 

 

 

 

83

 

 

 

 



 



 

 

 

 

$

(27

)

$

416

 

 

 

 



 



 

 

 

(3)  

Diluted net loss per share and share count reflect the weighted average number of common shares used in the basic net loss per share calculation. Potentially dilutive securities were not included in the compilation of diluted net loss per share for the periods which had a net loss because to do so would have been anti-dilutive.

- 33 -


Use of Non-GAAP Financial Measures

          We believe that evaluating the Company’s 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 we also disclose certain non-GAAP information because it is useful in understanding the Company’s performance as it excludes non-cash and other special charges or credits that many investors and management feel may obscure the Company’s true operating performance. Likewise, we use these non-GAAP financial measures to manage and assess the profitability of the business and determine a portion of our employee compensation. We do not consider stock-based compensation expenses and other special charges and related tax adjustments in managing the core operations. These measures are not based on any standardized methodology prescribed by GAAP and are not necessarily comparable to similar measures presented by other companies. Non-GAAP net loss is calculated by adjusting GAAP net loss for stock-based compensation expense, special charges and the related tax impact. Non-GAAP net loss per share per share is calculated by dividing Non-GAAP net loss by the weighted average number of 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 table below.

- 34 -


RECONCILIATION OF GAAP TO NON-GAAP FINANCIAL MEASURES
(Amounts in thousands, except per share amounts)
(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

Year Ended
June 30,

 

 

 


 

 

 

2010

 

2009

 

 

 


 


 

 

 

 

 

 

 

 

 

GAAP net loss available to stockholders:

 

$

(12,804

)

$

(12,659

)

 

 

 

 

 

 

 

 

 

Adjustments for non-GAAP items (1)

 

 

10,627

 

 

14,557

 

 

 

 

 

 

 

 

 

 

 

Tax effect of non-GAAP adjustments

 

 

(195

)

 

(675

)

 

 

 



 



 

 

 

 

 

 

 

 

 

 

Non-GAAP net income (loss) available to stockholders

 

$

(2,372

)

$

1,223

 

 

 



 



 

 

 

 

 

 

 

 

 

 

GAAP diluted net loss per share:

 

$

(0.29

)

$

(0.29

)

 

 

 

 

 

 

 

 

 

Adjustments for non-GAAP items

 

 

0.24

 

 

0.32

 

 

 

 

 

 

 

 

 

 

 

Tax effect of non-GAAP adjustments

 

 

0.00

 

 

0.00

 

 

 

 



 



 

 

 

 

 

 

 

 

 

 

Non-GAAP diluted net income (loss) per share:

 

$

(0.05

)

$

0.03

 

 

 



 



 

 

 

 

 

 

 

 

 

 

Shares Used in Non-GAAP diluted per share calculation

 

 

44,804

 

 

44,994

 

 

 

 

 

 

 

 

 

 


 

 

 

 

 

 

 

(1)

Adjustments for non-GAAP items include:

 

 

 

 

 

 

 

 

Stock-based compensation

 

$

10,654

 

$

9,758

 

 

 

 

 

 

 

 

 

 

 

Litigation settlement

 

 

 

 

4,110

 

 

 

 

 

 

 

 

 

 

 

Restructuring charge (benefit)

 

 

(27

)

 

416

 

 

 

 

 

 

 

 

 

 

 

Cancellation of contractual obligation included in sales and marketing

 

 

 

 

273

 

 

 

 



 



 

 

 

 

 

 

 

 

 

 

 

Adjustments for non-GAAP items

 

$

10,627

 

$

14,557

 

 

 

 



 



 


           Results of Operations

          The following table sets forth selected consolidated statements of operations data as a percentage of total revenue for each of the periods indicated.

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended June 30,

 

 

 


 

 

 

2010

 

2009

 

2008

 

 

 


 


 


 

Revenue:

 

 

 

 

 

 

 

 

 

 

Product

 

 

79

%

 

81

%

 

86

%

Support and services

 

 

21

%

 

19

%

 

14

%

 

 



 



 



 

Total revenue

 

 

100

%

 

100

%

 

100

%

Cost of revenue:

 

 

 

 

 

 

 

 

 

 

Product

 

 

27

%

 

28

%

 

29

%

Support and services

 

 

8

%

 

8

%

 

8

%

 

 



 



 



 

Total cost of revenue

 

 

35

%

 

36

%

 

37

%

 

 



 



 



 

Gross profit

 

 

65

%

 

64

%

 

63

%

Operating expenses:

 

 

 

 

 

 

 

 

 

 

Research and development

 

 

23

%

 

23

%

 

21

%

Sales and marketing

 

 

38

%

 

33

%

 

29

%

General and administrative

 

 

13

%

 

14

%

 

13

%

Litigation settlement

 

 

 

 

3

%

 

 

 

 



 



 



 

Total operating expenses

 

 

74

%

 

73

%

 

63

%

 

 



 



 



 

Operating income (loss)

 

 

(9

)%

 

(9

)%

 

 

Other income, net

 

 

 

 

1

%

 

3

%

 

 



 



 



 

Income (loss) before benefit from (provision for) income tax

 

 

(9

)%

 

(8

)%

 

3

%

Income tax benefit (provision)

 

 

 

 

(1

)%

 

(1

)%

 

 



 



 



 

Net income (loss)

 

 

(9

)%

 

(9

)%

 

2

%

 

 



 



 



 

- 35 -


Fiscal 2010 compared to Fiscal 2009

           Revenue.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year ended

 

Change

 

 

 


 


 

 

 

June 30,
2010

 

June 30,
2009

 

$

 

%

 

 

 


 


 


 


 

 

 

(in thousands, except percentages)

 

Revenue

 

$

148,464

 

$

134,822

 

$

13,642

 

 

10

%

          The increase was due to increases in both product revenue and support and services revenue. Product revenue was $117.1 million in 2010, an increase of $7.5 million or 7%, from $109.6 million in 2009, as a result of higher sales volumes of $12.5 million primarily from our U.S. telecom carrier resellers, partially offset by a slight decline in average selling prices of approximately $5 million. Support and services revenue was $31.3 million in 2010, an increase of $6.0 million, or 24%, from $25.3 million in 2009, as a result of a $4.5 million increase in revenue associated with post-contractual support contracts, an increase of $0.5 million in professional services, $0.3 million increase in installations revenue and a $0.7 million increase in training revenue.

          Gross margin.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year ended

 

Change

 

 

 


 


 

 

 

June 30,
2010

 

June 30,
2009

 

$

 

%

 

 

 


 


 


 


 

 

 

(in thousands, except percentages)

 

Cost of revenue

 

$

52,051

 

$

49,197

 

$

2,854

 

 

6

%

Gross profit

 

$

96,413

 

$

85,625

 

$

10,788

 

 

13

%

Gross margin

 

 

65

%

 

64

%

 

n/a

 

 

1

%

          The increase in gross margin was attributable to an increase in support and services gross margin from 56% in 2009 to 63% in 2010. The product gross margin remained unchanged at 65% in 2009 and 2010. Support and services gross margin increased due to support and services revenue increasing by 24% and service costs only increasing by 5%, compared to the same period in 2009. The service costs increase was limited to 5% as we deployed employee resources to a lower cost region outside of our California headquarters office. The increase in the gross profit for support and services was primarily due to the ability to support a larger customer base with similar number of employees in 2010.

           Operating expenses.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year ended

 

Change

 

 

 


 


 

 

 

June 30,
2010

 

June 30,
2009

 

$

 

%

 

 

 


 


 


 


 

 

 

(in thousands, except percentages)

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

Research and development

 

$

33,596

 

$

30,724

 

$

2,872

 

 

9

%

Sales and marketing

 

$

55,973

 

$

44,652

 

$

11,321

 

 

25

%

General and administrative

 

$

19,888

 

$

19,596

 

$

292

 

 

1

%

Litigation settlement

 

$

 

$

4,110

 

$

(4,110

)

 

(100

)%

           Research and development . These expenses represented 23% of total revenue in both 2010 and 2009. Compensation, including stock-based compensation, for research and development employees accounted for $2.3 million of the increase, primarily as a result of increased headcount during the year. The increase in research and development expenses also

- 36 -


included $0.8 million in consulting and outside services, $0.2 million in incentive compensation expense and $0.1 million each in legal expenses associated with trademark and patent costs.. These increases were primarily offset by a decrease of $0.4 million in non-recurring engineering expenses and decrease of $0.1 million in issued equipment expenses related to usage in beta programs.

           Sales and marketing. These expenses represented 38% and 33% of total revenue in 2010 and 2009, respectively. The increase in sales and marketing expense included increases of $3.8 million in advertising and promotional expenses, $2.7 million in labor costs due to growth in headcount, and $2.6 million in commissions. Additional increase in sales and marketing expenses included increases of $1.0 million in consulting expenses, $0.9 million in travel expenses. The increase in headcount from 128 in 2009 to 158 in 2010 was to augment the sales force with the objective to generate future revenues.

           General and administrative . These expenses represented 13% and 14% of total revenue in 2010 and 2009, respectively. Compensation for general and administrative employees, including stock-based compensation, accounted for $1.7 million of the increase. Additional increases in general and administrative expenses included $1.1 million in consulting/outside services, $0.2 million in travel expense. These increases were partially offset by a decrease of $1.3 million in legal expenses due to the resolution of the litigation with Mitel, $1.1 million in bad debt expense and $0.4 million in restructuring expense.

           Litigation Settlement. We recorded a charge of $4.1 million as a result of the agreement to settle our litigation with Mitel in April 2009. There was no such charge in fiscal 2010.

           Other income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year ended

 

Change

 

 

 


 


 

 

 

June 30,
2010

 

June 30,
2009

 

$

 

%

 

 

 


 


 


 


 

 

 

(in thousands, except percentages)

 

Other Income, net

 

$

84

 

$

1,141

 

$

(1,057

)

 

(93

)%

           Other income. Other income primarily consists of interest earned on our cash and cash equivalents and short-term investments and foreign currency translation gains and losses. The decrease in other income is primarily attributable to significantly reduced interest rates earned on relatively stable cash and investment balances.

           Income tax provision (benefit).

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year ended

 

Change

 

 

 


 


 

 

 

June 30,
2010

 

June 30,
2009

 

$

 

%

 

 

 


 


 


 


 

 

 

(in thousands, except percentages)

 

Income tax provision (benefit)

 

$

(156

)

$

343

 

$

(499

)

 

(145

)%

Income tax provision (benefit). The income tax benefit was $(0.2) million in 2010 compared to an income tax provision of approximately $0.3 million in 2009. The $(0.2) million income tax benefit primarily relates to estimated benefit related to carrying back the FY10 losses to FY06-FY08 to claim a tax refund of approximately $0.4 million offset by $0.2 million foreign and minimum state taxes. In 2009, we incurred a loss before provision for income tax; however, due to differences related to book vs. tax, we generated taxable income in 2009. Accordingly, we recorded an income tax benefit in 2010 and an income tax expense in 2009.

          Fiscal 2009 compared to Fiscal 2008

       Revenue.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year ended

 

 

 

 

 


 

Change

 

 

 

June 30,

 

June 30,

 


 

 

 

2009

 

2008

 

$

 

%

 

 

 


 


 


 


 

 

 

(in thousands, except percentages)

 

Revenue

 

$

134,822

 

$

128,729

 

$

6,093

 

 

5

%

- 37 -


          The increase was primarily attributable to increased support and services revenue. Support and services revenue was $25.3 million in 2009, an increase of $7.1 million, or 39%, from $18.2 million in 2008, as a result of a $5.5 million increase in revenue associated with post-contractual support contracts accompanying new system sales, post-contractual support contract renewals, a $0.7 million increase in installations revenue and a $0.6 million increase in training services revenue. Product revenue declined marginally to $109.6 million in 2009 from $110.5 million in 2008 due to a decrease in revenue from ShoreGear switches, IP phones and software licenses, all of which had slight decline in average selling prices, partially offset by higher volumes. The average selling price decline was primarily driven by increased discounting due to the world wide economic recession that reduced the level of IT capital spending at enterprises and specifically impacted the IP Telephony market which has declined significantly in the last year.

           Gross margin.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year ended

 

 

 

 

 


 

Change

 

 

 

June 30,

 

June 30,

 


 

 

 

2009

 

2008

 

$

 

%

 

 

 


 


 


 


 

 

 

(in thousands, except percentages)

 

Cost of revenue

 

$

49,197

 

$

47,502

 

$

1,695

 

 

4

%

Gross profit

 

$

85,625

 

$

81,227

 

$

4,398

 

 

5

%

Gross margin

 

 

63.5

%

 

63.1

%

 

n/a

 

 

1

%

          The increase in gross margin was attributable to an increase in support and services gross margin from 45% in 2008 to 56% in 2009. This increase was partially offset by a decline in product gross margin from 66% in 2008 to 65% in 2009 due to a decline in average selling price of our ShoreGear Switches of 10% and a decline in our IP Phones of 2%. Support and services gross margin increased due to support and services revenue increasing by 39% and service costs only increasing by 10%, compared to the same period in 2008. The service costs increase was limited to 10% as the Company deployed employee resources to a lower cost region outside of our California headquarters office. Compensation for support and services employees, the largest category of support and service costs, increased 16% in 2009, primarily due to an increase in stock-based compensation and an increase in headcount from 52 employees at June 30, 2008 to 55 employees at June 30, 2009.

           Operating expenses.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year ended

 

 

 

 

 


 

Change

 

 

 

June 30,

 

June 30,

 


 

 

 

2009

 

2008

 

$

 

%

 

 

 


 


 


 


 

 

 

(in thousands, except percentages)

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

Research and development

 

$

30,724

 

$

26,811

 

$

3,913

 

 

15

%

Sales and marketing

 

$

44,652

 

$

37,869

 

$

6,783

 

 

18

%

General and administrative

 

$

19,596

 

$

17,645

 

$

1,951

 

 

11

%

Litigation settlement

 

$

4,110

 

$

 

$

4,110

 

 

n/a

 

           Research and development . These expenses represented 23% and 21% of total revenue in 2009 and 2008, respectively. Compensation, including stock-based compensation, for research and development employees accounted for $4.1 million of the increase, primarily as a result of increased headcount during the year. The increase in research and development expenses also included $0.2 million each in legal expenses associated with trademark and patent costs and in depreciation, $0.5 million in facilities, $0.3 million corporate bonus and $0.1 million each in travel and software expenses. These increases were primarily offset by a decrease of $1.1 million in non-recurring engineering expenses, and decreases of $0.3 million each in issued equipment expenses related to usage in beta programs and in consulting and professional services.

           Sales and marketing. These expenses represented 33% and 29% of total revenue in 2009 and 2008, respectively. Compensation, including stock-based compensation for sales and marketing employees represented $4.9 million of the increase. The increase in sales and marketing compensation included increases of $1.0 million in stock-based compensation, $1.5 million in commissions and $2.4 million due to increased headcount during the year. Additional increase in sales and

- 38 -


marketing expenses included increases of $0.2 million each in restructuring expenses, consulting expenses, facilities expenses, and in travel expenses, and $1.1 million in promotional expenses.

           General and administrative . These expenses represented 14% and 13% of total revenue in 2009 and 2008, respectively. Compensation for general and administrative employees, including stock-based compensation, accounted for $0.6 million of the increase. Additional increases in general and administrative expenses included $0.8 million in the provision for doubtful accounts, $0.1 million each in depreciation expense, employee relations expenses, equipment expenses and restructuring expenses, $0.3 million in sales tax expense and $0.2 million each in telecom and in legal expenses. These increases were partially offset by a decrease of $0.3 million in facilities expenses and $0.2 million in corporate bonus expense.

           Litigation Settlement. We recorded a charge of $4.1 million as a result of the agreement to settle our litigation with Mitel in April 2009.

           Other income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year ended

 

 

 

 

 


 

Change

 

 

 

June 30,

 

June 30,

 


 

 

 

2009

 

2008

 

$

 

%

 

 

 


 


 


 


 

 

 

(in thousands, except percentages)

 

Other Income, net

 

$

1,141

 

$

4,101

 

$

(2,960

)

 

(72

)%

          Other income. Other income is primarily composed of interest earned on our cash and cash equivalents and short-term investments and foreign currency translation gains and losses. The decrease in other income is primarily attributable to reduced interest rates earned on relatively stable cash and investment balances. Interest income decreased $2.8 million, or 66%, from 2008 to 2009 due to substantially lower interest rates. In addition, foreign currency translation losses increased $0.2 million in 2009 compared to 2008.

           Income tax provision.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year ended

 

 

 

 

 


 

Change

 

 

 

June 30,

 

June 30,

 


 

 

 

2009

 

2008

 

$

 

%

 

 

 


 


 


 


 

 

 

(in thousands, except percentages)

 

Tax provision

 

$

343

 

$

861

 

$

(518

)

 

(60

)%

           Income tax provision. The income tax provision was $0.3 million in 2009, a decrease of $0.6 million, from approximately $0.9 million in 2008. We incurred a loss before provision for income tax in 2009; however, due to differences related to book vs. tax, we generated taxable income in 2009 and accordingly, we recorded an income tax provision in 2009. We were profitable in 2008 and had an effective tax rate of approximately 28.7% as a result of utilizing portions of the deferred tax asset and reducing the related valuation allowance.

Liquidity and Capital Resources

           Cash and Cash Equivalents and Investments.

 

 

 

 

 

 

 

 

 

 

 

The following table summarizes our cash and cash equivalents and short-term investments (in thousands):

 

 

 

Year ended June 30,

 

 

 


 

 

 

2010

 

2009

 

2008

 

 

 






 

Cash and cash equivalents

 

$

68,426

 

$

73,819

 

$

68,672

 

Short-term investments

 

 

47,375

 

 

33,847

 

 

34,139

 

 

 



 



 



 

Total

 

$

115,801

 

$

107,666

 

$

102,811

 

 

 



 



 



 

                As of June 30, 2010, our principal sources of liquidity consisted of cash and cash equivalents and short-term investments of $115.8 million and net accounts receivable of $24.6 million.

- 39 -


          Our principal uses of cash historically have consisted of the purchase of finished goods inventory from our contract manufacturers, payroll and other operating expenses related to the development of new products and purchases of property and equipment.

          We believe that our $115.8 million of cash and cash equivalents and short-term investments at June 30, 2010, together with cash flows from our operations will be sufficient to fund our operating requirements for at least the next 12 months. Our future capital requirements will depend on many factors, including our rate of revenue growth, the expansion of our sales and marketing activities, the timing and extent of our expansion into new territories, the timing of introductions of new products and enhancements to existing products, the continuing market acceptance of our products and acquisition activities. We may enter into agreements relating to potential investments in, or acquisitions of, complementary businesses or technologies in the future, which could also require us to seek additional equity or debt financing. Additional funds may not be available on terms favorable to us or at all.

          The following table shows our cash flows from operating activities, investing activities and financing activities for the stated periods:

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended June 30,

 

 

 


 

 

 

2010

 

2009

 

2008

 

 

 


 


 


 

 

 

(In thousands)

 

Cash provided by operating activities

 

$

11,181

 

$

7,447

 

$

8,153

 

Cash used in investing activities

 

$

(19,743

)

$

(5,494

)

$

(36,519

)

Cash provided by financing activities

 

$

3,169

 

$

3,194

 

$

79,712

 

     Cash flows from operating activities

          Our cash flows from operating activities are significantly influenced by our cash expenditures to support the growth of our business in areas such as research and development, sales and marketing and administration. Our operating cash flows are also influenced by our working capital needs to support growth and fluctuations in inventory, accounts receivable, vendor accounts payable and other assets and liabilities. We procure finished goods inventory from our contract manufacturers and typically pay them in 30 days. We extend credit to our channel partners and typically collect in 30 to 60 days, although these time periods can vary and can be longer. In some cases we prepay for license rights to third-party products in advance of sales.

          Cash provided by operating activities is generated by net income (loss) adjusted for certain non-cash items and changes in assets and liabilities. Cash provided by operating activities was $11.2 million for 2010 as compared to cash provided by operations of $7.4 million for 2009 and $8.2 million for 2008. The increase in cash provided by operations in fiscal year 2010 compared to fiscal year 2009 resulted primarily from the period-to-period change in cash flows relating to operating activities. Deferred revenue increased by $6.2 million, primarily due to the deferral of revenue from sales of post contractual support contracts exceeding the revenue recognized from post contractual support contracts, increases in accrued liabilities and other of $5.1 million and in accrued employee compensation of $3.4 million, decreases in inventories of $1.9 million and other assets of $1.2 million. These sources of cash were partially offset by uses of cash associated with an increase in accounts receivable of $3.1 million due to increased sales in 2010 compared to 2009 and increase in prepaid and other current assets of $4.0 million. Further, noncash adjustments were higher in 2010 compared to 2009 by $0.9 million.

          Net cash provided by operating activities in 2009 partly consisted of net loss of $12.7 million. Noncash adjustments were higher in 2009 compared to 2008, including stock-based compensation expense, which was higher in 2009 by $2.3 million. Noncash adjustments included $9.8 million in stock-based compensation, $1.1 million in provision for doubtful accounts, $0.2 million loss on disposal of property and equipment and $2.0 million in depreciation expense. These were partially offset by $0.2 million in excess tax benefits from stock options exercised. In addition, the period-to-period change in cash flows relating to operating activities is composed of increases in deferred revenue of $3.8 million, primarily due to the deferral of revenue from sales of post contractual support contracts exceeding the revenue recognized from post contractual support contracts, and increases in accrued liabilities and other of $2.3 million and in accounts payable of $1.8 million, decreases in prepaid expenses and other current assets of $0.5 million, and inventory of $0.2 million. These sources of cash were partially offset by uses of cash associated with an increase in accounts receivable of $0.6 million due to increased sales in 2009 compared to 2008.

          Net cash provided by operating activities in 2008 partly consisted of net income of $2.1 million. Noncash adjustments were higher in 2008 compared to 2007, including stock-based compensation expense, which was higher in 2008 by $4.6 million. This was partially offset by a higher deferred tax benefit of $1.7 million in 2008. In addition, the period-to-period change in cash flows relating to operating activities was also affected by an increase in deferred revenue of $4.7 million, primarily due to the deferral of revenue from sales of post contractual support contracts exceeding the revenue

- 40 -


recognized from post contractual support contracts, and an increase in accrued liabilities and other of $2.3 million, accrued employee compensation of $1.8 million, primarily attributable to increased headcount. These sources of cash were partially offset by uses of cash associated with an increase in accounts receivable of $2.7 million due to increased sales in 2008 compared to 2007, an increase in inventories of $5.0 million primarily due to business growth and an increase in other assets of $1.9 million.

     Cash flows from investing activities

          We have classified our investment portfolio as available for sale and our investments are made with a policy of capital preservation and liquidity as the primary objectives. We may hold investments to maturity; however, we may sell an investment at any time if the quality rating of the investment declines, the yield on the investment is no longer attractive or we are in need of cash. Because we invest only in investment securities that are highly liquid with a ready market, we believe that the purchase, maturity or sale of our investments has no material impact to our overall liquidity.

          Net cash used in investing activities was $19.7 million, $5.5 million, and $36.5 million in 2010, 2009 and 2008, respectively. Net cash used in investing activities in 2010 was primarily related to investments made in U.S. government sponsored securities and corporate bonds and commercial paper of $23.8 million, partially offset by the net amount of sales and maturities of $10.1 million. Also, $1.4 million was used to purchase technology licenses and patents and $4.7 million was used to purchase property and equipment. Net cash used in investing activities in 2009 was primarily related to $4.1 million used to purchase technology licenses and patents and $1.8 million used to purchase property and equipment. This was partially offset by sale/maturities of investments made in U.S. government sponsored securities and corporate bonds and commercial paper. Net cash used in investing activities in 2008 was primarily related to investments made in U.S. government sponsored securities and corporate bonds and commercial paper. Our requirements for additional capital expenditures are subject to change depending upon several factors, including our needs based on our changing business and industry and market conditions.

     Cash flows from financing activities

          Net cash provided by financing activities was $3.2 million, $3.2 million and $79.7 million, in 2010, 2009 and 2008, respectively. In 2010, we generated proceeds of $3.0 million from the sale of employee stock purchase plan shares and the exercise of common stock options and $0.2 million from tax benefit of stock options exercised. In 2009, we generated proceeds of $3.0 million from the sale of employee stock purchase plan shares and the exercise of common stock options and $0.2 million from tax benefit of stock options exercised. In 2008, we generated proceeds of $78.6 million from our initial public offering including payment of other offering costs, $0.8 million from exercise of common stock options and received tax benefit of stock options exercised of $0.3 million.

Contractual Obligations

          The following is a summary of our contractual obligations as of June 30, 2010:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Payments Due by Period

 

 

 


 

 

 

Total

 

Less Than
1 Year

 

1-3 Years

 

3-5 Years

 

Thereafter

 

 

 

(In thousands)

 

Operating lease obligations

 

$

6,262

 

$

1,926

 

$

2,944

 

$

1,392

 

$

 

Non-cancellable purchase commitments for finished goods

 

 

20,106

 

 

20,106

 

 

 

 

 

 

 

Software license commitments

 

 

2,750

 

 

1,250

 

 

1,500

 

 

 

 

 

 

 



 



 



 



 



 

Total

 

$

29,118

 

$

23,282

 

$

4,444

 

$

1,392

 

$

 

 

 



 



 



 



 



 

Off-Balance Sheet Arrangements

          We do not have any material off-balance sheet arrangements (Other than those disclosed above within Contractual Obligations) nor do we have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which are established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

Critical Accounting Policies and Estimates

          Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America, or GAAP. These accounting principles require us to make certain estimates and judgments that can affect the reported amounts of assets and liabilities as of the dates of the consolidated financial statements, the disclosure

- 41 -


of contingencies as of the dates of the consolidated financial statements, and the reported amounts of revenue and expenses during the periods presented. Although we believe that our judgments and estimates are reasonable under the circumstances, actual results may differ from those estimates.

          We believe the following to be our critical accounting policies because they are important to the portrayal of our financial condition and results of operations and they require critical management judgments and estimates about matters that are uncertain:

 

 

 

 

Revenue recognition;

 

 

 

 

Allowance for doubtful accounts;

 

 

 

 

Stock-based compensation;

 

 

 

 

Inventory valuation; and

 

 

 

 

Accounting for income taxes.

          If actual results or events differ materially from those contemplated by us in making these estimates, our reported financial condition and results of operations for future periods could be materially affected. See Risk Factors” for certain matters that may affect our future financial condition or results of operations.

          Revenue Recognition

          Product Revenue . Our software is integrated with our hardware and is essential to the functionality of the integrated system product. Product sales typically include a perpetual license to our software, except in limited circumstances such as sales of spare or replacement handsets, back-up switches and additional business applications. We recognize revenue, depending on whether the hardware is sold in a multiple-element arrangement with software and post-contractual support or on a standalone basis if the enterprise customer purchases hardware, software, or maintenance support separately. For the initial sale, we generally bundle together the hardware, software, and post-contractual support contracts with terms of up to five years. Thereafter, if the enterprise customer increases the number of end user deployments and/or functionality, it may add more hardware, software, and related post-contractual support by purchasing them separately. We evaluate existence of vendor-specific objective evidence, or VSOE, of fair value for post-contractual support and, installation and services and training, as noted below.

          We recognize product revenue when persuasive evidence of an arrangement exists, product has shipped or delivery has occurred (depending on when title passes), the sales price is fixed or determinable and free of contingencies and significant uncertainties, and collection is probable. Our fee is considered fixed or determinable at the execution of an agreement, based on specific products and quantities to be delivered at specified prices. Our agreements generally do not include rights of return or acceptance provisions. To the extent that our agreements contain acceptance terms, we recognize revenue upon product acceptance, unless the acceptance provision is deemed to be perfunctory. We maintain a reserve for sales returns based on historical experience. Payment terms generally range from net 30 to net 60 days. In the event payment terms are extended materially from our standard business practices, the fees are deemed to not be fixed or determinable and revenue is recognized when the payments become due. We assess the ability to collect from channel partners based on a number of factors, including creditworthiness and past transaction history. If the channel partner is not deemed creditworthy, we defer all revenue from the arrangement until payment is received and all other revenue recognition criteria have been met. Shipping charges are included in product revenue and the related shipping costs are included in cost of product revenue.

          We monitor and analyze the accuracy of sales returns estimates by reviewing actual returns and adjust it for future expectations to determine the adequacy of our current and future reserve needs. If actual future returns and allowances differ from past experience and expectation, additional allowances may be required.

          We have arrangements with channel partners to reimburse the channel partners for cooperative marketing costs meeting specified criteria. The reimbursements are limited to 50% of the actual costs charged to the channel partners by third-party vendors for advertising, trade shows and other related sales and marketing activities for which we receive an identifiable benefit, subject to a limit of the total cooperative marketing allowance earned by each channel partner. Moreover, we record the reimbursements to the channel partners meeting such specified criteria within sales and marketing expenses in the accompanying consolidated statements of operations.

          Post-Contractual Support. Our support and services revenue is primarily derived from post-contractual support. We account for post-contractual support revenue based on VSOE of fair value, regardless of any separate prices stated within the contract for each element. VSOE of fair value is limited to the price charged when the same element is sold separately. VSOE of fair value is established for support through prior renewals of post-contractual support contracts, which establishes a price which is based on a standalone sale. To determine the fair value of the price charged, we analyze both the selling prices when

- 42 -


elements are sold separately as well as the concentrations of those prices. We believe those concentrations have been sufficient to enable us to establish VSOE of fair value for the post-contract support revenues.

          We currently use the residual method to determine the amount of product revenue to be recognized. Under the residual method, the fair value of the undelivered elements, such as post-contractual support, installation services and training, are deferred and the remaining portion of the sales amount is recognized as product revenue. The fair value of the post-contractual support is recognized as support and services revenue on a straight-line basis over the term of the related support period, which can be up to five years in length.

          Installation and training. Installation services are sold on an elective basis. Channel partners or enterprise customers generally perform installations without our involvement, so we do not recognize substantial revenue from installation services. As installation is typically performed by the channel partner or enterprise customer, it is not considered essential to the functionality of the delivered elements. Installation is generally priced at established rates based on estimated hours to install our systems. Training services are also sold on an elective basis, both to channel partners and to enterprise customers, and is purchased both with system orders and on a standalone basis. VSOE of fair value has been established for training. We recognize revenue related to installation services and training upon delivery of the service. If VSOE of fair value does not exist for installation, training or commitments to provide specified upgrades, services or additional products to customers in the future, as has been the case from time to time in the past, we defer all revenue from the arrangement until the earlier of the point at which VSOE of fair value does exist or all such elements from the arrangement have been delivered.

     Allowance for Doubtful Accounts

          We review our allowance for doubtful accounts on a quarterly basis by assessing individual accounts receivable that materially exceed due dates. Risk assessment for these accounts includes historical collections experience with the specific account and with our similarly situated accounts coupled with other related credit factors that may evidence a risk of default and loss to us. Accordingly, the amount of this allowance will fluctuate based upon changes in revenue levels, collection of specific balances in accounts receivable and estimated changes in channel partner credit quality or likelihood of collection. If the financial condition of our channel partners were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. The allowance for doubtful accounts represents management’s best estimate, but changes in circumstances, including unforeseen declines in market conditions and collection rates, may result in additional allowances in the future or reductions in allowances due to future recoveries.

     Stock-Based Compensation

          Stock-Based Compensation — The Company amortizes stock-based compensation expense based upon the fair value of stock-based awards on a straight-line basis over the requisite vesting period as defined in the applicable plan documents. Corporate income tax benefits realized upon exercise or vesting of an award in excess of that previously recognized in earnings, referred to as an excess tax benefit, are presented in the consolidated statements of cash flows as a financing activity. Realized excess tax benefits are credited to additional paid-in capital in the consolidated balance sheets.

          Stock-based compensation expense recognized in the Consolidated Statements of Operations has been reduced for forfeitures since it is based on awards ultimately expected to vest, it. If factors change and we employ different assumptions in the application of our option-pricing model in future periods or if we experience different forfeiture rates, the compensation expense that is derived may differ significantly from what we have recorded in the current year.

     Inventory Valuation

          Inventories consist principally of finished goods and are stated at the lower of cost or market value, with cost being determined under a standard cost method that approximates first-in, first out. Inventory valuation reserves are established to reduce the carrying amounts of our inventories to their net estimated realizable values. Inventory valuation reserves are generally based on historical usage and expected demand. If future demand or market conditions are less favorable than our projections, additional inventory valuation reserves could be required and would be reflected in cost of product revenue in the period in which the reserves are taken. Inventory valuation reserves were $0.5 million and $0.6 million as of June 30, 2010 and 2009, respectively. Once a reserve is established, it is maintained until the unit to which it relates is sold or scrapped.

     Accounting for Income Taxes

          The Company accounts for income taxes using the asset and liability method as prescribed by Statement of Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes. Deferred income taxes are recognized by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment

- 43 -


date. The measurement of deferred tax assets is reduced, if necessary, by a valuation allowance for any tax benefit of which future realization is uncertain.

     During the year ended June 30, 2010, the increase in total deferred tax assets of $9.7 million and related increase in the valuation allowance of $11.4 million was primarily related to the increase in gross net operating loss and tax credit carryforwards due to the favorable tax ruling from the Internal Revenue Service related to Section 382. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of deferred tax assets will not be realized. The realization of deferred tax assets is based on several factors, including the Company’s past earnings and the scheduling of deferred taxes and projected income from operating activities. As of June 30, 2010, management does not believe it is more likely than not that the deferred tax assets relating to U.S. federal and state operations are realizable. The Company intends to maintain the valuation allowance until sufficient positive evidence exists to support reversal of some or all of the valuation allowance. The Company’s income tax expense (benefit) recorded in the future will be reduced or increased in the event changes to the valuation allowance are required.

Recent Accounting Pronouncements

          Refer to Note 1 of Notes to Consolidated Financial Statements in this Form 10-K for a discussion of the expected impact of recently issued accounting pronouncements.

 

 

I TEM 7A.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market Risk

          We are exposed to various market risks, including changes in foreign currency exchange rates. Market risk is the potential loss arising from adverse changes in market rates and prices, such as foreign currency exchange and interest rates. We do not enter into derivatives or other financial instruments for trading or speculative purposes. We may enter into financial instrument contracts with major financial institutions to manage and reduce the impact of changes in foreign currency exchange rates in the future. We had no forward exchange contracts outstanding as of June 30, 2010.

          In addition, we currently hold our investment portfolio in accounts with three financial firms. While we do not invest our cash in obligations of these firms, if these firms were to experience financial or other regulatory difficulties, it might be difficult for us to access our investments in a timely manner.

Interest Rate Risk

          We maintain an investment portfolio of various holdings, types, and maturities. These securities are generally classified as available for sale and consequently, are recorded on the balance sheet at fair value with unrealized gains and losses reported as a separate component of accumulated other comprehensive income (loss). At any time, a sharp rise in interest rates could have a material adverse impact on the fair value of our investment portfolio. Conversely, declines in interest rates could have a material positive impact on interest earnings for our portfolio. We do not currently hedge these interest rate exposures.

          The following table presents the hypothetical change in fair values in the financial instruments we held at June 30, 2010 that are sensitive to changes in interest rates. The modeling technique used measures the change in fair values arising from selected potential changes in interest rates on our investment portfolio, which had a fair value of $47.4 million at June 30, 2010. Market changes reflect immediate hypothetical parallel shifts in the yield curve of plus or minus 100, 50 and 25 basis points (BPS).

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Decrease in interest rates

 

Increase in interest rates

 

 

 


 


 

(in thousands)

 

-100 BPS

 

-50 BPS

 

-25 BPS

 

25 BPS

 

50 BPS

 

100 BPS

 

Total Fair Market Value

 

$

47,803

 

$

47,589

 

$

47,482

 

$

47,268

 

$

47,161

 

$

46,947

 

Percent Change in Fair Value

 

 

0.90

%

 

0.45

%

 

0.23

%

 

(0.23

)%

 

(0.45

)%

 

(0.90

)%

- 44 -


 

 

 

I TEM 8.

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

 

SHORETEL, INC. AND SUBSIDIARIES

 

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

 

 

Page

 

 


Report of Independent Registered Public Accounting Firm

 

46

Consolidated Balance Sheets

 

47

Consolidated Statements of Operations

 

48

Consolidated Statements of Redeemable Convertible Preferred Stock and Stockholders’ Equity and Comprehensive Income (Loss)

 

49

Consolidated Statements of Cash Flows

 

50

Notes to Consolidated Financial Statements

 

51

- 45 -


R EPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of
ShoreTel, Inc.
Sunnyvale, California

          We have audited the accompanying consolidated balance sheets of ShoreTel, Inc. and subsidiaries (the “Company”) as of June 30, 2010 and 2009, and the related consolidated statements of operations, redeemable convertible preferred stock and stockholders’ equity and comprehensive income (loss), and cash flows for each of the three years in the period ended June 30, 2010. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements based on our audits.

          We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

          In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of ShoreTel, Inc. and subsidiaries as of June 30, 2010 and 2009, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 2010, in conformity with accounting principles generally accepted in the United States of America.

          We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of June 30, 2010, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated September 10, 2010 expressed an unqualified opinion on the Company’s internal control over financial reporting.

/s/ DELOITTE & TOUCHE LLP

San Jose, California
September 10, 2010

- 46 -


SHORETEL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands except per share amounts)

 

 

 

 

 

 

 

 

 

 

June 30,

 

 

 


 

 

 

2010

 

2009

 

 

 


 


 

ASSETS

CURRENT ASSETS:

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

68,426

 

$

73,819

 

Short-term investments

 

 

47,375

 

 

33,847

 

Accounts receivable, net of allowances of $876 and $1,330 as of June 30, 2010 and June 30, 2009, respectively

 

 

24,596

 

 

21,454

 

Inventories

 

 

9,954

 

 

11,805

 

Prepaid expenses and other current assets

 

 

8,125

 

 

3,110

 

 

 



 



 

Total current assets

 

 

158,476

 

 

144,035

 

PROPERTY AND EQUIPMENT - Net

 

 

6,019

 

 

3,475

 

OTHER ASSETS

 

 

6,226

 

 

8,114

 

 

 



 



 

TOTAL

 

$

170,721

 

$

155,624

 

 

 



 



 

 

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

CURRENT LIABILITIES:

 

 

 

 

 

 

 

Accounts payable

 

$

7,868

 

$

7,774

 

Accrued liabilities and other

 

 

10,061

 

 

4,494

 

Accrued employee compensation

 

 

8,261

 

 

4,895

 

Deferred revenue

 

 

19,450

 

 

15,255

 

 

 



 



 

Total current liabilities

 

 

45,640

 

 

32,418

 

LONG-TERM LIABILITIES:

 

 

 

 

 

 

 

Long-term deferred revenue

 

 

9,269

 

 

7,236

 

Other long-term liabilities

 

 

1,346

 

 

2,198

 

 

 



 



 

Total liabilities

 

 

56,255

 

 

41,852

 

 

 



 



 

 

 

 

 

 

 

 

 

COMMITMENTS AND CONTINGENCIES (Note 9)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

STOCKHOLDERS’ EQUITY:

 

 

 

 

 

 

 

Preferred stock, par value $.001 per share, authorized 5,000 shares; none issued and outstanding

 

 

 

 

 

 

 

 

 

 

 

 

 

Common stock and additional paid-in capital, par value $.001 per share, authorized 500,000; issued and outstanding, 45,370 and 44,362 shares as of June 30, 2010 and June 30, 2009, respectively

 

 

222,491

 

 

209,102

 

Deferred compensation

 

 

 

 

(54

)

Accumulated other comprehensive income

 

 

191

 

 

136

 

Accumulated deficit

 

 

(108,216

)

 

(95,412

)

 

 



 



 

Total stockholders’ equity

 

 

114,466

 

 

113,772

 

 

 



 



 

TOTAL

 

$

170,721

 

$

155,624

 

 

 



 



 

See notes to consolidated financial statements

- 47 -


SHORETEL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended June 30,

 

 

 


 

 

 

2010

 

2009

 

2008

 

 

 


 


 


 

 

 

 

 

 

 

(Amounts in thousands, except per share amounts)

 

REVENUE:

 

 

 

 

 

 

 

 

 

 

Product

 

$

117,138

 

$

109,555

 

$

110,496

 

Support and services

 

 

31,326

 

 

25,267

 

 

18,233

 

 

 



 



 



 

Total revenue

 

 

148,464

 

 

134,822

 

 

128,729

 

COST OF REVENUE:

 

 

 

 

 

 

 

 

 

 

Product

 

 

40,471

 

 

38,149

 

 

37,466

 

Support and services

 

 

11,580

 

 

11,048

 

 

10,036

 

 

 



 



 



 

Total cost of revenue

 

 

52,051

 

 

49,197

 

 

47,502

 

GROSS PROFIT

 

 

96,413

 

 

85,625

 

 

81,227

 

OPERATING EXPENSES:

 

 

 

 

 

 

 

 

 

 

Research and development

 

 

33,596

 

 

30,724

 

 

26,811

 

Sales and marketing

 

 

55,973

 

 

44,652

 

 

37,869

 

General and administrative

 

 

19,888

 

 

19,596

 

 

17,645

 

Litigation settlement

 

 

 

 

4,110

 

 

 

 

 



 



 



 

Total operating expenses

 

 

109,457

 

 

99,082

 

 

82,325

 

 

 



 



 



 

LOSS FROM OPERATIONS

 

 

(13,044

)

 

(13,457

)

 

(1,098

)

OTHER INCOME (EXPENSE):

 

 

 

 

 

 

 

 

 

 

Interest income

 

 

408

 

 

1,399

 

 

4,141

 

Other

 

 

(324

)

 

(258

)

 

(40

)

 

 



 



 



 

Total other income

 

 

84

 

 

1,141

 

 

4,101

 

 

 



 



 



 

INCOME (LOSS) BEFORE INCOME TAX BENEFIT (PROVISION)

 

 

(12,960

)

 

(12,316

)

 

3,003

 

Income tax benefit (provision)

 

 

156

 

 

(343

)

 

(861

)

 

 



 



 



 

NET INCOME (LOSS)

 

$

(12,804

)

$

(12,659

)

$

2,142

 

 

 



 



 



 

Net income (loss) per common share available to common stockholders:

 

 

 

 

 

 

 

 

 

 

Basic

 

$

(0.29

)

$

(0.29

)

$

0.05

 

 

 



 



 



 

Diluted

 

$

(0.29

)

$

(0.29

)

$

0.05

 

 

 



 



 



 

Weighted average shares used in computing net income (loss) per share available to common stockholders:

 

 

 

 

 

 

 

 

 

 

Basic

 

 

44,804

 

 

43,714

 

 

42,413

 

Diluted

 

 

44,804

 

 

43,714

 

 

44,861

 


 


See notes to consolidated financial statements

- 48 -


SHORETEL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF REDEEMABLE CONVERTIBLE
PREFERRED STOCK AND STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME (LOSS)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common Stock
and

Additional Paid-
In-
Capital

 

 

 

 

 

 

 

 

 

 

 

 

 

Redeemable
Convertible
Preferred Stock

 

 

 

 

 

 

Accumulated
Other
Comprehensive
Income
(Loss)

 

 

 

 

 

 

 

 

 

 

 

Note
Receivable
from
Stockholders

 

 

 

 

 

 

 

 

 

 

Deferred
Stock
Compensation

 

 

 

 

 

Total
Stockholders’
Equity

 

 

 


 


 

 

 

 

Accumulated
Deficit

 

 

 

 

Shares

 

Amount

 

Shares

 

Amount

 

 

 

 

 

 

 

 


 


 


 


 


 


 


 


 


 

 

 

(Amounts in thousands)

 

 

 


 


 


 


 


 


 


 


 


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BALANCE - July 1, 2007

 

 

23,316

 

$

56,341

 

 

10,132

 

$

53,303

 

$

(237

)

$

 

$

 

$

(84,895

)

$

(31,829

)

Proceeds from initial public offering, net of offering costs

 

 

 

 

 

 

 

 

9,085

 

 

77,328

 

 

 

 

 

 

 

 

 

 

 

 

 

 

77,328

 

Preferred stock warrants converted to common stock warrants

 

 

 

 

 

 

 

 

 

 

 

549

 

 

 

 

 

 

 

 

 

 

 

 

 

 

549

 

Conversion of preferred stock to common stock

 

 

(23,316

)

 

(56,341

)

 

23,316

 

 

56,341

 

 

 

 

 

 

 

 

 

 

 

 

 

 

56,341

 

Exercise of warrants

 

 

 

 

 

 

 

 

61

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common stock issued under stock-based compensation plans

 

 

 

 

 

 

 

 

747

 

 

857

 

 

 

 

 

 

 

 

 

 

 

 

 

 

857

 

Stock-based compensation expense

 

 

 

 

 

 

 

 

 

 

 

7,336

 

 

95

 

 

 

 

 

 

 

 

 

 

 

7,431

 

Vesting of accrued early exercised stock options

 

 

 

 

 

 

 

 

 

 

 

220

 

 

 

 

 

 

 

 

 

 

 

 

 

 

220

 

Income tax benefit related to stock option exercises

 

 

 

 

 

 

 

 

 

 

 

250

 

 

 

 

 

 

 

 

 

 

 

 

 

 

250

 

Components of comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized loss on short-term investments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(76

)

 

 

 

 

(76

)

Net income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2,142

 

 

2,142

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

Comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2,066

 

 

 



 



 



 



 



 



 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BALANCE – June 30, 2008

 

 

 

 

 

 

43,341

 

 

196,184

 

 

(142

)

 

 

 

(76

)

 

(82,753

)

 

113,213

 

Common stock issued under stock-based compensation plans

 

 

 

 

 

 

 

 

1,021

 

 

3,004

 

 

 

 

 

 

 

 

 

 

 

 

 

 

3,004

 

Stock-based compensation expense

 

 

 

 

 

 

 

 

 

 

 

9,670

 

 

88

 

 

 

 

 

 

 

 

 

 

 

9,758

 

Vesting of accrued early exercised stock options

 

 

 

 

 

 

 

 

 

 

 

54

 

 

 

 

 

 

 

 

 

 

 

 

 

 

54

 

Income tax benefit related to stock option exercises

 

 

 

 

 

 

 

 

 

 

 

190

 

 

 

 

 

 

 

 

 

 

 

 

 

 

190

 

Components of comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized gain on short-term investments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

212

 

 

 

 

 

212

 

Net loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(12,659

)

 

(12,659

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

Comprehensive loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(12,447

)

 

 



 



 



 



 



 



 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BALANCE - June 30, 2009

 

 

 

 

 

 

44,362

 

 

209,102

 

 

(54

)

 

 

 

136

 

 

(95,412

)

 

113,772

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common stock issued under stock-based compensation plans

 

 

 

 

 

 

 

 

1,008

 

 

2,978

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2,978

 

Stock-based compensation expense

 

 

 

 

 

 

 

 

 

 

 

10,600

 

 

54

 

 

 

 

 

 

 

 

 

 

 

10,654

 

Vesting of accrued early exercised stock options

 

 

 

 

 

 

 

 

 

 

 

18

 

 

 

 

 

 

 

 

 

 

 

 

 

 

18

 

Income tax benefit (deficiency) related to stock option exercises

 

 

 

 

 

 

 

 

 

 

 

(207

)

 

 

 

 

 

 

 

 

 

 

 

 

 

(207

)

Components of comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized gain on short-term investments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

55

 

 

 

 

 

55

 

Net loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(12,804

)

 

(12,804

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

Comprehensive loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(12,749

)

 

 



 



 



 



 



 



 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BALANCE - June 30, 2010

 

 

 

$

 

 

45,370

 

$

222,491

 

$

 

$

 

$

191

 

$

(108,216

)

 

114,466

 

 

 



 



 



 



 



 



 



 



 



 

See notes to consolidated financial statements

- 49 -


SHORETEL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended June 30,

 

 

 


 

 

 

2010

 

2009

 

2008

 

 

 


 


 


 

 

 

(In thousands)

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

(12,804

)

$

(12,659

)

$

2,142

 

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

 

 

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

2,804

 

 

1,965

 

 

1,606

 

Amortization (accretion) of premium (discount) on investments

 

 

217

 

 

27

 

 

(198

)

Stock-based compensation expense

 

 

10,654

 

 

9,758

 

 

7,431

 

Excess tax benefit from stock options exercised

 

 

(191

)

 

(190

)

 

(250

)

Loss on disposal of property and equipment and other assets

 

 

340

 

 

191

 

 

270

 

Deferred tax benefit

 

 

(26

)

 

 

 

(1,748

)

Provision (benefit) for doubtful accounts receivable

 

 

(83

)

 

1,066

 

 

245

 

Changes in assets and liabilities:

 

 

 

 

 

 

 

 

 

 

Accounts receivable

 

 

(3,059

)

 

(611

)

 

(2,743

)

Inventories

 

 

1,851

 

 

203

 

 

(4,951

)

Prepaid expenses and other current assets

 

 

(4,022

)

 

480

 

 

57

 

Other assets

 

 

1,179

 

 

(85

)

 

(1,880

)

Accounts payable

 

 

(325

)

 

1,796

 

 

(586

)

Accrued liabilities and other

 

 

5,052

 

 

2,332

 

 

2,283

 

Accrued employee compensation

 

 

3,366

 

 

(652

)

 

1,761

 

Deferred revenue

 

 

6,228

 

 

3,826

 

 

4,714

 

 

 



 



 



 

Net cash provided by operating activities

 

 

11,181

 

 

7,447

 

 

8,153

 

 

 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

 

 

 

 

 

Purchases of property and equipment

 

 

(4,650

)

 

(1,842

)

 

(2,407

)

Purchases of investments

 

 

(23,835

)

 

(35,087

)

 

(51,267

)

Proceeds from sale/maturities of investments

 

 

10,145

 

 

35,558

 

 

17,250

 

Purchase of software licenses and other

 

 

(1,403

)

 

(4,123

)

 

 

Long-term deposit on operating facility

 

 

 

 

 

 

(95

)

 

 



 



 



 

Net cash used in investing activities

 

 

(19,743

)

 

(5,494

)

 

(36,519

)

 

 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

 

 

 

 

 

Proceeds from initial public offering, received net of underwriting discounts

 

 

 

 

 

 

80,265

 

Initial public offering costs

 

 

 

 

 

 

(1,660

)

Proceeds from issuance of common stock

 

 

3,103

 

 

3,004

 

 

857

 

Taxes paid on vested and released stock awards

 

 

(125

)

 

 

 

 

Excess tax benefit from stock options exercised

 

 

191

 

 

190

 

 

250

 

 

 



 



 



 

Net cash provided by financing activities

 

 

3,169

 

 

3,194

 

 

79,712

 

 

 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

 

 

(5,393

)

 

5,147

 

 

51,346

 

CASH AND CASH EQUIVALENTS - Beginning of the year

 

 

73,819

 

 

68,672

 

 

17,326

 

 

 



 



 



 

CASH AND CASH EQUIVALENTS - End of the year

 

$

68,426

 

$

73,819

 

$

68,672

 

 

 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:

 

 

 

 

 

 

 

 

 

 

Cash paid (refunds) for taxes, net of refunds

 

$

(156

)

$

1,196

 

$

1,398

 

 

 

 

 

 

 

 

 

 

 

 

NONCASH FINANCING AND INVESTING ACTIVITIES:

 

 

 

 

 

 

 

 

 

 

Conversion of redeemable convertible preferred stock to common stock

 

$

 

$

 

$

56,341

 

Reclassification of initial public offering costs from other assets to common stock

 

$

 

$

 

$

2,752

 

Reclassification of preferred stock warrant liability to common stock

 

$

 

$

 

$

549

 

Unpaid portion of property and equipment purchases included in period-end accounts payable

 

$

647

 

$

196

 

$

185

 

Vesting of accrued early exercised stock options

 

$

18

 

$

54

 

$

220

 

Unpaid portion of purchases of other assets included in period-end accounts payable and accrued liabilities

 

$

 

$

215

 

$

200

 

See notes to consolidated financial statements

- 50 -


SHORETEL, INC. AND SUBSIDIARIES

N OTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. THE COMPANY AND SIGNIFICANT ACCOUNTING POLICIES

          The Company - ShoreTel, Inc. was incorporated in California on September 17, 1996 and reincorporated in Delaware on June 22, 2007. ShoreTel, Inc. and its subsidiaries (referred herein as “the Company”) is a leading provider of Pure Internet Protocol, or IP, unified communications systems for enterprises. The Company’s systems are based on its distributed software architecture and switch-based hardware platform which enable multi-site enterprises to be served by a single telecommunications system. The Company’s systems enable a single point of management, easy installation and a high degree of scalability and reliability, and provide end users with a consistent, full suite of features across the enterprise, regardless of location. As a result, management believes that the Company’s systems enable enhanced end user productivity and provide lower total cost of ownership and higher customer satisfaction than alternative systems.

          Fiscal Year End - The Company operates on a fiscal year ending June 30.

          Principles of Consolidation - The accompanying consolidated financial statements include the accounts of the Company’s wholly owned subsidiaries located in Germany, the United Kingdom and Australia. All transactions and balances between the parent and the subsidiaries have been eliminated in consolidation. The functional currency of the subsidiaries is the U.S. dollar. Functional currency monetary assets and liabilities are translated at the rates of exchange on the balance sheet date, and local currency revenues and expenses are translated at average rates of exchange during the period. Gains and losses resulting from the process of remeasuring foreign currency financial statements into U.S. dollars are included in other income (expense).

          Use of Estimates - The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. The use of estimates are included in certain areas including revenue recognition, allowance for doubtful accounts, stock-based compensation, inventory and other assets valuation, and accounting for income taxes. Actual results could differ from those estimates.

          Certain Significant Risks and Uncertainties - The Company participates in a dynamic high-technology industry. Changes in any of the following areas could have a material adverse effect on the Company’s future financial position, results of operations, or cash flows: reliance on sole-source suppliers; general economic conditions; advances and trends in new technologies; competitive pressures; changes in the overall demand for its future products; acceptance of the Company’s products; litigation or claims against the Company based on intellectual property, patent, regulatory, or other factors; and the Company’s ability to attract and retain employees necessary to support its growth.

          Concentration of Credit Risk - Financial instruments, which potentially subject the Company to concentrations of credit risk, consist principally of cash and cash equivalents, short-term investments and accounts receivable. As of June 30, 2010, substantially all of the Company’s cash and cash equivalents and short-term investments were managed by multiple financial institutions. Accounts receivable are typically unsecured and are derived from revenue earned from the customers. The Company performs ongoing credit evaluations of its customers and maintains allowances for potential credit losses. At June 30, 2010 and 2009, no enterprise customer or channel partner comprised more than 10% of total accounts receivable. For the year ended June 30, 2010, 2009 and 2008, no enterprise customer or channel partner comprised more than 10% of total revenue.

          Fair Value of Financial Instruments The carrying amounts of the Company’s financial instruments, including cash and cash equivalents, accounts receivable, accounts payable, and accrued liabilities, approximate their respective fair market values due to the short maturities of these financial instruments. The fair values of short-term investments are determined using quoted market prices for those securities or similar financial instruments.

          Dependence on Suppliers - The Company depends in part upon contractors to manufacture, assemble, and deliver items in a timely and satisfactory manner. The Company obtains certain components and subsystems from a single or a limited number of sources. A significant interruption in the delivery of such items or the demise of a supplier could have a material adverse effect on the Company’s operations.

          Cash and Cash Equivalents - The Company considers all highly liquid investments purchased with an original or remaining maturity of less than three months at the date of purchase to be cash equivalents. Cash and cash equivalents are maintained with various financial institutions.

- 51 -


          Investments - The Company’s short-term investments are comprised of U.S. Government agency securities, corporate notes and commercial paper. These investments are held in the custody of three major financial institutions. The specific identification method is used to determine the cost basis of disposed fixed income securities. At June 30, 2010 and 2009, the Company’s investments were classified as available-for-sale. These investments are recorded in the Consolidated Balance Sheets at fair value with unrealized gains or losses reported as a separate component of accumulated other comprehensive income (loss), net of tax.

The Company recognizes an impairment charge when a decline in the fair value of its investments below the cost basis is judged to be other-than-temporary. The Company considers various factors in determining whether to recognize an impairment charge, including the length of time and extent to which the fair value has been less than the Company’s cost basis, the financial condition and near-term prospects of the investee, and the Company’s intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery in market value.

          Allowance for Doubtful Accounts. The Company records its allowance for doubtful accounts based upon its assessment of various factors. The Company considers historical experience, the age of the accounts receivable balances, the credit quality of its customers, current economic conditions and other factors that may affect customers’ ability to pay to determine the level of allowance required.

          The change in allowance for doubtful accounts is summarized as follows (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

June 30,

 

 

 


 

 

 

2010

 

2009

 

2008

 

 

 


 


 


 

Allowance for doubtful accounts - beginning

 

$

1,330

 

$

414

 

$

320

 

Current period provision (benefit)

 

 

(83

)

 

1,066

 

 

245

 

Write-offs charged to allowance (net of recoveries)

 

 

(371

)

 

(150

)

 

(151

)

 

 









 

Allowance for doubtful accounts - ending

 

$

876

 

$

1,330

 

$

414

 

 

 









 

          Inventories - Inventories, which consist principally of raw materials, finished goods and inventory in process/transit, are stated at the lower of cost or market, with cost being determined under a standard cost method that approximates first-in, first-out.

          Property and Equipment - Property and equipment are stated at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets, which range from two to five years. Leasehold improvements are amortized over the shorter of the estimated useful lives of the asset or the lease term.

          Long-Lived Assets  — The Company evaluates the carrying value of long-lived assets to be held and used including intangible assets, when events or circumstances warrant such a review. The carrying value of a long-lived asset to be held and used is considered impaired when the anticipated separately identifiable undiscounted cash flows from such an asset are less than the carrying value of the asset. In that event, an impairment loss is recognized based on the amount by which the carrying value exceeds the fair value of the long-lived asset. Fair value is determined primarily using the anticipated cash flows discounted at a rate commensurate with the risk involved.

          Revenue Recognition - The Company’s revenue is related to the sale of enterprise IP telecommunications systems, which include hardware, primarily phones and voice switches, and software components and may also include training, installation and post-contractual support for the products. The Company’s business strategy is centered on selling to enterprise customers through channel partners, rather than directly. Hence, sales transactions are generally made to a channel partner. Certain larger enterprise customers prefer to purchase directly from the Company. Many of these large account sales are channel partner-assisted and the Company compensates the channel partner in much the same way as if the channel partner had made the sale directly. The compensation to the channel partner is recorded as an offset to the revenues associated with the direct sale to the enterprise customer.

          Product Revenue - The Company’s software is integrated with hardware and is essential to the functionality of the integrated system product. Revenue is recognized depending on whether the hardware is sold in a multiple-element arrangement with software and post-contractual support or on a standalone basis if the customer purchases hardware, software, or post- contractual support separately. At the initial purchase, the customer generally bundles together the hardware, software components and up to five years of post-contractual support. Thereafter, if the enterprise customer increases end users and functionality, it may add more hardware, software, and related post-contractual support by purchasing them separately. The Company evaluates vendor-specific objective evidence (VSOE) of fair value for post-contractual support, installation services and training, and other undelivered elements as noted below.

- 52 -


          Product revenue is recognized when persuasive evidence of an arrangement exists, product has shipped or delivery has occurred (depending on when title passes), the sales price is fixed or determinable and free of contingencies and significant uncertainties, and collection is probable. The fee is considered fixed or determinable at the execution of an agreement, based on specific products and quantities to be delivered at specified prices. The agreements with customers generally do not include rights of return or acceptance provisions. To the extent that the Company’s agreements contain acceptance terms, the Company recognizes revenue upon product acceptance, unless the acceptance provision is deemed to be perfunctory. Even though substantially all of the contractual agreements do not provide return privileges, there are circumstances for which the Company will accept a return. The Company maintains a reserve for such returns based on historical experience. Payment terms to customers generally range from net 30 to net 60 days. In the event payment terms are extended materially from the Company’s standard business practices, the fees are deemed to not be fixed or determinable and revenue is recognized when the payment becomes due. The Company assesses the ability to collect from its customers based on a number of factors, including credit worthiness and past transaction history of the customer. If the customer is not deemed credit worthy, the Company defers all revenue from the arrangement until payment is received and all other revenue recognition criteria have been met. Shipping charges billed to customers are included in product revenue and the related shipping costs are included in cost of product revenue.

          Provisions for return allowances and product warranties are recorded at the time revenue is recognized based on the Company’s historical experience. The provision for return allowances is recorded as a reduction to revenues on the statement of operations and is included as a reduction to account receivables on the balance sheet.

          The Company has arrangements with resellers of their products to reimburse the resellers for cooperative marketing costs meeting specified criteria. The reimbursements are limited to 50% of the actual costs charged to the channel partners by third-party vendors for advertising, trade show activities and other related sales and marketing activities for which the Company receives an identifiable benefit (goods and services that the Company could have purchased directly from third-party vendors), subject to a limit of the total cooperative marketing allowance earned by each channel partner. The Company records the reimbursements to the channel partners meeting such specified criteria within sales and marketing expenses in the accompanying consolidated statements of operations.

          Post-Contractual Support - The Company’s support and service revenues are primarily derived from post-contractual support. The Company accounts for post-contractual support revenues based on the nature of the arrangement. If an arrangement includes multiple elements, the fee is allocated to the various elements based on VSOE of fair value, regardless of any separate prices stated within the contract for each element. VSOE of fair value is limited to the price charged when the same element is sold separately. VSOE of fair value is established for post-contractual support through prior renewals of post-contractual support from existing customers, which establishes a price based on a standalone sale. To determine the fair value of the price charged, the Company analyzes both the selling prices when elements are sold separately as well as the concentrations of those prices. The Company believes those concentrations have been sufficient to enable us to establish VSOE of fair value for the post-contract support revenues.

          The Company offers one, three and five year post-contractual support contracts. The decision to procure support is elected by the enterprise customer, but most channel partners and their enterprise customers desire post-contractual support so an initial system sale usually includes post-contractual support. The majority of post-contractual support contracts are sold to channel partners, under which the channel partner provides first level support to the enterprise customer and the Company provides support, as needed, to the channel partner. In a lesser number of cases, the Company provides support directly to the enterprise customer.

          The Company uses the residual method to determine the amount of product revenue to be recognized. Under the residual method, the fair value of the undelivered elements, such as post-contractual support installation services and training, is deferred and the remaining portion of the sales amount is recognized as product revenue. The fair value of the post-contractual support is recognized on a straight-line basis over the term of the related support period, which is typically one to five years.

          Installation and Training- Installation is sold on an elective basis. As installation is typically performed by the channel partner or enterprise customer, and it is not considered essential to the functionality of the delivered elements. Installation, when performed by the Company, is by its nature sold only with an accompanying system order. Installation is generally priced at established rates based on estimated hours required to install the accompanying system.

          The Company recognizes revenue related to installation services and training upon delivery of the service.

          If VSOE of fair value does not exist for installation, training or commitments to provide specified upgrades, services or additional products to customers in the future, as has been the case from time to time in the past, the Company defers all revenue from the arrangement until the earlier of the point at which VSOE of fair value does exist or all such elements from the arrangement have been delivered.

          Warranties - The majority of the Company’s products are covered by a one-year limited manufacturer’s warranty. Estimated contractual warranty obligations are recorded when related sales are recognized based on historical experience.

- 53 -


The determination of such provision requires the Company to make estimates of product return rates and expected costs to repair or replace the product under warranty. If actual costs differ significantly from these estimates, additional amounts are recorded when such costs are probable and can be reasonably estimated. The provision for product warranties are recorded within cost of goods sold on the statement of operations and included within accrued liabilities and other on the balance sheet.

          The change in accrued warranty expense is summarized as follows (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

June 30,

 

 

 


 

 

 

2010

 

2009

 

2008

 

 

 


 


 


 

Accrued warranty balance - beginning

 

$

261

 

$

239

 

$

167

 

Current period accrual

 

 

330

 

 

292

 

 

313

 

Warranty expenditures charged to accrual

 

 

(276

)

 

(270

)

 

(241

)

 

 



 



 



 

Accrued warranty balance - ending

 

$

315

 

$

261

 

$

239

 

 

 



 



 



 

          Research and Development Costs - Research and development expenditures, which include software development costs, are expensed as incurred. Software development costs incurred subsequent to the time a product’s technological feasibility has been established through the time the product is available for general release to customers are subject to capitalization.

          Income Taxes – The Company utilizes the asset and liability method of accounting for income taxes. Deferred income taxes are recognized by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The measurement of deferred tax assets is reduced, if necessary, by a valuation allowance for any tax benefit of which future realization is uncertain.

          Stock-Based Compensation – The Company measures the cost of employee services received in exchange for an award of equity instruments based on the grant date fair value of the award. The Company elected to use the Prospective Transition method to new awards and to awards modified, repurchased or canceled after the effective date of July 1, 2006. The Company has a stock-based employee compensation plan (Option Plan). Generally, stock options granted to employees vest 25% one year or 50% two years from the grant date and 1/48 each month thereafter, and have a term of ten years.

          The following table shows total stock-based compensation expense included in the accompanying Consolidated Statements of Operations for the years ended June 30, 2010, 2009 and 2008 (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended June 30,

 

 

 


 

 

 

2010

 

2009

 

2008

 

 

 


 


 


 

Cost of product revenue

 

$

139

 

$

113

 

$

74

 

Cost of support and services revenue

 

 

838

 

 

799

 

 

545

 

Research and development

 

 

3,064

 

 

2,829

 

 

2,005

 

Sales and marketing

 

 

3,400

 

 

3,468

 

 

2,447

 

General and administrative

 

 

3,213

 

 

2,549

 

 

2,360

 

 

 



 



 



 

Total stock-based compensation expense

 

$

10,654

 

$

9,758

 

$

7,431

 

 

 



 



 



 

          Compensation expense related to equity instruments issued to nonemployees is recognized as the equity instruments vest. At each reporting date, the Company revalues the compensation. As a result, stock-based compensation expense related to unvested equity instruments issued to nonemployees fluctuates as the fair value of the Company’s common stock fluctuates. The Company uses the Black-Scholes option-pricing model to value options granted to non-employees. The related expense is recorded over the period in which the related services are received.

          Foreign currency translation - The Company’s foreign operations are subject to exchange rate fluctuations and foreign currency transaction costs, however, the majority of sales transactions are denominated in U.S. dollars. Foreign currency denominated sales, costs and expenses are recorded at the average exchange rates during the year. Gains or losses resulting from foreign currency transactions are included in other income in the consolidated statements of operations.

          Comprehensive income (loss) - Comprehensive income (loss) is defined as the change in equity during a period from nonowner sources. Comprehensive income (loss) consists of net income (loss) and other comprehensive income (loss), which is a separate component of stockholders’ equity. Other comprehensive income (loss) includes unrealized gains and losses on the Company’s available-for-sale securities. Other comprehensive income (loss) for fiscal years 2010, 2009 and 2008 has

- 54 -


been disclosed within the consolidated statements of redeemable convertible preferred stock and stockholders’ equity and comprehensive income (loss).

          Recent Accounting Pronouncements

          During the first quarter of fiscal year 2010, the Company adopted the new Accounting Standards Codification (ASC) as issued by the FASB. The ASC has become the source of authoritative GAAP recognized by the FASB to be applied by nongovernmental entities. The ASC is not intended to change or alter existing GAAP. The adoption of the ASC did not have a material impact on the Company’s consolidated financial statements.

          In October 2009, the Financial Accounting Standards Board (“FASB”) issued an accounting standards update that revises accounting and reporting requirements for arrangements with multiple deliverables that are excluded from the scope of existing software revenue guidance. This update requires the use of an estimated selling price to determine the selling price of a deliverable in cases where neither vendor-specific objective evidence nor third-party evidence is available, which is expected to increase the ability for entities to separate deliverables in multiple-deliverable arrangements and, accordingly, to decrease the amount of revenue deferred in these cases. Additionally, this update requires the total selling price of a multiple-deliverable arrangement to be allocated at the inception of the arrangement to all deliverables based on relative selling prices. This update is to be applied prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, which for the Company is July 1, 2010. The Company is currently evaluating the impact of adoption of this update on our financial position, results of operations and cash flows and the impact of adoption is not expected to be material.

          In October 2009, the FASB issued an accounting standards update that clarifies which revenue allocation and measurement guidance should be used for arrangements that contain both tangible products and software, in cases where the software is more than incidental to the tangible product as a whole. More specifically, if the software sold with or embedded within the tangible product is essential to the functionality of the tangible product, then this software as well as undelivered software elements that relate to this software is excluded from the scope of existing software revenue guidance, which is expected to decrease the amount of revenue deferred in these cases. This update is to be applied prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, which for the Company is July 1, 2010. The Company is currently evaluating the impact of adoption of this update on our financial position, results of operations and cash flows and the impact of adoption is not expected to be material.

          In January 2010, the FASB issued amended guidance on fair value measurements and disclosures. The new guidance requires additional disclosures regarding fair value measurements, amends disclosures about postretirement benefit plan assets, and provides clarification regarding the level of disaggregation of fair value disclosures by investment class. This guidance is effective for interim and annual reporting periods beginning after December 15, 2009, except for certain Level 3 activity disclosure requirements that will be effective for reporting periods beginning after December 15, 2010. Accordingly, the Company adopted this amendment in the third quarter of fiscal 2010, except for the additional Level 3 requirements which will be adopted in 2011. The adoption of this amendment did not have a significant impact on the Company’s financial position, results of operations or cash flows.

2. BALANCE SHEET COMPONENTS

          Balance sheet components consisted of the following:

 

 

 

 

 

 

 

 

 

 

As of June 30,

 

 

 


 

 

 

2010

 

2009

 

 

 


 


 

 

 

(Amounts in thousands)

 

Inventories:

 

 

 

 

 

 

 

Raw materials

 

$

335

 

$

398

 

Inventory in process/transit

 

 

526

 

 

962

 

Finished goods

 

 

9,093

 

 

10,445

 

 

 



 



 

Total inventories

 

$

9,954

 

$

11,805

 

 

 



 



 

 

 

 

 

 

 

 

 

Prepaid expenses and other current assets:

 

 

 

 

 

 

 

Prepaid expenses and other receivables

 

$

7,778

 

$

2,435

 

Deferred cost of revenue

 

 

347

 

 

315

 

Deferred taxes

 

 

 

 

360

 

 

 



 



 

Total prepaid expenses and other current assets

 

$

8,125

 

$

3,110

 

 

 



 



 

 

 

 

 

 

 

 

 

Property and equipment:

 

 

 

 

 

 

 

Computer equipment and tooling

 

$

9,559

 

$

5,281

 

Software

 

 

1,354

 

 

1,086

 

Furniture and fixtures

 

 

1,196

 

 

1,064

 

Leasehold improvements & others

 

 

583

 

 

387

 

 

 



 



 

Total property and equipment

 

$

12,692

 

$

7,818

 

Less accumulated depreciation and amortization

 

 

(6,673

)

 

(4,343

)

 

 



 



 

Property and equipment – Net

 

$

6,019

 

$

3,475

 

 

 



 



 

 

 

 

 

 

 

 

 

Deferred revenue:

 

 

 

 

 

 

 

Product

 

$

966

 

$

988

 

Support and services

 

 

27,753

 

 

21,503

 

 

 



 



 

Total deferred revenue

 

$

28,719

 

$

22,491

 

 

 



 



 

- 55 -


The following is a summary of the Company’s long-term other assets (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 2010

 

June 30, 2009

 

 

 


 


 

 

 

Gross
Carrying
Amount

 

Accumulated
Amortization

 

Net Carrying
Amount

 

Gross
Carrying
Amount

 

Accumulated
Amortization

 

Net Carrying
Amount

 

 

 


 


 


 


 


 


 

Licensed technology

 

$

2,310

 

$

(532

)

$

1,778

 

$

1,860

 

$

(131

)

$

1,729

 

Intangible assets in pre-release

 

 

3,247

 

 

 

 

3,247

 

 

2,478

 

 

 

 

2,478

 

 

 



 



 



 



 



 



 

Other intangible assets

 

$

5,557

 

$

(532

)

 

5,025

 

$

4,338

 

$

(131

)

 

4,207

 

 

 



 



 

 

 

 



 



 

 

 

 

Prepaid royalties

 

 

 

 

 

 

 

 

914

 

 

 

 

 

 

 

 

2,285

 

Deferred tax asset

 

 

 

 

 

 

 

 

53

 

 

 

 

 

 

 

 

1,388

 

Deposits and other

 

 

 

 

 

 

 

 

234

 

 

 

 

 

 

 

 

234

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 



 

Total other assets

 

 

 

 

 

 

 

$

6,226

 

 

 

 

 

 

 

$

8,114

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 



 

          Other intangible asset categories previously disclosed have been separated into amounts in use and amounts in pre-release to conform to current categories presented.

          The intangible assets are all amortizable and have original estimated useful lives of three to six years.

          Amortization of intangible assets for fiscal 2010, 2009 and 2008 was $0.4 million, $0.1 million and zero, respectively.

          The estimated amortization expenses for intangible assets for the next five years and thereafter are as follows (in thousands):

 

 

 

 

 

Years Ending June 30,

 

 

 

 


 

 

 

 

2011

 

$

453

 

2012

 

 

453

 

2013

 

 

453

 

2014

 

 

338

 

2015

 

 

81

 

Thereafter

 

 

 

 

 



 

Total

 

$

1,778

 

 

 



 

3. SHORT-TERM INVESTMENTS

          The following is a summary of the Company’s short-term investments (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 2010

 

 

 


 

 

 

Amortized Cost

 

Gross Unrealized
Gains

 

Gross Unrealized
Losses

 

Fair Value

 

 

 


 


 


 


 

 

 

Corporate notes and commercial paper

 

$

33,280

 

$

142

 

$

(50

)

$

33,372

 

U.S. Government agency securities

 

 

13,904

 

 

99

 

 

 

 

14,003

 

 

 



 



 



 



 

Total short-term investments

 

$

47,184

 

$

241

 

$

(50

)

$

47,375