ShoreTel, Inc.
ShoreTel Inc (Form: 10-Q, Received: 11/05/2010 06:05:55)
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

 

 

(Mark one)

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

For the quarterly period ended September 30, 2010

OR

 

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

For the transition period from              to             

Commission File Number 001-33506

 

 

SHORETEL, INC.

(Exact name of Registrant as specified in its charter)

 

 

 

Delaware   77-0443568

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

960 Stewart Drive, Sunnyvale, California   94085-3913
(Address of principal executive offices)   (Zip Code)

(408) 331-3300

(Registrant’s telephone number, including area code)

 

 

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   ¨

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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes   ¨     No   ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer   ¨    Accelerated filer   x
Non-accelerated filer   ¨   (Do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes   ¨     No   x

As of November 1, 2010, 45,910,520 shares of the registrant’s common stock were outstanding.

 

 

 


Table of Contents

 

SHORETEL, INC. AND SUBSIDIARIES

FORM 10-Q for the Quarter Ended September 30, 2010

INDEX

 

          Page  
PART I: Financial Information      3   

Item 1

   Financial Statements (Unaudited)      3   
  

Condensed Consolidated Balance Sheets as of September 30, 2010 and June 30, 2010

     3   
  

Condensed Consolidated Statements of Operations for the three months ended September 30, 2010 and 2009

     4   
  

Condensed Consolidated Statements of Cash Flows for the three months ended September 30, 2010 and 2009

     5   
  

Notes to Condensed Consolidated Financial Statements

     6   

Item 2

   Management’s Discussion and Analysis of Financial Condition and Results of Operations      16   

Item 3

   Quantitative and Qualitative Disclosures About Market Risk      25   

Item 4

   Controls and Procedures      25   
PART II: Other information      25   

Item 1

   Legal Proceedings      25   

Item 1A

   Risk Factors      25   

Item 2

   Unregistered Sales of Equity Securities and Use of Proceeds      26   

Item 6

   Exhibits      26   
   Signatures      26   
   Exhibit Index      27   

 

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PART I. FINANCIAL INFORMATION

 

ITEM 1: FINANCIAL STATEMENTS (Unaudited)

SHORETEL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except per share amounts)

(Unaudited)

 

     September 30,
2010
    June 30,
2010
 
ASSETS     

CURRENT ASSETS:

    

Cash and cash equivalents

   $ 65,842      $ 68,426   

Short-term investments

     50,394        47,375   

Accounts receivable, net of allowance of $824 and $876 as of September 30, 2010 and June 30, 2010, respectively

     25,543        24,596   

Inventories

     10,533        9,954   

Prepaid expenses and other current assets

     4,457        8,125   
                

Total current assets

     156,769        158,476   

PROPERTY AND EQUIPMENT, net

     7,816        6,019   

OTHER ASSETS

     5,910        6,226   
                

TOTAL ASSETS

   $ 170,495      $ 170,721   
                
LIABILITIES AND STOCKHOLDERS’ EQUITY     

CURRENT LIABILITIES:

    

Accounts payable

   $ 7,419      $ 7,868   

Accrued liabilities and other

     9,090        10,061   

Accrued employee compensation

     8,446        8,261   

Deferred revenue

     20,646        19,450   
                

Total current liabilities

     45,601        45,640   

LONG-TERM LIABILITIES:

    

Long-term deferred revenue

     9,958        9,269   

Other long-term liabilities

     1,362        1,346   
                

Total liabilities

     56,921        56,255   
                

COMMITMENTS AND CONTINGENCIES (Note 11)

    

STOCKHOLDERS’ EQUITY:

    

Preferred stock, $0.001 par value: authorized 5,000; none issued and outstanding

     —          —     

Common stock and additional paid-in capital, par value $0.001 per share, authorized 500,000; issued and outstanding, 45,614 and 45,370 shares as of September 30, 2010 and June 30, 2010, respectively

     225,189        222,491   

Accumulated other comprehensive income

     246        191   

Accumulated deficit

     (111,861     (108,216
                

Total stockholders’ equity

     113,574        114,466   
                

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY

   $ 170,495      $ 170,721   
                

See Notes to Condensed Consolidated Financial Statements

 

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SHORETEL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

(Unaudited)

 

     Three Months Ended
September 30,
 
     2010     2009  

REVENUE:

    

Product

   $ 35,226      $ 26,843   

Support and services

     9,053        6,907   
                

Total revenue

     44,279        33,750   

COST OF REVENUE:

    

Product (1)

     11,767        9,533   

Support and services (1)

     2,976        2,584   
                

Total cost of revenue

     14,743        12,117   

GROSS PROFIT

     29,536        21,633   

OPERATING EXPENSES:

    

Research and development (1)

     10,322        7,197   

Sales and marketing (1)

     17,203        12,017   

General and administrative (1)

     6,133        4,651   
                

Total operating expenses

     33,658        23,865   
                

LOSS FROM OPERATIONS

     (4,122     (2,232

OTHER INCOME:

    

Interest income

     208        106   

Other

     379        22   
                

Total other income

     587        128   
                

LOSS BEFORE INCOME TAX PROVISION

     (3,535     (2,104

INCOME TAX PROVISION

     (110     (22
                

NET LOSS

   $ (3,645   $ (2,126
                

Net loss per share — basic and diluted

   $ (0.08   $ (0.05
                

Shares used in computing net loss per share — basic and diluted

     45,444        44,385   
                

 

(1)     Includes stock-based compensation expense as follows:

    

Cost of product revenue

   $ 35      $ 27   

Cost of support and services revenue

     200        111   

Research and development

     824        638   

Sales and marketing

     868        699   

General and administrative

     897        615   
                

Total stock-based compensation expense

   $ 2,824      $ 2,090   
                

See Notes to Condensed Consolidated Financial Statements

 

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SHORETEL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

     Three Months Ended
September 30,
 
     2010     2009  

CASH FLOWS FROM OPERATING ACTIVITIES:

    

Net loss

   $ (3,645   $ (2,126

Adjustments to reconcile net loss to net cash provided by operating activities:

    

Depreciation and amortization

     796        644   

Amortization (accretion) of premium (discount) on investments

     172        30   

Stock-based compensation expense

     2,824        2,090   

Loss on disposal of property and equipment

     13        —     

Provision (benefit) for doubtful accounts receivable

     (52     67   

Changes in assets and liabilities:

    

Accounts receivable

     (895     2,414   

Inventories

     (579     (1,263

Prepaid expenses and other current assets

     3,668        (426

Other assets

     203        368   

Accounts payable

     (555     (868

Accrued liabilities and other

     (955     1,045   

Accrued employee compensation

     185        2,149   

Deferred revenue

     1,885        1,123   
                

Net cash provided by operating activities

     3,065        5,247   
                

CASH FLOWS FROM INVESTING ACTIVITIES:

    

Purchases of property and equipment

     (2,387     (1,280

Purchases of investments

     (3,136     (2,031

Proceeds from sales/maturities of investments

     —          6,635   

Purchases of software license and other

     —          (295
                

Net cash (used in) provided by investing activities

     (5,523     3,029   
                

CASH FLOWS FROM FINANCING ACTIVITIES:

    

Proceeds from issuance of common stock

     176        97   

Taxes paid on vested and released stock awards

     (302     —     
                

Net cash (used in) provided by financing activities

     (126     97   
                

NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS

     (2,584     8,373   

CASH AND CASH EQUIVALENTS - Beginning of period

     68,426        73,819   
                

CASH AND CASH EQUIVALENTS - End of period

   $ 65,842      $ 82,192   
                

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION

    

Cash paid (refunded) during the period for income taxes, net

   $ (1,578   $ —     

NONCASH INVESTING AND FINANCING ACTIVITIES:

    

Vesting of accrued early exercised stock options

   $ —        $ 7   

Purchase of property and equipment included in period-end accounts payable

   $ 753      $ 258   

Purchase of other assets included in period-end accounts payable

   $ —        $ 240   

See Notes to Condensed Consolidated Financial Statements

 

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SHORETEL, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Description of Business

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.

2. Basis of Presentation and Significant Accounting Policies

The accompanying condensed consolidated financial statements as of September 30, 2010 and for the three months ended September 30, 2010 and 2009 have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations. However, the Company believes that the disclosures are adequate to make the information presented not misleading. These Condensed Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and the notes thereto, included in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2010.

In the opinion of the management, all adjustments (which include normal recurring adjustments, except as disclosed herein) necessary to present a fair statement of financial position as of September 30, 2010, results of operations for the three months ended September 30, 2010 and 2009, and cash flows for the three months ended September 30, 2010 and 2009, as applicable, have been made. The results of operations for the three months ended September 30, 2010 are not necessarily indicative of the operating results to be expected for the full fiscal year or any future periods.

Computation of Net Loss per Share

Basic net loss per common share is determined by dividing net loss by the weighted average number of common shares during the period. Diluted net loss per common share is determined by dividing net loss by the weighted average number of common shares used in the basic loss per common share calculation plus the number of common shares that would be issued assuming conversion of all potentially dilutive securities outstanding under the treasury stock method. Potentially dilutive securities were not included in the computation of dilutive net loss per share for the three months ended September 30, 2010 and 2009, because to do so would have been anti-dilutive. Potentially dilutive securities of 8.8 million and 8.0 million for the three months ended September 30, 2010 and 2009, respectively, were not included in the computation of dilutive net loss per share because to do so would have been anti-dilutive.

Comprehensive income

Other comprehensive income consists of net income (loss) for the period plus unrealized gains (losses) on short-term investments. Accordingly, comprehensive income (loss) was $(3.6) million and $(2.0) million for the three months ended September 30, 2010 and 2009, respectively.

Recently Adopted Accounting Pronouncements

In October 2009, the Financial Accounting Standards Board (“FASB”) amended the accounting standards for revenue recognition to remove tangible products containing software components and non-software components that function together to deliver the product’s essential functionality from the scope of industry specific software revenue recognition guidance. In October 2009, the FASB also amended the standards for multiple deliverable revenue arrangements to:

 

  (i) provide updated guidance on whether multiple deliverables exist, how the deliverables in an arrangement should be separated, and how the arrangement consideration should be allocated among its elements;

 

  (ii) require an entity to allocate the revenue using estimated selling prices (ESP) of the deliverables if there is no vendor specific objective evidence (VSOE) or third party evidence of selling price (TPE); and

 

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  (iii) eliminate the use of the residual method and require an entity to allocate revenue using the relative selling price method.

This new accounting guidance became applicable to the Company beginning the first quarter of its fiscal 2011. The Company adopted this guidance for transactions that were entered into or materially modified on or after July 1, 2010 using the prospective basis of adoption.

The Company derives its revenue from sales of IP telecommunications systems and related support and services. The typical system includes a combination of IP phones, switches and software applications. 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’s core software (herein after referred to as ‘essential software’) is integrated with hardware and is essential to the functionality of the integrated system product. The Company also sells additional software which provides increased features and functions, but is not essential to the overall functionality of the integrated system products (herein after referred to as ‘non-essential software’). At the initial purchase, the customer generally bundles together the hardware, essential software, non-essential software, as needed 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 components, and related post-contractual support by purchasing them separately.

This guidance does not generally change the units of accounting for the Company’s revenue transactions. Most of the products and services continue to qualify as separate units of accounting. Many of the Company’s products have both software and non-software components that function together to deliver the essential functionality of the integrated system product. The Company analyzes all of its software and non-software products and services and considers the features and functionalities of the individual elements and the stand alone sales of those individual components among other factors, to determine which elements are essential or non-essential to the overall functionality of the integrated system product.

For transactions entered into prior to the first quarter of fiscal 2011, the Company recognized revenue based on industry specific software revenue recognition guidance. In accordance with industry specific software revenue recognition guidance, the Company utilized 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, is deferred and the remaining portion of the arrangement consideration is recognized as product revenue. 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 based on the volume and pricing of the stand alone sales within a narrow range. 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.

For transactions entered into or materially modified on or after the beginning of the first quarter of fiscal 2011, the total arrangement fees were allocated to all the deliverables based on their respective relative selling prices. The relative selling price is determined using VSOE when available. When VSOE cannot be established, the Company attempts to determine the TPE for the deliverables. TPE is determined based on competitor prices for similar deliverables when sold separately by the competitors. Generally the Company’s product offerings differ from those of its competitors and comparable pricing of its competitors is often not available. Therefore, the Company is typically not able to determine TPE. When the Company is unable to establish selling price using VSOE or TPE, the Company uses ESP in its allocation of arrangement fees. The ESP for a deliverable is determined as the price at which the Company would transact if the products or services were sold on a stand alone basis.

 

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The Company has been able to establish VSOE for its professional and post contractual support services mainly based on the volume and the pricing of the stand alone sales for these services within a narrow range. The Company establishes its ESP for products by considering factors including, but not limited to, geographies, customer segments and pricing practices. The determination of ESP is made through consultation with and formal approval by the Company management. The Company regularly reviews VSOE, TPE and ESP and maintains internal controls over the establishment and updates of these estimates. The Company does not expect a material impact in the near term from the changes in VSOE, TPE or ESP.

The Company’s multiple element arrangements may include non-essential software deliverables that are subject to the industry specific software revenue recognition guidance. The revenue for these multiple element arrangements is allocated to the non-essential software deliverables and the non-software deliverables based on the relative selling prices of all of the deliverables in the arrangement using the hierarchy in the new revenue accounting guidance. As the Company has not been able to obtain VSOE for all of the non-essential software deliverables in the arrangement, revenue allocated to such non-essential software elements is recognized using the residual method in accordance with industry specific software revenue recognition guidance as the Company was able to obtain VSOE for the undelivered elements bundled with such non-essential software elements. Under the residual method, the amount of revenue recognized for the delivered non-essential software elements equaled the total allocated consideration less the VSOE of any undelivered elements bundled with such non-essential software elements.

Total revenue as reported and pro forma net sales that would have been reported during the three months ended September 30, 2010, if the transaction entered into or materially modified on or after July 1, 2010 were subject to previous accounting guidance, are shown in the following table (in thousands):

 

     Three months ended September 30, 2010
(Unaudited)
 
     As reported      Pro Forma basis as if
the previous
accounting guidance
were in effect
 

Total revenue

   $ 44,279       $ 44,208   

The impact to total revenue during the three months ended September 30, 2010 of the new revenue accounting guidance was primarily to increase product revenues.

In terms of the timing and pattern of revenue recognition, the new accounting guidance for revenue recognition is not expected to have a significant effect on net sales in periods after the initial adoption when applied to multiple element arrangements due to the existence of VSOE for most of the Company’s service offerings which remain undelivered after the software and non-software tangible products are delivered at the inception of the arrangement. The Company’s future revenue recognition for multiple element arrangements is not expected to differ materially from the results in the current period. However, as the Company’s marketing and product strategies evolve, the Company may modify its pricing practices in the future, which could result in changes in selling prices, including both VSOE and ESP which could impact future revenues.

 

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3. Balance Sheet Details

Balance sheet components consist of the following:

 

(In thousands)

   September 30,
2010
    June 30,
2010
 

Inventories:

    

Raw materials

   $ —        $ 335   

Inventory in process/transit

     640        526   

Finished goods

     9,893        9,093   
                
   $ 10,533      $ 9,954   
                

Prepaid expenses and other current assets:

    

Prepaid expenses and other receivables

   $ 3,913      $ 7,778   

Deferred cost of revenue

     544        347   
                
   $ 4,457      $ 8,125   
                

Property and equipment, net:

    

Computer equipment and tooling

   $ 9,672      $ 9,559   

Software

     2,238        1,354   

Furniture and fixtures

     1,522        1,196   

Leasehold improvements and other

     1,686        583   
                

Total property and equipment

     15,118        12,692   

Less accumulated depreciation and amortization

     (7,302     (6,673
                

Property and equipment - net

   $ 7,816      $ 6,019   
                

Deferred revenue - current and long-term:

    

Product

   $ 1,429      $ 966   

Support and services

     29,175        27,753   
                

Total deferred revenue

   $ 30,604      $ 28,719   
                

Other assets:

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

 

     September 30, 2010      June 30, 2010  
     Gross Carrying
Amount
     Accumulated
Amortization
    Net Carrying
Amount
     Gross Carrying
Amount
     Accumulated
Amortization
    Net Carrying
Amount
 

Licensed technology

   $ 2,310       $ (577   $ 1,733       $ 2,310       $ (532   $ 1,778   

Intangible assets in pre-release

     3,183         —          3,183         3,247         —          3,247   
                                                   

Other intangible assets

   $ 5,493       $ (577     4,916       $ 5,557       $ (532     5,025   
                                       

Prepaid royalties

          704              914   

Deferred tax asset

          53              53   

Deposits and other

          237              234   
                           

Total other assets

        $ 5,910            $ 6,226   
                           

The intangible assets are all amortizable and have original estimated useful lives of three to six years. Amortization of intangible assets for the three months ended September 30, 2010 and 2009 was $0.1 million and $0.1 million, 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 (remaining 9 months)

   $ 340   

2012

     453   

2013

     453   

2014

     406   

2015

     81   
        

Total

   $ 1,733   
        

 

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Short-Term Investments:

The following tables summarize the Company’s short-term investments (in thousands):

 

     Amortized Cost      Gross Unrealized
Gains
     Gross Unrealized
Losses
    Fair
Value
 

As of September 30, 2010

          

Corporate notes and commercial paper

   $ 25,622       $ 111       $ —        $ 25,733   

US Government agency securities

     24,526         135         —          24,661   
                                  

Total short-term investments

   $ 50,148       $ 246       $ —        $ 50,394   
                                  

As of June 30, 2010

          

Corporate notes and commercial paper

   $ 33,280       $ 142       $ (50   $ 33,372   

US Government agency securities

     13,904         99         —          14,003   
                                  

Total short-term investments

   $ 47,184       $ 241       $ (50   $ 47,375   
                                  

The following table summarizes the maturities of the Company’s fixed income securities (in thousands):

 

     Amortized Cost      Fair Value  

As of September 30, 2010

     

Less than 1 year

   $ 36,976       $ 37,139   

Due in 1 to 3 years

     13,172         13,255   
                 

Total

   $ 50,148       $ 50,394   
                 

 

     Amortized Cost      Fair Value  

As of June 30, 2010

     

Less than 1 year

   $ 33,956       $ 34,133   

Due in 1 to 3 years

     13,228         13,242   
                 

Total

   $ 47,184       $ 47,375   
                 

Actual maturities may differ from the contractual maturities because borrowers may have the right to call or prepay certain obligations.

4. Fair Value Disclosure

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in the principal market (or most advantageous market, in the absence of a principal market) for the asset or liability in an orderly transaction between market participants at the measurement date. Further, entities are required to maximize the use of observable inputs and minimize the use of unobservable inputs in measuring fair value, and to utilize a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. The three levels of inputs used to measure fair value are as follows:

 

   

Level 1 — Quoted prices in active markets for identical assets or liabilities.

 

   

Level 2 — Observable inputs other than quoted prices included within Level 1, including quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; and inputs other than quoted prices that are observable or are derived principally from, or corroborated by, observable market data by correlation or other means.

 

   

Level 3 — Unobservable inputs that are supported by little or no market activity, are significant to the fair value of the assets or liabilities, and reflect our own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances.

 

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The tables below set forth the Company’s cash equivalents and short-term investments measured at fair value on a recurring basis (in thousands):

 

     As of September 30, 2010  
     Fair Value      Level 1      Level 2      Level 3  

Assets

           

Cash and cash equivalents:

           

Money market funds

   $ 50,893       $ 50,893         —           —     

Short-term investments:

           

Corporate notes and commercial paper

     25,733         —           25,733         —     

US Government agency securities

     24,661         —           24,661         —     
                                   

Total financial instruments measured and recorded at fair value

   $ 101,287       $ 50,893       $ 50,394       $ —     
                                   

The above table excludes $14.9 million of cash balances on deposit at banks.

 

     As at June 30, 2010  
     Fair Value      Level 1      Level 2      Level 3  

Assets

           

Cash and cash equivalents:

           

Money market funds

   $ 51,660       $ 51,660       $ —         $ —     

Short-term investments:

           

Corporate notes and commercial paper

     33,372         —           33,372         —     

US Government agency securities

     14,003         —           14,003         —     
                                   

Total financial instruments measured and recorded at fair value

   $ 99,035       $ 51,660       $ 47,375       $ —     
                                   

The above table excludes $16.8 million of cash balances on deposit at banks.

Cash equivalents are classified within Level 1 of the fair value hierarchy because they are valued using quoted market prices. Investment securities are classified within Level 2 of the fair value hierarchy because they are valued based on other observable inputs, including broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency. The types of instruments valued based on quoted market prices in active markets include money market securities. The types of instruments valued based on other observable inputs include corporate notes and commercial paper and US Government agency securities.

5. Income Taxes

The Company recorded an income tax expense of $0.1 million and $22,000 for the three months ended September 30, 2010 and 2009.

The income tax provision of $0.1 million for the three months ended September 30, 2010 was calculated under the annual effective tax rate method. The effective tax rate for the three months ended September 30, 2010 differs from the statutory federal rate of 35% primarily as a result of nondeductible stock-based compensation expenses and state taxes.

The income tax provision of $22,000 for the three months ended September 30, 2009 represents the tax provision for the profitable jurisdictions based upon income earned during the period while no tax benefit was accrued on the loss jurisdictions.

The Company maintains liabilities for uncertain tax positions. As of September 30, 2010 and June 30, 2010, the Company’s total amount of unrecognized tax benefits were $2.1 million. Of the total $2.1 million of unrecognized tax benefit, only $0.3 million if recognized would impact the effective tax rate.

While management believes that the Company has adequately provided for all tax positions, amounts asserted by tax authorities could be greater or less than the Company’s current position. Accordingly, the Company’s provisions on federal, state and foreign tax related matters to be recorded in the future may change as revised estimates are made or the underlying matters are settled or otherwise resolved. The Company does not expect its unrecognized tax benefits to change materially over the next 12 months.

The Company’s only major tax jurisdiction is the United States. The Company has recently been notified by the Internal Revenue Service (IRS) of their examination for fiscal years 2008 and 2009 and is in the early stage of contacting the IRS to discuss the extent and timing of their requested examination. Other tax years from 2000 through 2010 remain open and subject to tax examination by the appropriate governmental agencies in the United States.

 

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6. Common Stock

Common Shares Reserved for Issuance

At September 30, 2010, the Company has reserved shares of common stock for issuance as follows (in thousands):

 

Reserved under stock option plans

     12,561   

Reserved under employee stock purchase plan

     642   

Conversion of warrants

     1   
        

Total

     13,204   
        

7. Stock-Based Compensation

The Company estimated the grant date fair value of stock option awards and Employee Stock Purchase Plan (ESPP) rights using the Black-Scholes option valuation model with the following assumptions:

 

     Three Months Ended
September 30,
 

Employee Incentive Plans

   2010     2009  

Expected life of option (in years)

     6.08-6.26        6.08-6.46   

Expected life of ESPP right (in years)

     0.50        0.50   

Risk-free interest rate for option

     1.55     2.47

Risk-free interest rate for ESPP right

     0.19     0.27

Volatility for option

     57     58

Volatility for ESPP right

     46     138

Dividend yield

     0     0

During the three months ended September 30, 2010 and 2009, the Company recorded non-cash stock-based compensation expense of $2.8 million and $2.1 million respectively.

Compensation expense is recognized only for the portion of stock options that are expected to vest, assuming an expected forfeiture rate in determining stock-based compensation expense, which could affect the stock-based compensation expense recorded if there is a significant difference between actual and estimated forfeiture rates. As of September 30, 2010, total unrecognized compensation cost related to stock-based awards granted to employees and non-employee directors was $20.5 million. This cost will be amortized on a ratable basis over a weighted-average vesting period of approximately three years.

8. Stock Option Plan

In January 1997, the Board of Directors and stockholders adopted the 1997 stock option plan (the “1997 Plan”) which, as amended, provides for granting incentive stock options (“ISOs”) and nonqualified stock options (“NSOs”) for shares of common stock to employees, directors, and consultants of the Company. In September 2006, the Company’s board of directors increased the number of shares authorized and reserved for issuance under the 1997 Plan to 10,513,325 shares of common stock. In accordance with the 1997 Plan, the stated exercise price shall not be less than 100% and 85% of the estimated fair market value of common stock on the date of grant for ISOs and NSOs, respectively, as determined by the Board of Directors. The 1997 Plan provides that the options shall be exercisable over a period not to exceed ten years. Options generally vest ratably over four years from the date of grant. Options granted to certain executive officers are exercisable immediately and unvested shares issued upon exercise are subject to repurchase by the Company at the exercise price (“Class Two Options”). During the three months ended September 30, 2010 and 2009, no unvested shares were repurchased. The Company’s repurchase right for such options lapses as the options vest, generally over four years from the date of grant.

In February 2007, the Company adopted the 2007 Equity Incentive Plan (the “2007 Plan”) which, as amended, provides for grants of ISOs, NSOs, restricted stock units (“RSUs”) and restricted stock awards (“RSAs”) to employees, directors and consultants of the Company. This plan serves as the successor to the 1997 Plan, which terminated in January 2007. Five million shares of common stock were initially reserved for future issuance in the form of stock options, restricted stock awards or units, stock appreciation rights and stock bonuses. In February of each fiscal year, pursuant to the automatic increase provisions of the 2007 Plan, the Company’s board of directors increased the number of shares authorized and reserved for issuance under the 2007 Plan by 2.2 million both in 2009 and 2010.

 

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Class Two Options granted under the 1997 Plan to certain executive officers are exercisable immediately and shares issued upon exercise are subject to repurchase by the Company at the exercise price, in the event the employee is terminated; such repurchase right lapses gradually over a four year period. The Company does not consider the exercise of stock options substantive when the issued stock is subject to repurchase. Accordingly, the proceeds from the exercise of such options are accounted for as a deposit liability until the repurchase right lapses, at which time the proceeds are reclassified to permanent equity. As of September 30, 2010 and June 30, 2010, there were no shares of the Company’s common stock outstanding subject to repurchase resulting in no related recorded liability included in accrued liabilities.

Transactions under the 1997 and 2007 Option Plans are summarized as follows:

 

          Options Outstanding  

(In thousands, except per share data and contractual term)

  Shares Available
for Grant
    Number of
Shares
    Weighted
Average Exercise
Price
    Weighted
Average
Remaining
Contractual
Term
(in Years)
    Aggregate
Intrinsic
Value
 

Balance at July 1, 2010

    4,510        7,492      $ 4.59       

Termination of remaining shares available for grant under the 1997 Option Plan and other non-plan options

    (7     —          —         

Granted (weighted average fair value $2.49 per share)

    (928     928        4.56       

Exercised

    —          (126     1.39       

Cancelled, forfeited or expired

    576        (576     5.31       

Restricted stock units granted (see Note 10)

    (606     —          —         

Restricted stock units cancelled/forfeited

    205        —          —         
                     

Balance at September 30, 2010

    3,750        7,718      $ 4.59        6.7      $ 5,705   
                     

Vested and expected to vest at September 30, 2010

      7,310      $ 4.56        6.7      $ 5,612   
               

Vested and exercisable at September 30, 2010

      3,095      $ 3.87        6.0      $ 4,825   
               

The total pre-tax intrinsic value for options exercised in the three months ended September 30, 2010 and 2009 was $0.5 million and $0.4 million, respectively, representing the difference between the fair values of the Company’s common stock underlying these options at the dates of exercise and the exercise prices paid. There were 7,000 cancelled options that expired under the 1997 Option Plan due to the termination of that plan. These cancelled, expired options have been included in the option activity for the three months ended September 30, 2010.

9. Employee Stock Purchase Plan

On September 18, 2007, the Board of Directors approved the commencement of offering periods under a previously-approved employee stock purchase plan (the “ESPP”). The ESPP allows eligible employees to purchase shares of Company stock at a discount through payroll deductions. The ESPP consists of six-month offering periods commencing on May 1 st and November 1 st , each year. Employees purchase shares in the purchase period at 90% of the market value of the Company’s common stock at either the beginning of the offering period or the end of the offering period, whichever price is lower.

In February of fiscal 2010 and 2009, pursuant to the automatic increase provisions of the ESPP, the Company’s Board of Directors approved increases to the number of shares authorized and reserved for issuance under the ESPP by 449,000 shares and 438,000 shares, respectively, pursuant to the terms of that plan.

As of September 30, 2010, 642,000 shares had been reserved for future issuance.

10. Restricted Stock

Under the 2007 Plan, the Company issued restricted stock awards to non-employee directors electing to receive them in lieu of an annual cash retainer during the three months ended September 30, 2010.

In addition, restricted stock units can be issued under the 2007 Plan to eligible employees, and generally vest 25% at one year or 50% at two years from the date of grant and 25% annually thereafter.

 

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Restricted stock award and restricted stock unit activity for the three months ended September 30, 2010 and 2009 is as follows (in thousands):

 

     Three months ended
September 30, 2010
    Three months ended
September 30, 2009
 

Beginning balance

     809        507   

Awarded

     606        123   

Released

     (181     (19

Forfeited

     (141     (5
                

Ending balance

     1,093        606   
                

Information regarding restricted stock units outstanding at September 30, 2010 is summarized below:

 

     Number of Shares (thousands)      Weighted Average
Remaining
Contractual Lives
     Average Intrinsic
Value (thousands)
 

Shares outstanding

     1,093         2.11 years       $ 5,421   

Shares vested and expected to vest

     940         2.04 years         4,663   

11. Litigation, Commitments and Contingencies

Litigation — The Company was a party to the following material litigation:

U.S. Federal Court Class Action Litigation . On January 16, 2008, a purported stockholder class action lawsuit captioned Watkins v. ShoreTel, Inc., et al., was filed in the United States District Court for the Northern District of California against the Company, certain of its officers and directors, and the underwriters of the Company’s initial public offering. A second purported class action alleging the same claims were filed on January 29, 2008 and the lawsuits were consolidated. A second consolidated amended class action complaint was subsequently filed on March 2, 2009. The consolidated action was purportedly brought on behalf of those who purchased the Company’s common stock pursuant to the initial public offering on July 3, 2007, purports to allege claims for violations of the federal securities laws, and seeks unspecified compensatory damages and other relief. The Company and counsel for the lead plaintiffs reached an agreement in principle in February 2010 to settle the litigation for $3.0 million, pursuant to which, without admitting any liability or wrongdoing of any kind, the Company would pay the plaintiff class $0.3 million with the remaining $2.7 million funded by insurance. This settlement agreement, which resolved all the claims in the litigation, received final Court approval in October 2010.

California State Court Derivative Action . On January 30, 2008, a purported shareholder derivative lawsuit captioned Berkovitz v. Combs, et al., was filed in the Superior Court of the State of California, County of Santa Clara, against the Company (as a nominal defendant), its directors and certain officers. The complaint purported to allege claims for breach of fiduciary duty and other claims and seeks unspecified compensatory damages and other relief based on essentially the same allegations as the class action litigation. The Company and plaintiffs reached an agreement in principle to settle the litigation in February 2010, pursuant to which, without admitting any liability or wrongdoing of any kind, the Company adopted certain corporate remedial measures. This settlement agreement, which resolved all the claims in the litigation, is pending final Court approval.

General. The Company could become involved in litigation from time to time relating to claims arising out of the ordinary course of business or otherwise. Any litigation, regardless of outcome, is costly and time-consuming, can divert the attention of management and key personnel from business operations and deter distributors from selling the Company’s products and dissuade potential customers from purchasing the Company’s products.

Leases — The Company leases its facilities under noncancelable operating leases which expire at various times through 2015. The leases provide for the lessee to pay all cost of utilities, insurance, and taxes. Future minimum lease payments under the noncancelable leases as of September 30, 2010, are as follows (in thousands):

 

Years Ending June 30,

      

2011 (remaining 9 months)

   $ 1,476   

2012

     1,758   

2013

     1,235   

2014

     1,112   

2015

     280   
        

Total

   $ 5,861   
        

 

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Lease obligations for the Company’s foreign offices are denominated in foreign currencies, which were converted in the above table to U.S. dollars at the interbank exchange rate on September 30, 2010.

Rent expense for the three months ended September 30, 2010 and 2009 was $0.4 million and $0.3 million, respectively.

Purchase commitments — The Company had purchase commitments with contract manufacturers for inventory and with technology firms for usage of software licenses totaling approximately $32.8 million as of September 30, 2010.

Indemnification — Under the indemnification provisions of the Company’s customer agreements, the Company agrees to indemnify and defend its customers against infringement of any patent, trademark, or copyright of any country or the misappropriation of any trade secret, arising from the customers’ legal use of the Company’s services. The exposure to the Company under these indemnification provisions is generally limited to the total amount paid by the customers under pertinent agreements. However, certain indemnification provisions potentially expose the Company to losses in excess of the aggregate amount received from the customer. To date, there have been no claims against the Company or its customers pertaining to such indemnification provisions and no amounts have been recorded.

The Company also has entered into customary indemnification agreements with each of its officers and directors.

12. Segment Information

The Company is organized as, and operates in, one reportable segment: the development and sale of IP voice communication systems. The Company’s chief operating decision-maker is its Chief Executive Officer. The Company’s Chief Executive Officer reviews financial information presented on a consolidated basis for purposes of evaluating financial performance and allocating resources, accompanied by information about revenue by geographic regions. The Company’s assets are primarily located in the United States of America and not allocated to any specific region and it does not measure the performance of its geographic regions based upon asset-based metrics. Therefore, geographic information is presented only for revenue. Revenue by geographic region is based on the ship to address on the customer order.

The following presents total revenue by geographic region (in thousands):

 

     Three Months Ended
September 30,
 
     2010      2009  

United States

   $ 39,507       $ 30,495   

International

     4,772         3,255   
                 

Total revenues

   $ 44,279       $ 33,750   
                 

13. Subsequent Events

Acquisition of Agito Networks, Inc.

On October 19, 2010, the Company completed the acquisition of Agito Networks, Inc., a Delaware corporation (“Agito”) and Atoll Acquisition Corp., a Delaware corporation and wholly owned subsidiary of the Company (“Merger Sub”), pursuant to which the Company acquired Agito by merging the Merger Sub with and into Agito, with Agito as the surviving corporation and a wholly owned subsidiary of the Company (the “Merger”).

Of the total consideration (i) approximately $10.4 million was paid in cash at closing and (ii) approximately $1.0 million of cash was placed in escrow at closing for twelve months to secure claims for indemnification. The Company funded the merger consideration from its cash on hand.

Litigation Settlement

The Company received final court approval for its federal court class action litigation and California state court derivative action in October 2010. See Note 11 to our Financial Statements.

 

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ITEM 2. 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 condensed consolidated financial statements and related notes included elsewhere in this document. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those discussed below. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed above in the section entitled “Risk Factors.”

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 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 850 as of September 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 will 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 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 have 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 sales, customer support, general and administrative and engineering functions in Austin, Texas. The majority of our personnel work at these locations. Sales, engineering, and support personnel are 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 were 11% of our total revenue for the three months ended September 30, 2010 and were less than 10% of our total revenue for the three months ended September 30, 2009. 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.

 

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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 revenue attributable to existing enterprise customers, which currently represents a significant portion of our total revenue.

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 the Company’s 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 the rate of renewal 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 September 30, 2010 was $30.6 million, consisting of $1.4 million of deferred product revenue and $29.2 million of deferred support and services revenues, of which $20.6 million is expected to be recognized within one year.

Gross profit. Our gross profit for products is primarily affected by our ability to reduce hardware costs faster than the decline in average overall system prices. We have been able to maintain our product gross profit by reducing hardware costs through product redesign and volume discount pricing from our suppliers. We have also introduced new, lower cost hardware following these introductions, which has continued to improve our product gross profit. In general, product gross profit on our switches is greater than product gross profit 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 system sales. We consider our ability to monitor and manage these factors to be a key aspect of maintaining product gross profit and increasing our profitability.

Gross profit for support and services can be lower than gross profit 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 maximum 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 profit 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 expenses. 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 increases in our headcount. We intend to expand our workforce to support our anticipated growth, and therefore our ability to forecast and increase revenue is critical to managing our operating expenses and profitability.

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 metrics, as well as our own strategic considerations.

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.

 

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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 costs of personnel engaged in support and services, and are substantially fixed in the near term.

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 are devoting substantial resources to the development of additional functionality for existing products and the development of new products and related software applications.

Sales and marketing expenses. Sales and marketing expenses primarily include personnel costs, sales commissions, travel, marketing promotional and lead generation programs, 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, allowance for doubtful accounts, 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, net. Other income primarily consists of interest earned on cash and short-term investments, foreign exchange gains and other miscellaneous income.

Income tax provision. Income tax provision includes federal, state and foreign tax on our income. Historically, we accumulated substantial net operating loss and tax credit carryforwards. We account for income taxes under an asset and liability approach. Deferred income taxes reflect the impact of temporary differences between assets and liabilities recognized for financial reporting purposes and such amounts recognized for income tax reporting purposes, net operating loss carry-forwards and other tax credits measured by applying currently enacted tax laws. Valuation allowances are provided when necessary to reduce deferred tax assets to an amount that is more likely than not to be realized.

Critical Accounting Policies and Estimates

The preparation of our financial statements and related disclosures in conformity with generally accepted accounting principles in the United States of America, or GAAP, requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. These estimates and assumptions are based on historical experience and various other factors that we believe are reasonable under the circumstances. We consider our accounting policies related to revenue recognition, allowance for doubtful accounts, stock-based compensation, inventory valuation and accounting for income tax to be critical accounting policies. A number of significant estimates, assumptions, and judgments are inherent in our determination of when to recognize revenue, how to estimate the best evidence of selling price for revenue recognition, how to estimate doubtful accounts, the calculation of stock-based compensation expense, and how we value inventory. We base our estimates and judgments on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ materially from these estimates. Other than the changes resulting from the adoption of the new revenue recognition rules as discussed in Note 2 of the financial statements in the current quarter and establishing the estimated selling prices for products and services, management believes there have been no significant changes during the three months ended September 30, 2010 to the items that we disclosed as our critical accounting policies and estimates in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our 2010 Annual Report on Form 10-K filed with the Securities and Exchange Commission. For a description of those accounting policies, please refer to our 2010 Annual Report on Form 10-K.

 

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Results of Operations

The following table sets forth unaudited selected consolidated statements of operations data for three months ended September 30, 2010 and 2009 (Amounts in thousands, except per share amounts).

 

     Three Months Ended
September 30,
 
     2010     2009  

Revenue:

    

Product

   $ 35,226      $ 26,843   

Support and services

     9,053        6,907   
                

Total revenues

     44,279        33,750   

Cost of revenue

    

Product (1)

     11,767        9,533   

Support and services (1)

     2,976        2,584   
                

Total cost of revenue

     14,743        12,117   
                

Gross profit

     29,536        21,633   

Gross profit %

     66.7     64.1

Operating expenses:

    

Research and development (1)

     10,322        7,197   

Sales and marketing (1)

     17,203        12,017   

General and administrative (1)

     6,133        4,651   
                

Total operating expenses

     33,658        23,865   
                

Loss from operations

     (4,122     (2,232

Other income, net

     587        128   
                

Loss before provision for income taxes

     (3,535     (2,104

Provision for income taxes

     (110     (22
                

Net loss

   $ (3,645   $ (2,126
                

Net loss per share — basic and diluted (2)

   $ (0.08   $ (0.05

Shares used in computing net loss per share — basic and diluted (2)

     45,444        44,385   

 

(1)     Includes stock-based compensation as follows:

    

Cost of product revenue

   $ 35      $ 27   

Cost of support and services revenue

     200        111   

Research and development

     824        638   

Sales and marketing

     868        699   

General and administrative

     897        615   
                
   $ 2,824      $ 2,090   
                

(2)    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.

    

 

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

 

     Three Months Ended
September 30,
 
     2010     2009  

Revenue:

    

Product

     80     80

Support and services

     20     20
                

Total revenue

     100     100

Cost of revenue:

    

Product

     26     28

Support and services

     7     8
                

Total cost of revenue

     33     36
                

Gross profit

     67     64

Operating expenses:

    

Research and development

     23     21

Sales and marketing

     39     35

General and administrative

     14     14
                

Total operating expenses

     76     70
                

Operating loss

     (9 )%      (6 )% 

Interest and other income, net

     1 %     —     
                

Loss before benefit from income tax

     (8 )%      (6 )% 

Provision for income taxes

     —          —     
                

Net loss

     (8 )%      (6 )% 
                

Use of Non-GAAP Financial Measures

We believe that evaluating our ongoing operating results may limit the reader’s understanding if limited to reviewing only generally accepted accounting principles (GAAP) financial measures. Many investors and analysts have requested that, in addition to reporting financial information in accordance with GAAP we also disclose certain non-GAAP information because it is useful in understanding our performance as it excludes non-cash and other special charges or credits that many investors and management feel may obscure our true operating performance. Likewise, we use these non-GAAP financial measures to manage and assess the profitability of the business and determine a portion of our employee compensation. We do not consider stock-based compensation expenses and other special charges and related tax adjustments in managing our 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 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.

 

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RECONCILIATION OF GAAP TO NON-GAAP FINANCIAL MEASURES

(Amounts in thousands, except per share amounts)

(Unaudited)

     Three Months Ended
September 30,
 
     2010     2009  

GAAP net loss available to stockholders:

   $ (3,645   $ (2,126

Adjustments for non-GAAP items (1)

     3,349        2,063   

Tax effect of non-GAAP adjustments

     99        (28
                

Non-GAAP net loss available to stockholders

   $ (197   $ (91
                

GAAP diluted net loss per share :

   $ (0.08   $ (0.05

Adjustments for non-GAAP items

     0.08        0.05   

Tax effect of non-GAAP adjustments

     0.00        (0.00
                

Non-GAAP diluted net loss per share:

   $ (0.00   $ (0.00
                

Shares Used in Non-GAAP diluted per share calculation

     45,444        44,385   

 

(1)     Adjustments for non-GAAP items include:

    

Stock-based compensation

   $ 2,824      $ 2,090   

Restructuring expense (benefit), included in Research and development expenses

     —          (27

Executive Severance, included in General and administrative expenses

     525        —     
                

Adjustments for non-GAAP items

   $ 3,349      $ 2,063   
                

The following table sets forth GAAP and Non-GAAP reconciliation of operating expenses (amounts in thousands):

 

     Three Months Ended
September 30,
 
     2010     2009  

Total GAAP operating expenses

   $ 33,658      $ 23,865   

Stock-based compensation included in operating expenses

     (2,589     (1,952

Restructuring benefit included in Research and development expenses

     —          27   

Executive severance, included in General and administrative expenses

     (525     —     
                

Total Non-GAAP operating expenses

   $ 30,544      $ 21,940   
                

Non-GAAP items as a % of GAAP operating expenses

     (9 )%      (8 )% 

Comparison of the three months ended September 30, 2010 and September 30, 2009

Net Revenue.

 

     Three Months Ended
September 30,
 

(Dollars in thousands)

   2010      2009      Dollar
Variance
     Percent
Variance
 

Revenue

   $ 44,279       $ 33,750       $ 10,529         31

Net revenues increased by $10.5 million or 31% in the three months ended September 30, 2010 as compared to three months ended September 30, 2009. The increase was due to increases in products, support and services revenues. Product revenues in the three months ended September 30, 2010 are $35.2 million, an increase of $8.4 million or 31%. The increase in product revenue is attributable to the increase in customer base, from our domestic channel partners including our regional and national partners and international, resulting from the increased sales and marketing efforts during the last fiscal year and continuing in the current year. Support and services revenues in the three months ended September 30, 2010 were $9.1 million, an increase of $2.1 million or 31%. Increase in support and services revenue is due to the increase in support renewals and demand for services from a larger customer base.

 

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Cost of revenue and gross profit.

 

     Three Months Ended
September 30,
 

(Dollars in thousands)

   2010     2009     Dollar
Variance
     Percent
Variance
 

Cost of revenue

   $ 14,743      $ 12,117      $ 2,626         22

Gross profit

   $ 29,536      $ 21,633      $ 7,903         37

Gross margins

     66.7     64.1     

Cost of revenue . Gross margins increased from 64% in the three months ended September 30, 2009 to 67% in the three months ended September 30, 2010. Service margins in the three months ended September 30, 2010 are 67% of the service revenues as compared to 63% in three months ended September 30, 2009. The increase in gross margins of service revenue is due to the growth in revenues outpacing the increase in the cost of services and support and the reduction of the cost of the third party support.

Product gross margins in the three months ended September 30, 2010 were 67% of the product revenues as compared to 64% in the three months ended September 30, 2009. The increase in gross margins of product revenues is due to reduced costs on certain products and slower growth in operational costs associated with products revenues.

Operating expenses.

 

     Three Months Ended
September 30,
 

(Dollars in thousands)

   2010      2009      Dollar
Variance
     Percent
Variance
 

Research and development

   $ 10,322       $ 7,197       $ 3,125         43

Sales and marketing

     17,203         12,017         5,186         43

General and administrative

     6,133         4,651         1,482         32

Research and development. Compensation, including stock-based compensation, for research and development employees accounted for $1.7 million of the increase, primarily as a result of an increase in headcount by 39 employees at September 30, 2010. The increase also includes $0.7 million of consulting expenses and $0.3 million in higher allocation costs due to office expansion of our Austin, Texas facility and $0.1 million in additional employee bonuses.

Sales and marketing. The increase in sales and marketing expenses is mainly attributable to increases in advertisement and promotions of $1.7 million, employee compensation, including stock based compensation of $2.0 million, travel expenses of $0.5 million, sales commissions of $0.1 million and overall increase in office and facilities expenses of $0.4 million due to an increase in headcount by 57 employees as compared to September 30, 2009.

General and administrative.  The increase in general and administrative costs is due to an increase in employee compensation, including stock based compensation of $0.6 million, severance payments to the former CEO of $0.5 million and recruitment expenses of $0.2 million.

Other income, net.

 

     Three Months Ended
September 30,
 

(Dollars in thousands)

   2010      2009      Dollar
Variance
     Percent
Variance
 

Other income, net

   $ 587       $ 128       $ 459         359

Other income, net. The increase was primarily attributable to an increase in foreign exchange gain of $0.4 million due to strengthening of other foreign currencies relative to the US dollar and an increase in interest income of $0.1 million due to interest earned on a tax refund.

 

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Income tax provision.

 

     Three Months Ended
September 30,
 

(Dollars in thousands)

   2010      2009      Dollar
Variance
     Percent
Variance
 

Provision for income taxes

   $ 110       $ 22       $ 88         400
                                   

Income tax provision. The provision for income taxes increased by $88,000 in three months ended September 30, 2010 as compared to three months ended September 30, 2009.

Liquidity and Capital Resources

Balance Sheet and Cash Flows

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

 

     September 30,
2010
     June 30,
2010
     Increase/
(Decrease)
 

Cash, cash equivalents and short-term investments:

        

Cash and cash equivalents

   $ 65,842       $ 68,426       $ (2,584

Short-term investments

     50,394         47,375         3,019   
                          

Total

   $ 116,236       $ 115,801       $ 435   
                          

As of September 30, 2010, our principal sources of liquidity consisted of cash and cash equivalents and short-term investments of $116.2 million and accounts receivable, net of $25.5 million.

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 $116.2 million of cash and cash equivalents and short-term investments at September 30, 2010 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 addition of new business initiatives, the timing and extent of our expansion into new territories, the timing of introductions of new products and enhancements to existing products, the continuing market acceptance of our products and acquisition and licensing activities. We may enter into agreements relating to potential investments in, or acquisitions of, complementary businesses or technologies in the future, which could also require us to seek additional equity or debt financing. Please refer to Note 13 to the financial statements regarding the acquisition of Agito Networks, Inc. by the Company in October 2010. If needed, 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:

 

     Three Months Ended
September 30
 

(Dollars in thousands)

   2010     2009  

Net cash flow provided by (used in):

    

Operating activities

   $ 3,065      $ 5,247   

Investing activities

     (5,523     3,029   

Financing activities

     (126     97   
                

Net (decrease) increase in cash and cash equivalents

   $ (2,584   $ 8,373   
                

 

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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 operating expense 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 current 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. In some cases we also prepay for license rights to third-party products in advance of sales.

Net loss during the three months ended September 20, 2010 and 2009 included non-cash charges of $2.8 million and $2.1 million in stock-based compensation expense, respectively, and depreciation and amortization of $0.8 million and $0.6 million, respectively.

Cash provided by operating activities during the three months ended September 30, 2010 also reflect net changes in operating assets and liabilities, which provided $3.0 million consisting primarily of a decrease in prepaid and other current assets of $3.7 million, an increase in deferred revenue of $1.9 million due to higher maintenance support contracts, a decrease in other assets of $0.2 million, an increase in accrued employee compensation of $0.2 million, and partially offset by, increase in accounts receivables of $0.9 million due to a increase in days sales outstanding (DSO), a decrease of $1.0 million in accrued liabilities, an increase in inventories of $0.6 million and a decrease in accounts payables of $0.6 million.

Cash provided by operating activities during the three months ended September 30, 2009 also reflect net changes in operating assets and liabilities, which provided $4.5 million, consisting primarily of a significant decrease in accounts receivables of $2.4 million due to decrease in days sales outstanding (DSO), an increase in accrued employee compensation of $2.1 million, an increase in deferred revenue of $1.1 million, an increase of $1.0 million in accrued liabilities and other, partially offset by an increase in inventories of $1.3 million and a decrease in accounts payable of $0.9 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 in corporate bonds to maturity; however, we may sell an investment at any time if the quality rating of the investment declines, the yield on the investment is no longer attractive or we are in need of cash.

Net cash (used in) provided by investing activities was $(5.5) million during the three months ended September 30, 2010 and $3.0 million during the three months ended September 30, 2009, respectively. Net cash used in investing activities in the three months ended September 30, 2010 mainly related to net purchase of short-term investments of $3.1 million and purchase of fixed assets of $2.4 million. Net cash provided by investing activities in the three months ended September 30, 2009 related to net sale/maturities of short-term investments of $4.6 million, partially off-set by purchase of fixed assets and software licenses of $1.6 million.

Cash flows from financing activities

Net cash (used in) provided by financing activities was $(0.1) million and $0.1 million for the three months ended September 30, 2010 and 2009, respectively. In the three months ended September 30, 2010, the Company received $0.2 million on exercise of stock options and paid $0.3 million in form of taxes on the vested and released restricted stock units. The Company received $0.1 million on exercise of stock options in the three months ended September 30, 2009.

Off-Balance Sheet Arrangements

We do not have any material off-balance sheet arrangements 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.

 

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Contractual obligations and commitments

The following table summarizes our contractual obligations as of September 30, 2010 and the effect that such obligations are expected to have on our liquidity and cash flows in future periods:

 

     Payments Due By Period  

(Dollars in thousands)

   Less than 1
Year
     1 - 3 Years      3 - 5 Years      5 years and after      Total  

Operating Leases

   $ 1,476       $ 2,993       $ 1,392       $ —         $ 5,861   

Purchase obligations

     32,849         —           —           —           32,849   
                                            

Total

   $ 34,325       $ 2,993       $ 1,392       $ —         $ 38,710   
                                            

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

For quantitative and qualitative disclosures about market risk affecting ShoreTel, Inc., see “Quantitative and Qualitative Disclosures About Market Risk” in Item 7A of Part II of our Annual Report on Form 10-K, for the fiscal year ended June 30, 2010. Our exposure to market risk has not changed materially since June 30, 2010.

 

ITEM 4. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures. Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, our disclosure controls and procedures were effective.

Internal Control Over Financial Reporting. There have not been any changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II: OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

See Note 11 to the Financial Statements.

 

ITEM 1A. RISK FACTORS

Except as noted below, there are no material changes in our risk factors as described in “Part I, Item 1A. Risk Factors” of our Annual Report on Form 10-K, for the fiscal year ended June 30, 2010.

We recently made an acquisition and may acquire other companies or technologies, which could divert our management’s attention, result in additional dilution to our stockholders, increase expenses, and otherwise disrupt our operations and harm our operating results.

We recently acquired a company, and we may acquire or invest in other businesses, products or technologies that we believe could complement or expand our capabilities or otherwise offer growth opportunities. The pursuit of potential acquisitions may divert the attention of management and cause us to incur various expenses in identifying, investigating, and pursuing suitable acquisitions, whether or not they are consummated. We cannot assure you that we will realize the anticipated benefits of these acquisitions.

There are inherent risks in integrating and managing corporate acquisitions, and the Company has limited experience with acquisitions. If we acquire additional businesses, we may not be able to integrate the acquired personnel, operations and technologies successfully, or effectively manage the combined business following the acquisition. We also may not achieve the anticipated benefits from the acquired business due to a number of factors, including:

 

   

unanticipated costs or liabilities associated with the acquisition;

 

   

incurrence of acquisition-related costs, which would be recognized as a current period expense under FASB Accounting Standards Codification (“ASC”) 805-20, Business Combinations ;

 

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diversion of management’s attention from other business concerns;

 

   

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

 

   

the potential loss of key employees;

 

   

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

 

   

use of substantial portions of our available cash to consummate the acquisition.

In addition, a significant portion of the purchase price of companies we acquire may be allocated to goodwill and other indefinite lived intangible assets, which must be assessed for impairment at least annually. Also, contingent considerations related to the acquisitions will be remeasured to fair value at each reporting period, with any changes in the value recorded as income or expense. In the future, if our acquisitions do not yield expected returns, we may be required to take charges to our operating results based on this impairment assessment process, which could harm our results of operations.

Future acquisitions could result in dilutive issuances of equity securities or the incurrence of debt, which could adversely affect our operating results. In addition, if an acquired business fails to meet our expectations, our operating results, business and financial condition may suffer.

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

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. As of September 30, 2010, the proceeds from our initial public offering have been 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.

 

ITEM 6. EXHIBITS

See Index to Exhibits following the signature page to this Form 10-Q, which is incorporated by reference herein.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Date: November 5, 2010

 

ShoreTel, Inc.
By:  

/s/    M ICHAEL E. H EALY

 

Michael E. Healy

Chief Financial Officer

 

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EXHIBIT INDEX

 

Exhibit

Number

  

Exhibit Title

10.1    Termination Release Agreement with John W. Combs dated September 29, 2010
31.1(1)    Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer.
31.2(1)    Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer.
32.1(1)    Section 1350 Certification of Chief Executive Officer.
32.2(1)    Section 1350 Certification of Chief Financial Officer.

 

(1) This certification accompanying this report pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 is not deemed filed with the Securities and Exchange Commission and is not to be incorporated by reference into any filing of the Company under the Securities Act of 1933 or the Securities Exchange Act of 1934 (whether made before or after the date of the Report), irrespective of any general incorporation language contained in such filing.

 

27

 

Exhibit 10.1

T ERMINATION R ELEASE A GREEMENT

In consideration of the severance benefits (the “ Severance Benefits ”) offered to me by ShoreTel, Inc. (the “ Employer ”) as set forth on Exhibit A and in connection with the termination of my employment, I agree to the following general release (the “ Release ”).

1. On behalf of myself, my heirs, executors, administrators, successors, and assigns, I hereby fully and forever generally release and discharge Employer, its current, former and future parents, subsidiaries, affiliated companies, related entities, employee benefit plans, and their fiduciaries, predecessors, successors, officers, directors, shareholders, agents, employees and assigns (collectively, the “Company”) from any and all claims, causes of action, and liabilities up through the date of my execution of the Release. The claims subject to this release include, but are not limited to, those relating to my employment with Employer and/or any predecessor or successor to Employer and the termination of such employment. All such claims (including related attorneys’ fees and costs) are barred without regard to whether those claims are based on any alleged breach of a duty arising in statute, contract, or tort. This expressly includes waiver and release of any rights and claims arising under any and all laws, rules, regulations, and ordinances, including, but not limited to: Title VII of the Civil Rights Act of 1964; the Older Workers Benefit Protection Act; the Americans With Disabilities Act; the Age Discrimination in Employment Act; the Fair Labor Standards Act; the National Labor Relations Act; the Family and Medical Leave Act; the Employee Retirement Income Security Act of 1974, as amended (“ERISA”); the Workers Adjustment and Retraining Notification Act; the California Fair Employment and Housing Act (if applicable); the provisions of the California Labor Code (if applicable); the Equal Pay Act of 1963; and any similar law of any other state or governmental entity. The parties agree to apply California law in interpreting the Release.

Accordingly, I further waive any rights under Section 1542 of the Civil Code of the State of California or any similar state statute. Section 1542 states: “A general release does not extend to claims which the creditor does not know or suspect to exist in his or her favor at the time of executing the release, which, if known to him or her, must have materially affected his or her settlement with the debtor.”

2. This Release does not extend to, and has no effect upon, any benefits that have accrued, and to which I have become vested, under any employee benefit plan within the meaning of ERISA sponsored by the Company.

 

  a.

In understanding the terms of the Release and my rights, I have been advised to consult with an attorney of my choice prior to executing the Release. I understand that nothing in this Release is intended to constitute an unlawful release or waiver of any of my rights under any laws and/or to prevent, impede, or interfere with my ability and/or rights, if any: (a) under applicable workers’ compensation laws; (b) to seek unemployment benefits; (c) to file a charge or complaint with a government agency such as but not limited to the Equal Employment Opportunity Commission, the National Labor Relations Board, or any applicable state agency; (d) provide truthful testimony if under subpoena to do so, (e) file a claim with any state or federal agency or to participate or cooperate in such a matter, and/or (f) to challenge the validity of this release. Furthermore, notwithstanding any provisions and covenants herein, the Release shall not waive (a) any rights to indemnification I may have as an officer or director of Employer or otherwise in connection with my employment with Employer, under applicable law or Employer’s bylaws or other governing instruments or any agreement addressing such subject matter between Employer and me (including any fiduciary insurance policy maintained by Employer under which I am covered) or under any merger or acquisition agreement addressing such subject matter, (b) any obligations owed to me as set forth on Exhibit A, (c) my rights of insurance under any liability policy covering Employer’s officers (in addition to the rights under subsection (a) above), or (d) any accrued but unpaid wages; any reimbursement for business expenses pursuant to Employer’s policies for such reimbursements, any outstanding


 

claims for benefits or payments under any benefit plans of Employer or subsidiaries, any accrued but unused vacation, any ongoing agreements evidencing outstanding equity awards granted to me, any obligations owed to me pursuant to the terms of outstanding written agreements between myself and Employer and any claims I may not release as a matter of law, including indemnification claims under applicable law. To the fullest extent permitted by law, any dispute regarding the scope of this general release shall be resolved through binding arbitration pursuant to Subsection h below, and the arbitration provision set forth in the Agreement.

 

  b. I understand and agree that Employer will not provide me with the Severance Benefits unless I execute the Release. I also understand that I have received or will receive, regardless of the execution of the Release, all wages owed to me together with any accrued but unused vacation pay, less applicable withholdings and deductions, earned through my termination date.

 

  c. As part of my existing and continuing obligations to Employer, I have returned to Employer all documents (and all copies thereof) and other property belonging to Employer that I have had in my possession at any time, including but not limited to files, notes, drawings, records, business plans and forecasts, financial information, specification, computer-recorded information, tangible property (including, but not limited to, computers, laptops, pagers, etc.), credit cards, entry cards, identification badges and keys; and any materials of any kind which contain or embody any proprietary or confidential information of Employer (and all reproductions thereof). I understand that, even if I did not sign the Release, I am still bound by any and all confidential/proprietary/trade secret information, non-disclosure and inventions assignment agreement(s) signed by me in connection with my employment with Employer, or with a predecessor or successor of Employer, pursuant to the terms of such agreement(s).

 

  d. I represent and warrant that I am the sole owner of all claims relating to my employment with Employer and/or with any predecessor of Employer, and that I have not assigned or transferred any claims relating to my employment to any other person or entity.

 

  e. I agree to keep the Severance Benefits and the provisions of this Release confidential and not to reveal their contents to anyone except my lawyer, my spouse or other immediate family member, and/or my financial consultant, or as required by legal process or applicable law.

 

  f. I understand and agree that the Release shall not be construed at any time as an admission of liability or wrongdoing by either the Company or myself.

 

  g. I agree that I will not make any negative or disparaging statements or comments, either as fact or as opinion, about the Company, its employees, officers, directors, shareholders, vendors, products or services, business, technologies, market position or performance. Nothing in this paragraph shall prohibit me from providing truthful information in response to a subpoena or other legal process.

 

  h. Any controversy or any claim arising out of or relating to the interpretation, enforceability or breach of the Release shall be settled by arbitration in accordance with the arbitration provision of the Employment Agreement between me and Employer dated February 22, 2010 (the “ Agreement ”). If for any reason the arbitration procedure set forth in the Agreement is unavailable, I agree to arbitration under the employment arbitration rules of the American Arbitration Association or any successor hereto. The parties further agree that the arbitrator shall not be empowered to add to, subtract from, or modify, alter or amend the terms of the Release. Any applicable arbitration rules or policies shall be interpreted in a manner so as to ensure their enforceability under applicable state or federal law.


 

  i. I agree that I have had at least twenty-one (21) calendar days in which to consider whether to execute the Release, no one hurried me into executing the Release during that period, and no one coerced me into executing the Release. I understand that the offer of the Severance Benefits and the Release shall expire on the twenty-second (22nd) calendar day after my employment termination date if I have not accepted it by that time. I further understand that Employer’s obligations under the Release shall not become effective or enforceable until the eighth (8th) calendar day after the date I sign the Release provided that I have timely delivered it to Employer (the “Effective Date”) and that in the seven (7) day period following the date I deliver a signed copy of the Release to Employer I understand that I may revoke my acceptance of the Release. I understand that the Severance Benefits will become available to me after the Effective Date.

 

  j. In executing the Release, I acknowledge that I have not relied upon any statement made by Employer, or any of its representatives or employees, with regard to the Release unless the representation is specifically included herein. Furthermore, the Release and the Agreement contain our entire understanding regarding eligibility for and the payment of severance benefits and supersedes any or all prior representations and agreements regarding the subject matter. Once effective and enforceable, this agreement can only be changed by another written agreement signed by me and an authorized representative of Employer.

 

  k. Should any provision of the Release be determined by an arbitrator, court of competent jurisdiction, or government agency to be wholly or partially invalid or unenforceable, the legality, validity and enforceability of the remaining parts, terms, or provisions are intended to remain in full force and effect. Specifically, should a court, arbitrator, or agency conclude that a particular claim may not be released as a matter of law, it is the intention of the parties that the general release and the waiver of unknown claims above shall otherwise remain effective to release any and all other claims. I acknowledge that I have obtained sufficient information to intelligently exercise my own judgment regarding the terms of the Release before executing the Release.

[S IGNATURE P AGE TO G ENERAL R ELEASE A GREEMENT F OLLOWS ]


 

EXECUTIVE’S ACCEPTANCE OF RELEASE

BEFORE SIGNING MY NAME TO THE RELEASE, I STATE THE FOLLOWING: I HAVE READ THE RELEASE, I UNDERSTAND IT AND I KNOW THAT I AM GIVING UP IMPORTANT RIGHTS. I HAVE OBTAINED SUFFICIENT INFORMATION TO INTELLIGENTLY EXERCISE MY OWN JUDGMENT. I HAVE BEEN ADVISED THAT I SHOULD CONSULT WITH AN ATTORNEY BEFORE SIGNING IT, AND I HAVE SIGNED THE RELEASE KNOWINGLY AND VOLUNTARILY.

Date delivered to employee              ,          .

Executed this      day of          ,          .

 

 

Signature

 

Name (Please Print)

[S IGNATURE P AGE TO G ENERAL R ELEASE A GREEMENT ]


 

Exhibit A

Severance Benefits

 

   

$525,000 representing 18 months of current annual base salary of $350,000

 

   

18 months of COBRA premiums following termination date

 

   

$74,375, representing prorated target bonus for fiscal 2011 based on one quarter of service at 100% achievement level (Determination of bonus: $350,000 x 85% (annual target) x 25% (for one quarter of service in fiscal 2011) x 100% of achievement = $74,375)

 

Exhibit 31.1

CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER

PURSUANT TO EXCHANGE ACT RULES 13a-14(a) AND 15(d)-14(a), AS ADOPTED

PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

I, Donald J. Girskis, certify that:

 

1. I have reviewed this quarterly report on Form 10-Q of ShoreTel, Inc.;

 

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in the Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

 

  a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

  b. Designed such internal control over financing reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

  c. Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

  d. Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 

  a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

  b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: November 5, 2010

 

/s/ Donald J. Girskis

Donald J. Girskis

Chief Executive Officer

(Principal Executive Officer)

 

Exhibit 31.2

CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER

PURSUANT TO EXCHANGE ACT RULES 13a-14(a) AND 15(d)-14(a), AS ADOPTED

PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

I, Michael E. Healy, certify that:

 

1. I have reviewed this quarterly report on Form 10-Q of ShoreTel, Inc.;

 

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in the Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

 

  a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

  b. Designed such internal control over financing reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

  c. Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

  d. Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 

  a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

  b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: November 5, 2010

 

/s/ Michael E. Healy

Michael E. Healy

Chief Financial Officer

(Principal Accounting and Financial Officer)

 

Exhibit 32.1

CERTIFICATION OF CHIEF EXECUTIVE OFFICER

PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

I, Donald J. Girskis, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Quarterly Report on Form 10-Q of ShoreTel, Inc. for the quarter ended September 30, 2010 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such Quarterly Report on Form 10-Q fairly presents in all material respects the financial condition and results of operations of ShoreTel, Inc.

Date: November 5, 2010

 

By:  

/s/ Donald J. Girskis

Name:   Donald J. Girskis
Title:  

Chief Executive Officer

(Principal Executive Officer)

This certification accompanies this Report pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and is not deemed filed with the Securities and Exchange Commission and is not to be incorporated by referenced into any filing of the Company under the Securities Act of 1933 or the Securities Exchange Act of 1934 (whether made on or before or after the date of this Report), irrespective at any general incorporation language contained in such filing.

 

Exhibit 32.2

CERTIFICATION OF CHIEF FINANCIAL OFFICER

PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED

PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

I, Michael E. Healy, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Quarterly Report on Form 10-Q of ShoreTel, Inc. for the quarter ended September 30, 2010 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such Quarterly Report on Form 10-Q fairly presents in all material respects the financial condition and results of operations of ShoreTel, Inc.

Date: November 5, 2010

 

By:  

/s/ Michael E. Healy

Name:   Michael E. Healy
Title:  

Chief Financial Officer

(Principal Accounting and Financial Officer)

This certification accompanies this Report pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and is not deemed filed with the Securities and Exchange Commission and is not to be incorporated by referenced into any filing of the Company under the Securities Act of 1933 or the Securities Exchange Act of 1934 (whether made on or before or after the date of this Report), irrespective at any general incorporation language contained in such filing.