ShoreTel, Inc.
ShoreTel Inc (Form: 10-K, Received: 09/08/2017 15:30:24)

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



Form 10-K

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

For the year ended June 30, 2017

or

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

Commission file number: 001-33506

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

Delaware
3661
77-0443568
(State or other jurisdiction of
incorporation or organization)
(Primary standard industrial
code number)
(I.R.S. employer identification no.)

960 Stewart Drive
Sunnyvale, CA 94085-3913
(408) 331-3300
(Address, including zip code, and telephone number, including area code, of Registrant’s principal executive offices)

Securities registered pursuant to Section 12(b) of the Act:

Title of each class
 
Name of each exchange on which registered
Common Stock, $0.001 par value
 
The NASDAQ Global Select Market

Securities registered pursuant to Section 12(g) of the Act:
None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No ☑

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No ☑

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 ☑ No o

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

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

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

Large accelerated filer o
Accelerated Filer ☑
Non-accelerated filer o (Do not check if a smaller reporting company)
Smaller reporting company o
Emerging Growth Company o
 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

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

The aggregate market value of the voting stock held by non-affiliates of the registrant as of December 31, 2016 was approximately $482.8 million (based on the last reported sale price of $7.15 on December 31, 2016 on The NASDAQ Global Select Market). This calculation does not reflect a determination that persons are affiliates for any other purposes. Shares of stock held by ten percent stockholders have been excluded from this calculation as they may be deemed affiliates.

The number of shares outstanding of the registrant’s common stock as of August 24, 2017 was 69,152,947.

DOCUMENTS INCORPORATED BY REFERENCE

Part III incorporates by reference certain information from the Registrant’s definitive proxy statement (the “2017 Proxy Statement”) for the 2017 Annual Meeting of Stockholders.

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TRADEMARKS

The ShoreTel logo, ShoreTel and Brilliantly Simple are trademarks or registered trademarks of ShoreTel, Inc. in the United States and/or other countries. All other trademarks, trade names and service marks herein are the property of their respective owners.

AVAILABLE INFORMATION

Our Internet address is www.shoretel.com. On our Internet website, we make publicly available free of charge our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission (“SEC”). The information that is contained on or that can be accessed through our Internet website is not part of this Annual Report on Form 10-K.

In addition, the public may read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains a website that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at http://www.sec.gov.

The charters of our Audit Committee, our Compensation Committee and our Corporate Governance and Nominating Committee, as well as our Code of Business Conduct and Ethics, are available on the Investor Relations section of our website under “Investor Relations – Corporate Governance/Leadership.” This information is also available by writing to us at the address on the cover of this Annual Report on Form 10-K.

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

PART I

ITEM 1. BUSINESS

Overview

ShoreTel is a leading provider of brilliantly simple business communication solutions. We focus on the small and medium sized businesses seeking a Unified Communications (“UC”) solution allowing them to communicate anytime, anyplace and through any device that they chose.

We provide this to the market via two solutions: ShoreTel Connect, our UC solution, and Contact Center offering and ShoreTel Summit, our platform for creating microservices. ShoreTel Connect delivers a fully featured UC solution and applications such as mobility, collaboration, and workgroups. ShoreTel Connect is unique in that it offers three different delivery models including cloud, onsite and hybrid. Connect Cloud provides a hosted voice solution to our customers. Connect Onsite provides our customers the ability to independently own and operate their equipment. Connect Hybrid enables our customers to use both our cloud and onsite offerings while still delivering the same user experience and providing our customers increased choice and flexibility. Summit, our Communications Platform as a Service (“CPaaS”) offering, delivers the option to create microservices or deeply integrate communications into any application or workflow.

We believe our solutions address changes in the UC market being driven by both technological advances and new workplace trends. We believe some of the current factors affecting the UC market include: the shift to consuming communications from the cloud, addressing an increasingly mobile workforce, the ongoing need for collaboration, a desire for multiple forms of communication and a need to integrate communications into workflows and applications. Our solutions are sold through our extensive network of over 1,100 authorized resellers and value-added distributors throughout the world served either by national distributors or by ShoreTel directly.

We were originally incorporated in California in September 1996 and reincorporated in Delaware in 2007. ShoreTel is based in Sunnyvale, California, and has regional offices in North America, Europe, Asia and Australia.

Pending Merger

On July 26, 2017, we entered into a definitive Agreement and Plan of Merger (“Merger Agreement”) with Mitel US Holdings, Inc., a Delaware corporation, Shelby Acquisition Corporation, a Delaware corporation and a wholly owned subsidiary of Parent (“Merger Sub”) and, with respect to certain obligations set forth in the Merger Agreement, Mitel Networks Corporation, a Canadian corporation. Pursuant to and subject to the terms and conditions of the Merger Agreement, Merger Sub has commenced an all-cash tender offer for any and all of ShoreTel’s outstanding shares of common stock, par value $0.001 per share, at a purchase price of $7.50 per share, net to the seller in cash, without interest, and subject to any required withholding of taxes. The transaction is subject to certain conditions, including the tender of at least one share more than half of all our common stock outstanding as well as regulatory and other related approvals. We have agreed to operate our business in the ordinary course during the period between the execution of the Merger Agreement and the effective time of the merger and have agreed to certain other customary restrictions on its operations, as set forth in the Merger Agreement.

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Evolution of Business Communications

We believe ShoreTel is at the forefront of the UC industry that is in transition. We believe customers seek flexibility and choice when making a purchase decision relating to Business Communications. We also deliver the ability to deeply integrate into an existing workflow or application. Providing our customers the capability to create communications-focused microservices or integrate communications affords us a unique differentiator in the UC market.

We deliver innovative solutions and have increased our global footprint. Specifically, we have executed on numerous initiatives to build upon our market momentum and plan to continue this trajectory. Key initiatives included:

Expansion of our Unified Communications as a Service (“UCaaS”) cloud solution into global theaters including the United Kingdom and Australia.
Enhancement of our collaboration portfolio with new solutions such as ShoreTel Teamwork, a virtual workspace and team messaging application, and multi-point video.
As UCaaS is being adopted by enterprise customers, the Summit CPaaS for Connect Cloud customers allows solution partners and ShoreTel to design purpose-built applications for business communications.
Introduction of ShoreTel Global Numbers allowing multi-national organizations to create a local presence in the countries they serve by establishing unique Direct Inward Dial or International Toll-free Service numbers in each country.
Enhancement of our user experience through updates to our web, desktop and mobility clients.

We have started to integrate ShoreTel Summit with our ShoreTel Connect portfolio of solutions. For example, all new Connect applications, such as Teamwork are built on the Summit technology stack with an Application Program Interface (“API”) first approach.

Our customers enjoy a broad approach to their UC requirements. Whether they are looking to acquire a cloud, onsite, hybrid UC solution or to further integrate that into their workflows and applications or whether they want to develop a specific communications application, we provide a solution to fit. Coupled with ready-made applications and supporting services such as ShoreTel Contact Center and professional services including ShoreTel Global Services and application and development professional services.

Hosted Architecture and Services for Hosted Customers

Our hosted services offer a secure and reliable business communications solution to organizations with minimal capital investment. At the heart of the hosted service is our call control technology, designed and developed by ShoreTel, culminating decades of our telephony experience. This technology was specifically designed to meet the unique requirements of the hosted communications market, offering a full portfolio of services to customers, including soft-switch services for ShoreTel Internet Protocol (“IP”) Telephony, as well as integrated software modules for ShoreTel Unified Communications, ShoreTel Contact Center, Business Intelligence Analytics and Reporting. By taking advantage of Infrastructure as a Service (“IaaS”), we can focus on delivering multi-tenant software serving many customers simultaneously. Hosted technologies are complemented by a series of service modules that enable billing, diagnostics, system monitoring, Communications Assistance for Law Enforcement Act (“CALEA”) regulatory compliance, emergency call routing and other related operational services. A variety of customer selectable network services are also available, including local and long distance network services, toll-free numbers, number porting, circuits from carriers and other value-added network services.

Hosted Operations

We have a centrally managed platform consisting of data management, monitoring and security, control and billing systems that support our hosted services. This platform consists of a customer quotation portal, customer provisioning, customer access, fraud control, network security, call routing, call monitoring, media processing and normalization, call reliability, call record storage and billing. Our platform monitors our process of digitizing and compressing voice and video into packets and transmitting these packets over data networks around the world. We maintain a call switching platform that manages call control and routes calls.

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Customer and Technical Support

We maintain a contact center that provides customer service and technical support to our customers. Customers can access our services directly through our website or receive customer service and technical support through telephone communication, e-mail support and online chat services. Our website also maintains a knowledge base repository that our customers and partners use for education and issue resolution.

Hosted Data Centers

ShoreTel takes advantage of IaaS delivered through data centers located in the United States, Europe and Australia. These data centers include sufficient physical building security, network operations and resiliency services and backup power generation. These operation centers house the application servers and proprietary technologies used to provide services to customers.

The key elements of our hosted applications and services include:

complete end-to-end solution offer for customers, including ShoreTel designed and developed phones, client and server applications, together with our own service and support centers, which results in the best possible service experience.
development and introduction of new services;
experience in customer implementations;
complete portfolio of operational services for billing, system management, and other requirements; and
support for industry standard interfaces, enabling support for third party devices from other vendors.

ShoreTel Business Communications for Onsite Deployment

We provide a unique modern hardware and software architecture for onsite customers, which offers the high availability and reliability needed for mission critical communications. Our onsite business communication solutions are comprised of hardware and software components including ShoreTel Voice Switches, ShoreTel Service Appliances, ShoreTel Client and Server Software Applications, such as ShoreTel Director, Small Business Edition 100, and ShoreTel IP Phones. All ShoreTel software applications may also be virtualized, operating on customer-provided general purpose servers.

ShoreTel Voice Switches : We offer a range of ShoreTel designed switches of varying capabilities to meet the needs of enterprises of all sizes. The modular nature of our switches allows our enterprise customers to easily expand their system capacity by deploying additional switches across their networks. The software on our voice switches may also be virtualized and operate on customer-provided, general purpose servers.
ShoreTel Service Appliances : We offer a range of ShoreTel designed appliances for specific applications such as instant messaging, conferencing and collaboration. The administration of these service appliances is functionally integrated with the IP Telephony Web Administration. Appliances are automatically recognized by the ShoreTel Director software and user functions are seamlessly integrated with the user management application, eliminating the complexity found with other systems.
ShoreTel Director : ShoreTel Director provides enterprises with a single point of system management, enabling IT administrators to view and manage the entire system from any location using a single application. A new end user’s extension, mailbox and automated attendant profile can be added on a single management screen, avoiding the additional work required with most Private Branch Exchanges (“PBXs”), voice mail systems and automated attendants.
Small Business Edition 100 : Our Small Business Edition (“SBE 100”) solution is targeted for smaller businesses with up to 100 users. It is a bundled solution consisting of system software, user licenses and voice switches that allows our business customers to economically scale our products and solutions as their organizations begin to grow and expand. Businesses that grow beyond the capacity of the SBE 100 solution may expand their investment by adding additional switches and licenses, while preserving their original investment and avoiding costly upgrades.

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ShoreTel IP Phones : ShoreTel designs and provides IP phones which incorporate the most recent applications, including visual voice mail, speaker phones supporting seven octaves of sound for superior clarity and performance, and integrated diagnostics for simplifying installation and management.

ShoreTel Business Communications for Hybrid Onsite Environments with Integrated Cloud Services Deployment

ShoreTel customers can extend their investments in their business communications solution by incorporating both cloud and onsite based approaches via ShoreTel Connect. ShoreTel Connect enables customers to add new sites and add new applications, such as Contact Center, Mobility, Instant Messaging, Presence, Fax and Scribe and will also enable customers to easily add new services that we introduce in the future.

Business Communication Solutions

ShoreTel provides a diverse set of solutions for both onsite and hosted customers, consisting of ShoreTel IP Telephony, ShoreTel Unified Communications, ShoreTel Contact Center, and professional services, including ShoreTel Global Services and application development services.

Unified Communications and Collaboration

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

Clients : Our strategy is to provide customers with a single, intuitive interface, delivered on mobile devices and via the desktop, giving access to all telephony and unified communications features. The ShoreTel desktop and mobility clients are designed to consume a minimal amount of space, delivering a consistent interaction between softphone, chats, video and screen share, regardless of the environment, while eliminating multiple applications and resulting in greater user productivity.
Team Collaboration: ShoreTel Teamwork is a team collaboration solution and virtual workspace for teams to hold persistent group chat sessions, share files, and manage or assign tasks. Users can create public or private workspaces for teams, projects, or topics. Instant Messaging - ShoreTel Connect users can instant message through their Connect client or mobile app. Group chat and 1:1 messaging is supported. Real-time presence is displayed via the Connect client, mobile client and ShoreTel desk phones.
Web and Audio Conferencing: ShoreTel physical or virtual Service Appliances deliver web and audio conferencing solutions for ShoreTel Connect and seamlessly integrates with desktop applications such as ShoreTel Connect client, Microsoft Outlook and Microsoft Skype for Business so users can create a new conference, view contacts’ calendars, and join meetings.
Video Conferencing : ShoreTel Connect client allows users to participate in peer-to-peer video as well as multi-point video conferencing. ShoreTel Connect client video capabilities enable users to communicate via video from their desktop, laptop or mobile device.
PBX Features: ShoreTel Connect solutions include robust PBX features based on over 20 years of development including all the basic PBX features (transfer, conference, class of service) but also advanced PBX features like monitor, whisper, coach, barge, record and shared call appearance.
Third Party Integrations: ShoreTel's native integrations and advanced applications deliver pre-packaged offerings that allow customers to enhance their solution with features like click-to-dial, screen pops, automated call records and simple note entry. Advanced integrations are also available for many popular business process systems, such as Microsoft Dynamics, Salesforce, Google G Suite, Skype for Business and Zendesk.

Contact Center

Contact Center enables organizations to route contacts to the most appropriate agent in a multisite contact center, regardless of location. ShoreTel Connect Contact Center includes a range of options including agent phones, switching infrastructure, end-user interfaces, and platform software for both onsite-based and cloud-based

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customers. The solution features capabilities including call handling, self-service, multi-media, and reporting. Contact Center applications provide a range of features to satisfy the needs of all-sized organizations, from basic call center capabilities to sophisticated, distributed multimedia contact centers.

ShoreTel Global Services

We complement our cloud, onsite and hybrid solution with a broad range of support services to help us maintain and expand our relationships with our enterprise customers and channel partners. Our product support contracts provide us with recurring revenue. Typically, our resellers provide many of these services, with ShoreTel providing manufacturer and escalation support as needed or, if requested by the enterprise customer or reseller, we can provide these services directly.

ShoreTel Global Services provides professional services, system design and installation, training and technical support including:

Professional services include standard and custom software development to: extend system capabilities; enable UC integration with other enterprise applications; streamline business processes; and, address enterprise customer-specific business opportunities. We also offer collaboration with third party developers via API and Software Development Kit through the ShoreTel TechConnect program.
System design and installation services include the best practices of deploying UC with regard to network requirements and capabilities as well as how to implement contact center and mobility for an enterprise.
Training services include certification programs for resellers, training programs at enterprise customer or reseller locations and self-paced, computer-based desktop training programs.
Our technical support services include web-based access support services and tools, access to technical support engineers, hardware replacement, as well as software updates and monitoring capabilities.

Application Development Services

ShoreTel offers custom application development and integration services for businesses with unique communication requirements. We offer businesses the option to enhance their communications solution by enabling the integration of business applications including customer relationship management (“CRM”) solutions such as Salesforce.com, Zendesk, Desk.com, NetSuite and Microsoft Dynamics, as well routing, interactive voice response and reporting solutions that automate business workflows and enhance operational oversight.

Customers and partners can create integrated applications using the open application interface of the system available for developers through the ShoreTel TechConnect.

Customers

As of June 30, 2017, our solutions have been installed by approximately 42,000 organizations in over 50 countries. We serve a wide range of vertical markets, including professional services, financial services, government, education, health care, sports and entertainment, manufacturing, non-profit organizations and technology industries.

Focus on Customer Satisfaction

We conduct formal customer reviews that involve our internal staff and third-party technical personnel to ensure smooth implementations and to resolve any issues that may arise. We follow up with ongoing check-ins to ensure customers are satisfied with their solution, surveying them regarding various aspects of the experience with ShoreTel. We use industry-recognized Net Promoter Score SM customer loyalty metrics to help ensure that we are meeting our customers’ expectations. Through this process, we gain valuable insights into the existing and future requirements of our customers’ activities and this helps us develop product enhancements that address the evolving requirements of customers.

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

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We also monitor our customers’ satisfaction with our channel partners by surveying our customers after the system is installed.

Sales and Marketing

We sell our onsite products, support and services primarily through an extensive network of channel partners that include value-added resellers, service providers, direct market resellers and value-added distributors. Our hosted services are sold through channel partners and our direct sales force. As of June 30, 2017, we had over 1,100 channel partners in our network. These channel partners range in size from single-site, regional firms with specialized products and services to multi-national firms that provide a full range of IT products and services. They also include top U.S. telecommunication carriers: AT&T and CenturyLink. Our channel partners market and sell our products into both the small-to-medium and mid-enterprise markets. Our channel partners in the U.S., Canada, the United Kingdom and Australia may offer both onsite and cloud solutions to their customers. In addition to our network of channel partners we utilize master agents and through them thousands of agents to promote and sell our hosted services.

We maintain a sales organization that manages the business relationship between ShoreTel and our partner network and master agents, recruiting, training and enabling them to market, sell and support ShoreTel solutions. In addition, we also have a ‘Client Sales’ team of sales personnel to assist our channel partners in selling to and providing support for customer accounts.

Research and Development

We have assembled a team of engineers with expertise in collaboration and UC technology, such as voice, messaging, conferencing, video, mobility, file sharing, contact center and workspaces. We have invested significant time and financial resources into the development of our architecture, including ShoreTel Connect, ShoreTel Summit, ShoreTel Connect Contact Center and ShoreTel Connect appliances which are available for both hosted and onsite customers.

Manufacturing and Suppliers

We outsource the manufacturing of our hardware products.

Currently, we have arrangements for the production of our phones, switches and mobility routers with a contract manufacturer with multiple locations including the United States and China. We also rely on a sole or limited number of suppliers for several key components utilized in the assembly of our products.

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

For more information on risks related to products and components, see “Risks Related to Our Business and Industry - Our business may be harmed if our contract manufacturers are not able to provide us with adequate supplies” and “Risks Related to Our Business and Industry - Our products incorporate some sole sourced components and the inability of these sole source suppliers to provide adequate supplies of these components may prevent us from selling our products for a significant period of time or limit our ability to deliver sufficient amounts of our products.”

We typically fulfill product orders out of our California, New York, United Kingdom, Australia or Singapore warehouses.

Financial Information about Geographic Areas

For financial information about geographic areas, refer to Note 14 to the Consolidated Financial Statements in Item 8 of this report.

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Competition

The market for business communication solutions is quickly evolving, highly competitive and subject to rapid technological change. As a result of the convergence of voice, video, messaging, mobility and data networking technologies that characterize IP enterprise UC solutions, we compete against vendors of hosted solutions and premise-based solutions, some of which have solutions in both markets and CPaaS providers.

Providers of cloud services include Tier 1 service providers such as AT&T, Telstra, British Telecom, Verizon, incumbent local exchange carriers, competitive local exchange carriers, and independent providers such as 8x8, RingCentral, Mitel, West IP Communications, Fuze, Vonage and Amazon Connect.
Providers of hosted communication services based on technologies from Avaya, Broadsoft, Cisco, Microsoft, Mitel, Unify and other technology platform vendors.
Providers of premise-based business communication equipment include Avaya, Cisco, Mitel, NEC and Unify.
Providers of Unified Communications software applications, include Avaya, Cisco, Interactive Intelligence, Microsoft, Mitel, NEC and Unify.
Providers of CPaaS include Twilio, Plivo, Vonage with Nexmo, Avaya Zang, Cisco Tropo and other API based technology platform vendors.

In addition, because the market for our products is subject to rapid technological change as the market evolves, we may face competition in the future from companies that do not currently compete in the enterprise unified communications market, including companies that currently compete in other sectors of the information technology, communications and software industries, Infrastructure-as-a-Service companies or communications companies that serve consumer rather than enterprise customers.

We may also face increased competition from Internet portal-focused providers who extend their portfolio to include business communications solutions, such as Amazon, Skype/Microsoft and Google.

As more enterprises converge their voice and data networks, the business information technology and communication applications deployed on converged networks will become more integrated. We may face increased competition from current leaders in information technology infrastructure, information technology, personal and business applications and the software that connects the network infrastructure to those applications.

We could also face competition from new market entrants, whether from new ventures or from established companies moving into the market. Competition from these other potential market entrants may take many forms, including offering products and applications like those we offer as part of a larger, bundled offering or as a cloud-based or hosted services offering. In addition, technological developments and consolidation within the communications industry result in frequent changes to our group of competitors.

Many of our current and potential competitors are substantially larger than we are and have higher brand familiarity with buyers, and significantly greater financial, sales, marketing, distribution, technical, manufacturing and other resources. We believe that we currently compete favorably with regard to the principal competitive factors applicable to our solutions, which include price, portfolio, feature set, reliability, scalability, usability, simplicity, total cost of ownership, customer satisfaction and service.

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

Regulatory

Voice over IP (“VoIP”) communication services, like ours, have been subject to less regulation at the state and federal levels than traditional telecommunications services. Providers of traditional telecommunications services are subject to the highest degree of regulation, while providers of information services are largely exempt from most federal and state regulations governing traditional common carriers. The Federal Communications Commission (“FCC”) has subjected VoIP service providers to a smaller subset of regulations

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that apply to traditional telecommunications service providers and have not yet classified VoIP services as either telecommunications or information. However, the FCC reviews the status of VoIP service providers and the services they provide and may increase regulations that apply to hosted services.

The effect of any future laws, regulations and orders on the hosted offering is unknown at this time. But as a general matter, increased regulation and the imposition of additional funding obligations increases service costs that may or may not be recoverable from our customers. This increased regulation could result in making our services less competitive with traditional telecommunications services if we increase our retail prices or decreasing our profit margins if we attempt to absorb such costs.

Intellectual Property

A factor of our success as a company is our ability to protect our core technology and intellectual property. To accomplish this, we rely on a combination of intellectual property rights, including patents, trade secrets, copyrights and trademarks, as well as customary contractual protections.

As of June 30, 2017, we had 157 patents issued in the United States, and had 30 patent applications in the United States. Our patents have been both internally developed and externally acquired. Our patents have a range of expiration dates. The earliest patent expired in 2016, and the last to expire will do so in 2035.

The steps we have taken to protect our intellectual property rights may not be adequate. Third parties may infringe or misappropriate our intellectual property rights and may challenge our issued patents. In addition, other parties may independently develop similar or competing technologies designed around any patents that are or may be issued to us. We intend to enforce our intellectual property rights vigorously, and from time to time, we may initiate claims against third parties that we believe are infringing on our intellectual property rights if we are unable to resolve matters satisfactorily through negotiation. If we fail to protect our proprietary rights adequately, our competitors could offer similar products, potentially significantly harming our competitive position and decreasing our revenue.

Employees

As of June 30, 2017, we had 1,158 employees in North America, Europe, Asia and Australia, of which 357 were in sales and marketing, 401 were in research and development, 262 were in global support and services, and 138 were in general and administrative functions. None of our employees are represented by labor unions and we consider current employee relations to be good.

Executive Officers

The following table sets forth information about our executive officers as of September 1, 2017:

Name
Age
Position as of September 1, 2016
Don Joos
47
President and Chief Executive Officer
Michael E. Healy
56
Senior Vice President and Chief Financial Officer
Eugenia Corrales
52
Senior Vice President of Solutions Group
Bharath Oruganti
43
Senior Vice President of Worldwide Business Operations
David Petts
54
Senior Vice President of Worldwide Sales and Customer Success
Allen Seto
41
Vice President and General Counsel

Don Joos has served as our President and Chief Executive Officer and a Director since August 2013. Mr. Joos served as our Senior Vice President of Business Operations from July 2012 to August 2013. Mr. Joos joined ShoreTel in April 2011 as our Vice President of Global Services. Prior to joining ShoreTel, from December 2001 to April 2011, Mr. Joos served in various senior management roles, including Vice President Channel Transformation, at Avaya, Inc., a provider of business communications and collaboration systems. Prior to this, Mr. Joos also held service and operational roles at SiteStuff, Inc., Williams Communication Solutions, LLC, Nortel Communication Solutions and Marshalls Inc. Mr. Joos holds a B.S. in Sports Management from Springfield College in Massachusetts.

Michael E. Healy has served as our Senior Vice President and Chief Financial Officer since May 2007. From February 2004 to May 2007, he served as Chief Financial Officer and Senior Vice President of Finance of

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Genesis Microchip Inc., a supplier of display image processors. From November 2002 to February 2004, Mr. Healy served as Chief Financial Officer of Jamcracker, Inc., a software and application service provider. From September 1997 to June 2002, Mr. Healy held various senior level finance positions at Exodus Communications, Inc., an Internet infrastructure outsourcing services provider, including as Senior Vice President of Finance prior to February 2002, and as its Chief Financial Officer and Corporate Treasurer from February 2002 to June 2002. From 1987 to 1997, Mr. Healy held various financial management positions at Apple Computer, Inc., and was an auditor at Deloitte & Touche LLP from 1983 to 1987. Mr. Healy holds a B.S. in Accounting from Santa Clara University and is a Certified Public Accountant (Inactive). Mr. Healy is a member of the American Institute of Certified Public Accountants and the California Society of Certified Public Accountant.

Eugenia Corrales has served as our Senior Vice President of Solutions Group since July 2016. From July 2015 to August 2016, Ms. Corrales served as our Senior Vice President of Product. From July 2013 to July 2015, Ms. Corrales served as Vice President and General Manager of the Computing Systems Group at Cisco Systems, Inc., a provider of Internet protocol based networking and other products related to the communications and information technology. From September 2012 to July 2013, Ms. Corrales was an independent consultant working with multiple networking and renewable energy startup companies. From June 2010 to September 2012, Ms. Corrales served as Chief Executive Officer and Executive Vice President of Engineering and Operations at Nanosolar, a developer of solar power technology. From June 2006 to June 2010, Ms. Corrales served as Chief Executive Officer at Sunmodular, a startup focusing on providing efficiencies to solar panel technology. Ms. Corrales holds a B.A. in Physics from Grinnell College and a M.S. in Mechanical Engineering from Stanford University.

David Petts has served as our Senior Vice President of Worldwide Sales and Customer Success since July 2012. From June 2005 to July 2012, Mr. Petts served in several sales leadership roles at Nokia Corporation, a mobile communications company. Prior to then, Mr. Petts held a number of executive management roles, both in the United States and the United Kingdom, with Hewlett Packard Company and Compaq Computer Corporation, providers of products, technologies, software, services and solutions. Mr. Petts holds a B.S. in Economics and Quantitative Studies from Queen Mary College, London University.

Bharath Oruganti has served as our Senior Vice President of Worldwide Business Operations since February 2014. Mr. Oruganti also served as our Vice President of Global Services from September 2012 to January 2014. Mr. Oruganti joined ShoreTel in October 2011 serving in the position of Senior Director of Technical Services. From February 2011 to October 2011, Mr. Oruganti served as President and Chief Operating Officer at Encore Media Metrics, LLC, a digital media startup focused on advanced insights and analytics. From September 2006 to February 2011, Mr. Oruganti served as Senior Manager in the Strategy and Operations practice at Deloitte Consulting LLP. Prior to then, Mr. Oruganti served in various positions, including Senior Manager of Global Customer Support, at Cadence Design Systems, Inc., a provider of semiconductor design software. Mr. Oruganti holds a B. Tech in Electronics and Communication Engineering from Andhra University, a M.S. in Electrical Engineering from University of Kentucky and an M.B.A. from the University of Texas at Austin.

Allen Seto has served as our Vice President and General Counsel since March 2013. Mr. Seto joined ShoreTel in June 2012 serving as Associate General Counsel. From January 2011 to May 2012, Mr. Seto served as Associate General Counsel at Taleo Corporation., a global provider of on-demand talent management software solutions. From February 2008 to January 2011, Mr. Seto served as Senior Corporate Counsel in the Corporate, Securities & Acquisitions group at Oracle Corporation. From July 2005 to January 2008, Mr. Seto served as Corporate Counsel at SYNNEX Corporation, a business process services company servicing resellers, retailers and original equipment manufacturers. Prior to then, Mr. Seto was in private practice at Skadden, Arps, Slate, Meagher & Flom LLP. Mr. Seto holds a J.D. from University of California, Los Angeles School of Law and a B.A. in Economics and a B.A. in Rhetoric from the University of California, Berkeley.

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ITEM 1A. RISK FACTORS

Risks Related to Our Business and Industry

We may not be able to complete our merger with Mitel and uncertainty concerning completion of the merger may adversely affect our business operations and financial results.

The closing of the merger is subject to the satisfaction of customary conditions. We cannot be certain that we will be able to satisfy or obtain a waiver of the other conditions to completion of the merger, in which case the merger may not be completed.

If the merger is not completed for any reason, our ongoing business and relationships may be adversely affected and the price of our common stock may be negatively impacted.

In addition, the Merger Agreement may be terminated by the Company or Mitel under certain circumstances. The restrictions on the conduct of our business prior to the consummation of the merger, and the uncertainties and risks concerning completion of the merger, may cause our business, sales, operations and financial results to suffer during the executory period or in the event the merger is not completed. The merger agreement requires us to conduct business in the ordinary course, subject to specific limitations, which may delay or prevent us from undertaking business opportunities that, absent the Merger Agreement, we might have pursued. The announcement of the merger and any delay in completing the merger may divert management’s attention from ongoing business operations, affect our ability to retain or recruit key employees and negatively impact our business relationships with customers and suppliers. In addition, the nature, cost and outcome of pending and future litigation and other legal proceedings, including any such proceedings related to the merger and instituted against us and others, may be material.

We may not be able to achieve our strategic initiatives and grow our business as anticipated.

We cannot assure you that we will be successful over the long term in transitioning internal and external views of our company to a software-based service delivery model and growing our business as anticipated. Our strategic initiatives have required us to devote significant financial and operational assets to these activities. However, at the same time, a growing focus on hosted revenues involves different types of revenue recognition and has different cost structures than our traditional product revenues. Our success depends on our ability to appropriately manage our expenses as we invest in these initiatives, enter into beneficial channel relationships, develop new solutions and successfully execute our marketing and sales strategies. If we are not able to execute on this strategy successfully or if our investments in these activities do not yield significant returns, our business may not grow as we anticipated, we could devote significant financial and other resources to developing solutions that never reach commercial success, which could adversely affect our operating results. In addition, if the UC industry transitions in a way we did not anticipate, we may not be able to shift our strategies and products rapidly enough to respond to such changes and we may not receive any return from such investments. Our competitors may also be developing new products to address transitions in the UC industry. If we are unable to successfully establish our new solutions, if our competitors’ products and services are better received, or if we fail to execute our strategies, our financial condition or results of operations could be negatively impacted and our ability to grow our business may be impacted.

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

The industry for Unified Communications is extremely competitive. Our competitors include 8x8, Avaya, Broadsoft, Cisco, Microsoft, Mitel, RingCentral, Vonage and Fuze. In addition, many of our hosted customers are not subject to long-term contractual commitments to purchase our services and can terminate our service and switch to competitors' offerings on relatively short notice.

Many of our competitors are substantially larger and have greater financial, technical, research and development, sales and marketing, manufacturing, distribution and other resources. We could also face competition from new entrants, whether from new ventures or from established companies moving in to the industry. Some competitors have advantages over us, including:

greater market presence, name recognition and brand reputation;
larger distribution channels;

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a larger installed base of telecommunications and networking systems with customers;
larger and more geographically distributed services and support organizations and capabilities;
a broader offering of telecommunications and networking products, applications and services;
a more established international presence to address the needs of global enterprises;
larger patent and intellectual property portfolios;
longer operating histories;
a longer history of implementing large-scale telecommunications or networking systems;
more established relationships with industry participants, customers, suppliers, distributors and other technology companies;
the ability to acquire technologies or consolidate with other companies in the industry to compete more effectively; and
the ability to bundle a broader offering of telecom and networking equipment and services into an IP PBX offering, and offer these products as part of a hosted services offering.

Given their capital resources, many of these competitors are in a better position to withstand any significant reduction in capital spending by enterprise customers on telecommunications equipment and are not as susceptible to downturns in a particular industry. This risk is enhanced because we focus our business primarily on the enterprise IP telecommunications industry.

Because some of our competitors have greater financial strength than we do and are able to offer a more diversified bundle of products and services, they have offered, and in the future may offer telecommunications products at lower prices than we do. In order to remain competitive from a cost perspective, we have in the past reduced the prices of our products, and we may be required to do so in the future, in order to gain enterprise customers. Price reductions could have a negative effect on our gross margins.

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

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

The convergence of voice, video, messaging and data networks and their wider deployment by enterprises has led information technology and communication applications deployed on converged networks to become more integrated. This integration has created an opportunity for the leaders in information technology, personal and business applications and the software that connects the network infrastructure to those applications, to enter the telecommunications industry and offer products that compete with our systems, commonly referred to as Unified Communications. Competition from these potential entrants may take many forms, and they may offer products and services similar to those we offer.

If the solutions offered by new competitors achieve substantial market penetration, or if we cannot integrate our products with such solutions, we may not be able to maintain or improve our market position, and our failure to do so could materially and adversely affect our business and results of operations.

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

We plan to further expand our operations to support the growth of our business. We will need to increase our spending in order to fund this development. This growth may place a significant strain on our management,

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administrative, operational and financial infrastructure. Our success will depend upon our ability to manage this growth effectively. If we do not increase our revenues commensurate to our increased spending, we may not be profitable. To manage the expected growth of our operations and personnel, we will need to continue to improve our operational, financial and management controls and our reporting systems and procedures. Failure to effectively manage growth could result in difficulty in filling customer orders, declines in product quality or customer satisfaction, increases in costs, production and distribution difficulties, and any of these difficulties could adversely impact our business performance and results of operations.

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

It is possible that the gross margins on our products and/or services will decrease in the future in response to competitive pricing pressures, including the bundling of more offerings included in a base price, new product introductions by us or our competitors, increases in data center costs, changes in the costs of components or telecommunications costs, manufacturing issues, the shift in our channel distribution model towards more value-added distributors, royalties we need to pay to use certain intellectual property, growth of our international business, or other factors. The margins on our hosted telephony service are also impacted by the fact that we also sell the broadband connection, which is typically a lower-margin business. In addition, until we achieve a sufficient base of cloud-based customers, the gross margins on our cloud services will tend to be lower. If we experience decreased gross margins and we are unable to respond in a timely manner by introducing and selling new, higher-margin solutions successfully and continually reducing our product and hosting costs, our gross margins may decline, which will harm our business and results of operations.

If we fail to respond to technological changes and evolving industry standards, our solutions could become obsolete or less competitive in the future.

Our industry is highly competitive and characterized by rapidly changing technologies and standards. Accordingly, our operating results depend upon, among other things, our ability to develop and introduce new solutions and our ability to reduce production costs of existing products and costs of providing our hosted services. Our long-term success will depend on our ability to stay ahead of these changes and avoid obsolescence of our solutions.

In addition, as industry standards evolve, it is possible that one standard becomes predominant in the market. This could facilitate the entry into the market for competing products and services, which could result in significant pricing pressure. Additionally, if one standard becomes predominant and we adopt that standard, enterprises may be able to create a unified, integrated system by using phones, switches, servers, applications, or other telecommunications products produced by different companies. Therefore, we may be unable to sell complete systems to enterprise customers because the enterprise customers elect to purchase portions of their telecommunications systems from our competitors.

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

A significant portion of our hosted and product, support and services revenue is generated through indirect channel sales. These indirect sales channels include third-party resellers and distributors that market and sell other solutions to customers. We expect indirect channel sales will continue to generate a significant portion of our revenue in the future. Therefore, our success is highly dependent upon establishing and maintaining successful relationships with third-party resellers and distributors, and the financial health of these resellers and distributors.

Recruiting, launching and retaining qualified channel partners and training them in our solutions requires significant time and resources. In order to develop and expand our distribution channel, we must continue to recruit larger and more productive channel partners. We must also scale and improve our processes and procedures that support our channel, including investment in personnel, systems and training, and those processes and procedures may become increasingly complex and difficult to manage.

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

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reduce sales of our products. Our channel partners may choose not to offer our products or services exclusively or at all. Our failure to establish and maintain successful relationships with channel partners would likely materially adversely affect our business, operating results and financial condition.

In addition, we rely on these entities to provide many of the installation, implementation and support services for our products. Accordingly, our success depends in large part on the effective performance of these channel partners. If a partner’s performance is ineffective, it may reflect poorly upon ShoreTel or negatively impact our business. By relying on channel partners, we may in some cases have little or no contact with the ultimate users of our products, thereby making it more difficult for us to establish brand awareness, ensure proper delivery and installation of our products, service ongoing enterprise customer requirements and respond to evolving enterprise customer needs. Additionally, some of our channel partners are smaller companies that may not have the same financial resources as other of our larger channel partners, which exposes us to collections risks.

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

Our company strategy and future success will depend, to a significant extent, on our ability to attract, integrate and retain our sales, technical and key personnel, namely our management and executive team and experienced sales and engineering personnel. Competition for skilled personnel is intense, particularly in many of the cities in which we operate. In addition, even if we succeed in hiring additional sales personnel, it may take some period of time before they become productive compounding any harm in the growth of our business from our inability to retain such sales personnel. Competitors have in the past and may in the future attempt to recruit our employees, and our management and key employees are not bound by agreements that could prevent them from terminating their employment at any time. If we fail to attract, integrate and retain key employees, our ability to manage and grow our business could be harmed, particularly if the departure of any executive or key employee results in a business interruption, or if we are not successful in preserving material knowledge of our departing employees.

The impact of the current economic climate and possible adverse credit markets may impact customer demand for our products and services.

Our business depends on the overall demand for information technology. Many of our existing and target customers are in the small and medium business sector. Our target customers may be more likely to be significantly affected by economic downturns than larger, more established businesses. Additionally, these customers often have limited discretionary funds which they may choose to spend on items other than our products and services. The purchase of our premise solution involves significant upfront expenditures. If credit is not available to them, it may be difficult or impossible for our resellers and/or end customers to purchase our premise products. If small and medium businesses experience economic hardship, this could negatively affect the overall demand for our products and services, delay and lengthen sales cycles and lead to slower growth or even a decline in our revenue.

We have made acquisitions in the past 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 have in the past and may in the future acquire or invest in other businesses, products or technologies. 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 acquisitions. We may not be able to integrate the acquired personnel, operations, product lines and technologies successfully, or effectively manage the combined business following an acquisition. We may also incur indebtedness in connection with any future acquisitions. We also may not achieve the anticipated benefits from the acquired business due to a number of factors, including:

unanticipated costs or liabilities associated with the acquisition;
incurrence of acquisition-related direct and indirect costs;

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diversion of management's attention from other business concerns;
risks related to entering into new markets;
harm to our existing business relationships with business partners and customers as a result of the acquisition;
the potential loss of key employees;
use of resources that are needed in other parts of our business;
risks associated with unknown liabilities, including liabilities for sales, use, telecom, utility and other taxes;
use of substantial portions of our available cash to consummate the acquisition; and
risks and costs associated with financing the acquisition.

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

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

A higher rate of customer terminations associated with our hosted services would negatively affect our business by reducing our revenue or requiring us to spend more money to grow our customer base.

Our churn rate, as defined in Item 7, for our hosted services could increase in the future if customers are not satisfied with our service. Other factors, including increased competition from other VoIP providers, alternative technologies, and adverse business conditions also adversely influence our churn rate.

Because of churn, we have to acquire new customers on an ongoing basis or sell additional services to existing customers to maintain our existing level of customers and revenues. As a result, marketing expenditures are an ongoing requirement of our business. If our churn rate increases, we will have to acquire even more new customers in order to maintain our existing revenues. We incur significant upfront costs to acquire new customers, and those costs are an important factor in determining our net profitability. Therefore, if we are unsuccessful in retaining customers or are required to spend significant amounts to acquire new customers beyond those budgeted, our revenue could decrease and our net income could decrease.

Success of our hosted services is dependent on the general growth and public acceptance of hosted communications.

Our future success depends on our ability to significantly increase revenues generated from our hosted services. VoIP networks must improve quality of service for real-time communications, managing effects such as packet jitter, packet loss, and unreliable bandwidth, so that service can be consistently provided. VoIP telephony equipment and services must achieve a similar level of reliability that users of the Public Switched Telephone Network (“PSTN”) or a Multiprotocol Line Switching network have come to expect from their telephone service, and the cost and feature benefits of VoIP must be sufficient to cause customers to switch away from traditional telephony service providers. If any or all of these factors fail to occur, our business may be affected adversely.

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

We outsource the manufacturing of our telephones and switches. Our reliance on contract manufacturers involves a number of potential risks, including the absence of adequate capacity, financial viability, ownership of certain elements of electronic designs, the ongoing viability of those contract manufacturers, and reduced control over delivery schedules.

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We depend on our contract manufacturers to finance the production of goods ordered and to maintain adequate manufacturing capacity. Global economic conditions could adversely impact the financial condition of our contract manufacturers and their suppliers that could impact our contract manufacturer’s ability to procure components or otherwise manufacture our products. We may be unable to procure timely delivery of acceptable products to our enterprise customers or incur substantially higher product costs if we move production to other contract manufacturers.

Our contract manufacturers may not have sufficient capacity to enable them to meet the demand for our products. Our contract manufacturers could have manufacturing engagements with companies that are much larger than we are and whose production needs are much greater than ours. As a result, our contract manufacturers may choose to reallocate resources to the production of products other than ours if capacity is limited.

In addition, our contract manufacturers do not have any written contractual obligation to accept any purchase order that we submit for the manufacture of any of our products nor do we have any assurance that our contract manufacturers will agree to manufacture and supply any or all of our requirements for our products. Furthermore, our contract manufacturers may unilaterally terminate their relationship with us or seek to increase the prices they charge us upon written notice subject to the terms of our agreement. As a result, we are not assured that our current manufacturers will continue to provide us with an uninterrupted supply of products at an acceptable price in the future.

Even if our contract manufacturers accept and fulfill our orders, it is possible that the products may not meet our specifications. Because we do not control the final assembly and quality assurance of our products, there is a possibility that these products may contain defects or otherwise not meet our quality standards, which could result in warranty claims against us that could adversely affect our operating results and future sales.

If our contract manufacturers are unable or unwilling to continue manufacturing our products in required volumes and to meet our quality specifications, or if they significantly increase their prices, whether caused by uncertain global economic conditions, tightening of the credit markets, their weak financial condition or otherwise, we will have to procure components on their behalf in the short term and identify one or more acceptable alternative contract manufacturers. The process of identifying and qualifying a new contract manufacturer can be time consuming, and we may not be able to substitute suitable alternative contract manufacturers in a timely manner or at acceptable prices. Additionally, transitioning to new contract manufacturers may cause delays in supply if the new contract manufacturers have difficulty manufacturing products to our specifications or quality standards and may result in unexpected costs to our business.

Any disruption in the supply of products from our contract manufacturers may harm our business and could result in a loss of sales, an increase in lead times on inventory orders and an increase in production costs resulting in lower gross product margins, which could adversely affect our business and results of operations.

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

The market for Unified Communications is evolving rapidly and is characterized by an increasing number of market entrants. As is typical of a rapidly evolving industry, the demand for and market acceptance of, enterprise IP and hosted telecommunications systems products and services are uncertain. Some analysts have estimated that revenue in the Worldwide Enterprise IP Telephony industry has declined and will continue to decline. We cannot assure you that enterprise telecommunications systems that operate on IP networks will become widespread. In particular, enterprises that have already invested substantial resources in other means of communicating information may be reluctant or slow to implement an IP telecommunications system that can require significant initial capital expenditures. If the demand for enterprise IP and hosted telecommunications systems fails to develop or develops more slowly than we anticipate, our solutions could fail to achieve market acceptance, which in turn could significantly harm our business.

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

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

The sales cycle for some of our solutions typically ranges from six to twelve months, or longer. As a result, we may have limited ability to forecast whether or in which period a sale will occur. The success of our sales process is subject to many factors, some of which we have little or no control over, including:

the timing of customers’ budget cycles and approval processes;
a technical evaluation or trial by potential enterprise customers;
our ability to introduce new products, features or functionality in a manner that suits the needs of a particular enterprise customer;
the announcement or introduction of competing products; and
the strength of existing relationships between our competitors and potential enterprise customers.

We may expend substantial time, effort and money educating our current and prospective enterprise customers as to the value of, and benefits delivered by, our solutions and ultimately fail to produce a sale. If we are unsuccessful in closing sales after expending significant resources, our operating results will be adversely affected. Furthermore, if sales forecasted for a particular period do not occur in such period, our operating results for that period could be substantially lower than anticipated and the market price of our common stock could decline.

Our products incorporate some sole sourced components and the inability of these sole source suppliers to provide adequate supplies of these components may prevent us from selling our products for a significant period of time or limit our ability to deliver sufficient amounts of our products.

We rely on sole or limited numbers of suppliers for several key components utilized in the assembly of our products. We do not have supply agreements with our sole source suppliers, and the components for our products are typically procured by our contract manufacturers. If we lose access to these components we may not be able to sell our products for a significant period of time, and we could incur significant costs to redesign our products or to qualify alternative suppliers.

In addition, any increase in the price of these components could reduce our gross margin and adversely impact our profitability. We may not be able to obtain a sufficient quantity of these components to meet the demands of enterprise customers in a timely manner or prices of these components may increase. In addition, problems with respect to yield and quality of these components and timeliness of deliveries could occur. These delays could also materially and adversely affect our operating results.

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

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

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

We generate forecasts of future demand for our hardware products several months prior to the scheduled delivery to our prospective customers and typically prior to receiving a purchase order from our customers. We therefore make significant investments before our resellers or customers place orders to purchase our products and before we know if corresponding shipment forecasts will be changed. Our resellers and customers are not

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contractually bound by the forecasts they provide us until they sign a purchase order, and the orders we ultimately receive often differ from original forecasts. If we underestimate demand for our hardware products, we will have inadequate inventory, which could result in delays in shipments, loss of orders and reduced revenues. This is exacerbated by the fact that lead times for materials and components that we need can vary significantly and depend on factors such as the specific supplier, contract terms and demand for each component at a given time. On the other hand, if we overestimate demand for our products and increase our inventory in anticipation of customer orders that do not materialize, we will have excess inventory and we will face a risk of significant inventory write-downs. Our failure to forecast demand accurately on a timely basis could result in a decrease in our revenues and gross margins.

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

Due to the complexity of the type of solutions we produce, there are significant technical risks that may affect our ability to introduce new solutions and features successfully. In addition, we must commit significant resources to developing new software, services and features before knowing whether our investments will result in software and services that are accepted by the market. The success of new software and services depends on many factors, including the ability of our software and services to compete with the offerings from our competitors, cost, and reliability.

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

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

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

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

We could be exposed to significant risks with our international operations.

Operating in international markets requires significant resources and management attention and will subject us to regulatory, economic and political risks that are different from those in the United States. Our international expansion efforts may not be successful. In addition, we will face risks in doing business internationally that could adversely affect our business, including:

our ability to comply with differing technical and environmental standards and certification requirements outside the United States;
difficulties and costs associated with staffing and managing foreign operations;

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lower gross margins due to higher discounting;
greater difficulty collecting accounts receivable and longer payment cycles;
the need to adapt our solutions for specific countries;
availability of reliable broadband connectivity and wide area networks in targeted areas for expansion;
changes in regulatory requirements;
tariffs, export controls and other non-tariff barriers such as quotas and local content rules;
more limited protection for intellectual property rights in some countries;
adverse tax consequences;
fluctuations in currency exchange rates, which could increase the price of our solutions outside of the United States, increase the expenses of our international operations and expose us to foreign currency exchange rate risk;
restrictions on the transfer of funds;
new and different sources of competition;
less access to the end customer where we use our two-tier distribution internationally; and
political and economic unrest and instability. For example, the United Kingdom’s recent referendum approving its exit from the European Union, commonly referred to as “Brexit”. As a result of the referendum, it is possible that there will be increased regulatory complexities that may adversely affect our operations and financial results. In addition, the announcement of Brexit caused significant volatility in global stock markets and currency exchange fluctuations that resulted in the strengthening of the U.S. dollar against foreign currencies in which we conduct business, which may adversely affect our results of operations and the value of our international assets and investments. In addition, the United Kingdom's withdrawal from the European Union could result in a global economic downturn, which could depress the demand for our solutions.

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

We could be the subject of malicious cyber acts or experience other breaches of network security.

In providing our services, we store, process and transmit confidential and sensitive information including financial, credit card, account and personal information which may be protected by regulations. We may be subject to cyber threats and network security breaches by employees or third parties. Our ability to securely handle such sensitive information is critical to our business. In addition, laws requiring notification of individuals regarding security breaches related to their personal information continue to be adopted and evolve. Security breaches regarding personal information and compliance with such notification requirements could lead to significant costs for compliance, regulatory fines and other liability. Such security breaches could also harm our reputation and negatively impact our ability to attract new customers or retain existing customers.

Further, to the extent that we represent to our customers that we are compliant with particular laws regulating the handling of confidential or sensitive information, such as HIPAA or PCI, any network security breach relating to such information may expose us to claims of unfair trade practices for misrepresenting our level of compliance, truth in advertising claims, investigations by federal and state law enforcement agencies, fines, penalties and other legal liability.

We continuously monitor the security of our networks and implement protective measures to prevent cyber threats. However, as cyber threats continue to evolve and become more sophisticated, we may not be able to address all such cyber threats, and the costs to continually protect against or remediate such cyber threats may adversely impact our profitability or increase the price of our offerings making them less competitive.

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The agreement governing our loan imposes restrictions on our business that may limit our business opportunities and hinder our ability to execute our business strategy.

Our Amended and Restated Credit Agreement (the “Credit Facility”) contains, and other agreements we may enter into in the future may contain, covenants imposing restrictions on our business, and requires us to maintain certain financial covenants. These restrictions and covenants may affect our ability to operate our business and may limit our ability to take advantage of potential business opportunities as they arise. These covenants place restrictions on our ability to, among other things, incur additional debt, create liens, consolidate or merge, dispose of any property, redeem common stock or make other distributions to stockholders, make investments or enter into transactions with affiliates.

Although we believe we are in compliance with all of our non-financial and financial covenants under the Credit Facility, our future ability to comply with these covenants may be affected by events beyond our control, including prevailing economic, financial, and industry conditions. In the event of our default under the Credit Facility, our lender could declare all amounts borrowed to be due and payable, together with accrued and unpaid interest. If we were unable to repay any debt owed, the lender could proceed against the collateral securing that debt.

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

If our cash and cash equivalents balances are not sufficient to meet our future cash requirements, we will need to seek additional capital, potentially through additional debt or equity financings, to fund our operations. We may also need to raise additional capital to take advantage of new business or acquisition opportunities. We may seek to raise capital by, among other things:

issuing additional common stock or other equity securities;
issuing debt securities; or
increasing or replacing our credit facility.

We may not be able to raise needed cash on terms acceptable to us or at all. Financings, if available, may be on terms that are dilutive or potentially dilutive to our stockholders. The holders of new securities may also receive rights, preferences or privileges that are senior to those of existing holders of common stock. In addition, if we were to raise cash through a debt financing, such debt may impose conditions or restrictions on our operations, which could adversely affect our business. If new sources of financing are required but are insufficient or unavailable, we would be required to modify our operating plans to the extent of available funding, which would harm our ability to maintain or grow our business.

Any denial or disruption of our hosted services whether from cyber attacks or failure in our physical infrastructure could lead to significant costs, reduce our revenue, and inhibit our ability to obtain future orders.

Our hosted services may be interrupted for a variety of reasons, including without limitation, cyber attacks or failures in the physical infrastructure network. We may be the subject of unauthorized entry, computer viruses, malicious software programs, or other forms of cyber attacks aimed to disrupt our services. While we implement backup systems, mitigation efforts and procedures and other security protocols to mitigate such attacks, we cannot assure you that such protocols will be sufficient now or in the future to prevent such cyber attacks.

The physical infrastructure network for our hosted services is operated by external companies in data centers. The network and data centers are subject to various points of failure. Problems with cooling equipment, generators, power supply, routers, switches, or other equipment, whether or not within our control, could result in service interruptions for our customers as well as equipment damage. Because our services do not require geographic proximity of our data centers to our customers, our infrastructure is consolidated into a few large facilities. Any failure or downtime in one of our leased data center facilities could affect a significant percentage of our customers. The destruction or severe impairment of any of our leased data center facilities could result in significant downtime of our services and the loss of customer data. Additionally, in connection with the expansion or consolidation of our existing leased data center facilities from time to time, there is an increased risk that service interruptions may occur as a result of server relocation or other unforeseen construction-related issues.

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Because our ability to attract and retain customers depends on our ability to provide customers with highly reliable service, even minor interruptions in our service could harm our reputation. We have taken and continue to take steps to improve our infrastructure to prevent service interruptions. However, service interruptions continue to be a significant risk for us and could materially impact our business.

Any future service interruptions could:

cause our customers to seek damages for losses incurred;
require us to replace existing equipment or add redundant facilities;
affect our reputation as a reliable provider of hosting services;
cause existing customers to cancel or elect to not renew their contracts; or
make it more difficult for us to attract new customers.

Any of these events could materially increase our expenses or reduce our revenue, which would have a material adverse effect on our operating results.

We could experience breaches in physical security or problems with our information systems.

Our business and operations depend on information systems, including those of third parties, to process customer orders, bill customers, provide technical support, and support accounting functions and financial planning. We have in the past and may in the future experience problems with our information systems that cause interruption in our business operations and our ability to respond to customer needs. Information systems are vulnerable to interruption for a variety of reasons, including without limitation, computer viruses, breaches of physical security, breaches of information security, and problems with third-party providers. The implementation of new information systems and the maintenance or upgrading of existing information systems may cause disruption to our operations and business and damage our reputation with customers. Such implementations can also be more expensive than estimated and divert management attention.

Fraudulent schemes could harm our business reputation and have a material adverse effect on our financial results.

Third parties have in the past and may continue to attempt in the future to defraud our customers and us by fraudulently inducing employees or consultants into disclosing account information, user names, passwords, personal identification numbers, or customer proprietary network information. Other fraudulent schemes can result in unauthorized use of services or access to customer account information or data. Breaches of network security, or the failure to mitigate such fraud or breaches may adversely affect our operating results. For example, we may be unable to prevent our customers from incurring charges from fraudulent international toll calls made with their phone numbers. We may be required to pay such fraudulent charges without reimbursement from our customers, and our reputation may be harmed. If our customer credit cards are compromised or people use stolen credit cards to pay for services, we may incur costs which may not be reimbursed or we may not be able to recover payment for our services.

If third-party technology and intellectual property included, or that we intend to include, in our solutions becomes unavailable to us, our software releases could be delayed while we license or develop equivalent technology or intellectual property, which could harm our business.

We incorporate certain third-party technologies and intend to utilize additional third-party technologies in the future. However, licenses to relevant third-party technology or updates to those technologies may not continue to be available to us on commercially reasonable terms, or at all. Therefore, we could face delays in product or software releases until equivalent technology can be identified, licensed or developed, and integrated into our current solutions. These delays, if they occur, could materially adversely affect our business.

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

There is considerable patent and other intellectual property development activity in our industry. Our success depends, in part, upon our not infringing upon the intellectual property rights of others. Our competitors, as well as a number of other “non-practicing entities” and individuals, own or claim to own intellectual property relating

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to our industry and may have substantially larger and broader patent portfolios than we do. From time to time, third parties have in the past and may in the future claim that we are infringing upon their intellectual property rights, and we may be found to be infringing upon such rights. Third parties have in the past sent us correspondence regarding their intellectual property and have filed litigation against us, and in the future we may receive claims that our products infringe or violate their intellectual property rights. Furthermore, we may be unaware of the intellectual property rights of others that may cover some or all of our technology or products. Any claims or litigation could cause us to incur significant expenses and, if successfully asserted against us, could require that we pay substantial damages or ongoing royalty payments, prevent us from selling our products, damage our reputation, or require that we comply with other unfavorable terms, any of which could materially harm our business. In addition, we may decide to pay substantial settlement costs in connection with any claim or litigation, whether or not successfully asserted against us. Even if we were to prevail, any litigation regarding our intellectual property could be costly and time-consuming and divert the attention of our management and key personnel from our business operations.

Litigation with respect to intellectual property rights in our industry is not uncommon and can often involve patent holding companies who have little or no product revenue and against whom our own patents may provide little or no deterrence. We may also be obligated to indemnify our customers or business partners in connection with any such litigation, which could further exhaust our resources. Furthermore, as a result of an intellectual property challenge, we may be required to enter into royalty, license or other agreements. We may not be able to obtain these agreements on terms acceptable to us or at all. We may have to incur substantial cost in re-designing our solutions to avoid infringement claims. In addition, disputes regarding our intellectual property rights may deter distributors from selling our products and dissuade potential customers from purchasing such solutions. As such, third-party claims with respect to intellectual property may increase our cost of goods sold or reduce the sales of our solutions, and may have a material and adverse effect on our business.

Failure to protect our intellectual property could substantially harm our business.

Our success and ability to compete are substantially dependent upon our intellectual property. We rely on patent, trademark and copyright law, trade secret protection and confidentiality or license agreements with our employees, enterprise customers, strategic partners and others to protect our intellectual property rights. However, the steps we take to protect our intellectual property rights may be inadequate. We cannot assure you that any additional patents will be issued. Even if patents are issued, they may not adequately protect our intellectual property rights or our solutions against competitors, and third-parties may challenge the scope, validity and/or enforceability of our issued patents. In addition, other parties may independently develop similar or competing technologies designed around any patents that may be issued to us.

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

Our success also depends on our ability to handle a large number of simultaneous calls, which our network may not be able to accommodate.

We expect the volume of simultaneous calls to increase significantly as our subscriber base grows. Our network hardware and software may be strained by heavy volume. If we fail to maintain an appropriate level of operating performance, or if our service is disrupted, our reputation could be hurt and we could lose customers or have to issues credits or refunds, all of which could have a material adverse effect on our business, financial condition or operating results.

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If we fail to establish and maintain proper and effective internal control over financial reporting, our operating results and our ability to operate our business could be harmed.

The Sarbanes-Oxley Act of 2002 requires, among other things, that we establish and maintain internal control over financial reporting and disclosure controls and procedures. In particular, under the current rules of the Securities and Exchange Commission (“SEC”), we must perform system and process evaluation and testing of our internal control over financial reporting to allow management to report on the effectiveness of our internal control over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act. Our independent registered public accounting firm is also required to report on our internal control over financial reporting. Our and our auditor’s testing may reveal deficiencies in our internal control over financial reporting that are deemed to be material weaknesses and render our internal control over financial reporting ineffective. We have incurred and we expect to continue to incur substantial accounting and auditing expense and expend significant management time in complying with the requirements of Section 404. If we are not able to comply with the requirements of Section 404, or if we or our independent registered public accounting firm identify deficiencies in our internal control over financial reporting that are deemed to be material weaknesses, the market price of our stock could decline and we could be subject to investigations or sanctions by the SEC, The NASDAQ Stock Market, or NASDAQ, or other regulatory authorities or subject to litigation. To the extent any material weaknesses in our internal control over financial reporting are identified in the future, we could be required to expend significant management time and financial resources to correct such material weaknesses or to respond to any resulting regulatory investigations or proceedings.

Catastrophic disasters or other events beyond our control such as earthquakes and hurricanes could damage our facilities or the facilities of our contract manufacturer or third party data center locations, which could cause us to curtail our operations.

Our principal offices and some of our disaster recovery sites are located in California near known earthquake fault zones and, therefore, are vulnerable to damage from earthquakes. We are also vulnerable to damage from other types of disasters, such as power loss, fire, floods and other similar events beyond our control such as acts of war or terrorism. If any disaster were to occur, our ability to operate our business could be seriously impaired. For example, power loss from natural disasters could cause outages to our data centers and interruption of service to our customers. Such outages could have an adverse effect on our brand, cause us to issue credits to our customers, increase our expenses from replacing equipment, and have other adverse effects on our results of operations. Natural disasters could also cause interruption of our information systems preventing us from responding to customer needs. In addition, we may not have adequate insurance to cover our losses resulting from disasters or other similar significant business interruptions.

Our hosted services must comply with industry standards, federal, state and local regulations, and compliance may be costly and/or require us to modify existing services.

Our hosted services rely on communication standards such as SIP and network standards such as Transmission Control Protocol/IP and User Datagram Protocol to interoperate with other vendors' equipment. There is currently a lack of agreement among industry leaders about which standard should be used for a particular application, and about the definition of the standards themselves. As standards evolve, we may be required to modify our existing products or develop and support new versions of our services.

We must also comply with certain federal, state and local requirements regarding how we interact with our customers, including marketing practices, consumer protection, privacy, law enforcement and billing issues, the provision of emergency calling services and the quality of service we provide to our customers. The failure of our services to comply, or delays in compliance, with various existing and evolving regulations could delay or interrupt the sales of our services, subject us to fines or other imposed penalties, or harm the perception and adoption rates of our service, any of which would have a material adverse effect on our business, financial condition or operating results.

Our emergency calling services are different from those offered by traditional wireline telephone companies and may expose us to significant liability. There may be risks associated with limitations associated with emergency dialing with our services.

Our emergency calling service differs from the emergency calling services offered by traditional wireline telephone companies. In each case, the differences may cause significant delays, or even failures, in callers' receipt of the emergency assistance they need.

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We route emergency calls to a service aggregation vendor, who in turn routes the calls to the local Public Safety Answering Point, or PSAP. The PSAP should have automatic access to the customer's telephone number and registered location information. If the number is not associated with an address in an emergency call, then the call is routed by the vendor to an emergency response center where a live answer takes place and the address is determined for routing to the correct PSAP. If a customer moves their service to a new location, the customer's registered location information must be updated and verified by the customer. Until that takes place, the customer will have to verbally advise the emergency dispatcher of his or her actual location at the time of an emergency call. This can lead to delays in the delivery of emergency services.

In addition, in the event that a customer experiences a broadband or power outage, or if a network failure were to occur, the customer will not be able to reach an emergency services provider using our services. Delays our customers may encounter when making emergency services calls and any inability of the answering point to automatically recognize the caller's location or telephone number can result in life threatening consequences. Customers may, in the future, attempt to hold us responsible for any loss, damage, personal injury or death suffered as a result of any failure of our emergency calling services.

There may be risks associated with our ability to comply with the requirements of federal law enforcement agencies.

The FCC requires all interconnected VoIP providers to comply with the Communications Assistance for Law Enforcement Act (“CALEA”). The FCC allows VoIP providers to comply with CALEA through the use of a solution provided by a trusted third party with the ability to extract call content and call-identifying information from a VoIP provider's network. While the FCC permits companies like us to use the services provided by these third parties to comply with CALEA, we are ultimately responsible for ensuring the timely delivery of call content and call-identifying information to law enforcement, and for protecting subscriber privacy. While we believe we are currently CALEA compliant, we could be subject to an enforcement action by the FCC or law enforcement agencies for any delays related to meeting, or if we fail to comply with, any current or future CALEA obligations.

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

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

Changes in regulatory compliance obligations of critical suppliers may adversely impact our operations.

The Dodd-Frank Wall Street Reform and Consumer Protection Act, (“Dodd-Frank Act”), includes Section 1502, related to additional disclosure requirements for certain minerals sourced from the Democratic Republic of Congo and surrounding countries, or conflict minerals, for which such conflict minerals are necessary to the functionality of a product manufactured, or contracted to be manufactured, by an SEC reporting company. The metals covered by the rules include tin, tantalum, tungsten and gold. Our suppliers may use these materials in the production processes. We will have to perform supply chain due diligence, third-party verification and possibly private sector audits on the sources of these metals. Global supply chains are complicated, with multiple layers and suppliers between the mine and the final product. Accordingly, we could incur significant cost related to the compliance process. While the impact of Section 1502 on our business is uncertain at this time, we could potentially have difficulty in procuring needed materials from conflict-free sources.

Increased taxes or regulatory fees on our services will increase our customers' cost of using our services and/or reduce our profit margins (to the extent the costs are not passed through to our customers) and we may be subject to liabilities for past sales and additional taxes, surcharges and fees.

Where we have filed federal, state and municipal tax returns such as sales, excise and ad valorem taxes, fees or surcharges for the services we provide, the interpretation and application of the tax laws and regulations

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applicable in such jurisdictions may be in conflict with the interpretation held by the states and municipalities where we do business. Any increase or changes in our collection of these taxes, fees or surcharges may have the effect of decreasing any price advantage we may have over other providers. Our compliance with these tax initiatives may make us less competitive with those competitors who choose not to comply with these tax initiatives. We have accrued for taxes that we believe are required to be remitted. If our ultimate liability exceeds the accrued amount, it could result in a material adverse effect on our earnings.

Changes in telecommunications regulation and tariffs could harm our business.

Changes in telecommunications requirements, or regulatory requirements in other industries in which we operate, in the United States or other countries could affect the sales of our solutions. Future changes in tariffs by regulatory agencies or application of tariff requirements to currently untariffed services could affect the sales of our solutions for certain classes of customers. Additionally, in the United States, our solutions must comply with various requirements and regulations of the Federal Communications Commission and other regulatory authorities. In countries outside of the United States, our products must meet various requirements of local telecommunications and other industry authorities. These changes could have a material adverse effect on our business, operating results, and financial condition.

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

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

Our business depends on continued and unimpeded access to the Internet and the development and maintenance of Internet infrastructure.

The adoption of any laws or regulations that adversely affect the growth, popularity or use of the Internet, including laws impacting Internet neutrality, could decrease the demand for our solution and increase our operating costs. For example, in 2015, the FCC adopted rules intended, in part, to maintain net neutrality and to prevent network operators from discriminating against legal traffic that transverse their networks. It is possible that the FCC could modify or rescind this rule. To the extent network operators attempt to use other laws or regulations to extract fees from us to deliver our services or otherwise engage in discriminatory practices, our business could be adversely impacted. Internationally, government regulation concerning the Internet, and in particular, network neutrality, may be developing or non-existent. Within such a regulatory environment, we could experience discriminatory or anti-competitive practices that could impede our domestic and international growth, cause us to incur additional expense or otherwise negatively affect our business.

We rely on third party network service providers to originate and terminate a significant portion of our public switched telephone network, or PTSN, calls, which could lead to business disruption if service providers ceased operations or terminated their services.

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

While we believe that relations with our current service providers are good, and we have contracts in place, there can be no assurance that these service providers will be able or willing to supply cost-effective services to

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us in the future or that we will be successful in signing up alternative or additional providers. Although we could replace our current providers, if necessary, our ability to provide service to our subscribers could be impacted during this timeframe and this could have an adverse effect on our business, financial condition or results of operations. The loss of access to, or requirement to change, the telephone numbers we provide to our customers also could have a material adverse effect on our business, financial condition or operating results.

Due to our reliance on these service providers, when problems occur in a network, it may be difficult to identify the source of the problem. The occurrence of hardware and software errors, whether caused by our service or another vendor's products, may result in the delay or loss of market acceptance of our products and any necessary revisions may force us to incur significant expenses. The occurrence of some of these types of problems may seriously harm our business, financial condition or operating results.

Our solutions contain third-party open source software components, and failure to comply with the terms of the underlying open source software licenses could restrict our ability to sell our products.

Our solutions contain software modules licensed to us under “open source” licenses. From time to time, there have been claims against companies that distribute or use open source software in their products and services, asserting that open source software infringes the claimants’ intellectual property rights. We could be subject to suits by parties claiming infringement of intellectual property rights in what we believe to be licensed open source software. Use and distribution of open source software may entail greater risks than use of third-party commercial software, as open source licensors generally do not provide warranties or other contractual protections regarding infringement claims or the quality of the code. Some open source licenses contain requirements that we make available source code for modifications or derivative works we create based upon the type of open source software we use. If we combine our proprietary software with open source software in a certain manner, we could, under certain open source licenses, be required to release the source code of our proprietary software to the public. This would allow our competitors to create similar products with lower development effort and time and ultimately could result in a loss of product sales for us.

Although we monitor our use of open source software to avoid subjecting our products to conditions we do not intend, the terms of many open source licenses have not been interpreted by United States courts, and there is a risk that these licenses could be construed in a way that could impose unanticipated conditions or restrictions on our ability to commercialize our products. In this event, we could be required to seek licenses from third parties to continue offering our products, to make our proprietary code generally available in source code form, to re-engineer our products or to discontinue the sale of our products if re-engineering could not be accomplished on a timely basis, any of which requirements could adversely affect our business, operating results and financial condition.

Risks Related to Ownership of Our Common Stock

Our stock price in the past has been volatile, and may continue to be volatile or may decline regardless of our operating performance, and investors may not be able to resell shares at or above the price at which they purchased the shares.

Our stock price has fluctuated significantly. If investors purchase shares of our common stock, they may not be able to resell those shares at or above the price at which they purchased them. The market price of our common stock may fluctuate significantly in response to numerous factors, many of which are beyond our control, including:

fluctuations in the overall stock market;
the financial projections we may provide to the public, any changes in these projections or our failure to meet these projections;
actual or anticipated fluctuations in our operating results;
changes in operating performance and stock market valuations of other technology companies generally, or those that sell communication products in particular;
changes in financial estimates by any securities analysts who follow our company, our failure to meet these estimates or failure of those analysts to initiate or maintain coverage of our stock;
ratings downgrades by any securities analysts who follow our company;

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the public’s response to our press releases or other public announcements, including our filings with the SEC;
announcements by us or our competitors of significant technical innovations, customer wins or losses, acquisitions, strategic partnerships, joint ventures or capital commitments;
introduction of technologies or product enhancements that reduce the need for our products;
market conditions or trends in our industry or the economy as a whole;
lawsuits threatened or filed against us and the outcome of such lawsuits;
shareholder activism;
future sales of our common stock by our officers, directors and significant stockholders;
speculation and uncertainty concerning the completion of our merger with Mitel; and
other events or factors, including those resulting from war, incidents of terrorism or responses to these events.

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

Our operating results may fluctuate in the future, which could cause our stock price to decline.

Our historical revenues and operating results have varied from quarter to quarter. Moreover, our actual or projected operating results for some quarters may not meet our own expectations, or the expectations of stock market analysts and investors, which may cause our stock price to decline. In addition to the factors discussed elsewhere in this “Risk Factors” section, a number of factors may cause our revenue to fall short of our expectations or cause fluctuations in our operating results, including:

adverse conditions specific to the Unified Communications industry, including decreased demand due to overall economic conditions or reduced discretionary spending by enterprises, rates of adoption of UC systems and services and introduction of new standards;
our ability to attract and retain larger and more productive channel partners;
the purchasing and budgeting cycles of customers, in particular, the tendency of some customers to wait until the end of a quarter in the hopes of obtaining a better price;
the timing and volume of shipments of our products during a quarter, particularly as we experience an increased level of sales occurring towards the end of a quarter;
delays in purchasing decisions by our customers from one quarter to the next, or later;
seasonality in our target markets;
our ability to attract new channel partners, retain existing channel partners, and their ability to generate revenues;
changes in accounting rules;
timing of product introductions;
the timing of recognition of revenue from sales to our customers;
changes in the mix of our solutions sold during a particular period;
our ability to control costs, including third-party manufacturing costs and costs of components;
our ability to maintain sufficient production volumes for our products from our contract manufacturers;

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volatility in our stock price, which may lead to higher stock-based compensation expenses;
volatility and fluctuation in foreign currency exchange rates;
the timing of costs related to the development or acquisition of technologies or businesses;
our ability to successfully expand our international operations;
general economic conditions or economic recession;
a significant growth of hosted and related services sales causing a negative impact to our short term earnings due to how revenue is recognized for hosted and related services as compared to the timing of the recognition of certain related expenses;
decline in interest rates on our investments; and
publicly-announced litigation, and the impact of such litigation on our operating results.

Because our operating expenses are largely fixed in the short-term, any shortfalls in revenue in a given period would have a direct and adverse effect on our operating results in that period. We believe that our quarterly and annual revenue and results of operations may vary significantly in the future and that period-to-period comparisons of our operating results may not be meaningful. You should not rely on the results of one period as an indication of future performance. If our revenues and operating results do not meet the expectations of our investors or securities analysts or fall below guidance we may provide to the market, the price of our common stock may decline.

A substantial portion of our product orders are usually received in the last month of each fiscal quarter, with a concentration of such orders in the final two weeks of the quarter. While we typically ship products shortly after the receipt of an order, we may have orders that have not shipped at the end of any given quarter. Because the amount of such product orders may vary, the amount, if any, of such orders at the end of a particular quarter is not a reliable predictor of our future performance.

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

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

prohibit stockholder action by written consent, thereby requiring all stockholder actions to be taken at a meeting of our stockholders;
limit who may call a special meeting of stockholders;
established a classified board of directors, so that not all members of our board of directors may be elected at one time;
provide our board of directors with the ability to designate the terms of and issue a new series of preferred stock without stockholder approval;
require the approval of two-thirds of the shares entitled to vote at an election of directors to adopt, amend or repeal our bylaws or repeal certain provisions of our certificate of incorporation;
allow a majority of the authorized number of directors to adopt, amend or repeal our bylaws without stockholder approval;
do not permit cumulative voting in the election of our directors, which would otherwise permit less than a majority of stockholders to elect directors;
set limitations on the removal of directors; and
restrict certain litigation against us to be brought only in the State of Delaware.

In addition, Section 203 of the Delaware General Corporation Law generally limits our ability to engage in any business combination with certain persons who own 15% or more of our outstanding voting stock or any of our associates or affiliates who at any time in the past three years have owned 15% or more of our outstanding

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voting stock. These provisions may have the effect of entrenching our management team and may deprive you of the opportunity to sell your shares to potential acquirers at a premium over prevailing prices. This potential inability to obtain a control premium could reduce the price of our common stock.

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

ITEM 2. PROPERTIES

Our headquarters, which is located in Sunnyvale, California, is a 63,781 square foot leased facility. This lease expires in September 2019. We also occupy leased facilities elsewhere in the United States, Europe, Canada, India, Singapore, Hong Kong and Australia.

We maintain a shipping and warehouse facility in Newark, California for our inventory and we rent space as needed at various third-party warehouses throughout the world.

We believe that our current facilities are suitable and adequate to meet our current needs.

ITEM 3. LEGAL PROCEEDINGS

Information with respect to this item may be found in Note 13 and Note 18 to the Consolidated Financial Statements in Item 8, which is incorporated herein by reference.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

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PART II.

ITEM 5. MARKET FOR OUR COMMON STOCK, RELATED STOCKHOLDER MATTERS AND PURCHASES OF EQUITY SECURITIES

Market Information

Our common stock has been traded on The NASDAQ Global Select Market under the symbol “SHOR” since July 3, 2007. The following table sets forth for the periods indicated the high and low sale prices of our common stock, as reported by The NASDAQ Global Select Market.

Year Ended June 30, 2017
High
Low
First Quarter
$
8.32
 
 
6.60
 
Second Quarter
 
8.35
 
 
6.40
 
Third Quarter
 
7.50
 
 
5.80
 
Fourth Quarter
 
6.75
 
 
5.80
 
Year Ended June 30, 2016
High
Low
First Quarter
$
7.63
 
 
6.75
 
Second Quarter
 
10.42
 
 
7.41
 
Third Quarter
 
8.61
 
 
7.00
 
Fourth Quarter
 
7.57
 
 
5.96
 

On August 24, 2017, the last reported sales price of our common stock on the NASDAQ Global Select Market was $7.48 per share.

Holders of Record

As of August 24, 2017, there were 63 stockholders of record of our common stock, although we believe there are approximately 6,300 beneficial owners since many brokers and other institutions hold our common stock on behalf of stockholders.

Dividend Policy

We have never declared or paid dividends on our common stock. We intend to retain any future earnings for use in our business and therefore we do not anticipate declaring or paying any cash dividends in the foreseeable future.

Issuer Purchases of Equity Securities

In May 2016, the Board of Directors authorized us to repurchase up to $20.0 million of the Company's common stock from time to time at the discretion of our management. This stock repurchase authorization has no expiration date.

During the three months ended June 30, 2017, we did not repurchase any common stock. As of June 30, 2017, we had a remaining authorization of $16.9 million for future share repurchases. The number of shares to be repurchased and the timing of such repurchases will be based on several factors, including the price of the Company's common stock and liquidity and general market and business conditions.

Stock Performance Graphs and Cumulative Total Return 1

The following graph shows the cumulative total stockholder return of an investment of $100 in cash on June 30, 2012 through June 30, 2017, for (i) our common stock, (ii) the S&P Small Cap 500 Index and (iii) the NASDAQ Telecommunications Index. Pursuant to applicable SEC rules, all values assume reinvestment of the full amount of all dividends, however no dividends have been declared on our common stock to date. The stockholder return shown on the graph below is not necessarily indicative of future performance, and we do not make or endorse any predictions as to future stockholder returns.

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

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This performance graph shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or the “Exchange Act,” or incorporated by reference into any filing of ours under the Securities Act of 1933, as amended, or the Exchange Act, except as shall be expressly set forth by specific reference in such filing.


$100 invested on June 30, 2012 in stock or index. Fiscal year ending June 30,

 
2012
2013
2014
2015
2016
2017
ShoreTel, Inc.
$
100.00
 
$
92.01
 
$
148.86
 
$
154.79
 
$
152.74
 
$
132.42
 
S&P Small Cap 500 Index
 
100.00
 
 
120.60
 
 
150.27
 
 
161.43
 
 
167.87
 
 
197.92
 
NASDAQ Telecommunications Index
 
100.00
 
 
135.77
 
 
171.20
 
 
181.90
 
 
179.99
 
 
221.54
 

Equity Compensation Plan Information

The following table summarizes information about our equity compensation plans as of June 30, 2017. All outstanding awards relate to our common stock.

Plan Category
Number of
Securities to be
Issued upon
Exercise of
Outstanding
Options,
Warrants and
Rights
Weighted
Average
Exercise Price
of Outstanding
Options,
Warrants and
Rights
Number of
Securities
Remaining
Available for
Future Issuances
under Equity
Compensation
Plans (excluding
securities in
column (a))
 
(a)
(b)
(c)
 
(In thousands, except per share amounts)
Equity compensation plans approved by security holders (1)
 
8,744
 
$
4.94
 
 
7,230
 
Equity compensation plans not approved by security holders
 
 
 
 
 
 
Total
 
8,744
 
$
4.94
 
 
7,230
 
(1) The number of securities remaining available for future issuance in column (c) includes 4,041,000 shares of common stock authorized and available for issuance under our 2015 Equity Incentive Plan (“2015 Plan”) and 3,189,000 shares of common stock authorized and

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available for issuance under our 2007 Employee Stock Purchase Plan (“ESPP”). The number of shares authorized for issuance under the ESPP is subject to an annual increase. The number of securities to be issued to participants in column (a) does not include shares of common stock to be issued to participants in consideration of aggregate participant contributions under the ESPP as of June 30, 2017. Restricted Stock Units and Awards have been excluded for purposes of computing weighted average exercise prices in column (b).

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

The following selected consolidated financial data should be read in connection with our consolidated financial statements and notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this Annual Report on Form 10-K. Our historical results are not necessarily indicative of the results to be expected in any future period.

 
Year Ended June 30,
 
2017
2016
2015
2014
2013
 
(In thousands, except per share amounts)
Revenue:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Hosted and related services
$
150,242
 
$
126,670
 
$
105,381
 
$
87,635
 
$
68,844
 
Product
 
131,174
 
 
158,232
 
 
181,272
 
 
184,952
 
 
186,190
 
Support and services
 
76,343
 
 
75,382
 
 
73,017
 
 
65,712
 
 
57,076
 
Total revenue
 
357,759
 
 
360,284
 
 
359,670
 
 
338,299
 
 
312,110
 
Cost of revenue:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Hosted and related services (1)
 
70,406
 
 
61,384
 
 
60,401
 
 
54,057
 
 
43,087
 
Product (1)
 
43,543
 
 
51,881
 
 
63,253
 
 
65,470
 
 
63,941
 
Support and services (1)
 
17,194
 
 
19,199
 
 
17,453
 
 
16,866
 
 
16,624
 
Total cost of revenue
 
131,143
 
 
132,464
 
 
141,107
 
 
136,393
 
 
123,652
 
Gross profit
 
226,616
 
 
227,820
 
 
218,563
 
 
201,906
 
 
188,458
 
Operating expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Research and development (1)
 
67,068
 
 
60,509
 
 
53,352
 
 
49,758
 
 
52,992
 
Sales and marketing (1)
 
127,637
 
 
126,123
 
 
118,931
 
 
110,977
 
 
120,222
 
General and administrative (1)
 
43,532
 
 
41,778
 
 
39,778
 
 
40,356
 
 
38,102
 
Settlements and defense fees
 
(30
)
 
56
 
 
8,475
 
 
 
 
 
Acquisition-related costs
 
 
 
1,489
 
 
 
 
 
 
 
Total operating expenses
 
238,207
 
 
229,955
 
 
220,536
 
 
201,091
 
 
211,316
 
Income (loss) from operations
 
(11,591
)
 
(2,135
)
 
(1,973
)
 
815
 
 
(22,858
)
Other income (expense):
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest expense
 
(455
)
 
(469
)
 
(531
)
 
(643
)
 
(1,722
)
Interest income and other (expense), net
 
541
 
 
(1,628
)
 
(939
)
 
(637
)
 
(690
)
Total other income (expense)
 
86
 
 
(2,097
)
 
(1,470
)
 
(1,280
)
 
(2,412
)
Loss before provision for (benefit from) income taxes
 
(11,505
)
 
(4,232
)
 
(3,443
)
 
(465
)
 
(25,270
)
Provision for income taxes
 
938
 
 
560
 
 
961
 
 
586
 
 
426
 
Net loss
$
(12,443
)
$
(4,792
)
$
(4,404
)
$
(1,051
)
$
(25,696
)
Net loss per common share (2) :
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Basic and diluted
$
(0.18
)
$
(0.07
)
$
(0.07
)
$
(0.02
)
$
(0.44
)
Shares used in computing net loss per share:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Basic and diluted
 
68,100
 
 
66,405
 
 
63,953
 
 
61,191
 
 
58,633
 
(1) Includes stock-based compensation expense as follows:
 
Year Ended June 30,
 
2017
2016
2015
2014
2013
 
(In thousands)
Cost of hosted and related services
$
261
 
$
1,272
 
$
1,215
 
$
626
 
$
188
 
Cost of product revenue
 
53
 
 
64
 
 
74
 
 
69
 
 
110
 
Cost of support and services revenue
 
370
 
 
590
 
 
497
 
 
569
 
 
760
 

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Year Ended June 30,
 
2017
2016
2015
2014
2013
 
(In thousands)
Research and development
 
2,256
 
 
1,854
 
 
1,928
 
 
1,704
 
 
2,789
 
Sales and marketing
 
2,909
 
 
2,569
 
 
2,391
 
 
1,996
 
 
2,921
 
General and administrative
 
3,940
 
 
2,522
 
 
2,308
 
 
2,352
 
 
3,837
 
Total stock-based compensation expense
$
9,789
 
$
8,871
 
$
8,413
 
$
7,316
 
$
10,605
 
(2) See Note 8 to the Consolidated Financial Statements in Item 8 for a description of the method used to compute basic and diluted net loss per share.
 
As of June 30,
 
2017
2016
2015
2014
2013
 
(In thousands)
Consolidated balance sheet data:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash, cash equivalents and short-term investments
$
115,888
 
$
108,159
 
$
90,187
 
$
56,145
 
$
51,276
 
Working capital
 
60,402
 
 
52,033
 
 
44,394
 
 
25,643
 
 
26,568
 
Total assets
 
339,452
 
 
342,338
 
 
326,456
 
 
306,949
 
 
301,307
 
Line of credit, net of debt issuance costs
 
 
 
 
 
 
 
29,004
 
 
19,946
 
Total stockholders’ equity
 
202,193
 
 
202,729
 
 
190,128
 
 
177,384
 
 
156,146
 
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this document. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those discussed below. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed above in the section entitled “Risk Factors.” We report results on a fiscal year ending June 30. For ease of reference within this section, 2017 refers to the fiscal year ended June 30, 2017, 2016 refers to the fiscal year ended June 30, 2016, and 2015 refers to the fiscal year ended June 30, 2015.

Overview

ShoreTel is a leading provider of brilliantly simple business communication solutions. We focus on the small and medium sized businesses seeking a Unified Communications (“UC”) solution allowing them to communicate anytime, anyplace and through any device that they chose.

We provide this to the market via two solutions: ShoreTel Connect, our UC solution, and Contact Center offering and ShoreTel Summit, our platform for creating microservices. ShoreTel Connect delivers a fully featured UC solution and applications such as mobility, collaboration, and workgroups. ShoreTel Connect is unique in that it offers three different delivery models including cloud, onsite and hybrid. Connect Cloud provides a hosted voice solution to our customers. Connect OnSite provides our customers the ability to independently own and operate their equipment. Connect Hybrid enables our customers to use both our cloud and onsite offerings while still delivering the same user experience and providing our customers increased choice and flexibility. Summit, our Communications Platform as a Service (“CPaaS”) offering, delivers the option to create microservices or deeply integrate communications into any application or workflow.

We believe our solutions address changes in the UC market being driven by both technological advances and new workplace trends. We believe some of the current factors affecting the UC market include: the shift to consuming communications from the cloud, addressing an increasingly mobile workforce, the ongoing need for collaboration, a desire for multiple forms of communication and a need to integrate communications into workflows and applications. Our solutions are sold through our extensive network of over 1,100 authorized resellers and value-added distributors throughout the world served either by national distributors or by ShoreTel directly.

We were originally incorporated in California in September 1996 and reincorporated in Delaware in 2007. ShoreTel is based in Sunnyvale, California, and has regional offices in North America, Europe, Asia and Australia. Additionally, our cloud-based services are provided from multiple data centers located in the United States, the United Kingdom and Australia. While most of our customers are located in the United States, we have

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remained fairly consistent in revenue from international sales, which accounted for approximately 8% of our total revenue in fiscal 2017, 2016 and 2015. We expect sales to customers in the United States will continue to comprise the majority of our sales in the foreseeable future if we remain a stand-alone company.

On July 26, 2017, we entered into a definitive Agreement and Plan of Merger (“Merger Agreement”) with Mitel US Holdings, Inc., a Delaware corporation, Shelby Acquisition Corporation, a Delaware corporation and a wholly owned subsidiary of Parent (“Merger Sub”) and, with respect to certain obligations set forth in the Merger Agreement, Mitel Networks Corporation, a Canadian corporation. Pursuant to and subject to the terms and conditions of the Merger Agreement, Merger Sub has commenced an all-cash tender offer for any and all of ShoreTel’s outstanding shares of common stock, par value $0.001 per share, at a purchase price of $7.50 per share, net to the seller in cash, without interest, and subject to any required withholding of taxes. The transaction is subject to certain conditions, including the tender of at least one share more than half of all our common stock outstanding as well as regulatory and other related approvals. We have agreed to operate our business in the ordinary course during the period between the execution of the Merger Agreement and the effective time of the merger and have agreed to certain other customary restrictions on its operations, as set forth in the Merger Agreement.

Key Business Metrics

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

Deferred revenue. Deferred revenue relates to the timing of revenue recognition for specific transactions based on delivery of service, support, specific commitments, product and services delivered to our value-added distributors that have not been delivered or sold through to resellers, and other factors. Deferred revenue primarily consists of billings or payments received in advance of revenue recognition from our transactions and are recognized as the revenue recognition criteria are met. Nearly all of our onsite system sales include the purchase of post-contractual support contracts with terms of up to five years, and our renewal rates on these contracts have historically been high. We recognize support revenue on a ratable basis over the term of the support contract. Since we receive payment for support in advance of recognizing the related revenue, we carry a deferred revenue balance on our consolidated balance sheet. Almost all of our hosted services are billed a month in advance. Billings that are collected before the service is delivered are included in the deferred revenue balance on our consolidated balance sheet. These amounts are recognized as revenue as the services are delivered. Our deferred revenue balance at June 30, 2017 was $82.8 million, of which $61.5 million is expected to be recognized within one year.

Gross margin. Our gross margin for hosted and related services is lower than the gross margins for support and services and product and is impacted primarily by the reselling of broadband circuits to customers, employee-related expense, data communication cost, data center costs, carrier cost, telecom taxes, and intangible asset amortization expense. We expect that with the growth in hosted and related services revenue, the gross margins may reflect improvement due to economies of scale, synergies and other cost reductions in our service delivery model.

Gross margins for products are primarily affected by our ability to reduce hardware costs faster than the decline in average overall system sales prices. We strive to increase our product gross margin by reducing hardware costs through product redesign and volume discount pricing from our suppliers. In general, product gross margin on our switches is greater than product gross margin on our IP phones. We consider our ability to monitor and manage these factors to be a key aspect of maintaining product gross margins and increasing our profitability if we remain a stand-alone company.

Gross margin for support and services is impacted primarily by labor-related expenses. The primary goal of our support and services function is to ensure a high level of customer satisfaction and our investments in support personnel and infrastructure are made with this goal in mind. 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.

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Operating expense. Our operating expenses are comprised primarily of compensation and benefits for our employees and related expenses such as travel. Accordingly, increases in operating expenses historically have been primarily related to increases in our headcount. We intend to expand our workforce as we grow if we remain a stand-alone company, and therefore, our ability to forecast revenue is critical to managing our operating expenses.

Average revenue per user . We calculate the average monthly service revenue per user (“ARPU”) for our hosted and related services revenue as the average monthly revenue divided by the average number of seats. The average monthly revenue is calculated as the total hosted and related service revenue from customers in the period, divided by the number of months in the period. The average number of seats is calculated as a simple average of users during the period. Our ARPU includes telecommunication internet circuits that we resell that could, as a percentage of our business, decline over time as our average customer size increases and therefore they are more likely to have their own networks already established. Our monthly ARPU for the three-month period ended June 30, 2017, 2016 and 2015 was approximately $48, $51 and $54, respectively. The decrease in ARPU was primarily due to a greater number of volume discounts related to increased sales to larger enterprise customers and a decrease in the resale of internet circuits to new customers as compared to the existing customer base.

Revenue churn . Revenue churn for our hosted and related services revenue is calculated by dividing the monthly recurring revenue from customers that have terminated during a period by the simple average of the total monthly recurring revenue from all customers in a given period. The effective management of the revenue churn is critical to our ability to maximize revenue growth and to maintain and improve margins if we remain a stand-alone company. Our annualized revenue churn for the three months ended June 30, 2017, 2016 and 2015 was approximately 5%, 6% and 4%, respectively.

Basis of Presentation

Revenue. We derive our revenue from sales of our onsite IP telecommunications systems, hosted services and related support and services.

Hosted and related services revenue. Hosted and related services and solutions consist primarily of our proprietary hosted VoIP UC system as well as other services such as foreign and domestic calling plans, certain UC applications, internet service provisioning, regulatory and telecommunications fees, training and other professional services. Our hosted and related services are sold through indirect channel resellers and a direct sales force. Our customers enter into one to three-year service agreements whereby they are billed for such services on a monthly basis. Revenue from our hosted and related services is recognized on a monthly basis as services are delivered. Revenue associated with various calling plans and internet services are recognized as such services are provided. Hosted and related services revenues accounted for 42%, 35% and 29% of our total revenues for fiscal 2017, 2016 and 2015, respectively. We expect that hosted and related services revenue will continue to increase as a percentage of total revenue if we remain a stand-alone company.

Product revenue . Product revenue consists of sales of our business communication systems. Our typical system includes a combination of IP phones, switches and software applications primarily for our onsite-based solutions. We sell our products through channel partners that include resellers and value-added distributors. Prices to a given channel partner for hardware and software products depend on that channel partner's volume and other criteria, as well as our own strategic considerations. Product revenue has accounted for 37%, 44%, and 51% of our total revenue for fiscal years 2017, 2016 and 2015, respectively. Product revenue may continue to decline in future periods if we remain a stand-alone company as we continue to focus a greater amount of our sales and marketing efforts to expand our hosted and related services revenue.

Support and services revenue. Support and services revenue primarily consists of post-contractual support, and to a lesser extent revenue from training services, professional services and onsite-based installations that we perform. Post-contractual support includes software updates which grant rights to unspecified software license upgrades and maintenance releases issued during the support period. Post-contractual support also includes both Internet- and phone-based technical support. Revenue from post-contractual support is recognized ratably over the contractual service period. Support and services revenues accounted for 21%, 21% and 20% of our total revenue for fiscal 2017, 2016 and 2015,

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respectively. Support and services revenue may decline in future periods if we remain a stand-alone company as new support contracts tied to product revenue decline primarily due to the decline in sales volume resulting from our shift in strategic focus from driving growth in product revenue to driving growth in hosted and related services revenue.

Cost of revenue. Cost of hosted and related services revenue consists of personnel and related costs of the hosted services, data center costs, data communication cost, data center costs, costs of regulatory and telecommunications fees, carrier cost and amortization of intangible assets. Cost of product revenue consists primarily of hardware costs, royalties and license fees for third-party software included in our systems, salary and related overhead costs of operations personnel, freight, warranty costs and provision for excess inventory. The majority of these costs vary with the unit volumes of products sold. Cost of support and services revenue consists of salary and related overhead costs of personnel engaged in support and service.

Research and development expenses. Research and development expenses primarily include personnel costs, outside engineering costs, professional services, prototype costs, test equipment, software usage fees and facilities expenses. Research and development expenses are recognized when incurred. We have capitalized development costs incurred from determination of technological feasibility through general release of the product to customers, although capitalized development costs historically have not been significant. We devoted substantial resources to the development of additional functionality of our solutions and the ongoing development of new product technologies and related software applications to support this solution. We intend to continue to make investments in our research and development efforts if we remain a stand-alone company because we believe they are essential to maintaining and improving our competitive position.

Sales and marketing expenses. Sales and marketing expenses primarily include personnel costs, sales and partner commissions, travel, marketing, promotional and lead generation programs, branding and advertising, trade shows, sales demonstration equipment, professional services fees, amortization of intangible assets, and facilities expenses. We plan to continue to invest in development of our distribution channel to enable us to expand into new geographies and further increase our sales to enterprise customers if we remain a stand-alone company. We expect that sales and marketing expenses will continue to be our largest operating expense category.

General and administrative expenses. General and administrative expenses primarily relate to our executive, finance, human resources, legal and information technology organizations. General and administrative expenses primarily consist of personnel costs, professional fees for legal, board of directors' costs, accounting, tax, compliance and information systems, travel, recruiting expense, depreciation expense and facilities expenses.

Settlements and defense fees . Settlements and defense fees relate to charges related to probable and estimable settlement amounts and professional fees incurred in connection with an unsolicited acquisition proposal.

Acquisition related costs. Acquisition-related costs relate to legal, accounting, consulting, investment banker and other costs directly related acquisitions

Interest expense. Interest expense primarily consists of interest expense associated with our Credit Facility.

Interest income and other (expense). Interest income and other (expense) primarily consists of interest earned on cash, cash equivalents and short-term investments, gains and losses on foreign currency translations and transactions and other miscellaneous items affecting our operating results.

Provision for income taxes . Provision for income taxes includes federal, state and foreign taxes on our income as well as any adjustments made to our valuation allowance for deferred tax assets. Since our inception, we have accumulated substantial net operating loss and tax credit carryforwards. We account for income taxes under an asset and liability approach. Deferred income taxes reflect the impact of temporary differences between assets and liabilities recognized for financial reporting purposes and such amounts recognized for income tax reporting purposes, net operating loss carryforwards and other tax credits are measured by applying current enacted tax laws. Valuation allowances are provided when necessary to reduce deferred tax assets to an amount that is more likely than not to be realized.

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Results of Operations

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

 
Year Ended June 30,
 
2017
2016
2015
Revenue:
 
 
 
 
 
 
 
 
 
Hosted and related services
 
42
%
 
35
%
 
29
%
Product
 
37
%
 
44
%
 
51
%
Support and services
 
21
%
 
21
%
 
20
%
Total revenue
 
100
%
 
100
%
 
100
%
Cost of revenue:
 
 
 
 
 
 
 
 
 
Hosted and related services
 
20
%
 
17
%
 
17
%
Product
 
12
%
 
15
%
 
17
%
Support and services
 
5
%
 
5
%
 
5
%
Total cost of revenue
 
37
%
 
37
%
 
39
%
Gross profit
 
63
%
 
63
%
 
61
%
Operating expenses:
 
 
 
 
 
 
 
 
 
Research and development
 
19
%
 
17
%
 
15
%
Sales and marketing
 
35
%
 
35
%
 
33
%
General and administrative
 
12
%
 
12
%
 
11
%
Settlements and defense fees
 
 
 
 
 
3
%
Acquisition-related costs
 
 
 
 
 
 
Total operating expenses
 
66
%
 
64
%
 
62
%
Income (loss) from operations
 
(3
%)
 
(1
)%
 
(1
)%
Other income (expense):
 
 
 
 
 
 
 
 
 
Interest expense
 
 
 
 
 
 
Interest income and other (expense), net
 
 
 
 
 
 
Total other income (expense)
 
 
 
 
 
 
Loss before provision for income taxes
 
(3
%)
 
(1
)%
 
(1
)%
Provision for income taxes
 
 
 
 
 
 
Net loss
 
(3
%)
 
(1
)%
 
(1
)%

Comparison of Fiscal 2017 to 2016 and Fiscal 2016 to 2015

Revenue

 
Year Ended
 
June 30,
2017
June 30,
2016
June 30,
2015
June 30, 2017 to June 30, 2016
June 30, 2016 to June 30, 2015
 
Change $
Change %
Change $
Change %
(In thousands, except percentages)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Hosted and related services revenue
$
150,242
 
$
126,670
 
$
105,381
 
$
23,572
 
 
19
%
$
21,289
 
 
20
%
Product revenue
 
131,174
 
 
158,232
 
 
181,272
 
 
(27,058
)
 
(17
%)
 
(23,040
)
 
(13
%)
Support and services revenue
 
76,343
 
 
75,382
 
 
73,017
 
 
961
 
 
1
%
 
2,365
 
 
3
%
Total revenue
 
357,759
 
 
360,284
 
 
359,670
 
 
(2,525
)
 
(1
%)
 
614
 
 
 

Total revenue decreased by $2.5 million in fiscal 2017 as compared to fiscal 2016 primarily related to a decrease in product revenue, partially offset by an increase in hosted and related services revenue. Total revenue increased by $0.6 million in fiscal 2016 as compared to fiscal 2015 primarily related to an increase in hosted and related services revenue and support and services revenue, partially offset by a decrease in product revenue. These changes were primarily due to a shift in our strategic focus from driving growth in product revenue to driving growth in hosted and related services revenue, which is a response to our belief that there is a shift in the

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UC industry from on onsite-based solutions to cloud-based solutions. This shift in focus is reflected in the decrease in product revenue and increase in hosted and related services revenue during fiscal 2017 and 2016.

Revenue from customers in the United States accounted for approximately 92% of total revenue for years ended June 30, 2016, 2015 and 2014.

Hosted and related services revenue

Hosted and related service revenue increased by $23.6 million, or 19%, in fiscal 2017 and by $21.3 million, or 20%, in fiscal 2016. As a result of our shift in our strategic focus from driving growth in product revenue to driving growth in hosted and related services revenue, we have experienced both continued growth in our hosted customer base and the use of additional services by existing customers resulting in increased hosted and related services revenue in both fiscal 2017 and 2016. During fiscal 2017 the increase in hosted and related services revenue was primarily due to an increase of $18.3 million in sales to new customers as well as an increase of $4.0 million in sales to existing customers. During fiscal 2016 the increase in hosted and related services revenue was primarily due to an increase of $13.6 million in sales to new customers as well as an increase of $5.8 million in sales to existing customers primarily due to market growth enabling the expansion of our customer base resulting from sales to new customers and additional sales to existing customers.

Product revenue

Product revenue decreased by $27.1 million, or 17%, in fiscal 2017 and by $23.0 million, or 13%, in fiscal 2016 primarily due to the decline in sales volume resulting from our shift in strategic focus from driving growth in product revenue to driving growth in hosted and related services revenue. This shift in strategic focus has caused us to experience a decrease in sales in all product lines. During fiscal 2017, the decrease in product revenue was primarily due to a $16.1 million decrease in software license sales, a $6.4 million decrease in phone sales and a $5.2 million decrease in switch sales. During fiscal 2016, the decrease in product revenue was primarily due to a $10.0 million decrease in software license sales, a $4.2 million decrease in switch sales and a $3.3 million decrease in phone sales. Product revenue may continue to decline in future periods if we remain a stand-alone company as we continue to focus a greater amount of our sales and marketing efforts to expand our hosted and related services revenue.

Support and services revenue

Support and services revenue increased by $1.0 million, or 1%, in fiscal 2017, as compared to fiscal 2017 and by $2.4 million, or 3%, in fiscal 2016 as compared to fiscal 2015. The increase in support and services revenue in both fiscal 2017 and 2016 was primarily due to additional sales to existing customers resulting in higher post-contractual support revenues supported by high renewal rates and continued expansion of our customer base resulting from sales to new customers who contract for support agreements.

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Gross margin

 
Year Ended
 
June 30,
2017
June 30,
2016
June 30,
2015
June 30, 2017 to June 30, 2016
June 30, 2016 to June 30, 2015
 
Change $
Change %
Change $
Change %
(In thousands, except percentages)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Hosted and related services cost of revenue
$
70,406
 
$
61,384
 
$
60,401
 
$
9,022
 
 
15
%
$
983
 
 
2
%
Product cost of revenue
 
43,543
 
 
51,881
 
 
63,253
 
 
(8,338
)
 
(16
%)
 
(11,372
)
 
(18
%)
Support and services cost of revenue
 
17,194
 
 
19,199
 
 
17,453
 
 
(2,005
)
 
(10
%)
 
1,746
 
 
10
%
Total cost of revenue
$
131,143
 
$
132,464
 
$
141,107
 
$
(1,321
)
 
(1
%)
$
(8,643
)
 
(6
%)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Hosted and related services gross profit
$
79,836
 
$
65,286
 
$
44,980
 
$
14,550
 
 
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