ShoreTel (SHOR) 10-Q 2010 Q1 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark one)

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

For the quarterly period ended March 31, 2010

OR

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

For the transition period from              to             

Commission File Number 001-33506

SHORETEL, INC.

(Exact name of Registrant as specified in its charter)

Delaware	77-0443568
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
960 Stewart Drive, Sunnyvale, California	94085-3913
(Address of principal executive offices)	(Zip Code)

(408) 331-3300

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

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

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

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

As of April 28, 2010, 45,013,674 shares of the registrant’s common stock were outstanding.

SHORETEL, INC. AND SUBSIDIARIES

FORM 10-Q for the Quarter Ended March 31, 2010

INDEX

		Page
PART I: Financial Information		3
Item 1	Financial Statements (Unaudited)	3
	Condensed Consolidated Balance Sheets as of March 31, 2010 and June 30, 2009	3
	Condensed Consolidated Statements of Operations for the three months and nine months ended March 31, 2010 and 2009	4
	Condensed Consolidated Statements of Cash Flows for the nine months ended March 31, 2010 and 2009	5
	Notes to Condensed Consolidated Financial Statements	6
Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	15
Item 3	Quantitative and Qualitative Disclosures About Market Risk	25
Item 4	Controls and Procedures	26
PART II: Other information		27
Item 1	Legal Proceedings	27
Item 1A	Risk Factors	27
Item 2	Unregistered Sales of Equity Securities and Use of Proceeds	27
Item 6	Exhibits	27
	Signatures	28
	Exhibit Index	29

2

PART I. FINANCIAL INFORMATION

ITEM 1: FINANCIAL STATEMENTS (Unaudited)

SHORETEL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except per share amounts)

(Unaudited)

	March 31, 2010			June 30, 2009
ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$	67,703		$	73,819
Short-term investments		46,878			33,847
Accounts receivable, net of allowance of $872 and $1,330 as of March 31, 2010 and June 30, 2009, respectively		19,617			21,454
Inventories		12,318			11,805
Prepaid expenses and other current assets		8,166			3,110
Total current assets		154,682			144,035
PROPERTY AND EQUIPMENT, net		5,350			3,475
OTHER ASSETS		6,516			8,114
TOTAL ASSETS	$	166,548		$	155,624
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Accounts payable	$	7,617		$	7,774
Accrued expenses and other		9,951			4,494
Accrued employee compensation		6,233			4,895
Deferred revenue		17,850			15,255
Total current liabilities		41,651			32,418
LONG-TERM LIABILITIES:
Long-term deferred revenue		8,723			7,236
Other long-term liabilities		2,272			2,198
Total liabilities		52,646			41,852
COMMITMENTS AND CONTINGENCIES (Note 11)
STOCKHOLDERS’ EQUITY:
Preferred stock, $0.001 par value: authorized 5,000; none issued and outstanding		—			—
Common stock and additional paid-in capital, par value $0.001 per share, authorized 500,000; issued and outstanding, 45,000 and 44,362 shares as of March 31, 2010 and June 30, 2009, respectively		218,206			209,102
Deferred stock compensation		(3	)		(54	)
Accumulated other comprehensive income		222			136
Accumulated deficit		(104,523	)		(95,412	)
Total stockholders’ equity		113,902			113,772
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	166,548		$	155,624

See Notes to Condensed Consolidated Financial Statements

3

SHORETEL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

(Unaudited)

	Three Months Ended March  31,						Nine Months Ended March  31,
	2010			2009 As Restated			2010			2009 As Restated
REVENUE:
Product	$	28,945		$	24,691		$	83,685		$	83,801
Support and services		8,089			6,546			22,556			18,631
Total revenue		37,034			31,237			106,241			102,432
COST OF REVENUE:
Product (1)		10,049			8,624			29,369			28,726
Support and services (1)		2,933			2,730			8,323			8,589
Total cost of revenue		12,982			11,354			37,692			37,315
GROSS PROFIT		24,052			19,883			68,549			65,117
OPERATING EXPENSES:
Research and development (1)		8,634			7,552			23,666			23,769
Sales and marketing (1)		14,726			11,472			39,653			34,484
General and administrative (1)		5,214			5,301			14,596			15,399
Litigation settlement (Note 11)		—			4,110			—			4,110
Total operating expenses		28,574			28,435			77,915			77,762
LOSS FROM OPERATIONS		(4,522	)		(8,552	)		(9,366	)		(12,645	)
OTHER INCOME (EXPENSE):
Interest income		100			188			296			1,208
Other		(220	)		(39	)		(128	)		(641	)
Total other income (expense)		(120	)		149			168			567
LOSS BEFORE BENEFIT FROM INCOME TAXES		(4,642	)		(8,403	)		(9,198	)		(12,078	)
BENEFIT FROM INCOME TAXES		153			1,056			87			154
NET LOSS	$	(4,489	)	$	(7,347	)	$	(9,111	)	$	(11,924	)
Net loss per share — basic and diluted	$	(0.10	)	$	(0.17	)	$	(0.20	)	$	(0.27	)
Shares used in computing net loss per share — basic and diluted		44,941			43,793			44,731			43,576
(1)    Includes stock-based compensation expense as follows:
Cost of product revenue	$	34		$	23		$	99		$	86
Cost of support and services revenue		207			184			553			606
Research and development		805			597			2,248			2,181
Sales and marketing		911			741			2,528			2,753
General and administrative		861			619			2,320			1,926
Total stock-based compensation expense	$	2,818		$	2,164		$	7,748		$	7,552

See Notes to Condensed Consolidated Financial Statements

4

SHORETEL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

	Nine Months Ended March 31,
	2010			2009 As Restated
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss	$	(9,111	)	$	(11,924	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization		2,045			1,440
Amortization (accretion) of premium (discount) on investments		72			(8	)
Stock-based compensation expense		7,748			7,552
Loss on disposal of property and equipment		155			184
Provision (benefit) for doubtful accounts receivable		(83	)		966
Changes in assets and liabilities:
Accounts receivable		1,920			1,679
Inventories		(513	)		2,344
Prepaid expenses and other current assets		(3,746	)		(305	)
Other assets		988			(268	)
Accounts payable		(273	)		(1,109	)
Accrued expenses and other		5,611			3,398
Accrued employee compensation		1,338			97
Deferred revenue		4,082			2,382
Net cash provided by operating activities		10,233			6,428
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment		(3,518	)		(1,431	)
Purchases of investments		(19,652	)		(18,040	)
Proceeds from sales/maturities of investments		6,635			33,558
Purchases of software license and other		(1,200	)		(1,070	)
Net cash (used in) provided by investing activities		(17,735	)		13,017
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock to employees		1,504			1,404
Taxes paid on vested and released stock awards		(118	)		—
Net cash provided by financing activities		1,386			1,404
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS		(6,116	)		20,849
CASH AND CASH EQUIVALENTS - Beginning of period		73,819			68,672
CASH AND CASH EQUIVALENTS - End of period	$	67,703		$	89,521
NONCASH INVESTING AND FINANCING ACTIVITIES:
Vesting of accrued early exercised stock options	$	18		$	46
Purchase of property and equipment included in period-end accounts payable		465			118
Purchase of other assets included in period-end accounts payable and other liabilities		—			1,530

See Notes to Condensed Consolidated Financial Statements

5

SHORETEL, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

1. Description of Business

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

2. Basis of Presentation and Significant Accounting Policies

The accompanying financial statements as of March 31, 2010 and for the three months and nine months ended March 31, 2010 and 2009 have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations. However, the Company believes that the disclosures are adequate to make the information presented not misleading. These Condensed Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and the notes thereto, included in the Company’s Annual Report on Form 10-K, as amended by Form 10-K/A for the fiscal year ended June 30, 2009.

In the opinion of the management, all adjustments (which include normal recurring adjustments, except as disclosed herein) necessary to present a fair statement of financial position as of March 31, 2010, results of operations for the three months and nine months ended March 31, 2010 and 2009, and cash flows for the nine months ended March 31, 2010 and 2009, as applicable, have been made. The results of operations for the three months and nine months ended March 31, 2010 are not necessarily indicative of the operating results for the full fiscal year or any future periods.

Computation of Net Loss per Share

Basic net loss per common share available to common stockholders is determined by dividing net loss available to common stockholders by the weighted average number of common shares available to common stockholders during the period. Diluted net loss per common share available to common stockholders is determined by dividing net loss available to common stockholders by the weighted average number of common shares available to common stockholders used in the basic loss per common share calculation plus the number of common shares that would be issued assuming conversion of all potentially dilutive securities outstanding under the treasury stock method. Potentially dilutive securities were not included in the computation of dilutive net loss per share for the three and nine months ended March 31, 2010 and 2009, because to do so would have been anti-dilutive. Potentially dilutive securities of 8.3 million and 8.1 million for the three and nine months ended March 31, 2010 and 2009, respectively, were not included in the computation of dilutive net loss per share because to do so would have been anti-dilutive.

Recent Accounting Pronouncements

In October 2009, the Financial Accounting Standards Board (“FASB”) issued an accounting standards update that revises accounting and reporting requirements for arrangements with multiple deliverables that are excluded from the scope of existing software revenue guidance. This update requires the use of an estimated selling price to determine the selling price of a deliverable in cases where neither vendor-specific objective evidence nor third-party evidence is available, which is expected to increase the ability for entities to separate deliverables in multiple-deliverable arrangements and, accordingly, to decrease the amount of revenue deferred in these cases. Additionally, this update requires the total selling price of a multiple-deliverable arrangement to be allocated at the inception of the arrangement to all deliverables based on relative selling prices. This update is to be applied prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, which for the Company is July 1, 2010. The Company is currently evaluating the impact of adoption of this update on our financial position, results of operations and cash flows.

In October 2009, the FASB issued an accounting standards update that clarifies which revenue allocation and measurement guidance should be used for arrangements that contain both tangible products and software, in cases where the software is more than incidental to the tangible product as a whole. More specifically, if the software sold with or embedded within the tangible product is essential to the functionality of the tangible product, then this software as well as undelivered software elements that relate to this software is excluded from the scope of existing software revenue guidance, which is expected to decrease the amount of revenue deferred in these cases. This update is to be applied prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, which for the Company is July 1, 2010. The Company is currently evaluating the impact of adoption of this update on our financial position, results of operations and cash flows.

6

In January 2010, the FASB issued amended guidance on fair value measurements and disclosures. The new guidance requires additional disclosures regarding fair value measurements, amends disclosures about postretirement benefit plan assets, and provides clarification regarding the level of disaggregation of fair value disclosures by investment class. This guidance is effective for interim and annual reporting periods beginning after December 15, 2009, except for certain Level 3 activity disclosure requirements that will be effective for reporting periods beginning after December 15, 2010. Accordingly, the Company adopted this amendment in the quarter ended March 31, 2010, except for the additional Level 3 requirements which will be adopted in 2011. The adoption of this amendment did not have a significant impact on the Company’s financial position, results of operations or cash flows.

In February 2010, the FASB issued amended guidance on subsequent events. Under this amended guidance, SEC filers are no longer required to disclose the date through which subsequent events have been evaluated in originally issued and revised financial statements. This guidance was effective immediately and the Company adopted this new guidance in the quarter ended March 31, 2010. The adoption of this amendment did not have a significant impact on the Company’s financial position, results of operations or cash flows.

3. Balance Sheet Details

Balance sheet components consist of the following:

(In thousands)	March 31, 2010			June 30, 2009
Inventories:
Raw materials	$	335		$	398
Work in process		988			962
Finished goods		10,995			10,445
	$	12,318		$	11,805
Prepaid expenses and other current assets:
Prepaid expenses	$	5,460		$	2,435
Deferred cost of revenue		355			315
Deferred tax asset/tax receivables		2,351			360
	$	8,166		$	3,110
Property and equipment, net:
Computer equipment and tooling	$	8,475		$	5,281
Software		1,230			1,086
Furniture and fixtures		1,161			1,064
Leasehold improvements and auto		508			387
Total property and equipment	$	11,374		$	7,818
Less accumulated depreciation and amortization		(6,024	)		(4,343	)
Property and equipment - net	$	5,350		$	3,475
Deferred revenue - current and long-term:
Product	$	1,082		$	988
Support and services		25,491			21,503
Total deferred revenue	$	26,573		$	22,491

7

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

	March 31, 2010							June 30, 2009
	Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount		Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount
Licensed technology	$	2,110	$	(419	)	$	1,691	$	1,860	$	(131	)	$	1,729
Intangible assets in pre-release		3,230		—			3,230		2,478		—			2,478
Other intangible assets	$	5,340	$	(419	)		4,921	$	4,338	$	(131	)		4,207
Prepaid royalties							1,283							2,285
Deferred tax asset							79							1,388
Deposits and other							233							234
Total other assets						$	6,516						$	8,114

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

Amortization of intangible assets for the three months ended March 31, 2010 and 2009 was $0.1 million and zero, respectively, and $0.3 million and $0.1 million for the nine months ended March 31, 2010 and 2009, respectively.

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

Years Ending June 30,
2010 (remaining 3 months)	$	104
2011		413
2012		413
2013		413
2014		297
Thereafter		51
Total	$	1,691

Short-Term Investments:

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

	Amortized Cost		Gross  Unrealized Gains		Gross Unrealized Losses			Fair Value
As of March 31, 2010
Corporate notes and commercial paper	$	30,251	$	152	$	(12	)	$	30,391
US Government agency securities		16,405		82		—			16,487
Total short-term investments	$	46,656	$	234	$	(12	)	$	46,878
As of June 30, 2009
Corporate notes and commercial paper	$	24,209	$	111		—		$	24,320
US Government agency securities		9,502		25		—			9,527
Total short-term investments	$	33,711	$	136		—		$	33,847

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

	Amortized Cost		Fair Value
As of March 31, 2010
Less than 1 year	$	23,921	$	24,046
Due in 1 to 3 years		22,735		22,832
Total	$	46,656	$	46,878
	Amortized Cost		Fair Value
As of June 30, 2009
Less than 1 year	$	6,646	$	6,677
Due in 1 to 3 years		27,065		27,170
Total	$	33,711	$	33,847

8

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

4. Fair Value Disclosure

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

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

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

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

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

	As of March 31, 2010
	Fair Value		Level 1		Level 2		Level 3
Assets
Cash and cash equivalents:
Money market funds	$	48,166	$	48,166		—		—
Short-term investments:
Corporate notes and commercial paper		30,391		—		30,391		—
US Government agency securities		16,487		—		16,487		—
Total financial instruments measured and recorded at fair value as of March 31, 2010	$	95,044	$	48,166	$	46,878	$	—

The above table excludes $19.5 million of cash balances on deposit at banks.

	As at June 30, 2009
	Fair Value		Level 1		Level 2		Level 3
Assets
Cash and cash equivalents:
Money market funds	$	64,704	$	64,704	$	—	$	—
Short-term investments:
Corporate notes and commercial paper		24,320		—		24,320		—
US Government agency securities		9,527		—		9,527		—
Total financial instruments measured and recorded at fair value as of June 30, 2009	$	98,551	$	64,704	$	33,847	$	—

The above table excludes $9.1 million of cash balances on deposit at banks.

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

5. Income Taxes

The Company recorded an income tax benefit of $0.2 million and $1.1 million for the three months ended March 31, 2010 and 2009. The benefit for income taxes for the nine months ended March 31, 2010 and 2009 was $0.1 million and $0.2 million, respectively.

9

The income tax benefit of $0.2 million and $0.1 million for the three and nine months ended March 31, 2010, respectively, are due primarily to an income tax benefit related to the timing of deductions in the federal income tax return, partially offset by a tax provision for the profitable jurisdictions and state taxes based upon income earned during the period with no tax benefit accrued on the loss jurisdictions. The income tax benefit for the nine months ended March 31, 2009 was calculated under the discrete method as management determined that an annual effective tax rate method would not provide a reliable estimate.

The “Emergency Economic Stabilization Act of 2008,” which contains the “Tax Extenders and Alternative Minimum Tax Relief Act of 2008”, was signed into law on October 3, 2008. Under the Act, the research credit was retroactively extended for amounts paid or incurred after December 31, 2007 and before January 1, 2010. The Company has calculated its federal R&D credit accordingly.

During the quarter ended March 31, 2010, the Company received a favorable tax ruling from the Internal Revenue Service. As a result of the ruling, at least $20 million of net operating losses that were previously limited by Section 382 of the Internal Revenue Code are now available to the Company to offset future taxable income. The deferred tax assets related to these net operating losses will have a full valuation allowance when they are reestablished. As a result, the Company plans to file an amended fiscal 2008 federal income tax return utilizing the available net operating loss and claim a tax refund for approximately $1.7 million.

The Company maintains a reserve allowance for uncertain tax positions. As of March 31, 2010, the Company’s total amount of unrecognized tax benefits were $1.9 million as compared to $1.5 million as of June 30, 2009, representing an increase of $0.4 million for the nine months ended March 31, 2010. The increase in the total unrecognized tax benefits is primarily due to Federal and California research tax credits. None of the total unrecognized tax benefits of the Company, if recognized, would impact the effective tax rate, as the Company has a full valuation allowance on its carryforward attributes.

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

The Company’s only major tax jurisdiction is the United States. The tax years 2000 through 2009 remain open and subject to tax examination by the appropriate governmental agencies in the United States.

6. Common Stock

Common Shares Reserved for Issuance

At March 31, 2010, the Company has reserved shares of common stock for issuance as follows (in thousands):

Reserved under stock option plans	12,950
Reserved under employee stock purchase plan	879
Conversion of warrants	2
Total	13,831

7. Stock-Based Compensation

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

	Nine Months Ended March 31,
Employee Incentive Plans	2010		2009
Expected life of option plan (in years)	6.08-6.50		4.58-6.08
Expected life of ESPP right (in years)	0.50		0.50
Risk-free interest rate for option plan	2.3-2.47	%	1.76-3.11	%
Risk-free interest rate for ESPP right	0.16-0.27	%	0.44-1.81	%
Volatility for option plan	57-58	%	59	%
Volatility for ESPP right	59-138	%	92-136	%
Dividend yield	0	%	0	%

During the three months ended March 31, 2010 and 2009, the Company recorded non-cash stock-based compensation expense of $2.8 million and $2.2 million respectively. During the nine months ended March 31, 2010 and 2009, the Company recorded non-cash stock-based compensation expense of $7.7 million and $7.6 million, respectively.

10

Compensation expense is recognized only for the portion of stock options that are expected to vest, assuming an expected forfeiture rate in determining stock-based compensation expense, which could affect the stock-based compensation expense recorded if there is a significant difference between actual and estimated forfeiture rates. As of March 31, 2010, total unrecognized compensation cost related to stock-based awards granted to employees and non-employee directors was $21.3 million. This cost will be amortized on a ratable basis over a weighted-average vesting period of approximately three years.

8. Stock Option Plan

In January 1997, the Board of Directors and stockholders adopted the 1997 stock option plan (the “1997 Plan”) which, as amended, provides for granting incentive stock options (“ISOs”) and nonqualified stock options (“NSOs”) for shares of common stock to employees, directors, and consultants of the Company. In September 2006, the Company’s board of directors increased the number of shares authorized and reserved for issuance under the 1997 Plan to 10,513,325 shares of common stock. In accordance with the 1997 Plan, the stated exercise price shall not be less than 100% and 85% of the estimated fair market value of common stock on the date of grant for ISOs and NSOs, respectively, as determined by the Board of Directors. The 1997 Plan provides that the options shall be exercisable over a period not to exceed ten years. Options generally vest ratably over four years from the date of grant. Options granted to certain executive officers are exercisable immediately and unvested shares issued upon exercise are subject to repurchase by the Company at the exercise price (“Class Two Options”). During the nine months ended March 31, 2010 and March 31, 2009, zero and 1,167 unvested shares were repurchased, respectively. The Company’s repurchase right for such options lapses as the options vest, generally over four years from the date of grant.

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

Class Two Options granted under the 1997 Plan to certain executive officers are exercisable immediately and shares issued upon exercise are subject to repurchase by the Company at the exercise price, in the event the employee is terminated; such repurchase right lapses gradually over a four year period. The Company does not consider the exercise of stock options substantive when the issued stock is subject to repurchase. Accordingly, the proceeds from the exercise of such options are accounted for as a deposit liability until the repurchase right lapses, at which time the proceeds are reclassified to permanent equity. As of March 31, 2010 and June 30, 2009, there were 1,042 and 20,626 shares subject to repurchase, respectively, of the Company’s common stock outstanding and $1,000 and $19,000, respectively, of related recorded liability, which is included in accrued liabilities.

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

			Options Outstanding
(In thousands, except per share data and contractual term)	Shares Available for Grant		Number of Shares		Weighted Average Exercise Price		Weighted Average Remaining Contractual Term (in Years)	Aggregate Intrinsic Value
Balance at July 1, 2009	3,359		7,256		$	4.19
Shares authorized	2,247
Termination of remaining shares available for grant under the 1997 Option Plan and other non-plan options	(27	)	—			—
Granted	(844	)	844			6.41
Exercised	—		(324	)		1.42
Cancelled, forfeited or expired	248		(248	)		4.84
Restricted stocks granted (see Note 10)	(359	)	—			—
Restricted stocks cancelled	47		—			—
Balance at March 31, 2010	4,671		7,528		$	4.53	6.8	$	16,702
Vested and expected to vest at March 31, 2010			6,940		$	4.47	6.8	$	15,876
Exercisable at March 31, 2010			2,616		$	3.25	6.2	$	9,460

The total pre-tax intrinsic value for options exercised in the nine months ended March 31, 2010 and 2009 was $1.6 million and $0.8 million, respectively, representing the difference between the estimated fair values of the Company’s common stock underlying these options at the dates of exercise and the exercise prices paid. There were 27,000 cancelled options that expired under the 1997 Option Plan due to the termination of that plan. These cancelled, expired options have been included in the option activity for the nine months ended March 31, 2010.

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9. Employee Stock Purchase Plan

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

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

As of March 31, 2010, 935,000 shares had been issued under the ESPP since inception and 879,000 shares had been reserved for future issuance.

10. Restricted Stock

Under the 2007 Plan, the Company issued restricted stock awards to non-employee directors electing to receive them in lieu of an annual cash retainer during the nine months ended March 31, 2010.

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

Restricted stock award and restricted stock unit activity for the nine months ended March 31, 2010 and 2009 is as follows (in thousands):

	Nine months ended March 31, 2010		Nine months ended March 31, 2009
Beginning balance	507		70
Awarded	359		522
Released	(88	)	(46	)
Forfeited	(27	)	(28	)
Ending balance	751		518

Information regarding restricted stock units outstanding at March 31, 2010 is summarized below:

	Number of Shares (thousands)	Weighted Average Remaining Contractual Lives	Average Intrinsic Value (thousands)
Shares outstanding	751	1.75 years	$	4,967
Shares vested and expected to vest	640	1.65 years		4,231

11. Litigation, Commitments and Contingencies

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

U.S. Federal Court Class Action Litigation. On January 16, 2008, a purported stockholder class action lawsuit captioned Watkins v. ShoreTel, Inc., et al., was filed in the United States District Court for the Northern District of California against the Company, certain of its officers and directors, and the underwriters of the Company’s initial public offering. A second purported class action alleging the same claims were filed on January 29, 2008 and the lawsuits were consolidated. A second consolidated amended class action complaint was subsequently filed on March 2, 2009. The consolidated action is purportedly brought on behalf of those who purchased the Company’s common stock pursuant to the initial public offering on July 3, 2007, purports to allege claims for violations of the federal securities laws, and seeks unspecified compensatory damages and other relief. The Company and counsel for the lead plaintiffs reached an agreement in principle in February 2010 to settle the litigation, pursuant to which, without admitting any liability or wrongdoing of any kind, the Company would pay the plaintiff class $250,000 with the remaining $2.75 million funded by insurance. This agreement, which is subject to final documentation and Court approval, would resolve all the claims in the litigation.

California State Court Derivative Action. On January 30, 2008, a purported shareholder derivative lawsuit captioned Berkovitz v. Combs, et al., was filed in the Superior Court of the State of California, County of Santa Clara, against the Company (as a nominal

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defendant), its directors and certain officers. The complaint purports to allege claims for breach of fiduciary duty and other claims and seeks unspecified compensatory damages and other relief based on essentially the same allegations as the class action litigation. The Company and plaintiffs have reached an agreement in principle to settle the litigation, pursuant to which, without admitting any liability or wrongdoing of any kind, the Company would adopt certain corporate remedial measures, terms of which are still being negotiated. Once documented, the settlement would be subject to Court approval.

On April 24, 2009, the Company and Mitel, the counter party, had entered into a confidential definitive agreement to settle the litigation between them. Under the terms of the agreement, the parties agreed to dismiss the patent litigation and trade libel litigation. Both matters were dismissed with prejudice on May 8, 2009. The agreement called for the Company to make payments totaling $5.0 million over four years. The present value of the payments was calculated to be $4.6 million, of which $0.5 million was estimated to be the value of the future right to use the technology covered by such patents and was recorded as a long term prepaid royalty asset that is being amortized to cost of revenue over approximately six years, which is the life of the patents. Accordingly, during the three months ended March 31, 2009, $4.1 million was recorded as litigation settlement.

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

Leases — The Company leases its facilities under noncancelable operating leases which expire at various times through 2015. The leases provide for the lessee to pay all cost of utilities, insurance, and taxes. Future minimum lease payments under the noncancelable leases as of March 31, 2010, are as follows (in thousands):

Years Ending June 30,
2010 (remaining 3 months)	$	426
2011		1,671
2012		1,576
2013		1,161
2014		1,112
Thereafter		280
Total	$	6,226

Lease obligations for the Company’s foreign offices are denominated in foreign currencies, which were converted in the above table to U.S. dollars at the interbank exchange rate on March 31, 2010.

Rent expense for the three months ended March 31, 2010 and 2009 was $0.4 million and $0.5 million, respectively, and $1.0 million and $1.4 million for the nine months ended March 31, 2010 and 2009, respectively.

Purchase commitments —The Company had purchase commitments with contract manufacturers for inventory and with technology firms for usage of software licenses totaling approximately $13.8 million as of March 31, 2010.

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

The Company also has entered into customary indemnification agreements with each of its officers and directors. The Company also has indemnification obligations to the underwriters of its initial public offering pursuant to the underwriting agreement executed in connection with that offering. As a result, the Company may have indemnification obligations to its officers, directors and underwriters in connection with the above-referenced securities-related litigation.

12. Segment Information

The Company is organized as, and operates in, one reportable segment: the development and sale of IP voice communication systems. The Company’s chief operating decision-maker is its Chief Executive Officer. The Company’s Chief Executive Officer reviews financial information presented on a consolidated basis for purposes of evaluating financial performance and allocating resources, accompanied by information about revenue by geographic regions. The Company’s assets are primarily located in the United States of America and not

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allocated to any specific region and it does not measure the performance of its geographic regions based upon asset-based metrics. Therefore, geographic information is presented only for revenue. Revenue by geographic region is based on the ship to address on the customer order.

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

	Three Months Ended March 31,				Nine Months Ended March 31,
	2010		2009		2010		2009
United States	$	33,473	$	28,824	$	96,160	$	95,186
International		3,561		2,413		10,081		7,246
Total revenues	$	37,034	$	31,237	$	106,241	$	102,432

13. Restructuring Costs

On March 31, 2009, the Company announced to the employees, a restructuring plan to lower its cost structure and improve efficiencies by reducing its worldwide workforce by approximately nine percent. As a result of the reduction in headcount, the Company recorded restructuring and other related charges, consisting of employee related termination costs in the three and nine months ended March 31, 2009.

There were no significant restructuring charges incurred in the three and nine months ended March 31, 2010. The following table sets forth the charges that are included in the operating expenses on the Company’s Consolidated Statement of Operations for the three and nine months ended March 31, 2009 (in thousands):

	Three and Nine months  ended March 31, 2009
	Add Charges		Deduct Cash Payments		Non-Cash Expense
Workforce reduction	$	501	$	—	$	—

14. Restatement of Previously Issued Consolidated Financial Statements

As previously disclosed in the Form 10-K/A filed with the Securities and Exchange Commission on November 5, 2009, the Company identified an error in stock-based compensation for the three and nine months ending March 31, 2009. The error was identified after the Company’s third-party software provider notified its clients, including the Company, that it made a change to how its software program calculates stock-based compensation expense. Specifically, the prior version of this software calculated stock-based compensation expense by incorrectly continuing to apply a weighted average forfeiture rate to the vested portion of stock option awards until the grant’s final vest date rather than reflecting actual forfeitures as vested. Thus, this accounting error relates to the timing of stock-based compensation expense.

The Company determined that stock-based compensation expense error related to the three and nine months ended March 31, 2009 was $0.3 million and $0.8 million, respectively.

The following tables present the effect of the restatement adjustments by financial statement line item for Condensed Consolidated Statement of Operations and Condensed Consolidated Statement of Cash Flows.

Condensed Consolidated Statement of Operations (in thousands):

	Three Months Ended March 31, 2009						Nine Months Ended March 31, 2009
	As previously reported			As restated			As previously reported			As restated
Cost of Revenue:
Product	$	8,623		$	8,624		$	28,720		$	28,726
Support and services	$	2,682		$	2,730		$	8,516		$	8,589
Total cost of revenue	$	11,305		$	11,354		$	37,236		$	37,315
Gross profit	$	19,932		$	19,883		$	65,196		$	65,117
Operating expenses:
Research and development	$	7,476		$	7,552		$	23,630		$	23,769
Sales and marketing	$	11,344		$	11,472		$	34,140		$	34,484
General and administrative	$	5,210		$	5,301		$	15,145		$	15,399
Total operating expenses	$	28,140		$	28,435		$	77,025		$	77,762
Loss from operations	$	(8,208	)	$	(8,552	)	$	(11,829	)	$	(12,645	)

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	Three Months Ended March 31, 2009						Nine Months Ended March 31, 2009
	As previously reported			As restated			As previously reported			As restated
Loss before benefit from income taxes	$	(8,059	)	$	(8,403	)	$	(11,262	)	$	(12,078	)
Net loss	$	(7,003	)	$	(7,347	)	$	(11,108	)	$	(11,924	)
Net loss per share — basic and diluted	$	(0.16	)	$	(0.17	)	$	(0.25	)	$	(0.27	)

Condensed Consolidated Statement of Cash Flows (in thousands):

	Nine Months Ended March 31, 2009
	As previously reported			As restated
Net loss	$	(11,108	)	$	(11,924	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Stock-based compensation expense	$	6,736		$	7,552
Net cash provided by operating activities	$	6,428		$	6,428

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the condensed consolidated financial statements and related notes included elsewhere in this document. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those discussed below. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed above in the section entitled “Risk Factors.”

The following discussion reflects the effects of the restatement discussed in Item 1 note 14 –Restatement of Previously Issued Consolidated Financial Statements to the Consolidated Financial Statements.

Overview

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

We sell our products primarily through channel partners that market and sell our systems to enterprises across all industries, including small, medium and large companies and public institutions. We believe our channel strategy allows us to reach a larger number of prospective enterprise customers more effectively than if we were to sell directly. The number of our authorized channel partners has more than doubled since June 30, 2004 to over 800 as of March 31, 2010. Channel partners typically purchase our products directly from us. Our internal sales and marketing personnel support these channel partners in their selling efforts. In some circumstances, the enterprise customer will purchase products directly from us, but in these situations we typically compensate the channel partner for its sales efforts. At the request of the channel partner, we will ship our products directly to the enterprise customer.

Most channel partners generally perform installation and implementation services for the enterprises that use our systems. In most cases, our channel partners provide the post-contractual support to the enterprise customer by providing first-level support services and purchasing additional services from us under a post-contractual support contract. For channel partners without support capabilities or that do not desire to provide support, we offer full support contracts to provide all of the support to enterprise customers.

We outsource the manufacturing of our products to contract manufacturers. Our outsourced manufacturing model allows us to scale our business without the significant capital investment and on-going expenses required to establish and maintain a manufacturing operation. Our phone and switch products are manufactured by contract manufacturers located in California and in China. Our contract manufacturers provide us with a range of operational and manufacturing services, including component procurement, final testing and assembly of our products. We work closely with our contract manufacturers to manage the cost of components, since our total manufacturing costs are directly tied to component costs. We regularly provide forecasts to our contract manufacturers, and we order products from our contract manufacturers based on our projected sales levels well in advance of receiving actual orders from our enterprise customers. We seek to maintain sufficient levels of finished goods inventory to meet our forecasted product sales with limited levels of inventory to compensate for unanticipated shifts in sales volume and product mix.

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

We are headquartered in Sunnyvale, California and the majority of our personnel work at this location. Sales, engineering, and support personnel are located throughout the United States and, to a lesser extent, in the United Kingdom, Germany, Belgium, Spain, Hong Kong, Singapore and Australia. Most of our enterprise customers are located in the United States. Revenue from international sales has been 10% or less of our total revenue for the three and nine months ended March 31, 2010 and 2009, respectively. Although we intend to focus on increasing international sales, we expect that sales to enterprise customers in the United States will continue to comprise the significant majority of our sales.

Key Business Metrics

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

Initial and repeat sales orders.Our goal is to attract a significant number of new enterprise customers and to encourage existing enterprise customers to purchase additional products and support. Many enterprise customers make an initial purchase and deploy additional sites at a later date, and also buy additional products and support as their businesses expand. As our installed enterprise customer base has grown we have experienced an increase in revenue attributable to existing enterprise customers, which currently represents a significant portion of our total revenue.

Deferred revenue. Deferred revenue relates to the timing of revenue recognition for specific transactions based on service, support, specific commitments and other factors. Deferred revenue primarily consists of billings or payments received in advance of revenue recognition from the Company’s transactions described above and are recognized as the revenue recognition criteria are met. Nearly all system sales include the purchase of post-contractual support contracts with terms of up to five years, and the rate of renewal on these contracts have been high historically. We recognize support revenue on a ratable basis over the term of the support contract. Since we receive payment for support in advance of our recognizing the related revenue, we carry a deferred revenue balance on our consolidated balance sheet. This deferred revenue helps provide predictability to our future support and services revenue. Accordingly, the level of purchases of post-contractual support with our product sales is an important metric for us along with the renewal rates for these services. Our deferred revenue balance at March 31, 2010 was $26.6 million, consisting of $1.1 million of deferred product revenue and $25.5 million of deferred support and services revenues, of which $17.9 million is expected to be recognized within one year.

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

Gross profit for support and services can be lower than gross profit for products, and is impacted primarily by personnel costs and labor related expenses. The primary goal of our support and services function is to ensure maximum customer satisfaction and our investments in support personnel and infrastructure are made with this goal in mind. We expect that as our installed enterprise customer base grows, we will be able to improve gross profit for support and services through economies of scale. However, the timing of additional investments in our support and services infrastructure could materially affect our cost of support and services revenue, both in absolute dollars and as a percentage of support and services revenue and total revenue, in any particular period.

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

Basis of Presentation

Revenue.We derive our revenue from sales of our IP telecommunications systems and related support and services. Our typical system includes a combination of IP phones, switches and software applications. Channel partners buy our products directly from us. Prices to a given channel partner for hardware and software products depend on that channel partner’s volume and customer satisfaction metrics, as well as our own strategic considerations. In circumstances where we sell directly to the enterprise customer in transactions that have been assisted by channel partners, we report our revenue net of any associated payment to the channel partners that assisted in such sales. This results in recognized revenue from a direct sale approximating the revenue that would have been recognized from a sale of a comparable system through a channel partner.

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

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

Research and development expenses.Research and development expenses primarily include personnel costs, outside engineering costs, professional services, prototype costs, test equipment, software usage fees and facilities expenses. Research and development expenses are recognized when incurred. We are devoting substantial resources to the development of additional functionality for existing products and the development of new products and related software applications.

Sales and marketing expenses.Sales and marketing expenses primarily include personnel costs, sales commissions, travel, marketing promotional and lead generation programs, advertising, trade shows, demo equipment, professional services fees and facilities expenses. We plan to continue to invest in development of our distribution channel by increasing the size of our field sales force and the number of our channel partners to enable us to expand into new geographies, including Europe and Asia Pacific, and further increase our sales to large enterprises. In conjunction with channel growth, we plan to increase the investment in our training and support of channel partners to enable them to more effectively sell our products. We also plan to continue investing in our domestic and international marketing activities to help build brand awareness and create sales leads for our channel partners. We expect that sales and marketing expenses will increase in absolute dollars and remain our largest operating expense category.

General and administrative expenses.General and administrative expenses relate to our executive, finance, human resources, legal and information technology organizations. Expenses primarily include personnel costs, professional fees for legal, accounting, tax, compliance and information systems, travel, allowance for doubtful accounts, recruiting expense, software amortization costs, depreciation expense and facilities expenses. In addition, as we expand our business, we expect to increase our general and administrative expenses.

Other income, net.Other income (expense) primarily consists of interest earned on cash and short-term investments, foreign exchange gain (loss) and other miscellaneous income (expense).

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

We believe we have had multiple ownership changes, as defined under Section 382 of the Internal Revenue Code, due to significant stock transactions in previous years, which had limited the realization of our net operating losses and tax credit carryforwards under Section 382 of the Internal Revenue Code in future periods. During the quarter ended March 31, 2010, the Company received a favorable tax ruling from the Internal Revenue Service related to Section 382. As a result of the ruling, at least $20 million of net operating losses that were previously limited by Section 382 of the Internal Revenue Code are now available to the Company to offset future taxable income and to recapture previously paid taxes. The deferred tax assets related to these net operating losses will have a full valuation allowance when they are reestablished. As a result, the Company plans to file an amended fiscal 2008 federal income tax return utilizing the available net operating losses and claim a tax refund for approximately $1.7 million, although we can provide no assurance as to the ultimate amount or timing of any refund.

Critical Accounting Policies and Estimates

The preparation of our financial statements and related disclosures in conformity with generally accepted accounting principles in the United States of America, or GAAP, requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. These estimates and assumptions are based on historical experience and various other factors that we believe are reasonable under the circumstances. We consider our accounting policies related to revenue recognition, allowance for doubtful accounts, stock-based compensation, inventory valuation and accounting for income tax to be critical accounting policies. A number of significant estimates, assumptions, and judgments are inherent in our determination of when to recognize revenue, how to estimate doubtful accounts,

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the calculation of stock-based compensation expense, and how we value inventory. We base our estimates and judgments on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ materially from these estimates. Management believes there have been no significant changes during the three months ended March 31, 2010 to the items that we disclosed as our critical accounting policies and estimates in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our 2009 Annual Report on Form 10-K/A filed with the Securities and Exchange Commission. For a description of those accounting policies, please refer to our 2009 Annual Report on Form 10-K, as amended by Form 10-K/A.

Results of Operations

The following table sets forth unaudited selected consolidated statements of operations data for three and nine months ended March 31, 2010 and 2009.

SHORETEL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Amounts in thousands, except per share amounts)

	Three Months Ended March 31,						Nine Months Ended March 31,
	2010			2009			2010			2009
Revenue:
Product	$	28,945		$	24,691		$	83,685		$	83,801
Support and services		8,089			6,546			22,556			18,631
Total revenues		37,034			31,237			106,241			102,432
Cost of revenue
Product (1)		10,049			8,624			29,369			28,726
Support and services (1)		2,933			2,730			8,323			8,589
Total cost of revenue		12,982			11,354			37,692			37,315
Gross profit		24,052			19,883			68,549			65,117
Gross profit %		64.9	%		63.7	%		64.5	%		63.6	%
Operating expenses:
Research and development (1,2)		8,634			7,552			23,666			23,769
Sales and marketing (1,2)		14,726			11,472			39,653			34,484
General and administrative (1,2)		5,214			5,301			14,596			15,399
Litigation settlement		—			4,110			—			4,110
Total operating expenses		28,574			28,435			77,915			77,762
Loss from operations		(4,522	)		(8,552	)		(9,366	)		(12,645	)
Other income, net		(120	)		149			168			567
Loss before provision for income taxes		(4,642	)		(8,403	)		(9,198	)		(12,078	)
Benefit from income taxes		153			1,056			87			154
Net loss	$	(4,489	)	$	(7,347	)	$	(9,111	)	$	(11,924	)
Net loss per share available to common stockholders:
Basic	$	(0.10	)	$	(0.17	)	$	(0.20	)	$	(0.27	)
Diluted (3)	$	(0.10	)	$	(0.17	)	$	(0.20	)	$	(0.27	)
Shares used in computing net loss per share available to common stockholders:
Basic		44,941			43,793			44,731			43,576
Diluted (3)		44,941			43,793			44,731			43,576
(1)    Includes stock-based compensation as follows:
Cost of product revenue	$	34		$	23		$	99		$	86
Cost of support and services revenue		207			184			553			606
Research and development		805			597			2,248			2,181
Sales and marketing		911			741			2,528			2,753
General and administrative		861			619			2,320			1,926
	$	2,818		$	2,164		$	7,748		$	7,552
(2)    Includes restructuring charge as follows:
Research and development	$	—		$	124		$	—		$	124
Sales and marketing		—			278			(27	)		278
General and administrative		—			99			—			99
	$	—		$	501		$	(27	)	$	501

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

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Use of Non-GAAP Financial Measures

We believe that evaluating the Company’s ongoing operating results may limit the reader’s understanding if limited to reviewing only generally accepted accounting principles (GAAP) financial measures. Many investors and analysts have requested that, in addition to reporting financial information in accordance with GAAP we also disclose certain non-GAAP information because it is useful in understanding the Company’s performance as it excludes non-cash and other special charges or credits that many investors and management feel may obscure the Company’s true operating performance. Likewise, we use these non-GAAP financial measures to manage and assess the profitability of the business and determine a portion of our employee compensation. We do not consider stock-based compensation expenses and other special charges and related tax adjustments in managing the core operations. These measures are not based on any standardized methodology prescribed by GAAP and are not necessarily comparable to similar measures presented by other companies. Non-GAAP net loss is calculated by adjusting GAAP net loss for stock-based compensation expense, special charges and the related tax impact. Non-GAAP net loss per share per share is calculated by dividing Non-GAAP net loss by the weighted average number of diluted shares outstanding for the period. These measures should not be considered in isolation or as a substitute for measures prepared in accordance with GAAP, and because these amounts are not determined in accordance with GAAP, they should not be used exclusively in evaluating our business and operations. We have provided a reconciliation of non-GAAP financial measures in the table below.

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RECONCILIATION OF GAAP TO NON-GAAP FINANCIAL MEASURES

(Amounts in thousands, except per share amounts)

(Unaudited)

	Three Months Ended March 31,						Nine Months Ended March 31,
	2010			2009			2010			2009
GAAP net loss available to stockholders:	$	(4,489	)	$	(7,347	)	$	(9,111	)	$	(11,924	)
Adjustments for non-GAAP items (1)		2,818			7,048			7,721			12,436
Tax effect of non-GAAP adjustments		4			(517	)		(28	)		(575	)
Non-GAAP net loss available to stockholders	$	(1,667	)	$	(816	)	$	(1,418	)	$	(63	)
GAAP diluted net loss per share:	$	(0.10	)	$	(0.17	)	$	(0.20	)	$	(0.27	)
Adjustments for non-GAAP items		0.06			0.16			0.17			0.28
Tax effect of non-GAAP adjustments		0.00			(0.01	)		0.00			(0.01	)
Non-GAAP diluted net loss per share:	$	(0.04	)	$	(0.02	)	$	(0.03	)	$	0.00
Shares Used in Non-GAAP diluted per share calculation		44,941			43,793			44,731			43,576
(1)    Adjustments for non-GAAP items include:
Stock-based compensation	$	2,818		$	2,164		$	7,748		$	7,552
Litigation settlement-Mitel		—			4,110			—			4,110
Restructuring expense (benefit)		—			501			(27	)		501
Cancellation of contractual obligation included in sales and marketing		—			273			—			273
Adjustments for non-GAAP items	$	2,818		$	7,048		$	7,721		$	12,436

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

	Three Months Ended March 31,				Nine Months Ended March 31,
	2010		2009		2010		2009
Revenue:
Product	78	%	79	%	79	%	82	%
Support and services	22	%	21	%	21	%	18	%
Total revenue	100	%	100	%	100	%	100	%
Cost of revenue:
Product	27	%	27	%	28	%	28	%
Support and services	8	%	9	%	8	%	8	%
Total cost of revenue	35	%	36	%	36	%	36	%
Gross profit	65	%	64	%	64	%	64	%
Operating expenses:
Research and development	23	%	24	%	22	%	23	%
Sales and marketing	40	%	37	%	37	%	34	%
General and administrative	14	%	17	%	14	%	15	%
Litigation settlement	—		13	%	—		4	%
Total operating expenses	77	%	91	%	73	%	76	%
Operating loss	(12	)%	(27	)%	(9	)%	(12	)%
Interest and other income, net	—		—		—		—
Loss before benefit from income tax	(12	)%	(27	)%	(9	)%	(12	)%
Benefit from income taxes	—		3	%	—		—
Net loss	(12	)%	(24	)%	(9	)%	(12	)%

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

	Three Months Ended March 31,						Nine Months Ended March 31,
	2010			2009			2010			2009
Total GAAP operating expenses	$	28,574		$	28,435		$	77,915		$	77,762
Stock-based compensation included in operating expenses		(2,577	)		(1,957	)		(7,096	)		(6,860	)
Litigation settlement-Mitel		—			(4,110	)		—			(4,110	)
Restructuring charge included in operating expenses		—			(501	)		27			(501	)
Cancellation of contractual obligation included in Sales and Marketing		—			(273	)		—			(273	)
Total Non-GAAP operating expenses	$	25,997		$	21,594		$	70,846		$	66,018
Non-GAAP items as a % of GAAP operating expenses		(9	)%		(24	)%		(9	)%		(15	)%

Comparison of the three months ended March 31, 2010 and March 31, 2009

Net Revenue.

	Three Months Ended March 31,
(Dollars in thousands)	2010		2009		Dollar Variance		Percent Variance
Revenue	$	37,034	$	31,237	$	5,797	19	%

The increase of $5.8 million was primarily attributable to an increase in sales of our products by $4.3 million or 17% to $29.0 million in the three months ended March 31, 2010 compared to $24.7 million in the three months ended March 31, 2009. Additionally, support and service increased by $1.6 million or 25% to $8.1 million in the three months ended March 31, 2010 compared to $6.5 million in the same period of 2009. The increase was attributable to revenue associated with post-contractual support contracts accompanying new system sales, post-contractual support contract renewals and increased revenue from training and installation services.

Cost of revenue and gross profit.

	Three Months Ended March 31,
(Dollars in thousands)	2010			2009			Dollar Variance		Percent Variance
Cost of revenue	$	12,982		$	11,354		$	1,628	14	%
Gross profit	$	24,052		$	19,883		$	4,169	21	%
Gross profit %		64.9	%		63.7	%

Cost of revenue. Gross profit increased from 63.7% in the three months ended March 31, 2009 to 64.9% in the three months ended March 31, 2010 primarily due to increase in support and service gross margin. Product gross profit percent remained comparable at 65% in the three months ended March 31, 2009 and March 31, 2008.

Support and services gross profit increased from 58.3% in the three months ended March 31, 2009 to 63.7% in the same period of 2010. In the three months ended March 31, 2010, support and services gross profit increased due to support and services revenue increasing by 24% and support and services cost increasing by only 7%, compared to the same period in 2009. The service cost increase was limited to 7% as the Company deployed employee resources to a lower cost region outside of our California headquarters office. Compensation for support and services employees, the largest category of support and service costs, remained comparable in the three months ended March 31, 2010 and March 31, 2009, although the headcount increased from 57 employees at March 31, 2009 to 62 employees at March 31, 2010.

Operating expenses.

	Three Months Ended March 31,
(Dollars in thousands)	2010		2009		Dollar Variance			Percent Variance
Research and development	$	8,634	$	7,552	$	1,082		14	%
Sales and marketing		14,726		11,472		3,254		28	%
General and administrative		5,214		5,301		(87	)	(2	)%
Litigation settlement-Mitel		—		4,110		(4,110	)	(100	)%

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Research and development. Compensation, including stock-based compensation, for research and development employees accounted for $0.8 million of the increase, primarily as a result of an increase in headcount to 161 employees at March 31, 2010, from 137 employees at March 31, 2009. Additionally, consulting and temporary help accounted for $0.4 million of the increase.

Sales and marketing.The increase in sales and marketing expenses is attributable to increases in advertisement and promotions of $1.7 million, employee compensation of $0.8 million and sales commissions of $0.5 million.

General and administrative. Legal costs, bad debt expense and rent accounted for $0.4 million, $0.4 million, $0.2 million, respectively, of the decrease. The decrease was partially off-set by a $0.2 million increase, each in employee compensation, employee costs and consulting and temporary personnel.

Litigation settlement. We recorded a charge of $4.1 million as a result of the agreement to settle our litigations with Mitel in the three months ended March 31, 2009.

Other income (expense),net.

	Three Months Ended March 31,
(Dollars in thousands)	2010			2009		Dollar Variance			Percent Variance
Other income (net)	$	(120	)	$	149	$	(269	)	(181	)%

Other income (expense),net.The decrease was primarily attributable to an increase in foreign currency exchange translation net loss of $0.2 million in the three months ended March 31, 2010 compared to the same period of 2009. Additionally, interest income (net) dropped by $0.1 million primarily due to a decline in overall interest rates in the three months ended March 31, 2010 compared to the same period of 2009.

Benefit from income taxes.

	Three Months Ended March 31,
	2010		2009		Dollar Variance			Percent Variance
Benefit from income taxes	$	153	$	1,056	$	(903	)	(86	)%

Income tax benefit.The income tax benefit of $0.2 million for the three months ended March 31, 2010 represents the tax benefit related to the timing of deductions in the federal income tax return, partially offset by a tax provision for the profitable jurisdictions and state taxes based upon income earned during the period with no tax benefit accrued on the loss jurisdictions. For the three months ended March 31, 2009, the Company had a tax benefit of $1.1 million on a pre-tax loss of $8.4 million. The tax benefit is primarily a result of the year to date losses which were greater than the non-deductible expenses and thus the prior quarters tax provision was reduced. This resulted in a benefit during the three months ended March 31, 2009.

Comparison of the Nine months ended March 31, 2010 and March 31, 2009

Net Revenues.

	Nine Months Ended March 31,
(Dollars in thousands)	2010		2009		Dollar Variance		Percent Variance
Revenue	$	106,241	$	102,432	$	3,809	4	%

The increase was primarily attributable to increase in sales of support and services. Support and services revenue was $22.6 million in the nine months ended March 31, 2010, an increase of $4.0 million, or 22%, from $18.6 million in the same period of 2009. The increase was attributable to revenue associated with post-contractual support contracts accompanying new system sales, post-contractual support contract renewals and increased revenue from training and installation services.

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Cost of revenue and gross profit.

	Nine Months Ended March 31,
(Dollars in thousands)	2010			2009			Dollar Variance		Percent Variance
Cost of revenue	$	37,692		$	37,315		$	377	1	%
Gross profit	$	68,549		$	65,117		$	3,432	5	%
Gross profit %		64.5	%		63.6	%

Cost of revenue. Gross profit increased from 63.6% in the nine months ended March 31, 2009 to 64.5% in the nine months ended March 31, 2010 primarily due to increase in support and service gross margin partially offset by a decline in product gross margin.

Support and services gross profit increased from 53.9% in the nine months ended March 31, 2009 to 63.1% in the same period of 2010. In the nine months ended March 31, 2010, support and services gross profit increased due to support and services revenue increasing by 21% and support and services cost decreasing by 3%, compared to the same period in 2009. The service costs decreased by 3% as the Company deployed employee resources to a lower cost region outside of our California headquarters office. Compensation for support and services employees, the largest category of support and service costs, decreased 5% in the nine months ended March 31, 2010, although the headcount increased from 57 employees at March 31, 2009 to 62 employees at March 31, 2010. The increase in support and services gross profit was partially offset by decrease in product gross profit from 66% in the nine months ended March 31, 2009 to 65% in the nine months ended March 31, 2010.

Operating expenses.

	Nine Months Ended March 31,
(Dollars in thousands)	2010		2009		Dollar Variance			Percent Variance
Research and development	$	23,666	$	23,769	$	(103	)	0	%
Sales and marketing	$	39,653	$	34,484	$	5,169		15	%
General and administrative	$	14,596	$	15,399	$	(803	)	(5	)%
Litigation settlement-Mitel		—		4,110		(4,110	)	(100	)%

Research and development. Research and development expenses decreased by $0.1 million primarily due to decreases in outside engineering service expenses of $0.7 million, bonus expense of $0.4 million, and equipment repair and maintenance of $0.1 million. These decreases were partially offset by increases in employee compensation of $0.9 million and software licenses and maintenance expenses of $0.2 million.

Sales and marketing.The increase in sales and marketing expenses is attributable to increases in advertisement expense of $2.2 million, employee compensation of $1.3 million, commissions of $0.8 million, contractor and outside help of $0.6 million and travel expenses of $0.6 million.

General and administrative. General and administrative expenses declined by $0.8 million primarily due to decreases in legal expenses of $1.1 million, bad debt expense of $1.1 million, and bonus of $0.2 million. These decreases were partially offset by increases in consulting and temporary labor personnel of $0.6 million, employee stock compensation of $0.4 million, employee-related costs of $0.3 million and professional fees of $0.2 million.

Litigation settlement. We recorded a charge of $4.1 million as a result of the agreement to settle our litigations with Mitel in the nine months ended March 31, 2009.

Other income (expense), net.

	Nine Months Ended March 31,
(Dollars in thousands)	2010		2009		Dollar Variance			Percent Variance
Other income (net)	$	168	$	567	$	(399	)	(70	)%

Other income (expense),net.The decrease was primarily attributable to a decline in interest income by $0.9 million due to lower overall interest rates in the nine months ended March 31, 2010 compared to the same period of 2009. This was partially offset by a net decrease in foreign currency exchange translation loss of $0.5 million in the nine months ended March 31, 2010 compared to the same period of 2009.

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Benefit from income taxes.

	Nine Months Ended March 31,
	2010		2009		Dollar Variance			Percent Variance
Benefit from income taxes	$	87	$	154	$	(67	)	(44	)%

Income tax benefit.The income tax benefit of $0.1 million for the nine months ended March 31, 2010 represents the tax benefit related to the timing of deductions in the federal income tax return, partially offset by a tax provision for the profitable jurisdictions and state taxes based upon income earned during the period with no tax benefit accrued on the loss jurisdictions. For the nine months ended March 31, 2009, the Company had a tax benefit of $0.2 million on a pre-loss of $12.1 million.

Liquidity and Capital Resources

Balance Sheet and Cash Flows

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

	March 31, 2010		June 30, 2009		Increase/ (Decrease)
Cash, cash equivalents and short-term investments:
Cash and cash equivalents	$	67,703	$	73,819	$	(6,116	)
Short-term investments		46,878		33,847		13,031
Total	$	114,581	$	107,666		6,915

As of March 31, 2010, our principal sources of liquidity consisted of cash and cash equivalents and short-term investments of $114.6 million and accounts receivable, net of $19.6 million.

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

We believe that our $114.6 million of cash and cash equivalents and short-term investments at March 31, 2010 will be sufficient to fund our operating requirements for at least 12 months. Our future capital requirements will depend on many factors, including our rate of revenue growth, the expansion of our sales and marketing activities, the addition of new business initiatives, the timing and extent of our expansion into new territories, the timing of introductions of new products and enhancements to existing products, the continuing market acceptance of our products and acquisition and licensing activities. We may enter into agreements relating to potential investments in, or acquisitions of, complementary businesses or technologies in the future, which could also require us to seek additional equity or debt financing. Additional funds may not be available on terms favorable to us or at all.

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

	Nine Months Ended
(Dollars in thousands)	March 31, 2010			March 31, 2009
Net cash flow provided by (used in):
Operating activities	$	10,233		$	6,428
Investing activities		(17,735	)		13,017
Financing activities		1,386			1,404
Net (decrease) increase in cash and cash equivalents	$	(6,116	)	$	20,849

Cash flows from operating activities

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

Net loss during the nine months ended March 31, 2010 and 2009 included non-cash charges of $7.7 million and $7.6 million in stock-based compensation expense, respectively, bad debt expense (benefit) of $(0.1) million and $1.0 million, respectively, and $2.0 million and $1.4 million in depreciation and amortization, respectively.

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Cash provided by operating activities during the nine months ended March 31, 2010 also reflect net changes in operating assets and liabilities, which provided $9.3 million consisting primarily of a significant decrease in accounts receivables of $1.9 million due to a decrease in days sales outstanding (DSO), an increase in accrued employee compensation of $1.3 million, an increase in deferred revenue of $4.1 million due to higher maintenance support contracts, an increase of $5.6 million in accrued liabilities, and a decrease in other assets of $1.0 million, partially offset by an increase in prepaid and other current assets of $3.7 million, an increase in inventories of $0.5 million and a decrease in accounts payables of $0.3 million.

Cash provided by operating activities during the nine months ended March 31, 2009 also reflect net changes in operating assets and liabilities, which provided $8.2 million, consisting primarily of a decrease in inventories of $2.3 million due to improved inventory turnover, a decrease in accounts receivable of $1.7 million, an increase in deferred revenue of $2.4 million and an increase in accrued liabilities and other long-term liabilities of $3.4 million, partially offset by a decrease in accounts payable of $1.1 million.

Cash flows from investing activities

We have classified our investment portfolio as “available for sale,” and our investments are made with a policy of capital preservation and liquidity as the primary objectives. We may hold investments in corporate bonds to maturity; however, we may sell an investment at any time if the quality rating of the investment declines, the yield on the investment is no longer attractive or we are in need of cash.

Net cash (used in) provided by investing activities was $(17.7) million and $13.0 million in the nine months March 31, 2010 and 2009, respectively. Net cash used in investing activities in the first nine months ended March 31, 2010 related to net purchase of short-term investments of $13.0 million, purchase of fixed assets of $3.5 million and purchase of a software license and other of $1.2 million. In the nine months ended March 31, 2009, cash provided by investing activities primarily related to the net short-term investments sold and matured.

Cash flows from financing activities

Net cash provided by financing activities was $1.4 million each for the nine months ended March 31, 2010 and 2009, primarily due from the exercise of common stock options and issuance of common stock under employee stock purchase plan.

Off-Balance Sheet Arrangements

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

Contractual obligations and commitments

The following table summarizes our contractual obligations as of March 31, 2010 and the effect that such obligations are expected to have on our liquidity and cash flows in future periods:

	Payments Due By Period
(Dollars in thousands)	Less than 1 Year		1 - 3 Years		3 - 5 Years		5 years and after		Total
Operating Leases	$	1,676	$	2,886	$	1664	$	—	$	6,226
Purchase obligations		11,311		2,000		500		—		13,811
Total	$	12,987	$	4,886	$	2,164	$	—	$	20,037

As of March 31, 2010, the Company’s total amount of unrecognized tax benefit was approximately $1.8 million of which none, if recognized, would impact the effective tax rate as the Company has a valuation allowance on its carryforward attributes. The Company does not expect its unrecognized tax benefits to change materially over the next 12 months.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

For quantitative and qualitative disclosures about market risk affecting ShoreTel, Inc., see “Quantitative and Qualitative Disclosures About Market Risk” in Item 7A of Part II of our Annual Report on Form 10-K, as amended by Form 10-K/A for the fiscal year ended June 30, 2009, which is incorporated herein by reference. Our exposure to market risk has not changed materially since June 30, 2009.

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ITEM 4. CONTROLS AND PROCEDURES

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

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

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PART II: OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

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

U.S. Federal Court Class Action Litigation. On January 16, 2008, a purported stockholder class action lawsuit captioned Watkins v. ShoreTel, Inc., et al., was filed in the United States District Court for the Northern District of California against the Company, certain of its officers and directors, and the underwriters of the Company’s initial public offering. A second purported class action alleging the same claims were filed on January 29, 2008 and the lawsuits were consolidated. A second consolidated amended class action complaint was subsequently filed on March 2, 2009. The consolidated action is purportedly brought on behalf of those who purchased the Company’s common stock pursuant to the initial public offering on July 3, 2007, purports to allege claims for violations of the federal securities laws, and seeks unspecified compensatory damages and other relief. The Company and counsel for the lead plaintiffs reached an agreement in principle in February 2010 to settle the litigation, pursuant to which, without admitting any liability or wrongdoing of any kind, the Company would pay the plaintiff class $250,000 with the remaining $2.75 million funded by insurance. This agreement, which is subject to final documentation and Court approval, would resolve all the claims in the litigation.

California State Court Derivative Action. On January 30, 2008, a purported shareholder derivative lawsuit captioned Berkovitz v. Combs, et al., was filed in the Superior Court of the State of California, County of Santa Clara, against the Company (as a nominal defendant), its directors and certain officers. The complaint purports to allege claims for breach of fiduciary duty and other claims and seeks unspecified compensatory damages and other relief based on essentially the same allegations as the class action litigation. The Company and plaintiffs have reached an agreement in principle to settle the litigation, pursuant to which, without admitting any liability or wrongdoing of any kind, the Company would adopt certain corporate remedial measures, terms of which are still being negotiated. Once documented, the settlement would be subject to Court approval. The Company could become involved in litigation from time to time relating to claims arising out of the ordinary course of business or otherwise. Any litigation, regardless of outcome, is costly and time-consuming, can divert the attention of management and key personnel from business operations and deter distributors from selling the Company’s products and dissuade potential customers from purchasing the Company’s products.

ITEM 1A. RISK FACTORS

There has been no material change in our risk factors as described in “Part I, Item 1A. Risk Factors” of our Annual Report on Form 10-K, as amended by Form 10-K/A for the fiscal year ended June 30, 2009.

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

Use of Proceeds from Public Offering of Common Stock

The effective date of the registration statement for our initial public offering was July 2, 2007. As of March 31, 2010, the proceeds from our initial public offering have been invested in cash, cash equivalents and short term investments. None of the use of the proceeds was made, directly or indirectly, to our directors, officers, or persons owning 10% or more of our common stock.

ITEM 6. EXHIBITS

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

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SIGNATURES

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

Date: May 6, 2010

ShoreTel, Inc.
By:	/s/    MICHAEL E. HEALY
	Michael E. Healy Chief Financial Officer

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EXHIBIT INDEX

Exhibit Number	Exhibit Title
3.01	Executive Employment Agreement with John W. Combs dated February 22, 2010
31.1(1)	Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer.
31.2(1)	Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer.
32.1(1)	Section 1350 Certification of Chief Executive Officer.
32.2(1)	Section 1350 Certification of Chief Financial Officer.

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

(b) Financial Statement Schedules.

All schedules have been omitted because they are either inapplicable or the required information has been given in the annual consolidated financial statements or the notes thereto.

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