**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington, D.C.
      20549**










**Form 10-Q**









(Mark
      one)


R
            **QUARTERLY
                REPORT PURSUANT TO SECTION 13 OR 15(d)****OF
                THE SECURITIES EXCHANGE ACT OF 1934****For
                the quarterly period ended September 30, 2007****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 jurisdictionof 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 R No £





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


Large
      accelerated filer £ Accelerated
      Filer £ Non-accelerated
      filer R





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





As
      of
      October 31, 2007, 42,622,671 shares of the registrant’s common stock were
      outstanding.











**SHORETEL,
      INC.**


**FORM
      10-Q for the Quarter Ended September 30, 2007**





**INDEX**





**Page****PART I:
                Financial Information**Item 1
            Financial
                Information (Unaudited)Condensed
                Consolidated Balance Sheets as of September 30, 2007 and June 30,
                2007
            3Condensed
                Consolidated Statements of Operations for the three months ended
                September
                30, 2007 and 2006
            4Condensed
                Consolidated Statements of Cash Flows for the three months ended
                September
                30, 2007 and 2006
            5Notes
                to Condensed Consolidated Financial Statements
            6Item 2
            Management’s
                Discussion and Analysis of Financial Condition and Results of
                Operations
            14Item 3
            Quantitative
                and Qualitative Disclosures About Market Risk
            21Item 4
            Controls
                and Procedures
            21**PART II:**
            **Other
                information**Item 1
            Legal
                Proceedings
            22Item 1A
            Risk
                Factors
            22Item 2
            Unregistered
                Sales of Equity Securities and Use of Proceeds
            35Item 3
            Defaults
                Upon Senior Securities
            35Item 4
            Submission
                of Matters to a Vote of Security Holders
            35Item
                5
            Other
                Information
            35Item
                6
            ExhibitsSignatures
            36




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)**




**September
                30,**
            
            **June
                30,****2007**
            
            **2007****ASSETS**CURRENT
                ASSETS:Cash
                and cash equivalents
            
            $
            99,192
            
            $
            17,326Accounts
                receivable, net of allowances of $391 and $320 as of September 30,
                2007 and June 30, 2007, respectively
            
            
            21,704
            
            
            19,411Inventories
            
            
            6,048
            
            
            7,057Prepaid
                expenses and other current assets
            
            
            3,203
            
            
            3,372Total
                current assets
            
            
            130,147
            
            
            47,166PROPERTY
                AND EQUIPMENT — Net
            
            
            3,338
            
            
            2,933OTHER
                ASSETS
            
            
            151
            
            
            2,935TOTAL
            
            $
            133,636
            
            $
            53,034**LIABILITIES,
                REDEEMABLE CONVERTIBLE PREFERRED****STOCK, AND**
              **SHAREHOLDERS’
                EQUITY (DEFICIT)**CURRENT
                LIABILITIES:


Accounts
                payable
            
            $
            4,993
            
            $
            7,433Accrued
                liabilities and other
            
            
            3,426
            
            
            2,807


Accrued
                employee compensation
            
            
            3,492
            
            
            3,782Deferred
                revenue
            
            
            11,162
            
            
            10,126Total
                current liabilities
            
            
            23,073
            
            
            24,148


LONG-TERM
                LIABILITIES:Preferred
                stock warrant liabilityLONG-TERM
                LIABILITIES:
            
            
            -
            
            
            549Long-term
                deferred revenuePreferred
                stock warrant liability
            
            
            4,441
            
            
            3,825Total
                long-term liabilitiesLong-term
                deferred revenue
            
            
            4,441
            
            
            4,374Total
                liabilitiesTotal
                long-term liabilities
            
            
            27,514
            
            
            28,522COMMITMENTS
                AND CONTINGENCIES (Note 11)REDEEMABLE
                CONVERTIBLE PREFERRED STOCK, authorized, 23,586 shares; issued and
                outstanding 0 and 23,316 shares as of September 30, 2007 and
                June 30, 2007, respectively (aggregate liquidation preference of
                $44,250 at June 30, 2007)COMMITMENTS
                AND CONTINGENCIES (Note 11)
            
            
            -
            
            
            56,341SHAREHOLDERS’
                EQUITY (DEFICIT):


Common
                stock, par value $.001 per share, authorized 500,000 shares as of
                September 30, 2007 and June 30, 2007, respectively; issued and
                outstanding, 42,618 and 10,132 shares as of September 30, 2007 and
                June 30, 2007, respectivelySHAREHOLDERS’
                DEFICIT:
            
            
            188,576
            
            
            53,206Deferred
                stock compensation
            
            
            (213
            )
            
            (237
            )


Accumulated
                deficit
            
            
            (82,241
            )
            
            (84,798
            )Total
                shareholders’ equity (deficit)
            
            
            106,122
            
            
            (31,829
            )


TOTAL
            
            $
            133,636
            
            $
            53,034




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**
              **September
                30,****2007**
            
            **2006**REVENUE:Product
            
            $
            28,125
            
            $
            18,467Support
                and services
            
            
            3,850
            
            
            1,948Total
                revenue
            
            
            31,975
            
            
            20,415COST
                OF REVENUE:


Product
                (1)
            
            
            9,404
            
            
            6,507Support
                and services (1)
            
            
            2,159
            
            
            1,445


Total
                cost of revenue
            
            
            11,563
            
            
            7,952GROSS
                PROFIT
            
            
            20,412
            
            
            12,463


OPERATING
                EXPENSES:Research
                and development (1)
            
            
            6,207
            
            
            3,117Sales
                and marketing (1)
            
            
            8,322
            
            
            5,677General
                and administrative (1)
            
            
            3,723
            
            
            2,573Total
                operating expenses
            
            
            18,252
            
            
            11,367INCOME
                FROM OPERATIONS
            
            
            2,160
            
            
            1,096


OTHER
                INCOME:Interest
                income
            
            
            1,161
            
            
            161Interest
                expense
            
            
            -
            
            
            (4
            )


Other
            
            
            42
            
            
            -


Total
                other income
            
            
            1,203
            
            
            157


INCOME
                BEFORE PROVISION FOR INCOME TAXES
            
            
            3,363
            
            
            1,253


PROVISION
                FOR INCOME TAXES
            
            
            (806
            )
            
            (207
            )


NET
                INCOME
            
            
            2,557
            
            
            1,046


ACCRETION
                OF PREFERRED STOCK
            
            
            -
            
            
            (13
            )


NET
                INCOME AVAILABLE TO COMMON SHAREHOLDERS
            
            $
            2,557
            
            $
            1,033Net
                income per common share available to common shareholders:


Basic
            
            $
            0.06
            
            $
            0.13


Diluted
            
            $
            0.06
            
            $
            0.03


Shares
                used in computing net income per share available to common
                shareholders:Basic
            
            
            41,881
            
            
            7,912Diluted
            
            
            44,989
            
            
            35,243


(1)
                Includes stock-based compensation expense as follows:Cost
                of product revenue
            
            $
            8
            
            $
            1Cost
                of support and services revenue
            
            
            58
            
            
            5Research
                and development
            
            
            254
            
            
            17Sales
                and marketing
            
            
            451
            
            
            97General
                and administrative
            
            
            294
            
            
            702Total
                stock-based compensation expense
            
            $
            1,065
            
            $
            822





See
      Notes
      to Condensed Consolidated Financial Statements





4





**SHORETEL,
      INC. AND SUBSIDIARIES**


**CONDENSED
      CONSOLIDATED STATEMENTS OF CASH FLOWS**


**(in
      thousands)**


**(unaudited)**




**Three
                Months Ended****September
                30,****2007**
            
            **2006****CASH
                FLOWS FROM OPERATING ACTIVITIES:**Net
                income
            
            $
            2,557
            
            $
            1,046Adjustments
                to reconcile net income to net cash provided by operating
                activities:Depreciation
                and amortization
            
            
            319
            
            
            236Stock
                compensation expense
            
            
            1,065
            
            
            822Provision
                for doubtful accounts receivable
            
            
            (40
            )
            
            (160
            )Changes
                in assets and liabilities:Accounts
                receivable
            
            
            (2,253
            )
            
            (2,216
            )Inventories
            
            
            1,009
            
            
            (199
            )Prepaid
                expenses and other current assets
            
            
            169
            
            
            109Other
                assets
            
            
            (82
            )
            
            -Accounts
                payable
            
            
            (2,554
            )
            
            1,332Accrued
                liabilities and other
            
            
            679
            
            
            (185
            )Accrued
                employee compensation
            
            
            (290
            )
            
            (601
            )Deferred
                revenue
            
            
            1,652
            
            
            1,200Net
                cash provided by operating activities
            
            
            2,231
            
            
            1,384**CASH
                FLOWS FROM INVESTING ACTIVITIES:**Purchases
                of property and equipment
            
            
            (679
            )
            
            (508
            )Net
                cash used in investing activities
            
            
            (679
            )
            
            (508
            )**CASH
                FLOWS FROM FINANCING ACTIVITIES:**


Proceeds
                from initial public offering, net of underwriting
                discounts
            
            
            80,265
            
            
            -Repayment
                of capital leases
            
            
            -
            
            
            (1
            )Exercise
                of common stock options (including proceeds from unvested
                shares)
            
            
            49
            
            
            70Repayment
                of shareholder notes issued in connection with stock option
                exercises
            
            
            -
            
            
            12


Net
                cash provided by financing activities
            
            
            80,314
            
            
            81NET
                INCREASE IN CASH AND CASH EQUIVALENTS
            
            
            81,866
            
            
            957CASH
                AND CASH EQUIVALENTS — Beginning of period
            
            
            17,326
            
            
            12,333


CASH
                AND CASH EQUIVALENTS — End of period
            
            $
            99,192
            
            $
            13,290


**NONCASH
                  INVESTING AND FINANCING ACTIVITIES:**Conversion
                  of redeemable convertible preferred stock to common stock
              
              $
              56,341
              
              $
              -Reclassification
                  of initial public offering costs from Other assets toCommon
                  stock
              
              $
              2,866
              
              $
              -Reclassification
                  of preferred stock warrant liability to common stock.
              
              $
              549
              
              $
              -Vesting
                  of accrued early exercised stock options..
              
              $
              60
              
              $
              -Purchase
                  of property and equipment included in period-end accounts
                  payable
              
              $
              40
              
              $
              31Initial
                  public offering costs included in period-end accounts
                  payable
              
              $
              70
              
              $
              -





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 Internet Protocol, or IP, telecommunications 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.





In
      July
      2007, the Company completed an initial public offering, or IPO, of common stock
      in which it sold and issued 9,085,000 shares of common stock, including
      1,185,000 shares sold by the Company pursuant to the underwriters’ exercise of
      their over-allotment, at an issue price of $9.50 per share. The Company raised
      a
      total of $86.3 million in gross proceeds from the IPO, or approximately $77.4
      million in net proceeds after deducting underwriting discounts of $6.0 million
      and other offering costs of $2.9 million. Upon closing of the IPO, all shares
      of
      redeemable convertible preferred stock outstanding automatically converted
      into
      23,316,406 shares of common stock. In addition, all outstanding warrants to
      purchase shares of the Company’s redeemable convertible preferred stock were
      converted into warrants to purchase an aggregate of 67,703 shares of common
      stock.





**2.**
            **Basis
                of Presentation**





The
      accompanying financial data as of September 30, 2007 and for the three months
      ended September 30, 2007 and 2006 has been prepared by the Company, without
      audit, pursuant to the rules and regulations of the Securities and Exchange
      Commission (SEC). Certain information and footnote disclosures normally included
      in financial statements prepared in accordance with accounting principles
      generally accepted in the United States have been condensed or omitted pursuant
      to such rules and regulations. However, the Company believes that the
      disclosures are adequate to make the information presented not misleading.
      These
      Condensed Consolidated Financial Statements should be read in conjunction with
      the Consolidated Financial Statements and the notes thereto, included in the
      Company’s Annual Report on Form 10-K for the fiscal year ended June 30,
      2007.





In
      the
      opinion of management, all adjustments (which include normal recurring
      adjustments, except as disclosed herein) necessary to present a fair statement
      of financial position as of September 30, 2007, results of operations and cash
      flows for the quarters ended September 30, 2007 and 2006, as applicable, have
      been made. The results of operations for the quarter ended September 30, 2007
      are not necessarily indicative of the operating results for the full fiscal
      year
      or any future periods.





**Computation
      of Net Income per Share**





Basic
      net
      income per common share available to common shareholders is determined by
      dividing net income available to common shareholders by the weighted average
      number of common shares available to common shareholders during the period.
      Diluted net income per common share available to common shareholders is
      determined by dividing net income available to common shareholders by the
      weighted average number of common shares available to common shareholders used
      in the basic net income 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.





**Recent
      Accounting Pronouncements**





In
      June
      2006, the FASB issued FIN No. 48 (FIN 48), *Accounting
      for*  *Uncertainty
      in Income Taxes* - *an
      interpretation of FASB Statement No. 109* .
      FIN 48 applies to all tax positions within the scope of FASB Statement
      No. 109, applies a “more likely than not” threshold for tax benefit
      recognition, identifies a defined methodology for measuring benefits and
      increases the disclosure requirements for companies. FIN 48 was adopted by
      the Company effective July 1, 2007 (See Note 5).





6


In
      September 2006, the FASB issued SFAS No. 157 (SFAS 157), *Fair
      Value*  *Measurements* .
      This
      Statement defines fair value, establishes a framework for measuring fair value
      in generally accepted accounting principles, and expands disclosures about
      fair
      value measurements. This Statement applies under other accounting pronouncements
      that require or permit fair value measurements, the Board having previously
      concluded in those accounting pronouncements that fair value is the relevant
      measurement attribute. Accordingly, this Statement does not require any new
      fair
      value measurements. This Statement is effective for financial statements issued
      for fiscal years beginning after November 15, 2007, and interim periods
      within those fiscal years. The Company does not expect the adoption of
      SFAS 157 in fiscal year 2009 to have a material impact on its results of
      operations or financial position.





In
      February 2007, the FASB issued SFAS No. 159, *The
      Fair Value Option for*  *Financial
      Assets and Financial Liabilities* (SFAS 159).
      SFAS 159 permits entities to choose, at specified election dates, to
      measure eligible items at fair value (or “fair value option”) and to report in
      earnings unrealized gains and losses on those items for which the fair value
      option has been elected. SFAS 159 also requires entities to display the
      fair value of those assets and liabilities on the face of the balance sheet.
      SFAS 159 establishes presentation and disclosure requirements designed to
      facilitate comparisons between entities that choose different measurement
      attributes for similar types of assets and liabilities. SFAS 159 is
      effective for the Company as of the first quarter of 2009. The Company is
      currently evaluating the impact of this pronouncement on its financial
      statements.





**Reclassifications**





Separate
      line item disclosure of the provision for doubtful accounts receivable has
      been
      provided in the condensed consolidated statement of cash flows for the three
      months ended September 30, 2006 to conform to the current period
      presentation.





**3.**
            **Balance
                Sheet Details**





Balance
      sheet components consist of the following:




**September
                30,**
            
            **June
                30,****2007**
            
            **2007****(Amounts
                in thousands)**Inventories:


Raw
                materials
            
            $
            9
            
            $
            47Inventory
                in process/transit
            
            
            223
            
            
            325Finished
                goods
            
            
            5,816
            
            
            6,685Total
                inventories
            
            $
            6,048
            
            $
            7,057Prepaid
                expenses and other current assets:Prepaid
                expenses
            
            $
            2,167
            
            $
            2,600Deferred
                cost of revenue
            
            
            756
            
            
            772Deferred
                taxes
            
            
            280
            
            
            -Total
                prepaid expenses and other current assets
            
            $
            3,203
            
            $
            3,372


Property
                and equipment:Computer
                equipment and tooling
            
            $
            4,458
            
            $
            3,573Software
            
            
            1,008
            
            
            982Furniture
                and fixtures
            
            
            504
            
            
            403Leasehold
                improvements
            
            
            216
            
            
            203Total
                property and equipment
            
            
            6,186
            
            
            5,161Less
                accumulated depreciation and amortization
            
            
            2,848
            
            
            2,228Property
                and equipment — net
            
            $
            3,338
            
            $
            2,933Deferred
                Revenue - current and long-term:Product
            
            $
            2,419
            
            $
            2,618Support
                and services
            
            
            13,184
            
            
            11,333$
            15,603
            
            $
            13,951





7


**4.**
            **Related
                Party Transactions**





*Unsecured
      Promissory Note* —
      In October 1997, the Company issued an unsecured promissory note in the
      principal amount of $350,000 to an officer and shareholder for the purchase
      of
      stock upon exercise of incentive stock options. The note bears interest at
      6.34%
      per annum and allows the Company to repurchase the unvested shares within 60
      days of termination at a price equal to the original exercise price. The
      principal and any accrued but unpaid interest were due on the earlier of
      (a) October 27, 2004 or (b) two years after the termination of
      the officer’s employment, the Company’s initial public offering or a merger or
      acquisition of the Company. In January 2002, the officer was terminated and
      in
      connection therewith, the Company forgave $230,000 plus related accrued interest
      and reserved the remaining principal balance of $120,000 plus related accrued
      interest. In addition, the Company repurchased the unvested shares and amended
      the terms of the remaining notes issued, such that they are nonrecourse. Due
      to
      the conversion of these full recourse notes to non-recourse, the deemed new
      awards were subject to variable accounting. As such, additional stock-based
      compensation expense was recorded to the extent the Company’s share price
      appreciated above the value for which the Company had already recorded
      compensation charges. Stock-based compensation expense recorded for these awards
      in the three months ended September 30, 2006 was $699,000. In March 2007, the
      Company entered into a Note Repayment Agreement whereby the borrower surrendered
      57,671 shares of the Company’s common stock (with an estimated fair value
      of $536,000) to repay in full the outstanding principal and interest balances
      due under this note resulting in a recovery of $191,000 recorded as a reduction
      of general and administrative expense of $120,000 and interest income of $71,000
      for the year ended June 30, 2007.





**5.**
            **Income
                Taxes**





The
      provision for income taxes of $0.8 million and $0.2 million for the three months
      ended September 30, 2007 and 2006, respectively, is based on the estimated
      effective tax rates for the respective fiscal years including the impact of
      the
      change in valuation allowance associated with the utilization of net operating
      loss and tax credit carryforwards.





Effective
      July 1, 2007, the Company adopted the provisions of FIN 48, *Accounting
      for Uncertainty in Income Taxes-an interpretation of FASB Statement
      No. 109* .
      FIN 48
      contains a two-step approach to recognizing and measuring uncertain tax
      positions accounted for in accordance with SFAS No. 109, *Accounting
      for Income Taxes* .
      The
      first step is to evaluate the tax position for recognition by determining if
      the
      weight of available evidence indicates that it is more likely than not that
      the
      position will be sustained on audit, including resolution of related appeals
      or
      litigation processes, if any. The second step is to measure the tax benefit
      as
      the largest amount that is more than 50% likely of being realized upon ultimate
      settlement.





The
      cumulative effect of adoption of FIN 48 did not result in an adjustment to
      the
      Company’s tax liability for unrecognized income tax benefits. The total amount
      of gross unrecognized tax benefits as of the date of adoption for federal and
      state purposes was $0.7 million and $0.45 million, respectively. These gross
      unrecognized tax benefits would affect the effective tax rate if realized.





The
      Company’s policy to include interest and penalties related to unrecognized tax
      benefits within the provision for taxes on the condensed consolidated condensed
      statements of income did not change as a result of implementing the provisions
      of FIN 48. Management determined that no accrual for interest or penalties
      was
      needed as of the date of the adoption of FIN 48 and the Company had no amount
      accrued at June 30, 2007.





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
      recorded 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.
      As of September 30, 2007, management does not believe that the Company’s
      estimates, as otherwise provided for, on such tax positions will significantly
      increase or decrease within the next twelve months.





The
      federal research tax credit expires on December 31, 2007. Currently, Congress
      is
      discussing the extension and/or revision of the federal research tax credit,
      and
      no new law has been passed to date.





The
      Company’s only major tax jurisdiction is the United States. The tax years 1997
      through 2006 remain open and subject to tax examination by the appropriate
      governmental agencies in the United States.




**6.**
            **Redeemable
                Convertible Preferred Stock and Stock
                Warrants**





Upon
      the
      Company’s initial public offering in July 2007, all outstanding shares of
      preferred stock were converted into common stock. In addition, all outstanding
      warrants to purchase shares of preferred stock were converted into warrants
      to
      purchase common stock. As of September 30, 2007, there was no redeemable
      convertible preferred stock or preferred stock warrants
      outstanding.





8


*Preferred
      Stock Warrants* — In
      prior years, the Company issued warrants to purchase Series E and Series F
      redeemable convertible preferred stock. These warrants converted to common
      stock
      warrants upon the completion of the Company’s IPO in July 2007. The Company
      recorded the fair value of the warrants at the time of grant using the
      Black-Scholes option-pricing model.





The
      Company has the following common stock warrants outstanding as of September
      30,
      2007.





·
            Warrants
                to purchase 685 shares of common stock issued with respect to an
                equipment
                lease line signed in June 1998, exercisable at $21.18 per
                share.


·
            Warrants
                to purchase 1,224 shares of common stock issued in February 2001
                for
                consulting services, exercisable at $26.22 per
                share.


·
            Warrants
                to purchase 5,336 shares of common stock issued with respect to a
                line of
                credit in March 2001, exercisable at $9.37 per
                share.


·
            Warrants
                to purchase 62,367 shares of common stock issued with respect to
                a line of
                credit in September 2003, exercisable at $0.80 per
                share.





As
      of
      June 30, 2007, the Company recorded a liability of $549,000 for the fair value
      of the Series E and Series F redeemable convertible preferred stock
      warrants, in accordance with FASB Staff Position FAS 150-5, *Issuer’s*  *Accounting
      under FASB Statement No. 150 for Freestanding Warrants and
      Other*  *Similar
      Instruments on Shares that are Redeemable.* The
      warrants were valued at June 30, 2007 using the Black-Scholes option value
      model based on the estimated fair value of the underlying Series E and
      Series F preferred stock, volatility of 55%, expected term of three months
      and a risk free interest rate of 4.76%. **** ** The
      warrant liability was reclassified to common stock in July 2007 when the
      preferred stock converted to common stock upon completion of the Company’s
      IPO.





**7.**
            **Common
                Stock**





***Reverse
      Stock Split***





In
      June
      2007, the Company effected a 1-for-10 reverse stock split of the Company’s
      common stock and redeemable convertible preferred stock (collectively, “Capital
      Stock”). All of the share numbers, share prices, and exercise prices have been
      adjusted, on a retroactive basis, to reflect this 1-for-10 reverse stock
      split.





***Initial
      Public Offering***





On
      July 9, 2007, the Company closed its initial public offering. The offering
      raised net proceeds of approximately $77.4 million, after deducting
      underwriting discounts and payment of professional services rendered in
      connection with the offering. In connection with the offering, all outstanding
      shares of redeemable convertible preferred stock were converted into an
      aggregate of 23,316,406 shares of common stock.





***Common
      Shares Subject to Repurchase***





At
      September 30, 2007 **,** 593,139 shares
      of common stock were subject to repurchase in connection with the early exercise
      of stock options under the Company’s stock option plan.





***Common
      Shares Reserved for Issuance***





At
      September 30, 2007, the Company has reserved shares of common stock for
      issuance as follows (in thousands):





Reserved
                under stock option plans
            
            
            9,044Conversion
                of warrants
            
            
            70Total
            
            
            9,114





**8.**
            **Stock-Based
                Compensation**





Prior
      to
      July 1, 2006, the Company accounted for employee stock options using the
      intrinsic value method in accordance with Accounting Principles Board Opinion
      No. 25, *Accounting
      for Stock Issued to Employees* ,
      or
      APB 25, and Financial Accounting Standards Board Interpretation No. (FIN)
      44, *Accounting
      for Certain Transactions Involving Stock Compensation, an Interpretation of
      APB
      No. 25* ,
      and had
      adopted the disclosure only provisions of Statement of Financial Accounting
      Standards, or SFAS No. 123, *Accounting
      for Stock-Based Compensation* ,
      or
      SFAS 123, and SFAS No. 148, *Accounting
      for Stock-Based Compensation — Transition and Disclosure* ,
      or
      SFAS 148.





9




In
      accordance with APB 25, stock-based compensation expense, which is a
      non-cash charge, resulted from stock option grants at exercise prices that,
      for
      financial reporting purposes, were deemed to be below the estimated fair value
      of the underlying common stock on the date of grant.




Effective
      July 1, 2006, the Company adopted the fair value recognition provisions of
      SFAS No. 123(revised 2004), *Share-Based
      Payment* ,
      or
      SFAS 123(R), using the prospective transition method, which requires the
      Company to apply the provisions of SFAS 123(R) only to awards newly
      granted, modified, repurchased or cancelled, after the adoption date. Under
      this
      transition method, the Company began recognizing stock-based compensation
      expense July 1, 2006 based on the grant date fair value of stock option
      awards granted or modified after July 1, 2006. Prior to and during fiscal
      2006, the Company categorized our options into two classes. Class One includes
      all options granted with four-year vesting and no ability to exercise prior
      to
      vesting. Class Two includes options granted with four-year vesting but allow
      for
      early exercisability. The Company discontinued granting Class Two options as
      of
      June 30, 2007. The Company recognizes stock-based compensation expense for
      both
      Class One and Class Two on a straight-line basis over the options’ expected
      vesting terms, generally four years. The Company estimated the grant date fair
      value of stock option awards under the provisions of SFAS 123(R) using the
      Black-Scholes option valuation model with the following assumptions:




**Three Months Ended**
            
            **Three
                Months Ended****September
                30,********2007**
            
            **September 30,
                2006****Class
                One**
            
            **Class
                Two**Expected
                life
            
            
            6.08
                years
            
            
            6.08
                years
            
            
            4.0
                yearsInterest
                rate range
            
            
            4.5
            %
            
            4.8
            %
            
            4.8
            %Volatility
            
            
            55
            
            
            71
            
            
            55Dividend
                yield
            
            
            0
            
            
            0
            
            
            0





During
      the three month periods ended September 30, 2007 and 2006, the Company recorded
      non-cash stock-based compensation expense of $1.1 million and $0.8 million
      under
      SFAS 123(R), respectively.  The income tax benefit associated with
      stock-based compensation expense for the three months periods ended 
September  30, 2007 and 2006 was $0.2 million.





SFAS 123(R)
      requires that compensation expense be 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. The estimated forfeiture rate for the
      three months ended September 30, 2007 and 2006 was 11.5% and 13%, respectively. As
      of
      September 30, 2007, total unrecognized compensation cost related to
      stock-based awards granted to employees and non-employee directors was
      $13,794,000, net of estimated forfeitures of $4,352,000 This cost will be
      amortized on a straight-line basis over a weighted-average vesting period of
      approximately four years.





**9.**
            **Stock
                Option Plan**





In
      January 1997, the Board of Directors and shareholders 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. There were no repurchases of unvested shares in the three months
      ended September 30, 2007 and 2006. The Company’s repurchase right for such
      options lapses as the options vest, generally over four years from the date
      of
      grant.





10


In
      February 2007, the Company adopted the 2007 Equity Incentive Plan (the “2007
      Plan”) which, as amended, provides for grants of incentive common stock options
      (“ISOs”) and nonqualified common stock options (“NSOs”) 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
      are
      reserved for future issuance in the form of stock options, restricted stock
      awards or units, stock appreciation rights and stock bonuses. In accordance
      with
      the 2007 Plan, the stated exercise price of ISOs and NSOs shall not be less
      than
      100% and 85%, respectively, of the estimated fair market value of common stock
      on the date of grant, as determined by the Board of Directors. Additionally,
      the
      2007 Plan provides for automatic annual increases of shares available for
      issuance of up to 5% of the number of common shares then outstanding. The 2007
      Plan provides that the options shall be exercisable over a period not to exceed
      ten years.





Class Two
      options granted to certain executive officers are exercisable immediately and
      shares issued upon exercise are subject to repurchase by the Company at the
      exercise price, in the event the employee is terminated; such repurchase right
      lapses gradually over a four year period. The Company does not consider the
      exercise of stock options substantive when the issued stock is subject to
      repurchase. Accordingly, the proceeds from the exercise of such options are
      accounted for as a deposit liability until the repurchase right lapses, at
      which
      time the proceeds are reclassified to permanent equity. As of September 30,
      2007
      and June 30, 2007, there were 593,124 and 767,612 shares subject to
      repurchase, respectively, of the Company’s common stock outstanding and $232,000
      and $292,000 , respectively, of related recorded liability, which is included
      in
      accrued liabilities.





During
      fiscal year 2006, the Company had outstanding loans to certain executives and
      employees pursuant to the 1997 Plan for the purchase of stock upon the exercise
      of incentive stock options in the aggregate amounts of $231,000. The loan
      agreements allow the Company to repurchase the unvested shares within
      60 days of termination at a price equal to the original exercise price. The
      loans bear interest at rates ranging from 6.4% — 8.0% per annum and are due
      upon the earlier of termination of employment or four years from the option
      exercise date. All loans were due by June 30, 2006. In March 2003, the
      Company amended the terms of the loans, such that they are nonrecourse. Of
      the
      271,790 shares purchased, 127,418 were unvested at the time of the note
      amendments. During the year ended June 30, 2007, one employee repaid his
      loan in the amount of $12,000 plus accrued interest of $7,000. In March 2007,
      the Company entered into a Note Repayment Agreement with the sole remaining
      note
      holder, whereby he agreed to surrender 57,671 shares of the Company’s
      common stock as full consideration for the principal and fully-reserved interest
      balances due on his stock loans and his promissory note (see Note 4).





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





**Shares**
              **Available**
              **for
                Grant**
            
            **Shares**
              **Subject
                to**
              **Options**
              **Outstanding**
            
            **Weighted-**
              **Average**
              **Exercise**
              **Price****(Amounts
                in thousands, except per share amounts)**Outstanding —
                June 30, 2007
            
            
            4,504
            
            
            4,626
            
            $
            4.57Options
                granted — (weighted average fair value of $7.05 per
                share)
            
            
            (864
            )
            
            864
            
            
            13.56Options
                exercised
            
            
            —
            
            
            (85
            )
            
            0.57Options
                canceled
            
            
            100
            
            
            (100
            )
            
            8.99Outstanding —
                September 30, 2007
            
            
            3,740
            
            
            5,305
            
            $
            6.01Options
                exercisable at September 30, 2007
            
            
            
            
            
            2,173
            
            $
            1.21




The
      total
      pre-tax intrinsic value for options exercised in the three months ended
      September 30, 2007 and 2006 was $1,085,000 and $307,000, 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. The weighted average fair value of options granted for the three
      months ended September 30, 2006 was $4.57 per share.  The total fair value
      of options vested during the three month periods ended September 30, 2007 and
      2006 was $2.4 million and $1.3 million, respectively.




11


The
      following table summarizes information about outstanding and exercisable options
      at September 30, 2007:





**Exercise**
              **Prices**
            
            **Options**
              **Outstanding**
            
            **Weighted**
              **Average**
              **Remaining**
              **Contractual**
              **Life
                (Years)**
            
            **Weighted**
              **Average**
              **Exercise**
              **Price**
            
            **Aggregate**
              **Intrinsic**
              **Value****(Amounts
                in thousands, except per share data)**$0.10
                - 0.30
            
            
            695
            
            
            5.97
            
            $
            0.21$0.40
            
            
            646
            
            
            7.70
            
            $
            0.40$0.80
                - 1.00
            
            
            729
            
            
            7.96
            
            $
            0.92$2.00
                - 3.00
            
            
            146
            
            
            7.95
            
            $
            2.51$3.20
            
            
            665
            
            
            9.03
            
            $
            3.20$3.60
                - $6.00
            
            
            118
            
            
            7.72
            
            $
            4.17$9.50
                - $10.50
            
            
            209
            
            
            9.74
            
            $
            10.49$11.30
            
            
            721
            
            
            9.53
            
            $
            11.30$11.40
            
            
            558
            
            
            9.64
            
            $
            11.40$12.55
                - 13.44
            
            
            144
            
            
            9.90
            
            $
            12.94$13.73
            
            
            674
            
            
            9.91
            
            $
            13.73Total
                Outstanding
            
            
            5,305
            
            
            8.56
            
            $
            6.01
            
            $
            44,079Exercisable
            
            
            2,173
            
            
            7.37
            
            $
            1.21
            
            $
            28,490Vested
                and expected to vest
            
            
            4,321
            
            
            8.30
            
            $
            5.64
            
            $
            37,495





**10.**
            **Employee
                Stock Purchase Plan**





On
      September 18, 2007, the Board of Directors approved the establishment of an
      employee stock purchase plan (the “ESPP”). The ESPP allows eligible employees to
      purchase shares of Company stock at a discount through payroll deductions.
      The
      ESPP consists of six-month offering periods, the first period commencing on
      November 1, 2007 and ending on or prior to April 30, 2008. Employees purchase
      shares in the purchase period at 90% of the market value of our common stock
      at
      either the beginning of the offering period or the end of the offering period,
      whichever price is lower.





**11.**
            **Commitments
                and Contingencies**





*Leases* —
      The Company leases its facilities under noncancelable operating leases which
      expire by June 2010. The leases provide for the lessee to pay all cost of
      utilities, insurance, and taxes. On October 1, 2005, the Company
      renegotiated the lease on its primary facility and increased the square footage
      under lease. In May 2007, the Company executed a new lease for its existing
      headquarters facility that extends until October 2009 and provides for minimum
      monthly base rent payments of $118,000 for the period from October 2007 to
      October 2008, and $124,000 for the period from October 2008 to October 2009.
      In
      addition, in May 2007 the Company executed a two-year lease for additional
      operational space at another location near its headquarters that terminates
      in
      September 2009 and provides for minimum monthly base rent payments of
      approximately $5,000.





Future
      minimum lease payments under the noncancelable leases as of September 30,
      2007, are as follows (in thousands):





**Years
                Ending June 30,**2008
                (remaining 9 months)
            
            $
            1,2342009
            
            
            1,5932010
            
            
            574$
            3,401





Lease
      obligations for the Company’s foreign offices are cited in foreign currencies,
      which were converted herein to U.S. dollars at the interbank exchange rate
      on September 30, 2007.





Rent
      expense for the three months ended September 30, 2007 and 2006 was $225,000
      and $183,000, respectively.





*Purchase
      commitments* —
      As of September 30, 2007 and June 30, 2007, the Company had non-cancelable
      purchase commitments with contract manufacturers totaling approximately
      $9,784,000 **** and
      $11,875,000, respectively, for finished goods.





*Litigation* — On
      June 27, 2007, a lawsuit was filed against the Company by Mitel Networks
      Corporation in the United States District Court for the Eastern District of
      Texas. Mitel alleges that the Company infringed four of its U.S. patents:
      U.S. Patent No. 5,940,834, entitled “Automatic Web
      Page Generator,” U.S. Patent No. 5,703,942 entitled “Portable
      Telephone User Profiles Using Central Computer,” U.S. Patent
      No. 5,541,983 entitled “Automatic Telephone Feature Selector” and
      U.S. Patent No. 5,657,446 entitled “Local Area Communications Server.”
On August 21, 2007, Mitel filed an amended complaint, which alleges that
      the Company infringes two additional U.S. patents held by Mitel:
      U.S. Patent No. 5,007,080, entitled “Communications System Supporting
      Remote Operations,” and U.S. Patent No. 5,657,377, entitled “Portable
      Telephone User Profiles.” The lawsuit includes claims that relate to components
      or features that are material to the Company’s products. In relation to its
      claims under each patent, Mitel seeks a permanent injunction against
      infringement, attorney’s fees and compensatory damages.





12


On
      July 31, 2007, the Company filed counterclaims in the Eastern District of
      Texas. In addition to denying all of Mitel’s claims of patent infringement, the
      counterclaim alleges that Mitel’s IP phone systems, including the Mitel 3300 IP
      Communications Platform, infringes the Company’s U.S. Patent
      No. 7,167,486 B2 entitled “Voice Traffic Through a Firewall.” The Company
      also filed claims for approximately $10 million in damages to its initial
      public offering and an injunction against Mitel in Ontario Superior Court for
      making false or misleading statements about the Company’s alleged
      infringement.





The
        Company believes it has meritorious defenses to Mitel’s claims and intends to
        vigorously defend the lawsuit.





*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.





*Line
      of Credit.* The
      Company had a $12.0 million line of credit with a bank. The line of credit
      terminated on June 26, 2007, and there were no borrowings under the line as
      of September 30, 2007 and June 30, 2007.





**12.**
            **Segment
                Information**





SFAS No. 131
      (SFAS 131), *Disclosures
      About Segments of an Enterprise and*  *Related
      Information* ,
      established standards for reporting information about operating segments.
      Operating segments are defined as components of an enterprise for which separate
      financial information is available and evaluated regularly by the chief
      operating decision-maker, or decision-making group, in deciding how to allocate
      resources and in assessing performance. 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, accompanied by information about
      revenue by geographic region, for purposes of evaluating financial performance
      and allocating resources. The Company has operations in North America, Asia
      Pacific and Europe; however, the portion of revenues that International
      operations contributes is less than 10% of consolidated revenues. As such,
      it
      does not meet the requirement under SFAS 131 to be reported as a separate
      segment. Revenue is attributed by geographic location based on the location
      of
      the billing address of the channel partner or enterprise customer if sold
      directly to the enterprise customer. The Company’s assets are primarily located
      in the United States of America and not allocated to any specific
      region.





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




**Three
                Months Ended**
              **September
                30,****2007**
            
            **2006**North
                America
            
            $
            30,912
            
            $
            20,210International
            
            
            1,063
            
            
            205Total
            
            $
            31,975
            
            $
            20,415





13





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








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





**Overview**





We
      are a
      leading provider of IP telecommunications systems 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 eleven models of our switches and ten models
      of
      our IP phones.





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





Our
      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 switch products are manufactured by
      a
      contract manufacturer in San Jose, California and our phone products are
      manufactured by a contract manufacturer in China. Our contract manufacturers
      provide us with a range of operational and manufacturing services, including
      component procurement, assembly and final testing of our products. We work
      closely with our contract manufacturers to manage the cost of components, since
      our total manufacturing costs are directly tied to component costs. We regularly
      provide forecasts to our contract manufacturers, and we order products from
      our
      contract manufacturers based on our projected sales levels well in advance
      of
      receiving actual orders from our enterprise customers. We seek to maintain
      sufficient levels of finished goods inventory to meet our forecasted product
      sales with limited levels of inventory to compensate for unanticipated shifts
      in
      sales volume and product mix.





Although
      we have historically sold our systems primarily to small and medium sized
      enterprises, we have expanded our sales and marketing activities to increase
      our
      focus on larger enterprise customers. Accordingly, we have implemented 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 and support personnel are located throughout the United
      States and, to a lesser extent, in the United Kingdom, Germany, Spain, Australia
      and Hong Kong. While we expanded our operations to Europe in 2005 and to the
      Asia Pacific region in 2006, most of our enterprise customers are located in
      the
      United States. Revenue from international sales was less than 5% of our total
      revenue for the three months ended September 30, 2007 and 2006, 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.





14


We
      have
      experienced significant growth in recent periods, with our total revenue growing
      to $32.0 million in the three months ended September 30, 2007 from
      $20.4 million in the same period of 2006. This growth in revenue has
      largely been driven by increased demand for IP telecommunications systems from
      new enterprise customers, as well as sales of additional products to our
      installed enterprise customer base. Our operating expenses have also increased
      significantly to $18.3 million for the three months ended September 30,
      2007 from $11.4 million for the same period of 2006 This growth in
      operating expenses has primarily been driven by our growth in headcount, to
      295 employees at September 30, 2007 as compared with
      199 employees at September 30, 2006, as well as the adoption of FAS123(R)
      which resulted in a significant increase in stock-based compensation expense.
      We
      expect to continue to add personnel in all functional areas.





**Key
      Business Metrics**





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





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





*Deferred
      revenue.* Nearly
      all system sales include the purchase of post-contractual support contracts
      with
      terms of up to five years, and our renewal rates on these contracts have been
      high historically. We recognize support revenue on a ratable basis over the
      term
      of the support contract. Since we receive payment for support in advance of
      our
      recognizing the related revenue, we carry a deferred revenue balance on our
      consolidated balance sheet. This deferred revenue helps provide predictability
      to our future support and services revenue. Accordingly, the level of purchases
      of post-contractual support with our product sales is an important metric for
      us
      along with the renewal rates for these services. Our deferred revenue balance
      at
      September 30, 2007 was $15.6 million, consisting of $2.4 million of
      deferred product revenue and $13.2 million of deferred support and services
      revenues, of which $11.2 million is expected to be recognized within one
      year.





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





Gross
      margin for support and services is significantly lower than gross margin for
      products, and is impacted primarily by personnel costs and labor related
      expenses. The primary goal of our support and services function is to ensure
      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 margin for
      support and services through economies of scale. However, the timing of
      additional investments in our support and services infrastructure could
      materially affect our cost of support and services revenue, both in absolute
      dollars and as a percentage of support and services revenue and total revenue,
      in any particular period.





*Operating
      expense management.* For
      the three month periods ended September 30, 2007 and 2006, we have managed
      our
      operating expenses so that they have generally increased consistent with our
      annual revenue growth. However, because of the additional expenses we incurred
      related to the growth of our general and administrative function in connection
      with becoming a public company, as well as our litigation-related expenses,
      our
      operating expenses may increase at a more rapid rate than our revenue. 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 revenue
      is
      critical to managing our operating expenses.





15


**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. Product revenue
      accounted for 88% and 90% of our total revenue for the three months ended
      September 30, 2007 and 2006, respectively.





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





*Cost
      of revenue.* Cost
      of product revenue consists primarily of hardware costs, royalties and license
      fees for third-party software included in our systems, salary and related
      overhead costs of operations personnel, freight, warranty costs and provision
      for excess inventory. The majority of these costs vary with the unit volumes
      of
      product sold. Cost of support and services revenue consists of salary and
      related overhead costs of personnel engaged in support and services, and hence
      is 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. We intend to continue to make
      significant investments in our research and development efforts because we
      believe they are essential to maintaining and improving our competitive
      position. Accordingly, we expect research and development expenses to continue
      to increase in absolute dollars.





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





*General
      and administrative expenses.* General
      and administrative expenses relate to our executive, finance, human resources,
      legal and information technology organizations. Expenses primarily include
      personnel costs, professional fees for legal, accounting, tax, compliance and
      information systems, travel, recruiting expense, software amortization costs,
      depreciation expense, facilities expenses, and allowance for bad debts. We
      have
      incurred, and we expect to continue to incur significant additional accounting,
      legal and compliance costs, including costs to comply with Sarbanes-Oxley 404
      as
      well as additional insurance, investor relations and other costs associated
      with
      being a public company. We also expect to incur additional general and
      administrative expenses related to our litigation with Mitel. In addition,
      as we
      expand our business, we expect to increase our general and administrative
      expenses.





In
      May
      2007, we entered into a new lease for our existing headquarters facility that
      extends until October 2009. In addition, in May 2007, we executed a new two-year
      lease for additional operational space in another location near our corporate
      headquarters that expires in September 2009. In addition, in March 2007, we
      executed a new three-year lease for our Australian subsidiary that expires
      in
      June 2010. As a result of these new leases, our operating lease obligations
      have
      increased significantly beginning in the fourth quarter of 2007.





*Other
      income.* Other
      income primarily consists of interest earned on cash balances and the change
      in
      fair value of preferred stock warrants.





*Income
      tax provision.* Income
      tax provision includes federal, state and foreign tax on our income. From
      inception through 2005 we accumulated substantial net operating loss and tax
      credit carryforwards. We fully reserved the significant majority of the deferred
      tax asset from these losses and tax credits on our financial statements. We
      were
      profitable in the three month periods ending September 30, 2007 and 2006 and
      had
      an effective tax rate of approximately 24% and 17%, respectively, as a result
      of
      utilizing portions of the deferred tax asset and reducing the related valuation
      allowance.





16


**Critical
      Accounting Policies and Estimates**





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 allow for doubtful accounts, the calculation of
      stock-based compensation expense and how we value inventory. We base our
      estimates and judgments on historical experience and on various other
      assumptions that we believe to be reasonable under the circumstances. Actual
      results could differ materially from these estimates. Management believes that
      with the exception of the adoption of FIN 48, *Accounting
      for Uncertainty of Income Taxes* - *an
      interpretation of FASB Statement No. 109* ,
      effective July 1, 2007, there have been no significant changes during the three
      months ended September 30, 2007 to the items that we disclosed as our critical
      accounting policies and estimates in Managements’s Discussion and Analysis of
      Financial Condition and Results of Operations in our 2007 Annual Report on
      Form
      10-K filed with the Securities and Exchange Commission. For a description of
      those accounting policies, please refer to our 2007 Annual Report on Form
      10-K.





**Results
      of Operations**





The
      following table sets forth selected consolidated statements of operations data
      for the two quarters indicated.





**Three
                Months Ended**
              **September 30,****2007**
            
            **2006****(In
                thousands)**Revenue:Product
            
            $
            28,125
            
            $
            18,467Support
                and services
            
            
            3,850
            
            
            1,948Total
                revenue
            
            
            31,975
            
            
            20,415Cost
                of revenue:Product(1)
            
            
            9,404
            
            
            6,507Support
                and services(1)
            
            
            2,159
            
            
            1,445Total
                cost of revenue
            
            
            11,563
            
            
            7,952Gross
                profit
            
            
            20,412
            
            
            12,463Operating
                expenses:Research
                and development(1)
            
            
            6,207
            
            
            3,117Sales
                and marketing(1)
            
            
            8,322
            
            
            5,677General
                and administrative(1)
            
            
            3,723
            
            
            2,573Total
                operating expenses
            
            
            18,252
            
            
            11,367Operating
                income
            
            
            2,160
            
            
            1,096Other
                income — net
            
            
            1,203
            
            
            157Income
                before provision for income tax
            
            
            3,363
            
            
            1,253Income
                tax provision
            
            
            (806
            )
            
            (207
            )Net
                income
            
            $
            2,557
            
            $
            1,046







(1)
            Includes
                stock-based compensation as follows:





**Three
                Months Ended September 30,****2007**
            
            **2006**Cost
                of product revenue
            
            $
            8
            
            $
            1Cost
                of support and services revenue
            
            
            58
            
            
            5Research
                and development
            
            
            254
            
            
            17Sales
                and marketing
            
            
            451
            
            
            97General
                and administrative
            
            
            294
            
            
            702Total
                stock-based compensation expense
            
            $
            1,065
            
            $
            822





17





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




**Three
                Months Ended September 30,****2007**
            
            **2006**Revenue:Product
            
            
            88
            %
            
            90
            %Support
                and services
            
            
            12
            %
            
            10
            %Total
                revenue
            
            
            100
            %
            
            100
            %Cost
                of revenue:Product
            
            
            29
            %
            
            32
            %Support
                and services
            
            
            7
            %
            
            7
            %Total
                cost of revenue
            
            
            36
            %
            
            39
            %Gross
                profit
            
            
            64
            %
            
            61
            %Operating
                expenses:Research
                and development
            
            
            19
            %
            
            15
            %Sales
                and marketing
            
            
            26
            %
            
            28
            %General
                and administrative
            
            
            12
            %
            
            13
            %Total
                operating expenses
            
            
            57
            %
            
            56
            %Operating
                income
            
            
            7
            %
            
            5
            %Other
                income, net
            
            
            4
            %
            
            1
            %Income
                before provision for income tax
            
            
            11
            %
            
            6
            %Provision
                for income taxes
            
            
            (3
            %)
            
            (1
            %)Net
                income
            
            
            8
            %
            
            5
            %





***First
      Quarter of Fiscal 2008 compared to First Quarter of Fiscal
      2007***





*Revenue.* Total
      revenue was $32.0 million in the three month period ended September 30,
      2007, an increase of $11.6 million, or 57%, from $20.4 million in the
      three month period ended September 30, 2006. This increase was primarily
      attributable to increased sales of our products and services. Product revenue
      was $28.1 million in the three month period ended September 30, 2007, an
      increase of $9.6 million, or 52%, from $18.5 million in the three
      month period ended September 30, 2006. Support and services revenue was
      $3.9 million in the three month period ended September 30, 2007, an
      increase of $1.9 million, or 98%, from approximately $2.0 million in
      the three month period ended September 30, 2006, as a result of increased
      revenue associated with post-contractual support contracts accompanying new
      system sales, post-contractual support contract renewals and increased revenue
      from training and professional services and installation services.





*Gross
      margin.* Total
      gross margin increased to 64% in the three month period ended September 30,
      2007
      from 61% in the three month period ended September 30, 2006. Product gross
      margin increased to 67% in the three month period ended September 30, 2007
      from
      65% in the three month period ended September 30, 2006. The increase in product
      gross margin was due to improved margins on hardware products as a result of
      an
      improved mix of hardware products that have higher margins than the comparable
      hardware products sold in the same period of the prior year. Support and
      services gross margin increased to 44% in the three month period ended September
      30, 2007 from 26% in the three month period ended September 30, 2006. The
      increase in support and services gross margin was due to support and service
      revenue increasing by 100% and service costs only increasing 49%, compared
      to
      the same period in 2006. Compensation for support and services employees, the
      largest category of support and service costs, increased 23% over the same
      period in 2006, as headcount increased from 33 employees at September 30,
      2006 to 40 employees at September 30, 2007.





*Research
      and development.* Research
      and development expenses increased $3.1 million, or 99%, to
      $6.2 million in the three month period ended September 30, 2007 from
      $3.1 million in the three month period ended September 30, 2006. These
      expenses represented 19% and 15% of total revenue, respectively, in those
      periods. Compensation, including stock based compensation, for research and
      development employees accounted for $2.0 million of the increase, primarily
      as a result of an increase in headcount to 103 employees at
      September 30, 2007, from 59 employees at September 30, 2006.
      Non-recurring engineering, facility expense and customer beta trial products
      accounted for $467,000, $162,000 and $128,000, respectively, of the increase.
      The remainder of the increase was primarily attributable to various expenses
      increasing including depreciation, software licenses and maintenance, and
      travel.





18


*Sales
      and marketing.* Sales
      and marketing expenses were $8.3 million in the three month period ended
      September 30, 2007, an increase of $2.6 million, or 47%, from
      $5.7 million in the three month period ended September 30, 2006. These
      expenses represented 26% and 28% of total revenue, respectively, in those
      periods. Compensation, including stock based compensation for sales and
      marketing employees represented $1.7 million of this increase, primarily as
      a result of an increase in headcount, to 101 employees at
      September 30, 2007 from 76 employees at September 30, 2006.
      Additionally, travel, marketing shows and events, and consulting and temporary
      help accounted for $293,000, $165,000 and $134,000 respectively, of the
      increase. The remainder of the increase was primarily attributable to various
      expenses increasing including training and channel partner conference events,
      lead generation activities, and recruiting.





*General
      and administrative.* General
      and administrative expenses were $3.7 million in the three month period
      ended September 30, 2007, an increase of $1.1 million, or 45%, from
      $2.6 million in the three month period ended September 30, 2006. These
      expenses represented 12% and 13% of total revenue, respectively, in those
      periods. Compensation, including stock-based compensation, for general and
      administrative employees accounted for $327,000 of the increase, primarily
      as a
      result of an increase in headcount, to 34 employees at September 30,
      2007 from 19 employees at September 30, 2006. General and administrative
      compensation expense in the three month period ended September 30, 2006 included
      $702,000 of stock-based compensation expense, most of which was associated
      with
      an outstanding option granted prior to the adoption of SFAS 123(R) that was
      subject to variable accounting. Variable accounting on this outstanding option
      ceased in March 2007 upon the repayment of the related note receivable in
      exchange for the surrender of shares of our common stock having a value equal
      to
      the amounts outstanding under the note. Legal, consulting and temporary help,
      audit and tax fees, and travel accounted for $414,000, $227,000, $178,000 and
      $164,000, respectively, of the increase. These increases were partially offset
      by a decline of $120,000 in the bad debt provision in the first quarter of
      fiscal 2008 compared to the same quarter in fiscal 2007.





*Other
      income.* Other
      income was $1.2 million in the three month period ended September 30, 2007,
      an
      increase of $1.0 million, from $157,000 in the three month period ended
      September 30, 2006. The increase was due primarily to higher interest income
      of
      $1.0 million associated with a significantly higher average cash balance
      resulting from raising $77.4 million net cash proceeds from our initial public
      offering in July 2007.





*Income
      tax provision.* The
      income tax provision was $0.8 million for the three months ended September
      30,
      2007, as compared to $0.2 million for the three months ended September 30,
      2006.
      The increase in the tax provision is primarily due to an increase in our taxable
      income, partially offset by the change in the valuation allowance associated
      with the utilization of net operating loss and tax credit carryforwards.





**Liquidity
      and Capital Resources**





As
      of
      September 30, 2007, our principal sources of liquidity consisted of cash
      and cash equivalents of $99.2 million and accounts receivable net of $21.7
      million. On July 9, 2007, we closed our initial public offering of
      9,085,000 shares of common stock at a price of $9.50 per share, resulting
      in net proceeds to us of approximately $77.4 million after deducting
      underwriting discounts and payment of other offering costs.





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 $99.2 million of cash and cash equivalents at
      September 30, 2007, together with cash flows from our operations will be
      sufficient to fund our operating requirements for at least 12 months.
      However, we may need to raise additional capital or incur indebtedness to
      continue to fund our operations in the future. Our future capital requirements
      will depend on many factors, including our rate of revenue growth, the expansion
      of our sales and marketing activities, the timing and extent of our expansion
      into new territories, the timing of introductions of new products and
      enhancements to existing products, the continuing market acceptance of our
      products and acquisition 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.





19


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





**Three
                Months Ended September 30,****2007**
            
            **2006****(In
                thousands)**Cash
                provided by operating activities
            
            $
            2,231
            
            $
            1,384Cash
                used in investing activities
            
            
            (679
            )
            
            (508
            )Cash
                provided by financing activities
            
            
            80,314
            
            
            81





***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
      50 to 60 days. In some cases we also prepay for license rights to
      third-party products in advance of sales.





Net
      cash
      provided by operating activities was $2.2 million and $1.4 million in the three
      month period ended September 30, 2007 and 2006, respectively. This increase
      was
      primarily attributable to net income of $2.6 million for the three months ended
      September 30, 2007 as compared to $1.0 million for the three months ended
      September 30, 2006. Noncash adjustments were higher in the three month period
      ended September 30, 2007 including stock-based compensation expense, which
      was
      higher by $0.2 million, and depreciation and amortization, which was higher
      by
      $0.1 million. In addition to the net income and non-cash charges, the
      period-to-period change in cash flows relating to operating activities was
      also
      positively affected by an increase in deferred revenue of $1.7 million, due
      primarily to the deferral of revenue from sales of post contractual support
      contracts exceeding the revenue recognized from post contractual support
      contracts, a decrease in inventories of $1.0 million due to strong period-end
      revenues and inventory management and an increase in accrued liabilities of
      $0.7
      million and other due to an increase of income taxes payable of $0.8 million
      at
      September 30, 2007. These sources of cash were partially offset by uses of
      cash
      associated with an increase in accounts receivable of $2.3 million due to
      increased sales in the first quarter of fiscal 2008 compared to the same period
      a year ago and an increase in accounts payable of $2.6 million due to increased
      purchasing activity to support our business growth and increased headcount.





Net
      cash
      provided by operating activities in the first three months of fiscal 2007
      consisted primarily of net income of $1 million, an increase in accounts
      payable of $1.3 million and deferred revenue of $1.2 million as well as
      stock-compensation expense of $0.8 million which was a non-cash charge. These
      sources of cash were partially offset by uses of cash associated with an
      increase in accounts receivable of $2.2 million due to the growth in
      revenues and a decrease of $0.6 million in accrued employee compensation costs
      as bonuses were paid in the first quarter of fiscal 2007.





***Cash
      flows from investing activities***





Cash
      flows from investing activities primarily relate to capital expenditures to
      support our growth.





Net
      cash
      used in investing activities was $0.7 million and $0.5 million in the
      first quarters of fiscal 2007 and 2006, respectively. Net cash used in investing
      activities in the first quarter of 2007 and 2006 was primarily for capital
      expenditures, primarily related to manufacturing tooling for the production
      of
      our hardware products, computer equipment for our research and development
      lab
      and to support our growth in headcount.





***Cash
      flows from financing activities***





Net
      cash
      provided by financing activities was $80.3 million and $81,000 in the three
      months ended September 2007 and 2006, respectively. In the first quarter of
      fiscal 2008, we generated proceeds of $80.3 million from our initial public
      offering prior to payment of other offering costs. Additionally, $49,000 and
      $70,000 was generated from the exercise of common stock options in the three
      months ended September 30, 2007 and 2006, respectively.





**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.





20





**ITEM 3.** ***QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK***





**Interest
      Rate Risk**





As
      of
      September 30, 2007, we had cash and cash equivalents of $99.2 million,
      which consisted of highly liquid money market instruments with original
      maturities of three months or less. Because of the short-term nature of these
      instruments, a sudden change in market interest rates would not be expected
      to
      have a material effect on our financial condition or results of
      operations.





**Foreign
      Currency Risk**





As
      we
      expand, we expect that many of our international enterprise customers will
      be
      invoiced in foreign currencies and our international sales and marketing
      operations will incur expenses that are denominated in foreign currencies.
      These
      revenues and expenses could be materially affected by currency fluctuations.
      Changes in currency exchange rates could adversely affect our consolidated
      results of operations or financial position. Additionally, our international
      sales and marketing operations maintain cash balances denominated in foreign
      currencies. As a result, we could incur unanticipated translation gains and
      losses. To date, the foreign currency effect on our cash and cash equivalents
      has been immaterial and we have not hedged our exposure to changes in foreign
      currency exchange rates. ******





**ITEM 4.** ***CONTROLS
      AND PROCEDURES***





We
      maintain “disclosure controls and procedures,” as such term is defined in
      Rule 13a-15(e) under the Exchange Act, that are designed to ensure that
      information required to be disclosed by us in reports that we file or submit
      under the Exchange Act is recorded, processed, summarized and reported within
      the time periods specified in SEC rules and forms, and that such information
      is
      accumulated and communicated to our management, including our Chief Executive
      Officer and Chief Financial Officer, as appropriate to allow timely decisions
      regarding required disclosure. In designing and evaluating our disclosure
      controls and procedures, management recognized that disclosure controls and
      procedures, no matter how well conceived and operated, can provide only
      reasonable, not absolute, assurance that the objectives of the disclosure
      controls and procedures are met. Additionally, in designing disclosure controls
      and procedures, our management necessarily was required to apply its judgment
      in
      evaluating the cost-benefit relationship of possible disclosure controls and
      procedures. Based on their evaluation at the end of the period covered by this
      quarterly report on Form 10-Q, our Chief Executive Officer and Chief
      Financial Officer have concluded that our disclosure controls and procedures
      were not effective in that we did not have sufficient internal controls related
      to the deferral of revenue for the entire arrangement fees associated with
      transactions in which vendor specific evidence of fair value does not exist
      for
      undelivered product elements.





We
      are in
      the process of taking steps intended to remedy this material weakness, and
      we
      will not be able to fully address this material weakness until these steps
      have
      been completed. We have commenced remediation activities, such as educating
      our
      sales and marketing personnel regarding revenue recognition policies and
      procedures, hiring a revenue recognition accounting manager, and a review
      process regarding customer communications.





A
      material weakness is a deficiency, or a combination of deficiencies, in internal
      control over financial reporting, such that there is a reasonable possibility
      that a material misstatement of the Company’s annual or interim financial
      statements will not be prevented or detected on a timely basis.





At
      the
      end of the fiscal year 2008, Section 404 of the Sarbanes-Oxley Act will
      require our management to provide an assessment of the effectiveness of our
      internal control over financial reporting. We are in the process of performing
      the system and process documentation, evaluation and testing required for
      management to make this assessment and for our independent auditors to provide
      its attestation report. We have not completed this process or its assessment,
      and this process will require significant amounts of management time and
      resources. In the course of evaluation and testing, management may identify
      deficiencies that will need to be addressed and remediated.





21


**PART II:**  **OTHER
      INFORMATION**





**ITEM
      1.**  **LEGAL
      PROCEEDINGS**





On
      June 27, 2007, a lawsuit was filed against us by Mitel Networks Corporation
      in the United States District Court for the Eastern District of Texas. Mitel
      alleges that we infringe four of its U.S. patents: U.S. Patent
      No. 5,940,834, entitled “Automatic Web Page Generator,”
U.S. Patent No. 5,703,942 entitled “Portable Telephone User Profiles
      Using Central Computer,” U.S. Patent No. 5,541,983 entitled “Automatic
      Telephone Feature Selector” and U.S. Patent No. 5,657,446 entitled
“Local Area Communications Server.” On August 21, 2007, Mitel filed an
      amended complaint, which alleges that we infringe two additional
      U.S. patents held by Mitel: U.S. Patent No. 5,007,080, entitled
“Communications System Supporting Remote Operations,” and U.S. Patent
      No. 5,657,377, entitled “Portable Telephone User Profiles.” The lawsuit
      includes claims that relate to components or features that are material to
      our
      products. In relation to its claims under each patent, Mitel seeks a permanent
      injunction against infringement, attorney’s fees and compensatory damages.




On
      July 31, 2007, we filed counterclaims in the Eastern District of Texas. In
      addition to denying all of Mitel’s claims of patent infringement, our
      counterclaim alleged that Mitel’s IP phone systems, including the Mitel 3300 IP
      Communications Platform, infringes ShoreTel’s U.S. Patent
      No. 7,167,486 B2 entitled “Voice Traffic Through a Firewall.” We also filed
      claims for approximately $10 million in damages to our initial public
      offering and an injunction against Mitel in Ontario Superior Court for making
      false or misleading statements about ShoreTel’s alleged infringement.




This
      litigation is causing us to incur significant expenses and costs. Negative
      developments with respect to the lawsuit could cause our stock price to decline,
      and an unfavorable resolution of this lawsuit could have an adverse and possibly
      material effect on our business and results of operations. If we do not prevail,
      we may be required to pay substantial damages, an injunction may be entered
      against us that prevents us from manufacturing, using, selling and importing
      our
      products; and a license to continue selling our products may not be available
      to
      us at all or may require us to pay substantial ongoing royalties and comply
      with
      unfavorable terms, any of which could materially harm our business. Even if
      we
      were to prevail, this litigation could be costly and time-consuming, divert
      the
      attention of our management and key personnel from our business operations
      and
      deter distributors from selling our products and dissuade potential enterprise
      customers from purchasing our products. We believe we have meritorious defenses
      to Mitel’s claims. We intend to vigorously defend the lawsuit.




We
      could
      become involved in litigation from time to time relating to claims arising
      out
      of our ordinary course of business or otherwise.





**ITEM
      1A.**  **RISK
      FACTORS**





**Risks
      Related to Our Business**





***Our
      recent profitability and growth rates may not be indicative of our
      future***  ***profitability
      or growth, and we may not be able to continue to maintain or
      increase***  ***our
      profitability or growth.***





While
      we
      have been profitable in recent periods, we had an accumulated deficit of $82.2
       million as of September 30, 2007. This accumulated deficit is
      attributable to net losses incurred from our inception in September 1996 through
      the end of the third quarter of fiscal 2005. We may not succeed in maintaining
      or increasing our profitability and could incur losses in future periods. We
      expect to incur significant additional operating expenses associated with being
      a public company. We also expect that our operating expenses, including
      recognition of stock-based compensation, will continue to increase in all areas
      as we seek to grow our business. If our gross profit does not increase to offset
      these expected increases in operating expenses, our operating results will
      be
      negatively affected. You should not consider our recent growth rates in terms
      of
      revenue and net income as indicative of our future growth. Accordingly we cannot
      assure you that we will be able to maintain or increase our profitability in
      the
      future.





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





The
      market for IP telecommunications and other telecommunications systems is
      extremely competitive. Our competitors include companies that offer IP systems,
      such as Cisco Systems, Inc. and 3Com Corporation, and that offer hybrid systems,
      such as Alcatel-Lucent, Avaya, Inc., Mitel Networks Corporation (which recently
      acquired Inter-Tel Incorporated) and Nortel Networks Corporation who is
      cooperating with Microsoft to enter the unified communications market. Several
      of the companies that offer hybrid systems are beginning to also offer IP
      telecommunications systems. Many of our competitors are substantially larger
      and
      have greater financial, technical, research and development, sales and
      marketing, manufacturing, distribution and other resources. We could also face
      competition from new market entrants, whether from new ventures or from
      established companies moving in to the market. These competitors have various
      other advantages over us, including:





22


•
            greater
                market presence, name recognition and brand
                reputation;





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





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





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





•
            a
                more established international presence to address the needs of global
                enterprises;





•
            substantially
                larger patent and intellectual property
                portfolios;





•
            longer
                operating histories;





•
            a
                longer history of implementing large-scale telecommunications or
                networking systems;





•
            more
                established relationships with industry participants, customers,
                suppliers, distributors and other technology
                companies; and





•
            the
                ability to acquire technologies or consolidate with other companies
                in the
                industry to compete more
                effectively.





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





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





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





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





The
      convergence of voice and data networks and their wider deployment by enterprises
      has led information technology and communication applications deployed on
      converged networks to become more integrated. This integration has created
      an
      opportunity for the leaders in information technology, personal and business
      applications and the software that connects the network infrastructure to those
      applications, to enter the telecommunications market and offer products that
      compete with our systems. Competition from these potential market entrants
      may
      take many forms, and they may offer products and applications similar to those
      we offer. For example, Microsoft Corporation has recently announced its unified
      communications product roadmap. This includes its recently announced “Office
      Communicator 2007,” which Microsoft stated will allow end users to control
      communications, including voice over IP, through the Office Communicator
      application on their PC, which we expect will provide functionality similar
      to
      that offered by our Personal Call Manager application. Microsoft has also
      introduced “Office Communications Server 2007,” a product that offers competing
      unified messaging capabilities. Microsoft has also developed an IP phone and
      has
      licensed the rights to produce such phones to third parties. In addition,
      Microsoft has also entered into alliances with several of our competitors,
      and
      in July 2006 announced an extensive relationship with Nortel for the production
      of IP-based communications equipment that will be integrated with the Microsoft
      systems and Office Communicator. Microsoft and other leaders in the information
      technology, personal and business applications and software industries, have
      substantial financial and other resources that they could devote to this
      market.





23


If
      Microsoft continues to move into the telecommunications market or if other
      new
      competitors from the information technology, personal and business applications
      or software industries enter the telecommunications market, the market for
      IP
      telecommunications systems will become increasingly competitive. If the
      solutions offered by Microsoft or other new competitors achieve substantial
      market penetration, we may not be able to maintain or improve our market
      position, and our failure to do so could materially and adversely affect our
      business and results of operations.





***If
      the emerging market for enterprise IP telecommunications systems does not
      fully***  ***develop,
      our future business would be harmed.***





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





•
            initial
                costs of implementation for a new system;





•
            quality
                of infrastructure;





•
            security
                concerns;





•
            equipment,
                software or other technology failures;





•
            regulatory
                encroachments;





•
            inconsistent
                quality of service;





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





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





Moreover,
      as IP-based data communications and telecommunications usage grow, the
      infrastructure used to support these services, whether public or private, may
      not be able to support the demands placed on them and their performance or
      reliability may decline. Even if enterprise IP telecommunications systems become
      more widespread in the future, we cannot assure you that our products will
      attain broad market acceptance.





***Our
      operating results have fluctuated in the past and may fluctuate in the future,
      which could cause our stock price***  ***to
      decline.***





Our
      quarterly and annual results of operations may fluctuate in the future as a
      result of a variety of factors, some of which may be outside of our control.
      If
      our results of operations fall below the expectations of securities analysts
      or
      investors, the price of our common stock could decline substantially.
      Fluctuations in our quarterly or annual results of operations may be due to
      a
      number of factors, including, but not limited to:





24


•
            the
                timing and volume of shipments of our products during a particular
                period;





•
            the
                timing and success of new product introductions by us or our
                competitors;





•
            the
                timing of recognition of revenue from sales to our
                customers;





•
            changes
                in our or our competitors’ pricing policies or sales
                terms;





•
            changes
                in the mix of our products and services sold during a particular
                period;





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





•
            our
                ability to control costs, including third-party manufacturing costs
                and
                costs of components;





•
            our
                ability to obtain sufficient supplies of components;





•
            our
                ability to maintain sufficient production volumes for our
                products;





•
            volatility
                in our stock price, which may lead to higher stock compensation expenses
                pursuant to Statement of Financial Accounting Standards No. 123(R),
                Share-Based Payment, or
                SFAS 123(R);





•
            publicly-announced
                litigation, such as the lawsuit by
                Mitel;





•
            the
                timing of costs related to the development or acquisition of technologies
                or businesses;





•
            conditions
                specific to the IP telecommunications market, such as rates of adoption
                of
                IP telecommunications systems and introduction of new
                standards;





•
            changes
                in domestic and international regulatory environments affecting the
                Internet and telecommunications
                industries;





•
            seasonality
                in our target markets; and





•
            the
                purchasing and budgeting cycles of enterprise
                customers.





Because
      our operating expenses are largely fixed in the short-term, any shortfalls
      in
      revenue in a given period would have a direct and adverse effect on our
      operating results in that period. We believe that our quarterly and annual
      revenue and results of operations may vary significantly in the future and
      that
      period-to-period comparisons of our operating results may not be meaningful.
      You
      should not rely on the results of one period as an indication of future
      performance.





***We
      rely on third-party resellers to sell our products, and disruptions to, or
      our***  ***failure
      to develop and manage, our distribution channels and the processes
      and***  ***procedures
      that support them could adversely affect our
      business.***





Approximately
      95% of our total revenue in the first quarter of fiscal 2008 was generated
      through indirect channel sales. These indirect sales channels consist of
      third-party resellers that market and sell telecommunications systems and other
      products and services to customers. We expect indirect channel sales will
      continue to generate a substantial majority of our total revenue in the future.
      Our future success is highly dependent upon establishing and maintaining
      successful relationships with a variety of third-party resellers of
      telecommunications products and services. In addition, we rely on these entities
      to provide many of the installation, implementation and support services for
      our
      products. Accordingly, our success depends in large part on the effective
      performance of these channel partners. By relying on channel partners, we may
      in
      some cases have little or no contact with the ultimate users of our products,
      thereby making it more difficult for us to establish brand awareness, ensure
      proper delivery and installation of our products, service ongoing enterprise
      customer requirements and respond to evolving enterprise customer needs. This
      difficulty could be more pronounced in international markets, where we expect
      that enterprise customers will purchase our systems from a channel partner
      that
      purchased through a distributor. Additionally, some of our channel partners
      are
      smaller companies that may not have the same financial resources as other of
      our
      larger channel partners, which could in some cases expose us to additional
      collections risk. As
      of
      June 30, 2007 and 2006, we had approximately 470 and 340 third-party resellers,
      respectively, in our channel partner program.  Historically, we have experienced relatively low turnover of the resellers
      in
      our program, with 46 and 19 partners leaving the program in fiscal 2007 and
      fiscal 2006, respectively.




25


Recruiting
      and retaining qualified channel partners and training them in our technology
      and
      products requires significant time and resources. In order to develop and expand
      our distribution channel, we must continue to scale and improve our processes
      and procedures that support our channel, including investment in systems and
      training, and those processes and procedures may become increasingly complex
      and
      difficult to manage. We have no long-term contracts or minimum purchase
      commitments with any of our channel partners, and our contracts with these
      channel partners do not prohibit them from offering products or services that
      compete with ours. Our competitors may be effective in providing incentives
      to
      existing and potential channel partners to favor their products or to prevent
      or
      reduce sales of our products. Our channel partners may choose not to offer
      our
      products exclusively or at all. Our failure to establish and maintain successful
      relationships with channel partners would likely materially adversely affect
      our
      business, operating results and financial condition.





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





The
      sales
      cycle for our products typically ranges from six to nine months, and in some
      cases can be over 12 months. Part of our strategy is to increasingly target
      our sales efforts on larger enterprises. Because the sales cycle for large
      enterprises is generally longer than for smaller enterprises, our sales cycle
      in
      the future may be even longer than it has been historically. As a result, we
      may
      have limited ability to forecast whether or in which period a sale will occur.
      The success of our product sales process is subject to many factors, some of
      which we have little or no control over, including:





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





•
            a
                technical evaluation or trial by potential enterprise
                customers;





•
            our
                ability to introduce new products, features or functionality in a
                manner
                that suits the needs of a particular enterprise
                customer;





•
            the
                announcement or introduction of competing
                products; and





•
            the
                strength of existing relationships between our competitors and potential
                enterprise customers.





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





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





We
      rely
      on sole or limited numbers of suppliers for several key components utilized
      in
      the assembly of our products. For example, we source semiconductors that are
      essential to the operation of our phones from separate single suppliers, and
      we
      have not identified or qualified any alternative suppliers for these components.
      We do not have supply agreements with our sole source suppliers, and the
      components for our products are typically procured by our contract
      manufacturers. If we lose access to these components we may not be able to
      sell
      our products for a significant period of time, and we could incur significant
      costs to redesign our products or to qualify alternative suppliers. This
      reliance on a sole source or limited number of suppliers involves several
      additional risks, including:





•
            supplier
                capacity constraints;





•
            price
                increases;





•
            timely
                delivery; and





•
            component
                quality.





26


This
      reliance is exacerbated by the fact that we maintain a relatively small amount
      of inventory and our contract manufacturers typically acquire components only
      as
      needed. As a result, our ability to respond to enterprise customer orders
      efficiently may be constrained by the then-current availability or the terms
      and
      pricing of these components. Disruption or termination of the supply of these
      components could delay shipments of our products and could materially and
      adversely affect our relationships with current and prospective enterprise
      customers. For example, in December 2004, our power supply component vendor
      was
      unable to provide sufficient components, and we had to obtain this component
      from another source. Also, from time to time we have experienced component
      quality issues with products obtained from our contract manufacturers. For
      example, in the first quarter of our 2005 fiscal year, we had to expend
      resources to fix keys that were not working properly on some of our phones.
      In
      addition, any increase in the price of these components could reduce our gross
      margin and adversely impact our profitability. We may not be able to obtain
      a
      sufficient quantity of these components to meet the demands of enterprise
      customers in a timely manner or that prices of these components may increase.
      In
      addition, problems with respect to yield and quality of these components and
      timeliness of deliveries could occur. These delays could also materially and
      adversely affect our operating results.





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





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





We
      depend
      on our contract manufacturers to finance the production of goods ordered and
      to
      maintain adequate manufacturing capacity. We do not exert direct control over
      our contract manufacturers, so we may be unable to procure timely delivery
      of
      acceptable products to our enterprise customers.





If
      sales
      of our products continue to grow, one or both of our contract manufacturers
      may
      not have sufficient capacity to enable it to increase production to meet the
      demand for our products. Moreover, both of our contract manufacturers could
      have
      manufacturing engagements with companies that are much larger than we are and
      whose production needs are much greater than ours. As a result, one or both
      of
      our contract manufacturers may choose to devote additional resources to the
      production of products other than ours if capacity is limited.





In
      addition, our contract manufacturers do not have any written contractual
      obligation to accept any purchase order that we submit for the manufacture
      of
      any of our products nor do we have any assurance that our contract manufacturers
      will agree to manufacture and supply any or all of our requirements for our
      products. Furthermore, either of our contract manufacturers may unilaterally
      terminate their relationship with us at any time upon 180 days notice with
      respect to the contract manufacturer of our switches and 120 days notice
      with respect to the contract manufacturer of our phones or seek to increase
      the
      prices they charge us. For example, in January 2005, one of our former contract
      manufacturers, which at the time was the sole manufacturer of our switches,
      notified us that it was terminating its relationship with us upon six months
      of
      advance notice, which required us to qualify and obtain a new contract
      manufacturer. As a result, we are not assured that our current manufacturers
      will continue to provide us with an uninterrupted supply of products of at
      an
      acceptable price in the future.





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





If
      our
      contract manufacturers are unable or unwilling to continue manufacturing our
      products in required volumes and to meet our quality specifications, or if
      they
      significantly increase their prices, we will have to identify one or more
      acceptable alternative contract manufacturers. The process of identifying and
      qualifying a new contract manufacturer can be time consuming, and we may not
      be
      able to substitute suitable alternative contract manufacturers in a timely
      manner or at acceptable prices. Additionally, transitioning to new contract
      manufacturers may cause delays in supply if the new contract manufacturers
      have
      difficulty manufacturing products to our specifications or quality standards.
      Furthermore, we do not own the electronic design for our phones, hence it may
      be
      more difficult or costly for us to change the contract manufacturer of our
      phones or to arrange for an alternate of or a replacement for these products
      in
      a timely manner should a transition be required. This could also subject us
      to
      the risk that our competitors could obtain phones containing technology that
      is
      the same as or similar to the technology in our phones.





Any
      disruption in the supply of products from our contract manufacturers may harm
      our business and could result in a loss of sales and an increase in production
      costs, which could adversely affect our business and results of
      operations.





27


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





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





***If
        we fail to make necessary improvements to address a material weakness in
        our***  ***internal
        control over financial reporting, we may not be able to report our
        financial***  ***results
        accurately and timely, any of which could harm our business, reputation
        and***  ***cause
        the price of our common stock to decline.***
 
 We
        had a
        material weakness in our internal control over financial reporting as of
        June
        30, 2007 in that we did not have sufficient internal control over financial
        reporting related to the deferral of revenue for the entire arrangement fees
        associated with transactions in which vendor specific evidence of fair value,
        or
        VSOE, does not exist for undelivered product elements.
 
 If
        VSOE
        of fair value does not exist for commitments to provide specified upgrades,
        services or additional products to customers in the future, as has been the
        case
        from time to time in the past, we defer all revenue from the arrangement
        until
        the earlier of the point at which VSOE of fair value does exist or all such
        elements from the arrangement have been delivered.
 
 A
        material weakness is a deficiency, or a combination of deficiencies, in internal
        control over financial reporting, such that there is a reasonable possibility
        that a material misstatement of the Company’s annual or interim financial
        statements will not be prevented or detected on a timely basis.
 
 This
        material weakness resulted in audit adjustments to our consolidated financial
        statements for the fiscal year ended June 30, 2007.
 
 We
        are in
        the process of taking steps intended to remedy this material weakness, and
        we
        will not be able to fully address this material weakness until these steps
        have
        been completed. If we fail to maintain the number and expertise of our staff
        for
        our accounting and finance functions and to improve and maintain internal
        control over financial reporting adequate to meet the demands of a public
        company, including the requirements of the Sarbanes- Oxley Act, we may be
        unable
        to report our financial results accurately. If we cannot do so, our business,
        reputation and stock price may decline.
 
 Even
        if
        we are able to report our financial statements accurately and timely, if
        we do
        not make all the necessary improvements to address the material weakness,
        continued disclosure of our material weakness will be required in future
        filings
        with the SEC, which could cause our reputation to be harmed and our stock
        price
        to decline.





***We
      have incurred, and expect to continue to incur significant increased costs
      as a
      result of operating as a public***  ***company,
      and our management is required to devote substantial time to
      public***  ***company
      compliance initiatives. These added costs and required management focus
      could***  ***adversely
      affect our operating results.***





As
      a
      public company, we have incurred and will continue to incur significant legal,
      accounting and other expenses that we did not incur as a private company. In
      addition, the Sarbanes-Oxley Act, as well as rules subsequently implemented
      by
      the SEC and the NASDAQ Stock Market, have imposed a variety of new requirements
      on public companies, including requiring changes in corporate governance
      practices. Our management and other personnel have been required to devote
      a
      substantial amount of time to these new compliance initiatives. Moreover, these
      rules and regulations have increased our legal and financial compliance costs
      and have made some activities more time-consuming and costly. For example,
      these
      new rules and regulations have made it more expensive for us to obtain director
      and officer liability insurance.





In
      addition, the Sarbanes-Oxley Act requires, among other things, that we maintain
      effective internal control over financial reporting and disclosure controls
      and
      procedures. In particular, commencing in fiscal 2008, we must perform system
      and
      process evaluation and testing of our internal control over financial reporting
      to allow management and our independent registered public accounting firm to
      report on the effectiveness of our internal control over financial reporting,
      as
      required by Section 404 of the Sarbanes-Oxley Act. Our compliance with
      Section 404 will require that we incur substantial accounting expense and
      expend significant management efforts. We currently do not have an internal
      audit group. We have recently hired additional accounting and financial staff
      with public company experience and technical accounting knowledge. If we are
      not
      able to comply with the requirements of Section 404 in a timely manner, or
      if we or our independent registered public accounting firm continues to note
      or
      identify deficiencies in our internal control over financial reporting that
      are
      deemed to be material weaknesses, the market price of our stock could decline
      and we could be subject to sanctions or investigations by the NASDAQ Stock
      Market, the SEC or other regulatory authorities, which would require additional
      financial and management resources.





28


In
      the
      three month period ended September 30, 2007, the increased costs associated
      with
      operating as a public company have had an impact on our net income, and in
      the
      future may cause us to reduce costs in other areas of our business or increase
      the prices of our products or services to offset the effect of such increased
      costs. Additionally, if these requirements continue to divert our management’s
      attention from other business concerns, they could have a material adverse
      effect on our business, financial condition and results of
      operations.





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





Our
      future growth depends on our ability to develop and introduce new products
      successfully. Due to the complexity of the type of products we produce, there
      are significant technical risks that may affect our ability to introduce new
      products and features successfully. In addition, we must commit significant
      resources to developing new products and features before knowing whether our
      investments will result in products that are accepted by the market. The success
      of new products depends on many factors, including:





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





•
            the
                cost of our products;





•
            the
                reliability of our products;





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





•
            the
                market acceptance of our products.





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





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





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





The
      telecommunications industry is highly competitive and characterized by rapidly
      changing technologies and standards, frequent product introductions and short
      product life cycles. Accordingly, our operating results depend upon, among
      other
      things, our ability to develop and introduce new products and our ability to
      reduce production costs of existing products. The process of developing new
      technologies and products is complex, and if we are unable to develop
      enhancements to, and new features for, our existing products or acceptable
      new
      products that keep pace with technological developments or industry standards,
      our products may become obsolete, less marketable and less competitive and
      our
      business will be harmed.





In
      addition, as industry standards evolve, it is possible that one standard becomes
      predominant in the market. This could facilitate the entry into the market
      of
      competing products, which could result in significant pricing pressure.
      Additionally, if one standard becomes predominant and we adopt that standard,
      enterprises may be able to create a unified, integrated system by using phones,
      switches, servers, applications, or other telecommunications products produced
      by different companies. Therefore, we may be unable to sell complete systems
      to
      enterprise customers because the enterprise customers elect to purchase portions
      of their telecommunications systems from our competitors. For example, if a
      single industry standard is adopted, customers may elect to purchase our
      switches, but could purchase software applications and phones from other
      vendors. This could reduce our revenue and gross margins if enterprise customers
      instead purchase primarily lower-margin products from us. Conversely, if one
      standard becomes predominant, and we do not adopt it, potential enterprise
      customers may choose to buy a competing system that is based on that
      standard.





29


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





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





***Our
      business could be harmed by adverse economic conditions in our target markets
      or***  ***reduced
      spending on information technology and telecommunication
      products.***





Our
      business depends on the overall demand for information technology, and in
      particular for telecommunications systems. The market we serve is emerging
      and
      the purchase of our products involves significant upfront expenditures. In
      addition, the purchase of our products can be discretionary and may involve
      a
      significant commitment of capital and other resources. Weak economic conditions
      in our target markets, or a reduction in information technology or
      telecommunications spending even if economic conditions improve, would likely
      adversely impact our business, operating results and financial condition in
      a
      number of ways, including longer sales cycles, lower prices for our products
      and
      reduced unit sales. For example, some of our sales are derived from the
      financial services market, which is experiencing a downturn related to the
      sub-prime mortgage market defaults, and this may cause a reduction in our sales
      to the financial services market in future periods.





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





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





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





We
      have
      recently experienced a period of rapid growth in our headcount and operations.
      In the last year and a half, we have more than doubled our workforce and
      significantly expanded our channel partner network and the number and size
      of
      enterprise customers implementing our systems. We anticipate that we will
      further expand our operations. This growth has placed, and future growth will
      place, a significant strain on our management, administrative, operational
      and
      financial infrastructure. Our success will depend in part upon our ability
      to
      manage this growth effectively. To manage the expected growth of our operations
      and personnel, we will need to continue to improve our operational, financial
      and management controls and our reporting systems and procedures. Failure to
      effectively manage growth could result in difficulty in filling enterprise
      customer orders, declines in product quality or customer satisfaction, increases
      in costs or other production and distribution difficulties, and any of these
      difficulties could adversely impact our business performance and results of
      operations.





30


***We
      are in the process of expanding our international operations, which exposes
      us
      to***  ***significant
      risks.***





To
      date
      we have limited international operations and have not had material revenue
      from
      international enterprise customers. The future success of our business will
      depend, in part, on our ability to expand our operations and enterprise customer
      base successfully worldwide. Operating in international markets requires
      significant resources and management attention and will subject us to
      regulatory, economic and political risks that are different from those in the
      United States. Because of our limited experience with international operations,
      our international expansion efforts may not be successful. In addition, we
      will
      face risks in doing business internationally that could adversely affect our
      business, including:





•
            our
                ability to comply with differing technical and environmental standards
                and
                certification requirements outside the United
                States;





•
            difficulties
                and costs associated with staffing and managing foreign
                operations;





•
            greater
                difficulty collecting accounts receivable and longer payment
                cycles;





•
            the
                need to adapt our products for specific countries;





•
            availability
                of reliable broadband connectivity and wide area networks in targeted
                areas for expansion;





•
            unexpected
                changes in regulatory requirements;





•
            difficulties
                in understanding and complying with local laws, regulations and customs
                in
                foreign jurisdictions;





•
            tariffs,
                export controls and other non-tariff barriers such as quotas and
                local
                content rules;





•
            more
                limited protection for intellectual property rights in some
                countries;





•
            adverse
                tax consequences;





•
            fluctuations
                in currency exchange rates, which could increase the price of our
                products
                outside of the United States, increase the expenses of our
                international operations and expose us to foreign currency exchange
                rate
                risk;





•
            restrictions
                on the transfer of funds; and





•
            new
                and different sources of competition.





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





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





Our
      success and ability to compete are substantially dependent upon our intellectual
      property. We rely on patent, trademark and copyright law, trade secret
      protection and confidentiality or license agreements with our employees,
      enterprise customers, strategic partners and others to protect our intellectual
      proprietary rights. However, the steps we take to protect our intellectual
      property rights may be inadequate. We currently have three issued patents and
      12
      patent applications in the United States. We also have one foreign patent
      application relating to one of our U.S. patents. We cannot assure you that
      any additional patents will be issued. Even if patents are issued, they may
      not
      adequately protect our intellectual property rights or our products against
      competitors, and third-parties may challenge the scope, validity and/or
      enforceability of our issued patents. In addition, other parties may
      independently develop similar or competing technologies designed around any
      patents that may be issued to us.





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





31


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





There
      is
      considerable patent and other intellectual property development activity in
      our
      industry. Our success depends, in part, upon our not infringing upon the
      intellectual property rights of others. Our competitors, as well have a number
      of other entities and individuals, own or claim to own intellectual property
      relating to our industry. From time to time, third parties may claim that we
      are
      infringing upon their intellectual property rights, and we may be found to
      be
      infringing upon such rights. Third-parties have in the past sent us
      correspondence regarding their intellectual property and have filed litigation
      against us, and in the future we may receive claims that our products infringe
      or violate their intellectual property rights. In this regard, Mitel Networks
      Corporation, one of our competitors, has filed a lawsuit alleging that we
      infringed six of its patents. See “Business — Legal Proceedings” for a
      further discussion of this lawsuit. Furthermore, we may be unaware of the
      intellectual property rights of others that may cover some or all of our
      technology or products. Any claims or litigation could cause us to incur
      significant expenses and, if successfully asserted against us, could require
      that we pay substantial damages or ongoing royalty payments, prevent us from
      selling our products, damage our reputation, or require that we comply with
      other unfavorable terms, any of which could materially harm our business. In
      addition, we may decide to pay substantial settlement costs in connection with
      any claim or litigation, whether or not successfully asserted against us. Even
      if we were to prevail, any litigation regarding our intellectual property could
      be costly and time-consuming and divert the attention of our management and
      key
      personnel from our business operations.





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





***Our
      products include third-party technology and intellectual property, which
      could***  ***present
      additional risks.***





We
      incorporate certain third-party technologies, such as our contact center,
      collaboration bridge and network monitoring software, into our products, and
      intend to utilize additional third-party technologies in the future. However,
      licenses to relevant third-party technology or updates to those technologies
      may
      not continue to be available to us on commercially reasonable terms, or at
      all.
      Furthermore, we do not own the electronic design for our phones, hence it may
      be
      difficult for us to arrange for an alternate of or a replacement for these
      products in a timely manner. Therefore, we could face delays in product releases
      until equivalent technology can be identified, licensed or developed, and
      integrated into our current products. These delays, if they occur, could
      materially adversely affect our business.





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





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





32


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





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





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





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





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





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





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





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





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





Although
      we anticipate that our current cash on hand and the proceeds from our initial
      public offering, which was completed in July 2007, will be sufficient to meet
      our currently anticipated cash needs through fiscal 2008, if our cash and cash
      equivalents balances and any cash generated from operations and from our initial
      public offering are not sufficient to meet our future cash requirements, we
      will
      need to seek additional capital, potentially through debt or equity financings,
      to fund our operations. We may also need to raise additional capital to take
      advantage of new business or acquisition opportunities. We may seek to raise
      capital by, among other things:





•
            issuing
                additional common stock or other equity
                securities;





•
            issuing
                debt securities; or





•
            borrowing
                funds under a credit facility.





33


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





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





If
      our
      existing stockholders sell a large number of shares of our common stock or
      the
      public market perceives that these sales may occur, the market price of our
      common stock could decline. Commencing 181 days from July 2, 2007, the
      lock-up and market stand off arrangements relating to our initial public
      offering will expire. As of October 31, 2007, an additional approximately
      33 million shares will become freely tradable without restriction or
      further registration under the federal securities laws, subject in some cases
      to
      the volume, manner of sale and other limitations under Rule 144 and
      701.





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





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





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





•
            limit
                who may call a special meeting of stockholders;





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





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





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





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





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





•
            set
                limitations on the removal of directors.





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





34


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





None





**ITEM
      3.**  **DEFAULTS
      UPON SENIOR SECURITIES**





None





**ITEM
      4.**  **SUBMISSION
      OF MATTERS TO A VOTE OF SECURITY HOLDERS**





None.




**ITEM 5.** ******  **OTHER
      INFORMATION**





Not
      applicable.





35


**SIGNATURES**





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





Date:
      November 13, 2007




ShoreTel,
                Inc.By:
            /s/
              Michael E. HealyMichael
                E. HealyChief
                Financial Officer







**INDEX
      TO FINANCIAL STATEMENT SCHEDULES**





**EXHIBIT INDEX**





**Exhibit**
              **Number**
            **Exhibit
                Title**31.1
            Rule 13a-14(a)/15d-14(a)
                Certification of Chief Executive Officer31.2
            Rule 13a-14(a)/15d-14(a)
                Certification of Chief Financial Officer32.1*
            Section 1350
                Certification of Chief Executive Officer.32.2*
            Section 1350
                Certification of Chief Financial
                Officer.





*
            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.






36