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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549





Form 10-Q





(Mark one)

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

For the quarterly period ended December 31, 2009

OR



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

For the transition period from              to

Commission File Number 001-33506





SHORETEL, INC.

(Exact name of Registrant as specified in its charter)







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

(408)
331-3300

(Registrants telephone number, including area code)





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

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

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



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

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

As of January 29, 2010, 44,913,626 shares of the registrants common
stock were outstanding.









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SHORETEL, INC. AND SUBSIDIARIES

FORM 10-Q for the Quarter Ended December 31, 2009

INDEX



|                              |  |                                                                                                                       |  |      |  | 
|----------------------------- |  | --------------------------------------------------------------------------------------------------------------------- |  | ---- |  | 
|                              |  |                                                                                                                       |  | Page
|PART I: Financial Information |  | 3                                                                                                                    
|                              |  |                                                                                                                      
|Item 1                        |  | Financial Statements (Unaudited)                                                                                      |  | 3   
|                              |  | Condensed Consolidated Balance Sheets as of December 31, 2009 and June 30, 2009                                       |  | 3   
|                              |  | Condensed Consolidated Statements of Operations for the three months and six months ended December
 31, 2009 and 2008 |  | 4   
|                              |  | Condensed Consolidated Statements of Cash Flows for the six months ended December 31, 2009 and 2008                   |  | 5   
|                              |  | Notes to Condensed Consolidated Financial Statements                                                                  |  | 6   
|Item 2                        |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                                 |  | 18  
|Item 3                        |  | Quantitative and Qualitative Disclosures About Market Risk                                                            |  | 29  
|Item 4                        |  | Controls and Procedures                                                                                               |  | 29  
|                              | 
|PART II: Other information    |  | 30                                                                                                                   
|                              |  |                                                                                                                      
|Item 1                        |  | Legal Proceedings                                                                                                     |  | 30  
|Item 1A                       |  | Risk Factors                                                                                                          |  | 30  
|Item 2                        |  | Unregistered Sales of Equity Securities and Use of Proceeds                                                           |  | 30  
|Item 3                        |  | Defaults Upon Senior Securities                                                                                       |  | 30  
|Item 4                        |  | Submission of Matters to a Vote of Security Holders                                                                   |  | 30  
|Item 5                        |  | Other Information                                                                                                     |  | 31  
|Item 6                        |  | Exhibits                                                                                                              |  | 31  
|                              |  | Signatures                                                                                                            |  | 32  
|                              |  | Exhibit Index                                                                                                         |  | 33  



2



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PART I. FINANCIAL INFORMATION



|ITEM 1: | FINANCIAL STATEMENTS (Unaudited)
|------- | --------------------------------

SHORETEL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except per share amounts)

(Unaudited)



|                                                                                                                                                                                                      |  |                   |          |   |               |   |         |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------- | -------- | - | ------------- | - | ------- | -
|                                                                                                                                                                                                      |  | December 31, 2009 |          |   | June 30, 2009 |  
|ASSETS                                                                                                                                                                                                |  |                   |          |   |               |   |         |  
|CURRENT ASSETS:                                                                                                                                                                                       |  |                   |          |   |               |   |         |  
|Cash and cash equivalents                                                                                                                                                                             |  | $                 | 78,778   |   |               | $ | 73,819  |  
|Short-term investments                                                                                                                                                                                |  |                   | 36,177   |   |               |   | 33,847  |  
|Accounts receivable, net of allowance of $1,106 and $1,330 as of December 31, 2009 and June 30, 2009,
respectively                                                                                    |  |                   | 18,750   |   |               |   | 21,454  |  
|Inventories                                                                                                                                                                                           |  |                   | 14,498   |   |               |   | 11,805  |  
|Prepaid expenses and other current assets                                                                                                                                                             |  |                   | 3,416    |   |               |   | 3,110   |  
|                                                                                                                                                                                                      |  |                   |          |   |               |   |         |  
|Total current assets                                                                                                                                                                                  |  |                   | 151,619  |   |               |   | 144,035 |  
|PROPERTY AND EQUIPMENT, net                                                                                                                                                                           |  |                   | 4,287    |   |               |   | 3,475   |  
|OTHER ASSETS                                                                                                                                                                                          |  |                   | 8,054    |   |               |   | 8,114   |  
|                                                                                                                                                                                                      |  |                   |          |   |               |   |         |  
|TOTAL ASSETS                                                                                                                                                                                          |  | $                 | 163,960  |   |               | $ | 155,624 |  
|                                                                                                                                                                                                      |  |                   |          |   |               |   |         |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                                                                  |  |                   |          |   |               |   |         |  
|                                                                                                                                                                                                      |  |                  
|CURRENT LIABILITIES:                                                                                                                                                                                  |  |                   |          |   |               |   |         |  
|Accounts payable                                                                                                                                                                                      |  | $                 | 8,800    |   |               | $ | 7,774   |  
|Accrued expenses and other                                                                                                                                                                            |  |                   | 5,451    |   |               |   | 4,494   |  
|Accrued employee compensation                                                                                                                                                                         |  |                   | 7,280    |   |               |   | 4,895   |  
|Deferred revenue                                                                                                                                                                                      |  |                   | 16,601   |   |               |   | 15,255  |  
|                                                                                                                                                                                                      |  |                   |          |   |               |   |         |  
|Total current liabilities                                                                                                                                                                             |  |                   | 38,132   |   |               |   | 32,418  |  
|LONG-TERM LIABILITIES:                                                                                                                                                                                |  |                   |          |   |               |   |         |  
|Long-term deferred revenue                                                                                                                                                                            |  |                   | 8,058    |   |               |   | 7,236   |  
|Other long-term liabilities                                                                                                                                                                           |  |                   | 2,250    |   |               |   | 2,198   |  
|                                                                                                                                                                                                      |  |                   |          |   |               |   |         |  
|Total liabilities                                                                                                                                                                                     |  |                   | 48,440   |   |               |   | 41,852  |  
|                                                                                                                                                                                                      |  |                   |          |   |               |   |         |  
|COMMITMENTS AND CONTINGENCIES (Note 11)                                                                                                                                                               |  |                   |          |   |               |   |         |  
|                                                                                                                                                                                                      |  |                  
|STOCKHOLDERS EQUITY:                                                                                                                                                                                 |  |                   |          |   |               |   |         |  
|Preferred stock, $0.001 par value: authorized 5,000; none issued and outstanding                                                                                                                      |  |                   |         |   |               |   |        |  
|Common stock and additional paid-in capital, par value $0.001 per share, authorized 500,000; issued and outstanding, 44,909 and
44,362 shares as of December 31, 2009 and June 30, 2009, respectively |  |                   | 215,359  |   |               |   | 209,102 |  
|Deferred stock compensation                                                                                                                                                                           |  |                   | (14      | ) |               |   | (54     | )
|Accumulated other comprehensive income                                                                                                                                                                |  |                   | 209      |   |               |   | 136     |  
|Accumulated deficit                                                                                                                                                                                   |  |                   | (100,034 | ) |               |   | (95,412 | )
|                                                                                                                                                                                                      |  |                   |          |   |               |   |         |  
|Total stockholders equity                                                                                                                                                                            |  |                   | 115,520  |   |               |   | 113,772 |  
|                                                                                                                                                                                                      |  |                   |          |   |               |   |         |  
|TOTAL LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                                                            |  | $                 | 163,960  |   |               | $ | 155,624 |  
|                                                                                                                                                                                                      |  |                   |          |   |               |   |         |  

See Notes to Condensed Consolidated Financial Statements



3



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SHORETEL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

(Unaudited)



|                                                                |  |                                |        |   |                              |   |        |      |  |   |                 |   |  |   |        |  
|--------------------------------------------------------------- |  | ------------------------------ | ------ | - | ---------------------------- | - | ------ | ---- |  | - | --------------- | - |  | - | ------ | -
|                                                                |  | Three Months EndedDecember 31, |        |   | Six Months EndedDecember 31, |  
|                                                                |  | 2009                           |        |   | 2008As Restated              |   |        | 2009 |  |   | 2008As Restated |  
|REVENUE:                                                        |  |                                |        |   |                              |   |        |      |  |   |                 |   |  |   |        |  
|Product                                                         |  | $                              | 27,897 |   |                              | $ | 29,096 |      |  | $ | 54,740          |   |  | $ | 59,110 |  
|Support and services                                            |  |                                | 7,560  |   |                              |   | 6,239  |      |  |   | 14,467          |   |  |   | 12,085 |  
|                                                                |  |                                |        |   |                              |   |        |      |  |   |                 |   |  |   |        |  
|Total revenue                                                   |  |                                | 35,457 |   |                              |   | 35,335 |      |  |   | 69,207          |   |  |   | 71,195 |  
|                                                                |  |                                |        |  
|COST OF REVENUE:                                                |  |                                |        |   |                              |   |        |      |  |   |                 |   |  |   |        |  
|Product (1)                                                     |  |                                | 9,787  |   |                              |   | 10,112 |      |  |   | 19,320          |   |  |   | 20,102 |  
|Support and services (1)                                        |  |                                | 2,806  |   |                              |   | 2,941  |      |  |   | 5,390           |   |  |   | 5,859  |  
|                                                                |  |                                |        |   |                              |   |        |      |  |   |                 |   |  |   |        |  
|Total cost of revenue                                           |  |                                | 12,593 |   |                              |   | 13,053 |      |  |   | 24,710          |   |  |   | 25,961 |  
|                                                                |  |                                |        |  
|GROSS PROFIT                                                    |  |                                | 22,864 |   |                              |   | 22,282 |      |  |   | 44,497          |   |  |   | 45,234 |  
|                                                                |  |                                |        |  
|OPERATING EXPENSES:                                             |  |                                |        |   |                              |   |        |      |  |   |                 |   |  |   |        |  
|Research and development (1)                                    |  |                                | 7,835  |   |                              |   | 8,423  |      |  |   | 15,032          |   |  |   | 16,217 |  
|Sales and marketing (1)                                         |  |                                | 12,910 |   |                              |   | 11,839 |      |  |   | 24,927          |   |  |   | 23,012 |  
|General and administrative (1)                                  |  |                                | 4,731  |   |                              |   | 4,051  |      |  |   | 9,382           |   |  |   | 10,098 |  
|                                                                |  |                                |        |   |                              |   |        |      |  |   |                 |   |  |   |        |  
|Total operating expenses                                        |  |                                | 25,476 |   |                              |   | 24,313 |      |  |   | 49,341          |   |  |   | 49,327 |  
|                                                                |  |                                |        |   |                              |   |        |      |  |   |                 |   |  |   |        |  
|LOSS FROM OPERATIONS                                            |  |                                | (2,612 | ) |                              |   | (2,031 | )    |  |   | (4,844          | ) |  |   | (4,093 | )
|OTHER INCOME (EXPENSE):                                         |  |                                |        |   |                              |   |        |      |  |   |                 |   |  |   |        |  
|Interest income                                                 |  |                                | 90     |   |                              |   | 392    |      |  |   | 196             |   |  |   | 1,020  |  
|Other                                                           |  |                                | 70     |   |                              |   | (406   | )    |  |   | 92              |   |  |   | (602   | )
|                                                                |  |                                |        |   |                              |   |        |      |  |   |                 |   |  |   |        |  
|Total other income (expense)                                    |  |                                | 160    |   |                              |   | (14    | )    |  |   | 288             |   |  |   | 418    |  
|                                                                |  |                                |        |   |                              |   |        |      |  |   |                 |   |  |   |        |  
|LOSS BEFORE PROVISION FOR INCOME TAXES                          |  |                                | (2,452 | ) |                              |   | (2,045 | )    |  |   | (4,556          | ) |  |   | (3,675 | )
|PROVISION FOR INCOME TAXES                                      |  |                                | (44    | ) |                              |   | (294   | )    |  |   | (66             | ) |  |   | (902   | )
|                                                                |  |                                |        |   |                              |   |        |      |  |   |                 |   |  |   |        |  
|NET LOSS                                                        |  | $                              | (2,496 | ) |                              | $ | (2,339 | )    |  | $ | (4,622          | ) |  | $ | (4,577 | )
|                                                                |  |                                |        |   |                              |   |        |      |  |   |                 |   |  |   |        |  
|Net loss per share  basic and diluted                          |  | $                              | (0.06  | ) |                              | $ | (0.05  | )    |  | $ | (0.10           | ) |  | $ | (0.11  | )
|                                                                |  |                                |        |   |                              |   |        |      |  |   |                 |   |  |   |        |  
|Shares used in computing net loss per share  basic and diluted |  |                                | 44,683 |   |                              |   | 43,622 |      |  |   | 44,533          |   |  |   | 43,470 |  
|                                                                |  |                                |        |   |                              |   |        |      |  |   |                 |   |  |   |        |  
|(1) Includes stock-based compensation expense as follows:       |  |                                |        |   |                              |   |        |      |  |   |                 |   |  |   |        |  
|Cost of product revenue                                         |  | $                              | 38     |   |                              | $ | 37     |      |  | $ | 65              |   |  | $ | 63     |  
|Cost of support and services revenue                            |  |                                | 235    |   |                              |   | 224    |      |  |   | 346             |   |  |   | 422    |  
|Research and development                                        |  |                                | 805    |   |                              |   | 854    |      |  |   | 1,443           |   |  |   | 1,584  |  
|Selling and marketing                                           |  |                                | 918    |   |                              |   | 1,014  |      |  |   | 1,617           |   |  |   | 2,012  |  
|General and administrative                                      |  |                                | 844    |   |                              |   | 469    |      |  |   | 1,459           |   |  |   | 1,307  |  
|                                                                |  |                                |        |   |                              |   |        |      |  |   |                 |   |  |   |        |  
|Total stock-based compensation expense                          |  | $                              | 2,840  |   |                              | $ | 2,598  |      |  | $ | 4,930           |   |  | $ | 5,388  |  
|                                                                |  |                                |        |   |                              |   |        |      |  |   |                 |   |  |   |        |  

See Notes to Condensed Consolidated Financial Statements



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SHORETEL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)



|                                                                                |  |                              |        |   |                 |   |        |  
|------------------------------------------------------------------------------- |  | ---------------------------- | ------ | - | --------------- | - | ------ | -
|                                                                                |  | Six Months EndedDecember 31, |       
|                                                                                |  | 2009                         |        |   | 2008As Restated |  
|CASH FLOWS FROM OPERATING ACTIVITIES:                                           |  |                              |        |   |                 |   |        |  
|Net loss                                                                        |  | $                            | (4,622 | ) |                 | $ | (4,577 | )
|Adjustments to reconcile net loss to net cash provided by operating activities: |  |                              |        |   |                 |   |        |  
|Depreciation and amortization                                                   |  |                              | 1,312  |   |                 |   | 962    |  
|Amortization/(accretion) of premium/discount on investments                     |  |                              | 51     |   |                 |   | (25    | )
|Stock-based compensation expense                                                |  |                              | 4,930  |   |                 |   | 5,388  |  
|Loss on disposal of property and equipment                                      |  |                              | 147    |   |                 |   | 112    |  
|Provision for doubtful accounts receivable                                      |  |                              | 67     |   |                 |   | 737    |  
|Changes in assets and liabilities:                                              |  |                              |        |   |                 |   |        |  
|Accounts receivable                                                             |  |                              | 2,637  |   |                 |   | (2,093 | )
|Inventories                                                                     |  |                              | (2,693 | ) |                 |   | 2,549  |  
|Prepaid expenses and other current assets                                       |  |                              | (306   | ) |                 |   | (618   | )
|Other assets                                                                    |  |                              | 791    |   |                 |   | (513   | )
|Accounts payable                                                                |  |                              | 677    |   |                 |   | (887   | )
|Accrued expenses and other                                                      |  |                              | 1,023  |   |                 |   | 480    |  
|Accrued employee compensation                                                   |  |                              | 2,329  |   |                 |   | 2,013  |  
|Deferred revenue                                                                |  |                              | 2,168  |   |                 |   | 3,656  |  
|                                                                                |  |                              |        |   |                 |   |        |  
|Net cash provided by operating activities                                       |  |                              | 8,511  |   |                 |   | 7,184  |  
|                                                                                |  |                              |        |   |                 |   |        |  
|CASH FLOWS FROM INVESTING ACTIVITIES:                                           |  |                              |        |   |                 |   |        |  
|Purchases of property and equipment                                             |  |                              | (1,721 | ) |                 |   | (985   | )
|Purchases of investments                                                        |  |                              | (8,943 | ) |                 |   | (8,016 | )
|Proceeds from maturities of investments                                         |  |                              | 6,635  |   |                 |   | 20,358 |  
|Purchases of software license and other                                         |  |                              | (931   | ) |                 |   | (660   | )
|                                                                                |  |                              |        |   |                 |   |        |  
|Net cash (used in) provided by investing activities                             |  |                              | (4,960 | ) |                 |   | 10,697 |  
|                                                                                |  |                              |        |   |                 |   |        |  
|CASH FLOWS FROM FINANCING ACTIVITIES:                                           |  |                              |        |   |                 |   |        |  
|Proceeds from issuance of common stock to employees                             |  |                              | 1,408  |   |                 |   | 1,348  |  
|                                                                                |  |                              |        |   |                 |   |        |  
|Net cash provided by financing activities                                       |  |                              | 1,408  |   |                 |   | 1,348  |  
|                                                                                |  |                              |        |   |                 |   |        |  
|NET INCREASE IN CASH AND CASH EQUIVALENTS                                       |  |                              | 4,959  |   |                 |   | 19,229 |  
|CASH AND CASH EQUIVALENTS - Beginning of period                                 |  |                              | 73,819 |   |                 |   | 68,672 |  
|                                                                                |  |                              |        |   |                 |   |        |  
|CASH AND CASH EQUIVALENTS - End of period                                       |  | $                            | 78,778 |   |                 | $ | 87,901 |  
|                                                                                |  |                              |        |   |                 |   |        |  
|NONCASH INVESTING AND FINANCING ACTIVITIES:                                     |  |                              |        |   |                 |   |        |  
|Vesting of accrued early exercised stock options                                |  | $                            | 14     |   |                 | $ | 40     |  
|Purchase of property and equipment included in period-end accounts payable      |  |                              | 560    |   |                 |   | 146    |  
|Purchases of other assets included in period-end accounts payable               |  |                              | 200    |   |                 |   | 130    |  

See Notes to
Condensed Consolidated Financial Statements



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##### Table of Contents

SHORETEL, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

1. Description of Business

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

2. Basis of Presentation and Significant Accounting Policies

The accompanying financial statements as of December 31, 2009 and for the three months and six months ended December 31, 2009 and 2008 have been prepared by the Company, without audit, pursuant
to the rules and regulations of the Securities and Exchange Commission (SEC). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United
States have been condensed or omitted pursuant to such rules and regulations. However, the Company believes that the disclosures are adequate to make the information presented not misleading. These Condensed Consolidated Financial Statements should
be read in conjunction with the Consolidated Financial Statements and the notes thereto, included in the Companys Annual Report on Form 10-K, as amended by Form 10-K/A for the fiscal year ended June 30, 2009.

In the opinion of the management, all adjustments (which include normal recurring adjustments, except as disclosed herein) necessary to
present a fair statement of financial position as of December 31, 2009, results of operations for the three months and six months ended December 31, 2009 and 2008, and cash flows for the six months ended December 31, 2009 and 2008, as
applicable, have been made. The results of operations for the three months and six months ended December 31, 2009 are not necessarily indicative of the operating results for the full fiscal year or any future periods.

Computation of Net Loss per Share

Basic net loss per common share available to common stockholders is determined by dividing net loss available to common stockholders by the weighted average number of common shares available to common
stockholders during the period. Diluted net loss per common share available to common stockholders is determined by dividing net loss available to common stockholders by the weighted average number of common shares available to common stockholders
used in the basic loss per common share calculation plus the number of common shares that would be issued assuming conversion of all potentially dilutive securities outstanding under the treasury stock method. Potentially dilutive securities were
not included in the computation of dilutive net loss per share for the three and six months ended December 31, 2009 and 2008, because to do so would have been anti-dilutive. Potentially dilutive securities of 8.0 million and
8.0 million for the three and six months ended December 31, 2009 and 2008, respectively, were not included in the computation of dilutive net loss per share because to do so would have been anti-dilutive.

Recent Accounting Pronouncements

In October 2009, the FASB issued an accounting standards update that revises accounting and reporting requirements for arrangements with multiple deliverables that are excluded from the scope of
existing software revenue guidance. This update requires the use of an estimated selling price to determine the selling price of a deliverable in cases where neither vendor-specific objective evidence nor third-party evidence is available, which is
expected to increase the ability for entities to separate deliverables in multiple-deliverable arrangements and, accordingly, to decrease the amount of revenue deferred in these cases. Additionally, this update requires the total selling price of a
multiple-deliverable arrangement to be allocated at the inception of the arrangement to all deliverables based on relative selling prices. This update is to be applied prospectively for revenue arrangements entered into or materially modified in
fiscal years beginning on or after June 15, 2010, which for the Company is July 1, 2010. Early adoption is permitted, and if this update is adopted early in other than the first quarter of an entitys fiscal year, then it must be
applied retrospectively to the beginning of that fiscal year. We are currently evaluating the impact of adoption of this update on our financial position, results of operations and cash flows.

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



6



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##### Table of Contents

SHORETEL, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(unaudited)

Subsequent Events

The Company has evaluated events and transactions subsequent to December 31, 2009 through February 5, 2010, the date of issuance of
Consolidated Financial Statements. During the period from January 1, 2010 to February 5, 2010, the Company did not have any material subsequent events.



7



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##### Table of Contents

SHORETEL, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(unaudited)

3. Balance Sheet Details

Balance sheet components consist of the following:



|                                               |  |                  |        |   |              |   |        |  
|---------------------------------------------- |  | ---------------- | ------ | - | ------------ | - | ------ | -
|(In thousands)                                 |  | December 31,2009 |        |   | June 30,2009 |  
|Inventories:                                   |  |                  |        |   |              |  
|Raw materials                                  |  | $                | 363    |   |              | $ | 398    |  
|Work in process                                |  |                  | 502    |   |              |   | 962    |  
|Finished goods                                 |  |                  | 13,633 |   |              |   | 10,445 |  
|                                               |  |                  |        |   |              |   |        |  
|                                               |  | $                | 14,498 |   |              | $ | 11,805 |  
|                                               |  |                  |        |   |              |   |        |  
|Prepaid expenses and other current assets:     |  |                  |        |   |              |   |        |  
|Prepaid expenses                               |  | $                | 2,803  |   |              | $ | 2,435  |  
|Deferred cost of revenue                       |  |                  | 254    |   |              |   | 315    |  
|Deferred tax asset                             |  |                  | 359    |   |              |   | 360    |  
|                                               |  |                  |        |   |              |   |        |  
|                                               |  | $                | 3,416  |   |              | $ | 3,110  |  
|                                               |  |                  |        |   |              |   |        |  
|Property and equipment, net:                   |  |                  |        |   |              |   |        |  
|Computer equipment and tooling                 |  | $                | 7,086  |   |              | $ | 5,281  |  
|Software                                       |  |                  | 1,128  |   |              |   | 1,086  |  
|Furniture and fixtures                         |  |                  | 1,113  |   |              |   | 1,064  |  
|Leasehold improvements and auto                |  |                  | 389    |   |              |   | 387    |  
|                                               |  |                  |        |   |              |   |        |  
|Total property and equipment                   |  | $                | 9,716  |   |              | $ | 7,818  |  
|Less accumulated depreciation and amortization |  |                  | (5,429 | ) |              |   | (4,343 | )
|                                               |  |                  |        |   |              |   |        |  
|Property and equipment - net                   |  | $                | 4,287  |   |              | $ | 3,475  |  
|                                               |  |                  |        |   |              |   |        |  
|Deferred revenue - current and long-term:      |  |                  |        |   |              |   |        |  
|Product                                        |  | $                | 660    |   |              | $ | 988    |  
|Support and services                           |  |                  | 23,999 |   |              |   | 21,503 |  
|                                               |  |                  |        |   |              |   |        |  
|Total deferred revenue                         |  | $                | 24,659 |   |              | $ | 22,491 |  
|                                               |  |                  |        |   |              |   |        |  

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



|                             |  |                      |       |                         |   |      |                    |  |                      |       |                         |   |       |                    |   |      |   |  |   |      
|---------------------------- |  | -------------------- | ----- | ----------------------- | - | ---- | ------------------ |  | -------------------- | ----- | ----------------------- | - | ----- | ------------------ | - | ---- | - |  | - | -----
|                             |  | December 31, 2009    |       | June 30, 2009          
|                             |  | Gross CarryingAmount |       | AccumulatedAmortization |   |      | Net CarryingAmount |  | Gross CarryingAmount |       | AccumulatedAmortization |   |       | Net CarryingAmount
|Licensed technology          |  | $                    | 2,010 |                         | $ | (302 | )                  |  | $                    | 1,708 |                         | $ | 1,760 |                    | $ | (126 | ) |  | $ | 1,634
|Purchased technology         |  | $                    | 100   |                         | $ | (15  | )                  |  | $                    | 85    |                         | $ | 100   |                    | $ | (5   | ) |  | $ | 95   
|Intangible assets in process |  |                      | 3,159 |                         |   |     |                    |  |                      | 3,159 |                         |   | 2,478 |                    |   |     |   |  |   | 2,478
|                             |  |                      |       |                         |   |      |                    |  |                      |       |                         |   |       |                    |   |      |   |  |   |      
|Other intangible assets      |  | $                    | 5,269 |                         | $ | (317 | )                  |  | $                    | 4,952 |                         | $ | 4,338 |                    | $ | (131 | ) |  | $ | 4,207
|                             |  |                      |       |                         |   |      |                    |  |                      |       |                         |   |       |                    |   |      |   |  |   |      
|Prepaid royalties            |  |                      |       |                         |   |      |                    |  |                      | 1,512 |                         |   |       |                    |   |      |   |  |   | 2,285
|Deferred tax asset           |  |                      |       |                         |   |      |                    |  |                      | 1,388 |                         |   |       |                    |   |      |   |  |   | 1,388
|Deposits and other           |  |                      |       |                         |   |      |                    |  |                      | 202   |                         |   |       |                    |   |      |   |  |   | 234  
|                             |  |                      |       |                         |   |      |                    |  |                      |       |                         |   |       |                    |   |      |   |  |   |      
|Total other assets           |  |                      |       |                         |   |      |                    |  | $                    | 8,054 |                         |   |       |                    |   |      |   |  | $ | 8,114
|                             |  |                      |       |                         |   |      |                    |  |                      |       |                         |   |       |                    |   |      |   |  |   |      



8



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##### Table of Contents

SHORETEL, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(unaudited)

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



|                      |  |   |      
|--------------------- |  | - | -----
|Years Ending June 30, |  |  
|2010                  |  | $ | 206  
|2011                  |  |   | 413  
|2012                  |  |   | 413  
|2013                  |  |   | 413  
|2014                  |  |   | 297  
|Thereafter            |  |   | 51   
|                      |  |   |      
|Total                 |  | $ | 1,793
|                      |  |   |      

Short-Term Investments:

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



|                                     |  |                |  |                       |  |                        |   |  |          
|------------------------------------ |  | -------------- |  | --------------------- |  | ---------------------- | - |  | ---------
|                                     |  | Amortized Cost |  | Gross UnrealizedGains |  | Gross UnrealizedLosses |   |  | FairValue
|As of December 31, 2009              |  |                |  |                       |  |                        |   |  |          
|Corporate notes and commercial paper |  | 19,569         |  | 151                   |  |                        |   |  | 19,720   
|US Government agency securities      |  | 16,407         |  | 57                    |  | (7                     | ) |  | 16,457   
|                                     |  |                |  |                       |  |                        |   |  |          
|Total short-term investments         |  | 35,976         |  | 208                   |  | (7                     | ) |  | 36,177   
|                                     |  |                |  |                       |  |                        |   |  |          
|As of June 30, 2009                  |  |                |  |                       |  |                        |   |  |          
|Corporate notes and commercial paper |  | 24,209         |  | 111                   |  |                        |   |  | 24,320   
|US Government agency securities      |  | 9,502          |  | 25                    |  |                       |   |  | 9,527    
|                                     |  |                |  |                       |  |                        |   |  |          
|Total short-term investments         |  | 33,711         |  | 136                   |  |                       |   |  | 33,847   
|                                     |  |                |  |                       |  |                        |   |  |          



9



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##### Table of Contents

SHORETEL, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(unaudited)

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



|                        |  |                |        |            |   |       
|----------------------- |  | -------------- | ------ | ---------- | - | ------
|                        |  | Amortized Cost |        | Fair Value
|As of December 31, 2009 |  |                |        |            |   |       
|Less than 1 year        |  | $              |       |            | $ |      
|Due in 1 to 3 years     |  |                | 35,976 |            |   | 36,177
|                        |  |                |        |            |   |       
|Total                   |  | $              | 35,976 |            | $ | 36,177
|                        |  |                |        |            |   |       
|                        |  |               
|                        |  | Amortized Cost |        | Fair Value
|As of June 30, 2009     |  |                |        |            |   |       
|Less than 1 year        |  | $              | 6,646  |            | $ | 6,677 
|Due in 1 to 3 years     |  |                | 27,065 |            |   | 27,170
|                        |  |                |        |            |   |       
|Total                   |  | $              | 33,711 |            | $ | 33,847
|                        |  |                |        |            |   |       

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

4. Fair Value Disclosure

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



| |  |  | Level 1  Quoted prices in active markets for identical assets or liabilities.
| | - |  | ------------------------------------------------------------------------------



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



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



10



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##### Table of Contents

SHORETEL, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(unaudited)

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



|                                                                                        |  |                         |        |         |   |         |  |         |        |  |   |  
|--------------------------------------------------------------------------------------- |  | ----------------------- | ------ | ------- | - | ------- |  | ------- | ------ |  | - | -
|                                                                                        |  | As of December 31, 2009
|                                                                                        |  | Fair Value              |        | Level 1 |   | Level 2 |  | Level 3
|Money market funds                                                                      |  | $                       | 58,788 |         | $ | 58,788  |  |         |       |  |   | 
|Corporate notes and commercial paper                                                    |  |                         | 19,720 |         |   |        |  |         | 19,720 |  |   | 
|US Government agency securities                                                         |  |                         | 16,457 |         |   |        |  |         | 16,457 |  |   | 
|                                                                                        |  |                         |        |         |   |         |  |         |        |  |   |  
|Total financial instruments measured and recorded at fair value as of December 31, 2009 |  | $                       | 94,965 |         | $ | 58,788  |  | $       | 36,177 |  | $ | 
|                                                                                        |  |                         |        |         |   |         |  |         |        |  |   |  

The above table excludes $20.0 million of cash
balances on deposit at banks.



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

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

5. Income Taxes

In the three months ended December 31, 2009, the Company recorded an income tax provision of $44,000 compared to an income tax provision of $0.3 million for the three months ended December 31,
2008. The provision for income taxes for the six months ended December 31, 2009 and 2008 was $66,000 and $0.9 million, respectively.

The income tax provision of $66,000 for the six months ended December 31, 2009 represents the tax provision for the profitable jurisdictions and state taxes based upon income earned during the period
while no tax benefit was accrued on the loss jurisdictions. The income tax provision for the six months ended December 31, 2008 of $0.9 million was calculated under the discrete method as management determined that an annual effective tax rate
method would not provide a reliable estimate.

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

We maintain liabilities for
uncertain tax positions. As of December 31, 2009, the Companys total amount of unrecognized tax benefits were $1.8 million as compared to $1.5 million as of June 30, 2009, representing an increase of $0.3 million for the first six



11



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##### Table of Contents

SHORETEL, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(unaudited)

months of fiscal 2010. The increase in the total
unrecognized tax benefits is primarily due to California research tax credits. None of the total unrecognized tax benefits of the Company, if recognized, would impact the effective tax rate, as the Company has a full valuation allowance on its
carryforward attributes.

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

The Companys only major tax jurisdiction is the United States. The tax years 2000 through 2008 remain open and subject to tax
examination by the appropriate governmental agencies in the United States.

6. Common Stock

Common Shares Reserved for Issuance

At December 31, 2009, the Company has reserved shares of common stock for issuance as follows (in thousands):



|                                            |  |       
|------------------------------------------- |  | ------
|Reserved under stock option plans           |  | 10,797
|Reserved under employee stock purchase plan |  | 430   
|Conversion of warrants                      |  | 2     
|                                            |  |       
|Total                                       |  | 11,229
|                                            |  |       

7. Stock-Based Compensation

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



|                                        |  |                              |   |  |           |  
|--------------------------------------- |  | ---------------------------- | - |  | --------- | -
|                                        |  | Six Months EndedDecember 31, |  
|Employee Incentive Plans                |  | 2009                         |   |  | 2008      |  
|Expected life of option plan (in years) |  | 6.08-6.46                    |   |  | 6.08-6.46 |  
|Expected life of ESPP right (in years)  |  | 0.50                         |   |  | 0.50      |  
|Risk-free interest rate for option plan |  | 2.3-2.47                     | % |  | 2.18-3.11 | %
|Risk-free interest rate for ESPP right  |  | 0.16-0.27                    | % |  | 1.81      | %
|Volatility for option plan              |  | 58                           | % |  | 59        | %
|Volatility for ESPP right               |  | 58-138                       | % |  | 92        | %
|Dividend yield                          |  | 0                            | % |  | 0         | %

During the
three months ended December 31, 2009 and 2008, the Company recorded non-cash stock-based compensation expense of $2.8 million and $2.6 million respectively, net of forfeitures. During the six months ended December 31, 2009 and 2008, the
Company recorded non-cash stock-based compensation expense of $4.9 million and $5.4 million, respectively, net of forfeitures.

Compensation expense is recognized only for the portion of stock options that are expected to vest, assuming an expected forfeiture rate in determining stock-based compensation expense, which could affect the stock-based compensation
expense recorded if there is a significant difference between actual and estimated forfeiture rates. As of December 31, 2009, total unrecognized compensation cost related to stock-based awards granted to employees and non-employee directors was
$21.2 million. This cost will be amortized on a ratable basis over a weighted-average vesting period of approximately three years.



12



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##### Table of Contents

SHORETEL, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(unaudited)

8. Stock Option Plan

In January 1997, the Board of Directors and stockholders adopted the 1997 stock option plan (the 1997 Plan) which, as amended,
provides for granting incentive stock options (ISOs) and nonqualified stock options (NSOs) for shares of common stock to employees, directors, and consultants of the Company. In September 2006, the Companys board of
directors increased the number of shares authorized and reserved for issuance under the 1997 Plan to 10,513,325 shares of common stock. In accordance with the 1997 Plan, the stated exercise price shall not be less than 100% and 85% of the estimated
fair market value of common stock on the date of grant for ISOs and NSOs, respectively, as determined by the Board of Directors. The 1997 Plan provides that the options shall be exercisable over a period not to exceed ten years. Options generally
vest ratably over four years from the date of grant. Options granted to certain executive officers are exercisable immediately and unvested shares issued upon exercise are subject to repurchase by the Company at the exercise price (Class Two
Options). During the six months ended December 31, 2009 and December 31, 2008, zero and 1,167 unvested shares were repurchased, respectively. The Companys repurchase right for such options lapses as the options vest, generally
over four years from the date of grant.

In February 2007, the Company adopted the 2007 Equity Incentive Plan (the 2007
Plan) which, as amended, provides for grants of ISOs, NSOs, restrictive stock units (RSUs) and restrictive stock awards (RSAs) to employees, directors and consultants of the Company. This plan serves as the successor to
the 1997 Plan, which terminated in January 2007. Five million shares of common stock were initially reserved for future issuance in the form of stock options, restricted stock awards or units, stock appreciation rights and stock bonuses. In February
2008, pursuant to the automatic increase provisions of the 2007 Plan, the Companys board of directors increased the number of shares authorized and reserved for issuance under the 2007 Plan by 2.1 million and 2.2 million in 2008 and
2009, respectively.

Class Two Options granted under the 1997 Plan to certain executive officers are exercisable immediately
and shares issued upon exercise are subject to repurchase by the Company at the exercise price, in the event the employee is terminated; such repurchase right lapses gradually over a four year period. The Company does not consider the exercise of
stock options substantive when the issued stock is subject to repurchase. Accordingly, the proceeds from the exercise of such options are accounted for as a deposit liability until the repurchase right lapses, at which time the proceeds are
reclassified to permanent equity. As of December 31, 2009 and June 30, 2009, there were 5,626 and 20,626 shares subject to repurchase, respectively, of the Companys common stock outstanding and $5,300 and $19,000, respectively, of
related recorded liability, which is included in accrued liabilities.

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



|                                                                                                          |  |                           |   |  |                     |   |  |                               |      |                                                   |     |                         |   |       
|--------------------------------------------------------------------------------------------------------- |  | ------------------------- | - |  | ------------------- | - |  | ----------------------------- | ---- | ------------------------------------------------- | --- | ----------------------- | - | ------
|                                                                                                          |  |                           |   |  | Options Outstanding
|(In thousands, except per share data and contractual term)                                                |  | Shares Availablefor Grant |   |  | Number ofShares     |   |  | WeightedAverage ExercisePrice |      | WeightedAverageRemainingContractualTerm(in Years) |     | AggregateIntrinsicValue
|Balance at July 1, 2009                                                                                   |  | 3,359                     |   |  | 7,256               |   |  | $                             | 4.19 |                                                   |     |                         |   |       
|Termination of remaining shares available for grant under the 1997 Option Plan and other non-plan options |  | (23                       | ) |  |                    |   |  |                               |     |                                                   |     |                         |   |       
|Granted                                                                                                   |  | (551                      | ) |  | 551                 |   |  |                               | 6.68 |                                                   |     |                         |   |       
|Exercised                                                                                                 |  |                          |   |  | (264                | ) |  |                               | 1.15 |                                                   |     |                         |   |       
|Cancelled, forfeited or expired                                                                           |  | 203                       |   |  | (203                | ) |  |                               | 4.80 |                                                   |     |                         |   |       
|Restricted stocks granted (see Note 10)                                                                   |  | (184                      | ) |  |                    |   |  |                               |     |                                                   |     |                         |   |       
|Restricted stocks cancelled                                                                               |  | 22                        |   |  |                    |   |  |                               |     |                                                   |     |                         |   |       
|Balance at December 31, 2009                                                                              |  | 2,826                     |   |  | 7,340               |   |  | $                             | 4.47 |                                                   | 6.9 |                         | $ | 11,286
|                                                                                                          |  |                           |   |  |                     |   |  |                               |      |                                                   |     |                         |   |       
|Vested and expected to vest at December 31, 2009                                                          |  |                           |   |  | 6,611               |   |  | $                             | 4.39 |                                                   | 6.9 |                         | $ | 10,716
|                                                                                                          |  |                           |   |  |                     |   |  |                               |      |                                                   |     |                         |   |       
|Exercisable at December 31, 2009                                                                          |  |                           |   |  | 2,061               |   |  | $                             | 2.75 |                                                   | 6.3 |                         | $ | 6,979 
|                                                                                                          |  |                           |   |  |                     |   |  |                               |      |                                                   |     |                         |   |       

The total pre-tax intrinsic value for options exercised in the six months ended December 31,
2009 and 2008 was $1.4 million and $0.6 million, respectively, representing the difference between the estimated fair values of the Companys common stock underlying these options at the dates of exercise and the exercise prices paid. There
were 23,000 cancelled options that expired under the 1997 Option Plan due to the termination of that plan. These cancelled, expired options have been included in the option activity for the six months ended December 31, 2009.



13



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##### Table of Contents

SHORETEL, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(unaudited)

9. Employee Stock Purchase Plan

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

On February 3, 2009 and February 6, 2008, pursuant to the automatic increase provisions of the ESPP, the Companys Board of Directors approved increases to the number of shares authorized
and reserved for issuance under the ESPP by 438,000 shares and 427,000 shares, respectively, pursuant to the terms of that plan.

As of December 31, 2009, 935,000 shares had been issued under the ESPP since inception and 430,000 shares had been reserved for future issuance.

10. Restricted Stock

Under the 2007 Plan, during the six months ended
December 31, 2009, the Company issued restricted stock awards to non-employee directors electing to receive them in lieu of an annual cash retainer.

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

Restricted stock award and restricted stock unit activity for the six months ended December 31, 2009 and 2008 is as
follows (in thousands):



|                  |  |                                   |   |  |                                   |  
|----------------- |  | --------------------------------- | - |  | --------------------------------- | -
|                  |  | Six months endedDecember 31, 2009 |   |  | Six months endedDecember 31, 2008 |  
|Beginning balance |  | 507                               |   |  | 70                                |  
|Awarded           |  | 184                               |   |  | 488                               |  
|Released          |  | (46                               | ) |  | (28                               | )
|Forfeited         |  | (14                               | ) |  | (18                               | )
|                  |  |                                   |   |  |                                   |  
|Ending balance    |  | 631                               |   |  | 512                               |  
|                  |  |                                   |   |  |                                   |  

Information regarding restricted stock units outstanding at December 31, 2009 is summarized below:



|                                   |  |                              |  |                                            |  |                                    |      
|---------------------------------- |  | ---------------------------- |  | ------------------------------------------ |  | ---------------------------------- | -----
|                                   |  | Number of Shares (thousands) |  | Weighted AverageRemainingContractual Lives |  | Average IntrinsicValue (thousands)
|Shares outstanding                 |  | 631                          |  | 1.65 years                                 |  | $                                  | 3,647
|Shares vested and expected to vest |  | 528                          |  | 1.55 years                                 |  |                                    | 3,054

11. Litigation, Commitments
and Contingencies

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

U.S. Federal Court Class Action Litigation. On January 16, 2008, a purported stockholder class action lawsuit captioned Watkins
v. ShoreTel, Inc., et al., was filed in the United States District Court for the Northern District of California against the Company, certain of its officers and directors, and the underwriters of the Companys initial public offering. A second
purported class action alleging



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##### Table of Contents

SHORETEL, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(unaudited)

the same claims were filed on January 29, 2008 and
the lawsuits were consolidated. A second consolidated amended class action complaint was subsequently filed on March 2, 2009. The consolidated action is purportedly brought on behalf of those who purchased the Companys common stock
pursuant to the initial public offering on July 3, 2007, purports to allege claims for violations of the federal securities laws, and seeks unspecified compensatory damages and other relief. Management believes that the Company has meritorious
defenses to these claims and intends to defend the litigation vigorously. It is not possible for the Company to quantify the extent of the potential liability, if any. As such, no liability for any potential loss has been accrued as of
December 31, 2009.

California State Court Derivative Action. On January 30, 2008, a purported shareholder
derivative lawsuit captioned Berkovitz v. Combs, et al., was filed in the Superior Court of the State of California, County of Santa Clara, against the Company (as a nominal defendant), its directors and certain officers. The complaint purports to
allege claims for breach of fiduciary duty and other claims and seeks unspecified compensatory damages and other relief based on essentially the same allegations as the class action litigation. On May 6, 2008, the parties stipulated to, and the
Court entered an order for, a temporary standstill of the case. It is not possible for the Company to quantify the extent of the potential liability, if any. As such, no liability for any potential loss has been accrued as of December 31, 2009.

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

Leases  The Company leases its facilities
under noncancelable operating leases which expire at various times through 2015. The leases provide for the lessee to pay all cost of utilities, insurance, and taxes. Future minimum lease payments under the noncancelable leases as of
December 31, 2009, are as follows (in thousands):



|                          |  |   |      
|------------------------- |  | - | -----
|Years Ending June 30,     |  |  
|2010 (remaining 6 months) |  | $ | 722  
|2011                      |  |   | 1,411
|2012                      |  |   | 1,332
|2013                      |  |   | 1,166
|2014                      |  |   | 1,112
|2015                      |  |   | 280  
|                          |  |   |      
|Total                     |  | $ | 6,023
|                          |  |   |      

Lease obligations for the Companys foreign
offices are denominated in foreign currencies, which were converted in the above table to U.S. dollars at the interbank exchange rate on December 31, 2009.

Rent expense for the three months ended December 31, 2009 and 2008 was $0.3 and $0.5 million respectively, and $0.6 million and $0.9 million for the six months ended December 31, 2009 and 2008,
respectively.

Purchase commitments The Company had purchase commitments with contract manufacturers for inventory and
with technology firms for usage of software licenses totaling approximately $13.7 million as of December 31, 2009 and $11.9 million as of June 30, 2009.

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.



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SHORETEL, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(unaudited)

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

12. Segment Information

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

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



|               |  |                                |        |                              |   |        |  |      |        |  |   |       
|-------------- |  | ------------------------------ | ------ | ---------------------------- | - | ------ |  | ---- | ------ |  | - | ------
|               |  | Three Months EndedDecember 31, |        | Six Months EndedDecember 31,
|               |  | 2009                           |        | 2008                         |   | 2009   |  | 2008
|United States  |  | $                              | 32,192 |                              | $ | 32,753 |  | $    | 62,687 |  | $ | 66,362
|International  |  |                                | 3,265  |                              |   | 2,582  |  |      | 6,520  |  |   | 4,833 
|               |  |                                |        |                              |   |        |  |      |        |  |   |       
|Total revenues |  | $                              | 35,457 |                              | $ | 35,335 |  | $    | 69,207 |  | $ | 71,195
|               |  |                                |        |                              |   |        |  |      |        |  |   |       

13. Restatement of Previously Issued Consolidated Financial
Statements

As previously disclosed in the Form 10-K/A filed with the Securities and Exchange Commission on
November 5, 2009, the Company identified an error in stock-based compensation for the three and six months ending December 31, 2008. The error was identified after the Companys third-party software provider notified its clients,
including the Company, that it made a change to how its software program calculates stock-based compensation expense. Specifically, the prior version of this software calculated stock-based compensation expense by incorrectly continuing to apply a
weighted average forfeiture rate to the vested portion of stock option awards until the grants final vest date rather than reflecting actual forfeitures as vested. Thus, this accounting error relates to the timing of stock-based compensation
expense.

The Company determined that stock-based compensation expense error related to the three and six months ended
December 31, 2008 was $0.4 million and $0.5 million, respectively.



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##### Table of Contents

SHORETEL, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(In thousands, except per share amounts)

(unaudited)

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

Consolidated Statement of Operations



|                                       |  |                                     |        |   |                                   |   |        |                       |  |   |             |   |  |   |        |  
|-------------------------------------- |  | ----------------------------------- | ------ | - | --------------------------------- | - | ------ | --------------------- |  | - | ----------- | - |  | - | ------ | -
|                                       |  | Three Months EndedDecember 31,
2008 |        |   | Six Months EndedDecember 31,
2008 |  
|                                       |  | As previouslyreported               |        |   | As restated                       |   |        | As previouslyreported |  |   | As restated |  
|COST OF REVENUE:                       |  |                                     |        |   |                                   |   |        |                       |  |   |             |   |  |   |        |  
|Product                                |  | $                                   | 10,111 |   |                                   | $ | 10,112 |                       |  | $ | 20,097      |   |  | $ | 20,102 |  
|Support and services                   |  | $                                   | 2,920  |   |                                   | $ | 2,941  |                       |  | $ | 5,834       |   |  | $ | 5,859  |  
|Total cost of revenue                  |  | $                                   | 13,031 |   |                                   | $ | 13,053 |                       |  | $ | 25,931      |   |  | $ | 25,961 |  
|Gross profit                           |  | $                                   | 22,304 |   |                                   | $ | 22,282 |                       |  | $ | 45,264      |   |  | $ | 45,234 |  
|                                       |  |                                     |        |  
|Operating expenses:                    |  |                                     |        |   |                                   |   |        |                       |  |   |             |   |  |   |        |  
|Research and development               |  | $                                   | 8,368  |   |                                   | $ | 8,423  |                       |  | $ | 16,154      |   |  | $ | 16,217 |  
|Sales and marketing                    |  | $                                   | 11,648 |   |                                   | $ | 11,839 |                       |  | $ | 22,796      |   |  | $ | 23,012 |  
|General and administrative             |  | $                                   | 3,925  |   |                                   | $ | 4,051  |                       |  | $ | 9,935       |   |  | $ | 10,098 |  
|Total operating expenses               |  | $                                   | 23,941 |   |                                   | $ | 24,313 |                       |  | $ | 48,885      |   |  | $ | 49,327 |  
|Loss from operations                   |  | $                                   | (1,637 | ) |                                   | $ | (2,031 | )                     |  | $ | (3,621      | ) |  | $ | (4,093 | )
|Loss before provision for income taxes |  | $                                   | (1,651 | ) |                                   | $ | (2,045 | )                     |  | $ | (3,203      | ) |  | $ | (3,675 | )
|Net loss                               |  | $                                   | (1,945 | ) |                                   | $ | (2,339 | )                     |  | $ | (4,105      | ) |  | $ | (4,577 | )
|Net loss per share  basic and diluted |  | $                                   | (0.04  | ) |                                   | $ | (0.05  | )                     |  | $ | (0.09       | ) |  | $ | (0.11  | )

Consolidated Statement of
Cash Flows (in thousands):



|                                                                                |  |                                   |        |   |             |   |        |  
|------------------------------------------------------------------------------- |  | --------------------------------- | ------ | - | ----------- | - | ------ | -
|                                                                                |  | Six Months EndedDecember 31,
2008 |       
|                                                                                |  | As previouslyreported             |        |   | As restated |  
|Net loss                                                                        |  | $                                 | (4,105 | ) |             | $ | (4,577 | )
|Adjustments to reconcile net loss to net cash provided by operating activities: |  |                                   |        |   |             |   |        |  
|Stock-based compensation expense                                                |  | $                                 | 4,916  |   |             | $ | 5,388  |  
|Net cash provided by operating activities                                       |  | $                                 | 7,184  |   |             | $ | 7,184  |  



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##### Table of Contents

|ITEM 2. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|------- | -------------------------------------------------------------------------------------

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

The following discussion reflects the effects of the restatement discussed in Item 1 note 13  Restatement of Previously Issued
Consolidated Financial Statements to the Consolidated Financial Statements.

Overview

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

We sell our products primarily through channel partners that market and sell our systems to enterprises across
all industries, including small, medium and large companies and public institutions. We believe our channel strategy allows us to reach a larger number of prospective enterprise customers more effectively than if we were to sell directly. The number
of our authorized channel partners has more than doubled since June 30, 2004 to over 800 as of December 31, 2009. Channel partners typically purchase our products directly from us. Our internal sales and marketing personnel support these
channel partners in their selling efforts. In some circumstances, the enterprise customer will purchase products directly from us, but in these situations we typically compensate the channel partner for its sales efforts. At the request of the
channel partner, we often ship our products directly to the enterprise customer.

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

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

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

We are headquartered in Sunnyvale, California and 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, Belgium, Spain, Hong Kong, Singapore and Australia. Most of our enterprise
customers are located in the United States. Revenue from international sales has been less than 10% of our total revenue for the three and six months ended December 31, 2009 and 2008, respectively. Although we intend to focus on increasing
international sales, we expect that sales to enterprise customers in the United States will continue to comprise the significant majority of our sales.

Key Business Metrics

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

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

Deferred
revenue. Deferred revenue relates to the timing of revenue recognition for specific transactions based on service, support, specific commitments and other factors. Deferred revenue primarily consists of billings or payments received in advance
of revenue recognition from the Companys transactions described above and are recognized as the revenue recognition criteria are met. Nearly all system sales include the purchase of post-contractual support contracts with terms of up to five
years, and the rate of renewal on these contracts have been high historically. We recognize support revenue on a ratable basis over the term of the support contract. Since we receive payment for support in advance of our recognizing the related
revenue, we carry a deferred revenue balance on our consolidated balance sheet. This deferred revenue helps provide predictability to our future support and services revenue. Accordingly, the level of purchases of post-contractual support with our
product sales is an important metric for us along with the renewal rates for these services. Our deferred revenue balance at December 31, 2009 was $24.7 million, consisting of $0.7 million of deferred product revenue and $24.0 million of
deferred support and services revenues, of which $16.6 million is expected to be recognized within one year.



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##### Table of Contents

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

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

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

Basis of Presentation

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

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

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

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

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

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



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##### Table of Contents

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

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

We believe we have had multiple ownership changes, as defined under Section 382 of the Internal Revenue Code, due to significant stock transactions in previous years, which limits the realization of
our net operating losses and tax credit carryforwards under Sections 382 and 383 of the Internal Revenue Code in future periods. Based on our final analysis performed in 2008, we believe the provisions of Section 382 results in the
forfeiture of significant amount of federal and California net operating loss carry-forward and research and development tax credit carry-forwards.

Critical Accounting Policies and Estimates

The preparation of our financial statements and related disclosures
in conformity with generally accepted accounting principles in the United States of America, or GAAP, requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. These estimates and
assumptions are based on historical experience and various other factors that we believe are reasonable under the circumstances. We consider our accounting policies related to revenue recognition, allowance for doubtful accounts, stock-based
compensation, inventory valuation and accounting for income tax to be critical accounting policies. A number of significant estimates, assumptions, and judgments are inherent in our determination of when to recognize revenue, how to estimate
doubtful accounts, the calculation of stock-based compensation expense, and how we value inventory. We base our estimates and judgments on historical experience and on various other assumptions that we believe to be reasonable under the
circumstances. Actual results could differ materially from these estimates. Management believes there have been no significant changes during the three months ended December 31, 2009 to the items that we disclosed as our critical accounting
policies and estimates in Managements Discussion and Analysis of Financial Condition and Results of Operations in our 2009 Annual Report on Form 10-K/A filed with the Securities and Exchange Commission. For a description of those accounting
policies, please refer to our 2009 Annual Report on Form 10-K, as amended by Form 10-K/A.



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Results of Operations

The following table sets forth selected consolidated statements of operations data for three and six months ended December 31, 2009 and 2008.



|                                                              |  |                                |        |   |                              |   |        |      |  |   |        |   |  |   |        |  
|------------------------------------------------------------- |  | ------------------------------ | ------ | - | ---------------------------- | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                                              |  | Three Months EndedDecember 31, |        |   | Six Months EndedDecember 31, |  
|(In thousands, except per share amounts)                      |  | 2009                           |        |   | 2008                         |   |        | 2009 |  |   | 2008   |  
|REVENUE:                                                      |  |                                |        |   |                              |   |        |      |  |   |        |   |  |   |        |  
|Product                                                       |  | $                              | 27,897 |   |                              | $ | 29,096 |      |  | $ | 54,740 |   |  | $ | 59,110 |  
|Support and services                                          |  |                                | 7,560  |   |                              |   | 6,239  |      |  |   | 14,467 |   |  |   | 12,085 |  
|                                                              |  |                                |        |   |                              |   |        |      |  |   |        |   |  |   |        |  
|Total revenue                                                 |  |                                | 35,457 |   |                              |   | 35,335 |      |  |   | 69,207 |   |  |   | 71,195 |  
|                                                              |  |                                |        |  
|COST OF REVENUE:                                              |  |                                |        |   |                              |   |        |      |  |   |        |   |  |   |        |  
|Product (1)                                                   |  |                                | 9,787  |   |                              |   | 10,112 |      |  |   | 19,320 |   |  |   | 20,102 |  
|Support and services (1)                                      |  |                                | 2,806  |   |                              |   | 2,941  |      |  |   | 5,390  |   |  |   | 5,859  |  
|                                                              |  |                                |        |   |                              |   |        |      |  |   |        |   |  |   |        |  
|Total cost of revenue                                         |  |                                | 12,593 |   |                              |   | 13,053 |      |  |   | 24,710 |   |  |   | 25,961 |  
|GROSS PROFIT                                                  |  |                                | 22,864 |   |                              |   | 22,282 |      |  |   | 44,497 |   |  |   | 45,234 |  
|                                                              |  |                                |        |  
|OPERATING EXPENSES:                                           |  |                                |        |   |                              |   |        |      |  |   |        |   |  |   |        |  
|Research and development (1)                                  |  |                                | 7,835  |   |                              |   | 8,423  |      |  |   | 15,032 |   |  |   | 16,217 |  
|Sales and marketing (1)                                       |  |                                | 12,910 |   |                              |   | 11,839 |      |  |   | 24,927 |   |  |   | 23,012 |  
|General and administrative (1)                                |  |                                | 4,731  |   |                              |   | 4,051  |      |  |   | 9,382  |   |  |   | 10,098 |  
|                                                              |  |                                |        |   |                              |   |        |      |  |   |        |   |  |   |        |  
|Total operating expenses                                      |  |                                | 25,476 |   |                              |   | 24,313 |      |  |   | 49,341 |   |  |   | 49,327 |  
|                                                              |  |                                |        |   |                              |   |        |      |  |   |        |   |  |   |        |  
|LOSS FROM OPERATIONS                                          |  |                                | (2,612 | ) |                              |   | (2,031 | )    |  |   | (4,844 | ) |  |   | (4,093 | )
|OTHER INCOME:                                                 |  |                                |        |   |                              |   |        |      |  |   |        |   |  |   |        |  
|Interest income                                               |  |                                | 90     |   |                              |   | 392    |      |  |   | 196    |   |  |   | 1,020  |  
|Other                                                         |  |                                | 70     |   |                              |   | (406   | )    |  |   | 92     |   |  |   | (602   | )
|                                                              |  |                                |        |   |                              |   |        |      |  |   |        |   |  |   |        |  
|Total other income                                            |  |                                | 160    |   |                              |   | (14    | )    |  |   | 288    |   |  |   | 418    |  
|                                                              |  |                                |        |   |                              |   |        |      |  |   |        |   |  |   |        |  
|LOSS BEFORE PROVISION FOR INCOME TAXES                        |  |                                | (2,452 | ) |                              |   | (2,045 | )    |  |   | (4,556 | ) |  |   | (3,675 | )
|PROVISION FOR INCOME TAXES                                    |  |                                | (44    | ) |                              |   | (294   | )    |  |   | (66    | ) |  |   | (902   | )
|                                                              |  |                                |        |   |                              |   |        |      |  |   |        |   |  |   |        |  
|NET LOSS                                                      |  | $                              | (2,496 | ) |                              | $ | (2,339 | )    |  | $ | (4,622 | ) |  | $ | (4,577 | )
|                                                              |  |                                |        |   |                              |   |        |      |  |   |        |   |  |   |        |  
|Net loss per share  basic and diluted                        |  | $                              | (0.06  | ) |                              | $ | (0.05  | )    |  | $ | (0.10  | ) |  | $ | (0.11  | )
|                                                              |  |                                |        |   |                              |   |        |      |  |   |        |   |  |   |        |  
|Shares used in computing net loss per sharebasic and diluted |  |                                | 44,683 |   |                              |   | 43,622 |      |  |   | 44,533 |   |  |   | 43,470 |  
|                                                              |  |                                |        |   |                              |   |        |      |  |   |        |   |  |   |        |  
|(1) Includes stock-based compensation expense as follows:     |  |                                |        |   |                              |   |        |      |  |   |        |   |  |   |        |  
|Cost of product revenue                                       |  | $                              | 38     |   |                              | $ | 37     |      |  | $ | 65     |   |  | $ | 63     |  
|Cost of support and services revenue                          |  |                                | 235    |   |                              |   | 224    |      |  |   | 346    |   |  |   | 422    |  
|Research and development                                      |  |                                | 805    |   |                              |   | 854    |      |  |   | 1,443  |   |  |   | 1,584  |  
|Selling and marketing                                         |  |                                | 918    |   |                              |   | 1,014  |      |  |   | 1,617  |   |  |   | 2,012  |  
|General and administrative                                    |  |                                | 844    |   |                              |   | 469    |      |  |   | 1,459  |   |  |   | 1,307  |  
|                                                              |  |                                |        |   |                              |   |        |      |  |   |        |   |  |   |        |  
|Total stock-based compensation expense                        |  | $                              | 2,840  |   |                              | $ | 2,598  |      |  | $ | 4,930  |   |  | $ | 5,388  |  
|                                                              |  |                                |        |   |                              |   |        |      |  |   |        |   |  |   |        |  



21



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Use of Non-GAAP Financial Measures

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

RECONCILIATION OF GAAP TO NON-GAAP FINANCIAL MEASURES

(Amounts in
thousands, except per share amounts)

(Unaudited)



|                                                      |  |                    |        |   |                  |   |        |      |  |   |        |   |  |   |        |  
|----------------------------------------------------- |  | ------------------ | ------ | - | ---------------- | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                                      |  | Three Months Ended |        |   | Six Months Ended |  
|                                                      |  | December 31,       |        |   | December 31,     |  
|                                                      |  | 2009               |        |   | 2008             |   |        | 2009 |  |   | 2008   |  
|GAAP net loss available to stockholders:              |  | $                  | (2,496 | ) |                  | $ | (2,339 | )    |  | $ | (4,622 | ) |  | $ | (4,577 | )
|Adjustments for non-GAAP items (1)                    |  |                    | 2,840  |   |                  |   | 2,598  |      |  |   | 4,903  |   |  |   | 5,388  |  
|Tax effect of non-GAAP adjustments                    |  |                    | (4     | ) |                  |   | (33    | )    |  |   | (32    | ) |  |   | (58    | )
|                                                      |  |                    |        |   |                  |   |        |      |  |   |        |   |  |   |        |  
|Non-GAAP net income available to stockholders         |  | $                  | 340    |   |                  | $ | 226    |      |  | $ | 249    |   |  | $ | 753    |  
|                                                      |  |                    |        |   |                  |   |        |      |  |   |        |   |  |   |        |  
|GAAP diluted net loss per share(2):                   |  | $                  | (0.06  | ) |                  | $ | (0.05  | )    |  | $ | (0.10  | ) |  | $ | (0.11  | )
|Adjustments for non-GAAP items                        |  |                    | 0.07   |   |                  |   | 0.06   |      |  |   | 0.11   |   |  |   | 0.13   |  
|Tax effect of non-GAAP adjustments                    |  |                    | 0.00   |   |                  |   | 0.00   |      |  |   | 0.00   |   |  |   | 0.00   |  
|                                                      |  |                    |        |   |                  |   |        |      |  |   |        |   |  |   |        |  
|Non-GAAP diluted net income per share(2):             |  | $                  | 0.01   |   |                  | $ | 0.01   |      |  | $ | 0.01   |   |  | $ | 0.02   |  
|                                                      |  |                    |        |   |                  |   |        |      |  |   |        |   |  |   |        |  
|Shares Used in Non-GAAP diluted per share calculation |  |                    | 46,127 |   |                  |   | 44,862 |      |  |   | 46,100 |   |  |   | 44,766 |  
|(1)    Adjustments for non-GAAP items include:        |  |                    |        |   |                  |   |        |      |  |   |        |   |  |   |        |  
|Stock-based compensation                              |  |                    | 2,840  |   |                  |   | 2,598  |      |  |   | 4,930  |   |  |   | 5,388  |  
|Restructuring benefit                                 |  |                    |       |   |                  |   |       |      |  |   | (27    | ) |  |   |       |  
|                                                      |  |                    |        |   |                  |   |        |      |  |   |        |   |  |   |        |  
|Adjustments for non-GAAP items (1)                    |  | $                  | 2,840  |   |                  | $ | 2,598  |      |  | $ | 4,903  |   |  | $ | 5,388  |  
|                                                      |  |                    |        |   |                  |   |        |      |  |   |        |   |  |   |        |  



|(2) | Diluted net income per share and share count reflect the weighted average number of common shares used in the basic net income per share calculation plus the effects of
potentially dilutive securities of 1,444, 1,240, 1,567 and 1,296 for the three and six months ended December 31, 2009 and 2008, respectively.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

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 EndedDecember 31, |    |  | Six Months EndedDecember 31, |   
|                                     |  | 2009                           |    |  | 2008                         |    |  | 2009 |    |  | 2008 |   
|Revenue:                             |  |                                |    |  |                              |    |  |      |    |  |      |   
|Product                              |  | 79                             | %  |  | 82                           | %  |  | 79   | %  |  | 83   | % 
|Support and services                 |  | 21                             | %  |  | 18                           | %  |  | 21   | %  |  | 17   | % 
|                                     |  |                                |    |  |                              |    |  |      |    |  |      |   
|Total revenue                        |  | 100                            | %  |  | 100                          | %  |  | 100  | %  |  | 100  | % 
|Cost of revenue:                     |  |                                |    |  |                              |    |  |      |    |  |      |   
|Product                              |  | 28                             | %  |  | 29                           | %  |  | 28   | %  |  | 28   | % 
|Support and services                 |  | 8                              | %  |  | 8                            | %  |  | 8    | %  |  | 8    | % 
|                                     |  |                                |    |  |                              |    |  |      |    |  |      |   
|Total cost of revenue                |  | 36                             | %  |  | 37                           | %  |  | 36   | %  |  | 36   | % 
|                                     |  |                                |    |  |                              |    |  |      |    |  |      |   
|Gross profit                         |  | 64                             | %  |  | 63                           | %  |  | 64   | %  |  | 64   | % 
|Operating expenses:                  |  |                                |    |  |                              |    |  |      |    |  |      |   
|Research and development             |  | 22                             | %  |  | 24                           | %  |  | 22   | %  |  | 23   | % 
|Sales and marketing                  |  | 36                             | %  |  | 34                           | %  |  | 36   | %  |  | 32   | % 
|General and administrative           |  | 13                             | %  |  | 11                           | %  |  | 13   | %  |  | 14   | % 
|                                     |  |                                |    |  |                              |    |  |      |    |  |      |   
|Total operating expenses (a)         |  | 71                             | %  |  | 69                           | %  |  | 71   | %  |  | 69   | % 
|                                     |  |                                |    |  |                              |    |  |      |    |  |      |   
|Operating loss                       |  | (7                             | )% |  | (6                           | )% |  | (7   | )% |  | (5   | )%
|Interest and other income, net       |  | 0                              | %  |  | 0                            | %  |  | 0    | %  |  | 0    | % 
|                                     |  |                                |    |  |                              |    |  |      |    |  |      |   
|Loss before provision for income tax |  | (7                             | )% |  | (6                           | )% |  | (7   | )% |  | (5   | )%
|Provision for income taxes           |  | 0                              | %  |  | (1                           | )% |  | 0    | %  |  | (1   | )%
|                                     |  |                                |    |  |                              |    |  |      |    |  |      |   
|Net loss                             |  | (7                             | )% |  | (7                           | )% |  | (7   | )% |  | (6   | )%
|                                     |  |                                |    |  |                              |    |  |      |    |  |      |   



23



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##### Table of Contents

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



|                                                        |  |                                |    |  |                              |    |  |        |    |  |        |   
|------------------------------------------------------- |  | ------------------------------ | -- |  | ---------------------------- | -- |  | ------ | -- |  | ------ | --
|                                                        |  | Three Months EndedDecember 31, |    |  | Six Months EndedDecember 31, |   
|                                                        |  | 2009                           |    |  | 2008                         |    |  | 2009   |    |  | 2008   |   
|Total GAAP operating expenses                           |  | 25,476                         |    |  | 24,313                       |    |  | 49,341 |    |  | 49,327 |   
|Stock-based compensation included in operating expenses |  | (2,567                         | )  |  | (2,337                       | )  |  | (4,519 | )  |  | (4,903 | ) 
|Restructuring benefit included in operating expenses    |  |                               |    |  |                             |    |  | 27     |    |  |       |   
|                                                        |  |                                |    |  |                              |    |  |        |    |  |        |   
|Total non-GAAP operating expenses                       |  | 22,909                         |    |  | 21,976                       |    |  | 44,849 |    |  | 44,424 |   
|                                                        |  |                                |    |  |                              |    |  |        |    |  |        |   
|Non-GAAP items as a % of GAAP operating expenses        |  | (10                            | )% |  | (10                          | )% |  | (9     | )% |  | (10    | )%

Comparison of the three
months ended December 31, 2009 and December 31, 2008

Net Revenue.



|                       |  |                                |        |      |   |                |  |                 |     |  |   |  
|---------------------- |  | ------------------------------ | ------ | ---- | - | -------------- |  | --------------- | --- |  | - | -
|                       |  | Three Months EndedDecember 31, |       
|(Dollars in thousands) |  | 2009                           |        | 2008 |   | DollarVariance |  | PercentVariance |    
|Revenue                |  | $                              | 35,457 |      | $ | 35,335         |  | $               | 122 |  | 0 | %

The increase
of $0.1 million was primarily attributable to an increase in sales of our support and service of $1.3 million or 21% which was $7.6 million in the three months ended December 31, 2009 compared to $6.2 million in the same period of 2008.
The increase was attributable to revenue associated with post-contractual support contracts accompanying new system sales, post-contractual support contract renewals and increased revenue from training and installation services. This increase was
partially offset by a decrease of product revenue of $1.2 million, or 4% to $27.9 million in the three months ended December 31, 2009 from $29.1 million in the three months ended December 31, 2008. The decrease in product revenue was due
to a decline in business from new customers mostly due to the economic downturn.

Cost of revenue and gross profit.



|                       |  |                                |        |   |      |   |        |                |  |   |                 |   |  |    |   
|---------------------- |  | ------------------------------ | ------ | - | ---- | - | ------ | -------------- |  | - | --------------- | - |  | -- | --
|                       |  | Three Months EndedDecember 31, |       
|(Dollars in thousands) |  | 2009                           |        |   | 2008 |   |        | DollarVariance |  |   | PercentVariance |  
|Cost of revenue        |  | $                              | 12,593 |   |      | $ | 13,053 |                |  | $ | (460            | ) |  | (4 | )%
|Gross profit           |  | $                              | 22,864 |   |      | $ | 22,282 |                |  | $ | 582             |   |  | 3  | % 
|Gross profit %         |  |                                | 64.5   | % |      |   | 63.1   | %              |  |   |                 |   |  |    |   

Cost of revenue. Gross profit increased from 63.1% in the three months ended
December 31, 2008 to 64.5% in the three months ended December 31,2009 primarily due to increase in support and service gross margin partially offset by a decline in product gross margin.

Support and services gross profit increased from 52.9% in the three months ended December 31, 2008 to 62.9% in the same period of 2009.
In the three months ended December 31, 2009, support and services gross profit increased due to support and services revenue increasing by 21% and support and services cost decreasing by 5%, compared to the same period in 2008. The service
costs



24



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##### Table of Contents

decreased by 5% as the Company deployed employee resources to a lower cost region outside of our California headquarters office. Compensation for support and services employees, the largest
category of support and service costs, decreased 5% in the three months ended December 31, 2009, although the headcount increased from 53 employees at December 31, 2008 to 60 employees at December 31, 2009. The increase in
support and services gross profit was partially offset by a decrease in product gross profit percent from 65.2% in the three months ended December 31, 2008 to 64.9% in the three months ended December 31, 2009. The decrease in product gross
profit was attributable to a decline in average selling price of our ShoreGear switches of 6% and a decline in our IP phones of 9%.

Operating expenses.



|                           |  |                                |        |      |   |                |  |   |                 |   |  |    |   
|-------------------------- |  | ------------------------------ | ------ | ---- | - | -------------- |  | - | --------------- | - |  | -- | --
|                           |  | Three Months EndedDecember 31, |       
|(Dollars in thousands)     |  | 2009                           |        | 2008 |   | DollarVariance |  |   | PercentVariance |  
|Research and development   |  | $                              | 7,835  |      | $ | 8,423          |  | $ | (588            | ) |  | (7 | )%
|Sales and marketing        |  | $                              | 12,910 |      | $ | 11,839         |  | $ | 1,071           |   |  | 9  | % 
|General and administrative |  | $                              | 4,731  |      | $ | 4,051          |  | $ | 680             |   |  | 17 | % 

Research
and development. Research and development expenses decreased by $0.6 million primarily due to decreases in outside engineering expenses of $0.4 million, bonus expenses of $0.3 million and legal expenses of $0.1 million. This decrease was
partially offset by an increase in employee compensation of $0.2 million and software costs of $0.1 million.

Sales and
marketing.The increase in sales and marketing expenses is attributable to increases in advertisement and promotions of $0.9 million, employee compensation of $0.6 million, consulting expenses of $0.3 million and travel of $0.3 million. This
increase was partially offset by decreases in commission expenses of $0.7 million and bonus expenses of $0.1 million.

General and administrative. General and administrative expenses increased by $0.7 million primarily due to increases in employee compensation of $0.5 million, bad debt expenses of $0.3 million and consulting and temporary labor
of $0.2 million. The increase was partially offset by decrease in legal expenses of $0.3 million.

Other income, net.



|                       |  |                                |     |      |   |     |                |  |                 |     |  |       |  
|---------------------- |  | ------------------------------ | --- | ---- | - | --- | -------------- |  | --------------- | --- |  | ----- | -
|                       |  | Three Months EndedDecember 31, |    
|(Dollars in thousands) |  | 2009                           |     | 2008 |   |     | DollarVariance |  | PercentVariance |    
|Other income (net)     |  | $                              | 160 |      | $ | (14 | )              |  | $               | 174 |  | -1243 | %

Other
income (net).The increase was primarily attributable to increase in foreign currency exchange translation net gain of $0.5 million in the three months ended December 31, 2009 compared to same period of 2008 due to higher fluctuation in
foreign currency exchange rates in the three months ended December 31, 2008 that had resulted in foreign exchange translation losses. This increase was partially offset by a decline in interest income of $0.3 million due to a decline in overall
interest rates in the three months ended December 31, 2009 as compared to the same period of 2008.

Provision for
income taxes.



|              |  |                                |    |      |   |                |  |   |                 |   |  |     |   
|------------- |  | ------------------------------ | -- | ---- | - | -------------- |  | - | --------------- | - |  | --- | --
|              |  | Three Months EndedDecember 31, |   
|              |  | 2009                           |    | 2008 |   | DollarVariance |  |   | PercentVariance |  
|Tax provision |  | $                              | 44 |      | $ | 294            |  | $ | (250            | ) |  | (85 | )%
|              |  |                                |    |      |   |                |  |   |                 |   |  |     |   

Income tax provision. The income tax provision of $44,000 for the three months ended
December 31, 2009 represents the tax provision for the profitable jurisdictions and state taxes based upon income earned during the period while no tax benefit was accrued on the loss jurisdictions. The income tax provision of $0.3 million for
the three months ended December 31, 2008 on a net loss of $2.0 million resulted in an effective tax rate of (14%). The negative effective tax rate is primarily a result of nondeductible stock compensation expenses, limitations on the
utilization of credit carryforwards and the impact of the valuation allowance.



25



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##### Table of Contents

Comparison of the six months ended December 31, 2009 and December 31, 2008

Net Revenues.



|                       |  |                              |        |      |   |                |  |   |                 |   |  |    |   
|---------------------- |  | ---------------------------- | ------ | ---- | - | -------------- |  | - | --------------- | - |  | -- | --
|                       |  | Six Months EndedDecember 31, |       
|(Dollars in thousands) |  | 2009                         |        | 2008 |   | DollarVariance |  |   | PercentVariance |  
|Revenue                |  | $                            | 69,207 |      | $ | 71,195         |  | $ | (1,988          | ) |  | (3 | )%

The decrease
was primarily attributable to decrease in sales of our products. Product revenue was $54.7 million in the six months ended December 31, 2009, a decrease of $4.4 million, or 7%, from $59.1 million in the same period of 2008. The decrease in
product revenue was due to a decline in business from new customers mostly due to the economic downturn. This decrease was partially offset by an increase of $2.4 million or 20% in support and services revenue which was $14.5 million in the six
months ended December 31, 2009 compared to $12.1 million in the same period of 2008. The increase was attributable to revenue associated with post-contractual support contracts accompanying new system sales, post-contractual support
contract renewals and increased revenue from training and installation services.

Cost of revenue and gross profit.



|                       |  |                              |        |   |      |   |        |                |  |   |                 |   |  |    |   
|---------------------- |  | ---------------------------- | ------ | - | ---- | - | ------ | -------------- |  | - | --------------- | - |  | -- | --
|                       |  | Six Months EndedDecember 31, |       
|(Dollars in thousands) |  | 2009                         |        |   | 2008 |   |        | DollarVariance |  |   | PercentVariance |  
|Cost of revenue        |  | $                            | 24,710 |   |      | $ | 25,961 |                |  | $ | (1,251          | ) |  | (5 | )%
|Gross profit           |  | $                            | 44,497 |   |      | $ | 45,234 |                |  | $ | (737            | ) |  | (2 | )%
|Gross profit %         |  |                              | 64.3   | % |      |   | 63.5   | %              |  |   |                 |   |  |    |   

Cost of revenue. Gross profit increased from 63.5% in the six months ended
December 31, 2008 to 64.3% in the six months ended December 31,2009 primarily due to increase in support and service gross margin partially offset by a decline in product gross margin.

Support and services gross profit increased from 51.5% in the six months ended December 31, 2008 to 62.7% in the same period of 2009.
In the six months ended December 31, 2009, support and services gross profit increased due to support and services revenue increasing by 20% and support and services cost decreasing by 8%, compared to the same period in 2008. The service costs
decreased by 8% as the Company deployed employee resources to a lower cost region outside of our California headquarters office. Compensation for support and services employees, the largest category of support and service costs, decreased 6% in the
six months ended December 31, 2009, although the headcount increased from 53 employees at December 31, 2008 to 60 employees at December 31, 2009. The increase in support and services gross profit was partially offset by
decrease in product gross profit from 66% in the six months ended December 31, 2008 to 65% in the six months ended December 31, 2009. The decrease in product gross profit was attributable to a decline in average selling price of our
ShoreGear switches of 11% and a decline in average selling price of IP phones of 10%.



26



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##### Table of Contents

Operating expenses.



|                           |  |                              |        |      |   |                |  |   |                 |   |  |    |   
|-------------------------- |  | ---------------------------- | ------ | ---- | - | -------------- |  | - | --------------- | - |  | -- | --
|                           |  | Six Months EndedDecember 31, |       
|(Dollars in thousands)     |  | 2009                         |        | 2008 |   | DollarVariance |  |   | PercentVariance |  
|Research and development   |  | $                            | 15,032 |      | $ | 16,217         |  | $ | (1,185          | ) |  | (7 | )%
|Sales and marketing        |  | $                            | 24,927 |      | $ | 23,012         |  | $ | 1,915           |   |  | 8  | % 
|General and administrative |  | $                            | 9,382  |      | $ | 10,098         |  | $ | (716            | ) |  | (7 | )%

Research
and development. Research and development expenses decreased by $1.2 million primarily due to decreases in outside engineering service expenses of $0.6 million, employee compensation of $0.3 million, equipment repair and maintenance of $0.2
million and travel expenses of $0.1 million.

Sales and marketing.The increase in sales and marketing expenses is
attributable to increases in employee compensation of $0.7 million, travel expenses of $0.4 million, commissions of $0.3 million, contractor and outside help of $0.3 million and advertisement expenses of $0.3 million.

General and administrative. General and administrative expenses declined by $0.7 million primarily due to decreases in bad debt
expenses of $0.7 million, legal expenses of $0.7 million and bonus of $0.2 million. The decreases were partially offset by increases in consulting and temporary labor help of $0.4 million and employee stock compensation of $0.3 million.

Other income, net.



|                       |  |                              |     |      |   |                |  |   |                 |   |  |     |   
|---------------------- |  | ---------------------------- | --- | ---- | - | -------------- |  | - | --------------- | - |  | --- | --
|                       |  | Six Months EndedDecember 31, |    
|(Dollars in thousands) |  | 2009                         |     | 2008 |   | DollarVariance |  |   | PercentVariance |  
|Other income (net)     |  | $                            | 288 |      | $ | 418            |  | $ | (130            | ) |  | (31 | )%

Other
income (net).The decrease was primarily attributable to decrease in interest income by $0.8 million due to a decline in overall interest rates in the six months ended December 31, 2009 compared to the same period of 2008. This was
partially offset by a net increase in foreign currency exchange translation gain of $0.7 million in the six months ended December 31, 2009 compared to same period of 2008 due to higher fluctuation in foreign currency exchange rates in the six
months ended December 31, 2008 that had resulted in foreign exchange translation losses.

Provision for income taxes.



|              |  |                              |    |      |   |                |  |   |                 |   |  |     |   
|------------- |  | ---------------------------- | -- | ---- | - | -------------- |  | - | --------------- | - |  | --- | --
|              |  | Six Months EndedDecember 31, |   
|              |  | 2009                         |    | 2008 |   | DollarVariance |  |   | PercentVariance |  
|Tax provision |  | $                            | 66 |      | $ | 902            |  | $ | (836            | ) |  | (93 | )%

Income tax
provision.The income tax provision of $66,000 for the six months ended December 31, 2009 represents the tax provision for the profitable jurisdictions and state taxes based upon income earned during the period while no tax benefit was
accrued on the loss jurisdictions. The income tax provision of $0.9 million for the six months ended December 31, 2008 on a net loss of $3.7 million resulted in an effective tax rate of (25)%. The negative effective tax rate is primarily a
result of nondeductible stock compensation expenses, limitations on the utilization of credit carryforwards and the impact of the valuation allowance.



27



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##### Table of Contents

Liquidity and Capital Resources

Balance Sheet and Cash Flows

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



|                                                   |  |                  |         |              |   |                     |  |   |      
|-------------------------------------------------- |  | ---------------- | ------- | ------------ | - | ------------------- |  | - | -----
|                                                   |  | December 31,2009 |         | June 30,2009 |   | Increase/(Decrease)
|Cash, cash equivalents and short-term investments: |  |                  |         |              |   |                     |  |   |      
|Cash and cash equivalents                          |  | $                | 78,778  |              | $ | 73,819              |  | $ | 4,959
|Short-term investments                             |  |                  | 36,177  |              |   | 33,847              |  |   | 2,330
|                                                   |  |                  |         |              |   |                     |  |   |      
|Total                                              |  | $                | 114,955 |              | $ | 107,666             |  |   | 7,289
|                                                   |  |                  |         |              |   |                     |  |   |      

As of December 31, 2009, our principal sources of
liquidity consisted of cash and cash equivalents and short-term investments of $115.0 million and accounts receivable net of $18.8 million.

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

We believe that our $115.0 million of cash and cash equivalents and
short-term investments at December 31, 2009 will be sufficient to fund our operating requirements for at least 12 months. Our future capital requirements will depend on many factors, including our rate of revenue growth, the expansion of our
sales and marketing activities, the addition of new business initiatives, the timing and extent of our expansion into new territories, the timing of introductions of new products and enhancements to existing products, the continuing market
acceptance of our products and acquisition and licensing activities. We may enter into agreements relating to potential investments in, or acquisitions of, complementary businesses or technologies in the future, which could also require us to seek
additional equity or debt financing. Additional funds may not be available on terms favorable to us or at all.

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



|                                          |  |                  |        |   |                  |   |       
|----------------------------------------- |  | ---------------- | ------ | - | ---------------- | - | ------
|                                          |  | Six Months Ended
|(Dollars in thousands)                    |  | December 31,2009 |        |   | December 31,2008
|Net cash flow provided by (used in):      |  |                  |        |   |                  |   |       
|Operating activities                      |  | $                | 8,511  |   |                  | $ | 7,184 
|Investing activities                      |  |                  | (4,960 | ) |                  |   | 10,697
|Financing activities                      |  |                  | 1,408  |   |                  |   | 1,348 
|                                          |  |                  |        |   |                  |   |       
|Net increase in cash and cash equivalents |  | $                | 4,959  |   |                  | $ | 19,229
|                                          |  |                  |        |   |                  |   |       

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 45
to 60 days. In some cases we also prepay for license rights to third-party products in advance of sales.

Net loss during the
six months ended December 31, 2009 and 2008 included non-cash charges of $4.9 million and $5.4 million in stock-based compensation expense, respectively, bad debt expense of $0.1 million and $0.7 million, respectively, and $1.3 million and $1.0
million in depreciation and amortization, respectively.

Cash provided by operating activities during the six months ended
December 31, 2009 also reflect net changes in operating assets and liabilities, which provided $6.6 million consisting primarily of a significant decrease in accounts receivables of $2.6 million due to a decrease in days sales outstanding
(DSO), an increase in accrued employee compensation of $2.3 million, an increase in deferred revenue of $2.2 million, an increase of $1.0 million in accrued liabilities, an increase in accounts payable of $0.7 million and a decrease in other assets
of $0.8 million, partially offset by an increase in inventories of $2.7 million, and a decrease in prepaid and other current assets of $0.3 million.



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Cash provided by operating activities during the six months ended December 31, 2008
also reflect net changes in operating assets and liabilities, which provided $4.6 million, consisting primarily of a decrease in inventories of $2.5 million due to improved inventory turnover, an increase in deferred revenue of $3.7 million, and an
increase in accrued employee compensation of $2.0 million, partially offset by an increase in accounts receivable of $2.1 million and a decrease in accounts payable of $ 0.9 million.

Cash flows from investing activities

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

Net cash (used in) provided by investing activities was $(5.0) million and $10.7 million in the six months December 31, 2009 and 2008,
respectively. Net cash used in investing activities in the first six months ended December 31, 2009 related to net purchase of short-term investments of $2.3 million, purchase of fixed assets of $1.7 million and purchase of a perpetual license
and patent of $0.9 million. In the six months ended December 31, 2008, cash provided by investing activities primarily related to the net short-term investments sold and matured.

Cash flows from financing activities

Net cash provided by financing activities was $1.4 million for the six months ended December 31, 2009 and $1.3 million for the six months ended December 31, 2008, respectively, primarily from
the exercise of common stock options and issuance of common stock under employee stock purchase plan.

Off-Balance Sheet Arrangements

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

Contractual obligations and commitments

The following table summarizes our contractual obligations as of December 31, 2009 and the effect that such obligations are expected to have on our liquidity and cash flows in future periods:



|                       |  |                        |        |             |   |             |  |                   |       |       |   |   |  |   |       
|---------------------- |  | ---------------------- | ------ | ----------- | - | ----------- |  | ----------------- | ----- | ----- | - | - |  | - | ------
|                       |  | Payments Due By Period
|(Dollars in thousands) |  | Less than 1Year        |        | 1 - 3 Years |   | 3 - 5 Years |  | 5 years and after |       | Total
|Operating Leases       |  | $                      | 1,423  |             | $ | 2,665       |  | $                 | 1,935 |       | $ |  |  | $ | 6,023 
|Purchase obligations   |  |                        | 11,221 |             |   | 2,000       |  |                   | 500   |       |   |  |  |   | 13,721
|                       |  |                        |        |             |   |             |  |                   |       |       |   |   |  |   |       
|Total                  |  | $                      | 12,644 |             | $ | 4,665       |  | $                 | 2,435 |       | $ |  |  | $ | 19,744
|                       |  |                        |        |             |   |             |  |                   |       |       |   |   |  |   |       

As of December 31, 2009, the Companys total
amount of unrecognized tax benefit was approximately $1.8 million of which none, if recognized, would impact the effective tax rate as the Company has a valuation allowance on its carryforward attributes. The Company does not expect its unrecognized
tax benefits to change materially over the next 12 months.



|ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
|------- | ----------------------------------------------------------

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



|ITEM 4. | CONTROLS AND PROCEDURES
|------- | -----------------------

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



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Internal Control Over Financial Reporting. In connection with the restatement
described in Note 13 to our unaudited condensed consolidated financial statements, we have previously reported that there was a material weakness in our internal control over financial reporting as of June 30, 2009 relating to the design of the
controls over the calculation of stock-based compensation expense related to the application of the forfeiture rate.

During
the quarter ended December 31, 2009, we designed and placed in operation new controls to remediate the material weakness. Specifically, we have upgraded to the most current version of the software during the second quarter of fiscal 2010, added
control procedures pursuant to which the Company tests the calculation of the third-party stock-based compensation system reports on a quarterly basis, and implemented timely review of the technical updates of the software.

As of December 31, 2009, we have determined that the new controls are effectively designed and have demonstrated effective operation to
conclude the material weakness identified as of June 30, 2009 has been remediated.

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

PART II: OTHER
INFORMATION



|ITEM 1. | LEGAL PROCEEDINGS
|------- | -----------------

There
was no material developments in our legal proceedings during the quarter ended December 31, 2009. The information set forth above under Part I, Item 1 note 11 contained in the Notes to Consolidated Condensed Financial
Statements is incorporated herein by reference.



|ITEM 1A. | RISK FACTORS
|-------- | ------------

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



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

Use of Proceeds from Public Offering of Common Stock

The effective date of
the registration statement for our initial public offering was July 2, 2007. As of December 31, 2009, the proceeds from our initial public offering have been invested in cash, cash equivalents and short term investments. None of the use of
the proceeds was made, directly or indirectly, to our directors, officers, or persons owning 10% or more of our common stock.



|ITEM 3. | DEFAULTS UPON SENIOR SECURITIES
|------- | -------------------------------

None.



|ITEM 4. | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
|------- | ---------------------------------------------------

We held our 2009 Annual Meeting of Stockholders on November 4, 2009. The first matter voted upon at the meeting was the election of three Class III directors to serve until the 2012 Annual Meeting of
Stockholders. At the meeting, Gary J. Daichendt, Michael Gregoire and Charles D. Kissner were elected as Class III directors, in an uncontested election, by the following vote:



|                   |  |            |  |               
|------------------ |  | ---------- |  | --------------
|Name               |  | Shares For |  | SharesWithheld
|Gary J. Daichendt  |  | 32,134,734 |  | 79,184        
|Michael Gregoire   |  | 32,134,734 |  | 79,184        
|Charles D. Kissner |  | 32,134,734 |  | 79,184        

Our board of
directors consists of eight members and is divided into three classes, with each class serving staggered three-year terms. The term of the Class I directors, Mark F. Bregman, John W. Combs. and Edward F. Thompson, will expire at the 2010 Annual
Meeting of Stockholders, and the term of the Class II directors, Edwin J. Basart and Kenneth D. Denman, will expire at the 2011 Annual Meeting of Stockholders.

The second matter voted upon at the meeting was the ratification of the appointment of Deloitte & Touche LLP as our independent registered public accounting firm for the fiscal year ending
June 30, 2010. At the meeting, the appointment of Deloitte & Touche LLP as our independent accountant was ratified by the following vote:



|           |  |               |  |                 
|---------- |  | ------------- |  | ----------------
|Shares For |  | SharesAgainst |  | SharesAbstaining
|32,153,802 |  | 55,395        |  | 4,721           



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|ITEM 5. | OTHER INFORMATION
|------- | -----------------

None.



|ITEM 6. | EXHIBITS
|------- | --------

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



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SIGNATURES

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

Date: February 5, 2010



ShoreTel, Inc.By:

/s/    MICHAEL E.
HEALYMichael E. Healy Chief Financial Officer




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EXHIBIT INDEX



|               |  |                                                                   
|-------------- |  | ------------------------------------------------------------------
|Exhibit Number |  | Exhibit Title                                                     
|3.01(1)        |  | Third Amended and Restated Bylaws                                 
|               | 
|31.1(2)        |  | Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer.
|               | 
|31.2(2)        |  | Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer.
|               | 
|32.1(2)        |  | Section 1350 Certification of Chief Executive Officer.            
|               | 
|32.2(2)        |  | Section 1350 Certification of Chief Financial Officer.            



|(1) | Incorporated by reference to the Registrants Quarterly Report on Form 10-Q for the quarter ended September 30, 2009 filed on November 9, 2009.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------

|(2) | This certification accompanying this report pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 is not deemed filed with the Securities and Exchange
Commission and is not to be incorporated by reference into any filing of the Company under the Securities Act of 1933 or the Securities Exchange Act of 1934 (whether made before or after the date of the Report), irrespective of any general
incorporation language contained in such filing.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

(b)Financial Statement Schedules.

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



33