---

---

UNITED STATES SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549


|Form 10-K
|---------
|         

|   |                                                                                          
|-- | -----------------------------------------------------------------------------------------
|x  | ANNUAL
 REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934    
|   | For the
 year ended June 30, 2010                                                        
|or
|o  | TRANSITION
 REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number: 001-33506

SHORETEL, INC.


(Exact name of Registrant as specified in its charter)


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

960 Stewart Drive 
Sunnyvale, CA 94085-3913 
(408) 331-3300(Address, including zip code, and telephone
number, including area code, of Registrants principal executive offices)Securities registered pursuant to
Section 12(b) of the Act: 
None.

Securities registered pursuant to Section 12(g) of the
Act: 
Shares of Common Stock, $0.001 par value

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

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

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 o

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 during the preceding
12 months (or for such shorter period that the registrant was required to
submit and post such files). Yes o No o

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

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

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

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

The
aggregate market value of the voting stock held by non-affiliates of the
registrant as of December 31, 2009 was approximately $116.3 million (based on
the last reported sale price of $5.78 on December 31, 2009 on The NASDAQ Global
Select Market). This calculation does not reflect a determination that persons
are affiliates for any other purposes. Shares of stock held by ten percent
stockholders have been excluded from this calculation as they may be deemed
affiliates.

The
number of shares outstanding of the registrants common stock as of September
1, 2010 was 45,490,124.

DOCUMENTS INCORPORATED BY REFERENCE

Part
III incorporates by reference certain information from the Registrants
definitive proxy statement (the 2010 Proxy Statement) for the 2010 Annual
Meeting of Stockholders.

---

---



TABLE OF CONTENTS

|           |                                                                                                         |  |     
|---------- | ------------------------------------------------------------------------------------------------------- |  | ----
|           |                                                                                                         |  | Page
|           |                                                                                                         |  |     
|           |                                                                                                         |  |     
|           | PART I                                                                                                  |  |     
|           |                                                                                                         |  |     
|Item
 1    | Business                                                                                                |  | 3   
|Item
 1A   | Risk
 Factors                                                                                           |  | 10  
|Item
 1B   | Unresolved
 Staff Comments                                                                              |  | 24  
|Item
 2    | Properties                                                                                              |  | 24  
|Item
 3    | Legal
 Proceedings                                                                                      |  | 24  
|Item
 4    | Reserved                                                                                                |  | 24  
|Item
 5    | Market
 for Our Common Stock and Related Stockholder Matters and Issuer Purchases of
 Equity Securities |  | 24  
|           |                                                                                                         |  |     
|           | PART II                                                                                                 |  |     
|           |                                                                                                         |  |     
|Item
 6    | Selected
 Consolidated Financial Data                                                                   |  | 29  
|Item
 7    | Managements
 Discussion and Analysis of Financial Condition and Results of Operations                  |  | 30  
|Item
 7A   | Quantitative
 and Qualitative Disclosures About Market Risk                                             |  | 44  
|Item
 8    | Financial
 Statements and Supplementary Data                                                            |  | 45  
|Item
 9    | Changes
 in and Disagreements with Accountants on Accounting and Financial Disclosure                   |  | 68  
|Item
 9A   | Controls
 and Procedures                                                                                |  | 68  
|Item
 9B   | Other
 Information                                                                                      |  | 71  
|           |                                                                                                         |  |     
|           | PART III                                                                                                |  |     
|Item
 10   | Directors
 and Executive Officers of the Registrant and Corporate Governance                            |  | 71  
|Item
 11   | Executive
 Compensation                                                                                 |  | 71  
|Item
 12   | Security
 Ownership of Certain Beneficial Owners and Management and Related Stockholder
 Matters        |  | 71  
|Item
 13   | Certain
 Relationships and Related Transactions, Director Independence                                  |  | 71  
|Item
 14   | Principal
 Accounting Fees and Services                                                                 |  | 71  
|           |                                                                                                         |  |     
|           | PART IV                                                                                                 |  |     
|Item
 15   | Exhibits
 and Financial Statement Schedules                                                             |  | 71  
|Signatures |                                                                                                         |  | 72  

---



TRADEMARKS

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

AVAILABLE INFORMATION

Our
Internet address is www.shoretel.com. On our Internet website, we make publicly
available free of charge our annual report on Form 10-K, quarterly reports on
Form 10-Q, current reports on Form 8-K, and amendments to those reports filed
or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act
of 1934 as soon as reasonably practicable after we electronically file such
material with, or furnish it to, the Securities and Exchange Commission.

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

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

- 2 -

---



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

|        |         
|------- | --------
|ITEM 1. | BUSINESS

Overview

We
are a leading provider of Internet Protocol, or IP, unified communications
systems for enterprises. Our systems are based on our distributed software
architecture and switch-based hardware platform which enable multi-site
enterprises to be served by a single system. Our 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, we believe our systems enable
enhanced end user productivity and provide lower total cost of ownership and
higher customer satisfaction than alternative systems.

Our
solution is comprised of ShoreTel Voice Switches, ShoreTel IP Phones and ShoreTel Software applications. We provide our systems to
enterprises across all industries, including small, medium and large companies
and public institutions. Our enterprise customers include multi-site Fortune
500 companies. As of June 30, 2010, we had sold our IP unified communications
systems to approximately 14,000 enterprise customers. We sell our systems
through our extensive network of over 800 channel partners.

We
have achieved broad industry recognition for our technology and high customer
satisfaction. We have won the best overall CustomerSat Acheivement award
(ACE) for three years in a row. For the last six years, IT executives surveyed
by Nemertes Research, an independent research firm, have rated ShoreTel highest
in customer satisfaction among leading enterprise unified communications
systems providers.

We
were originally incorporated in California in September 1996, and
reincorporated in Delaware in June 2007.

Products

We
provide a switch-based business communications systems for the enterprise. Our
solutions are based on our distributed software architecture and
appliance-based hardware platform that enable a single system to serve
multi-site enterprises. This architecture provides high network reliability and
allows for a single view of management and administration across all sites of a
multi-site enterprise. System administrators can make changes anywhere
throughout the system through a web browser interface that presents a
user-friendly view of the systems configuration. Our architecture also
provides end users with a consistent and full set of features across an
enterprise, regardless of location.

We
introduced our first suite of products in 1998 and have continued to add
features and functionality throughout our history. Our bundled solution is
comprised of ShoreTel Voice Switches, ShoreTel IP Phones and ShoreTel
System Software applications. As new
software versions of our solution have been released, existing enterprise
customers have been able to upgrade their switches, phones and applications,
allowing them to preserve their ShoreTel investment.

ShoreTel
Voice Switches. Our
switches provide call management functionality, and each switch in the system
is capable of independently establishing and terminating calls without relying
on a centralized call control server. As a result, enterprise unified
communications can survive a variety of LAN, WAN and hardware failures. The
high reliability of our switches is enhanced by two key design features: the
use of flash memory in lieu of disk drives and running an embedded operating
system optimized for real-time processing, such as call management. Unlike disk
drives, flash memory does not rely on mechanical movement, and therefore is
less likely to break down and cause our systems to fail. Furthermore, our
embedded operating system enables a higher performing and more reliable
software platform relative to server-centric IP systems because it is optimized
for real-time processing. The reliability of the system can be further improved
by adding an additional switch to the headquarters location to create n+1
redundancy, rather than requiring a dedicated back-up switch for each primary
switch to improve reliability as needed by alternative systems. In addition,
our switches connect to the public telephone network via one of several
interfaces, including high-density T1 and E1 interfaces. We offer a range of
switches of varying capabilities to meet the needs of enterprises of all sizes.
The modular nature of our switches allows our enterprise customers to easily
expand their system capacity by deploying additional switches across their
network.

- 3 -

---



ShoreTel
IP Phones. We offer
a range of innovative, high performance phones to meet the needs of the
different types of end users across the enterprise. Our phones are designed to
provide a superior combination of ergonomics, sound quality and appearance. We
offer a variety of phones that vary by size, display features, line capacity
and Gigabit Ethernet support. ShoreTel IP phones are designed to function
without any configuration, simplifying installation. Remote workers can also
utilize ShoreTel IP telephones using an integrated Virtual Private Network
(VPN) feature and mobile workers can select Wi-Fi phones that work with the
open interfaces of the system.

ShoreTel
Software applications.
Our software features a number of applications that facilitate the end user
experience and enterprise system management. In addition, we offer additional
business applications that integrate with core business processes to provide
enhanced end user productivity. An industry standard server is used to support
these applications, as opposed to the call management functions of our systems,
which run on switches. Our software consists of our proprietary software as
well as third-party applications and includes:

| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | ShoreTel
 Communicator. ShoreTel Communicator is a powerful unified
 communications (UC) application for users across an organization, whether an
 operator, a contact center agent, a knowledge worker or a road warrior.
 Available on multiple operating systems, ShoreTel Communicator makes it easy
 for people to communicate any way they choose: by video, voice (wired or
 wireless), instant messaging (IM), and more. One single interface makes
 training simple and reduces the IT workload because there is just a single
 application to support, and no additional servers to deploy and maintain.
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| |  | Office
 Anywhere. The
 Office Anywhere feature enables end users outside the office to manage calls
 with ShoreTel Communicator and to enjoy the same call handling productivity
 benefits as their office-based colleagues. Calls directed to the end users
 office phone are forwarded to the end users location, and the end users
 outbound calls appear to the called party as if they originated in the end
 users office. Using Office Anywhere, end users have the same call management
 and unified messaging features and functionality at remote locations as they
 have in their offices.         
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| |  | Unified
 Messaging. Unified
 Messaging integrates our voicemail application with Microsoft Outlook. This
 enables end users to receive, send, be notified of and play voice mail
 messages through their Microsoft Outlook email.                                                                                                                                                                                                                                                                                                                                                                                 
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| |  | Automated
 Attendant. Automated
 Attendant provides end users with a 24-hour automated call answering and
 routing capability that enables the enterprise to direct callers to
 appropriate individuals, workgroups or messages.                                                                                                                                                                                                                                                                                                                                                                                  
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| |  | ShoreTel
 Contact Center.
 Contact Center applications provide a range of features to satisfy the needs
 of all organizations, from basic call center capabilities to sophisticated
 distributed multimedia contact center capabilities. The virtual contact
 center is now a reality as Contact Center enables organizations to route
 incoming contacts to the most appropriate agent in a multisite contact
 center, regardless of location.                                                                                                                                                                   
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| |  | Converged
 Conferencing.
 ShoreTel Converged Conferencing enables enterprises to conduct large audio
 conferences and provides collaboration tools for application sharing, desktop
 sharing, instant messaging and end user presence information.                                                                                                                                                                                                                                                                                                                                                                
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| |  | Microsoft
 Integration. For
 customers seeking to leverage their investment in Microsofts Unified
 Communications portfolio, ShoreTel offers a range of integration options.
 Users can leverage their Microsoft Exchange messaging platform and Microsoft
 Office Communications Server installation with the ShoreTel solution as well
 as control their ShoreTel IP telephony using the Microsoft Office
 Communicator.                                                                                                                                                                                       
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| |  | System
 management. Our
 browser-based system management applications consist of ShoreTel Director.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| |  | ShoreTel
 Director. Director
 provides enterprises with a single point of system management, enabling IT
 administrators to view and manage the entire system of the enterprise from
 any location using a single application. A new end users extension, mailbox
 and automated attendant                                                                                                                                                                                                                                                                                                                       

- 4 -

---



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   | profile can be added from a
 single management screen, avoiding the additional work required with most
 Private Branch Exchanges (PBXs), voice mail systems and automated attendants.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |  | Business
 integration. We
 offer businesses the option to enhance their communication, enable their
 business applications pre-built solutions that integration with several
 customer relationship management (CRM) solutions (Salesforce.com, Microsoft
 Dynamics, Netsuite and RightNow) as well as cost recovery applications
 (Equitrak, Copitrak, and Lexis/Nexis Time Matters). These integrations are
 designed to improve the productivity of end users that use these applications
 by seamlessly integrating communications capabilities into their data-driven
 workflow. Customers or partners can create additional business integrations
 using the open interfaces of the system available for developers through
 ShoreTels Developer Network.

ShoreTel Global Services

We
complement our product offerings with a broad range of services that help us
maintain and expand our relationships with enterprise customers and channel
partners and, in the case of post-contractual support, provide us with
recurring revenue. Typically, our channel partners provide many of these
services, although we provide back up and escalation support as needed, or if
requested by the enterprise customer, we provide these services directly.

The
ShoreTel Global Services include post-contractual support, training, system
design and installation, and professional services as follows:

| |   |                                                                                                                                                                                                                                                                                                      
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Post-contractual support
 services include web-based access support services and tools, access to
 technical support engineers, hardware replacement and software updates. These
 services are typically offered under support contracts with terms of up to
 five years.                            
| |   |                                                                                                                                                                                                                                                                                                      
| |  | Training services include
 certification programs for channel partners, training programs at enterprise
 customer or channel partner locations and self-paced, desktop training
 programs.                                                                                                           
| |   |                                                                                                                                                                                                                                                                                                      
| |  | System design and
 installation services include the assessment of the unified communications
 requirements of a particular enterprise, the configuration of a system to
 maximize its efficiency, the management of the installation, and the
 subsequent testing and implementation of our systems.
| |   |                                                                                                                                                                                                                                                                                                      
| |  | Professional services
 include software development to improve system performance, enable
 integration of our systems with third party applications or legacy systems,
 streamline business processes and address enterprise customer-specific
 business opportunities.                              

Technology

Our
systems are based on a combination of our proprietary software,
industry-standard interfaces and protocols, and customized and off-the-shelf
hardware components. We have developed proprietary technologies that are
critical to the operation of the servers and ShoreTel Voice Switches within our
systems and provide our systems with the properties that distinguish them from
alternative IP systems.

The
key elements of our distributed software architecture are:

| |   |                                                                                                                                                                                    
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | software that allows a
 geographically-distributed system to operate and be managed as a single
 system;                                                                           
| |   |                                                                                                                                                                                    
| |  | software that enables
 calling between ShoreTel Voice Switches and allows calls to be distributed
 among Voice Switches instead of using a single centralized call control
 server;
| |   |                                                                                                                                                                                    
| |  | software that enables
 ShoreTel Voice Switches to obtain call routing information;                                                                                                 
| |   |                                                                                                                                                                                    
| |  | software that monitors the
 bandwidth consumed on each WAN segment and prevents the system from exceeding
 bandwidth limitations;                                                  
| |   |                                                                                                                                                                                    
| |  | software that monitors all
 call activity on Voice Switches, and enables integration of ShoreTel and
 third-party applications;                                                    
| |   |                                                                                                                                                                                    
| |  | software that coordinates
 the functions of all servers and Voice Switches on the system, allowing them
 to perform as a single, virtual server;                                   
| |   |                                                                                                                                                                                    
| |  | software that enables
 remote ShoreTel and third-party applications to access and modify our
 systems;                                                                             
| |   |                                                                                                                                                                                    
| |  | software that enables the
 Voices Switches to communicate with the application server, and receive
 system configuration information;                                              

- 5 -

---



| |   |                                                                                                                                                      
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------
| |  | software that allows each
 Voice Switch to maintain a comprehensive view of the system;                                                              
| |   |                                                                                                                                                      
| |  | software that provides a graphical
 user interface for our phones;                                                                                   
| |   |                                                                                                                                                      
| |  | software that allows the
 system to scale from small to large simply by adding additional components;
 and                                           
| |   |                                                                                                                                                      
| |  | software that allows
 centralized monitoring and management of the system independent of the geographical
 location of the users or system components

Our
switch-based software also uses industry-standard Session Initiation Protocol,
or SIP, and Media Gateway Control Protocol, or MGCP, for setting up calls.

ShoreTel
Voice Switches are comprised of off-the-shelf, embedded microprocessors and
networking components, such as ethernet controllers, and customized integrated
circuits. These Voice Switches run on an embedded operating system, and use
random access memory and flash memory and our switch call management software
for application processing. ShoreTel IP phones are comprised of enterprise IP
phone chips manufactured by Broadcom Corporation using customized LCD displays,
microphones speaker circuitry and custom software providing plug and play
installation and management, ease of use and a rich feature set.

ShoreTel
provides client and server-side application software for control and management
of IP phones for individuals, workgroups such as contact centers, as well as the
system manager. Client applications are available for personal computers,
mobile phones and web browsers.

Enterprise Customers

Our
enterprise customers include small, medium and large companies and public
institutions in a wide range of vertical markets, including professional
services, financial services, government, education, health care,
manufacturing, non-profit organizations, and technology industries. As of June
30, 2010, we had sold our IP unified communications systems to approximately
14,000 enterprise customers. Our broad enterprise customer base reflects our
historical strength in the small and medium-sized business and public
institution sectors.

We
believe that maintaining the highest possible levels of customer satisfaction
is critical to our ability to retain existing and gain new enterprise
customers. We believe that satisfied enterprise customers will purchase more of
our products and serve as advocates for our systems, and we work closely with
them as they deploy and use our systems. We follow implementation with a formal
review with the enterprise customer that involves contacts with our internal
staff and third-party technical personnel, and take prompt action to resolve
any issues that might have been identified. We also have frequent follow-up
contacts with our enterprise customers to promptly resolve issues and to ensure
that they are fully satisfied with their system. We also survey enterprise
customers that use technical support services to ensure that high-quality
support services are being provided. Through this process, we gain valuable
insights into the existing and future requirements of our enterprise customers
activities and this helps us develop product enhancements that address the
evolving requirements of enterprises.

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

We
also monitor our enterprise customers satisfaction with our channel partners
by surveying our enterprise customers after the system is installed. We
actively encourage our channel partners to maintain and improve our enterprise
customers levels of satisfaction. We also monitor our channel partners
satisfaction with ShoreTel, as their satisfaction with and advocacy of ShoreTel
is also very important to our success.

Sales and Marketing

We
sell our products and services primarily through an extensive network of
channel partners, including distributors in most international markets. As of
June 30, 2010, we had over 800 channel partners in our network. These channel
partners range in size from single-site, regional firms with specialized
products and services to multi-national firms that provide a full range of IT
products and services including the top three US telecommunication carriers:
AT&T, Verizon and Qwest. Our channel partners market and sell our products
into both the large enterprise and small-to-medium enterprise markets.

We
maintain a sales organization that recruits, qualifies and trains new channel
partners, participates in sales presentations to potential enterprise customers
and assesses customer feedback to assist in developing product roadmaps. As
part of our increased focus on sales to large accounts, we also have a major
accounts program whereby sales personnel assist

- 6 -

---



our channel
partners in selling to and providing support for large enterprise customer
accounts. No single channel partner accounted for 10 percent or more of our
total revenue in fiscal 2010.

We
believe our channel partner network allows us to effectively sell our systems
without the need to build large dedicated in-house sales and service
capabilities. We continue to work with existing channel partners to expand
their sales of our systems and to recruit new channel partners with a focus on
increasing market coverage.

Our
internal marketing team focuses on increasing brand awareness highlighting that
the ShoreTel solution is Brilliantly Simple compared to competitive
alternatives, communicating product advantages and generating qualified leads
for our sales force and channel partners. In addition to providing marketing
materials, we communicate product and service offerings through our
installed-base newsletters, e-mail and direct mail campaigns, print and
web-based advertising, press releases and web-based demonstrations.

Research and Development

We believe
that our ability to enhance our current products, develop and introduce new
products on a timely basis, maintain technological competitiveness and meet
enterprise customer requirements is essential to our success. To this end, we
have assembled a team of engineers with expertise in various fields, including
voice and IP communications, unified communications network design, data
networking and software engineering. Our principal research and development
activities are conducted in Sunnyvale, California and Austin, Texas. We have
invested significant time and financial resources into the development of our
architecture, including our switches and related software. We intend to
continue to expand our product offerings, improve the features available on our
products and integrate our systems with third-party enterprise applications.
Research and development expenses were $33.6 million, $30.7 million, and $26.8
million in fiscal 2010, 2009 and 2008, respectively.

Manufacturing and Suppliers

We
outsource the manufacturing of our hardware products. This outsourcing allows
us to:

| |   |                                                                                           
| | - | ------------------------------------------------------------------------------------------
| |  | avoid costly
 capital expenditures for the establishment of manufacturing operations;     
| |   |                                                                                           
| |  | focus on the
 design, development, sales and support of our hardware products; and        
| |   |                                                                                           
| |  | leverage the
 scale, expertise and purchasing power of specialized contract manufacturers.

Currently,
we have arrangements for the production of our switches with a contract
manufacturer in California and for the production of our phones with contract
manufacturers located in China. Our reliance on contract manufacturers involves
a number of potential risks, including the absence of adequate capacity,
ownership of certain elements of electronic designs, and reduced control over
delivery schedules. Our contract manufacturers provide us with a range of
operational and manufacturing services, including component procurement and
performing final testing and assembly of our products. We typically depend on
our contract manufacturers to procure components and to maintain adequate
manufacturing capacity. We typically fulfill product orders out of our Fremont,
California location or United Kingdom and Australia warehouses.

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

We
also rely on sole or limited numbers of suppliers for several key components
utilized in the assembly of our products. For example, our contract
manufacturers purchase semiconductors that are essential to the production of
our phones from a single source supplier, and we have not identified any
alternative suppliers for these components. This reliance is amplified by the
fact that our contract manufacturers maintain relatively low inventories and
acquire components only as needed. As a result, our ability to respond to
enterprise customer orders efficiently may be constrained by the then-current availability
or terms and pricing of these components. Constraints on our ability to respond
efficiently is partially offset by build-up of levels of safety stock inventory
which lets us respond to our enterprise customer orders in a timely manner. We
cannot assure you that we will be able to obtain a sufficient quantity of these
components in a timely manner to meet the demands of our enterprise customers
or that prices of these components will not increase. In addition, we cannot
assure you that our suppliers continue to offer components that we need. Any
delays or any disruption of the supply of these components could also
materially and adversely affect our operating results.

Financial Information about Geographic Areas

- 7 -

---



For financial information about
geographic areas, refer to Note 10 of the notes to the Consolidated Financial
Statements in Item 8 of this report.

Competition

The market
for enterprise IP unified communications systems is quickly evolving, highly
competitive and subject to rapid technological change. As a result of the
convergence of voice, video, messaging and data networking technologies that
characterize IP enterprise unified communications systems, we compete with
providers of enterprise unified communications systems, such as:

| |  |   |                                                                                                                                              
| |  | - | ---------------------------------------------------------------------------------------------------------------------------------------------
| |  |  | Providers of
 IP systems, including Cisco Systems                                                                                            
| |  |   |                                                                                                                                              
| |  |  | Providers of
 hybrid IP/TDM communication systems, including Aastra, Avaya, Alcatel-Lucent,
 Mitel Networks, NEC, Nortel Networks and Siemens
| |  |   |                                                                                                                                              
| |  |  | Providers of
 Unified Communications software applications providers, including Microsoft                                                    
| |  |   |                                                                                                                                              
| |  |  | Providers of
 Hosted PBX services from service providers, including ILECs and CLECs                                                          
| |  |   |                                                                                                                                              
| |  |  | Providers of
 Computer Server technologies bundles with telephony applications, including
 Hewlett-Packard.                                  

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

We
may face competition from internet portal focused providers extend their
portfolio to include business communications solutions, such and Google and
Yahoo.

In
particular, as more enterprises converge their voice and data networks, the
business information technology and communication applications deployed on
converged networks become more integrated. We may face increased competition
from current leaders in information technology infrastructure, information
technology, personal and business applications and the software that connects
the network infrastructure to those applications. This could include network
systems providers such as Brocade, Hewlett-Packard, and Juniper.

We
could also face competition from new market entrants, whether from new ventures
or from established companies moving into the market. Competition from these
and other potential market entrants may take many forms, including offering
products and applications similar to those we offer as part of a larger,
bundled offering. In addition, technological developments and consolidation
within the communications industry result in frequent changes to our group of
competitors. Many of our current and potential competitors are substantially
larger than we are and have higher brand familiarity with buyers, and
significantly greater financial, sales, marketing, and distribution, technical,
manufacturing and other resources. We believe that we currently compete
favorably with regard to the principal competitive factors applicable to our
products, which include:

| |  |   |                                                                                                                                                                                                      
| |  | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  |  | Lower
 selling costs for resellers and distributors with ease of implementation                                                                                                                      
| |  |   |                                                                                                                                                                                                      
| |  |  | Lowest total
 cost of ownership over a multi-year period compared to competitors IP and
 hybrid system backed by independent data from third parties such as Alinean
 Research and Nemertes Research
| |  |   |                                                                                                                                                                                                      
| |  |  | Highest rating in customer
 satisfaction, as reported by an independent third party, Nemertes Research
 for the last six years in a row                                                              
| |  |   |                                                                                                                                                                                                      
| |  |  | Superior product
 scalability without forklift upgrades from 10 to 10,000 users in a single
 image configuration                                                                                     
| |  |   |                                                                                                                                                                                                      
| |  |  | World class
 customer service and support from technicians and support centers located
 around the world                                                                                             
| |  |   |                                                                                                                                                                                                      
| |  |  | Greater ease of
 management for system administrators                                                                                                                                                
| |  |   |                                                                                                                                                                                                      
| |  |  | Intuitive productivity
 tools for employees with integrated unified communications capabilities                                                                                                      

- 8 -

---



| |  |   |                                                                                           
| |  | - | ------------------------------------------------------------------------------------------
| |  |  | Highest
 system availability and reliability with our N+1 distributed switch
 architecture

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

Intellectual
Property

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

We
have 16 patents issued in the United States, and have 41 patent applications in
the United States. We also have five foreign patents and four patent
applications relating to our United States patents.

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

Employees

As
of June 30, 2010, we had 479 employees in North America, Europe, Asia and
Australia, of which 158 were in sales and marketing, 168 were in engineering,
81 were in global support services, 47 were in general and administrative
functions and 25 were in operations. None of our employees are represented by
labor unions and we consider current employee relations to be good.

Executive
Officers

The
following table sets forth information about our executive officers as of
September 1, 2010:

| |                    |  |     |  |                                                
| | ------------------ |  | --- |  | -----------------------------------------------
| | Name               |  | Age |  | Position                                       
| |                    |  |     |  |                                                
| |                    |  |    
| | John W.
 Combs     |  | 63  |  | President
 and Chief Executive Officer         
| | Donald J.
 Girskis |  | 50  |  | Senior Vice
 President, Worldwide Sales        
| | Michael E.
 Healy  |  | 49  |  | Chief
 Financial Officer                       
| | Edwin J.
 Basart   |  | 61  |  | Founder,
 Chief Technology Officer and Director
| | Pedro E.
 Rump     |  | 54  |  | Vice
 President, Engineering and Operations    
| | Ava M. Hahn        |  | 37  |  | Vice
 President, General Counsel and Secretary 

John
W. Combs has served as our President and Chief
Executive Officer and as a director since July 2004. In addition, Mr. Combs
served as our Chairman from February 2007 to July 2010. From July 2002 to May
2004, Mr. Combs served as Chairman and Chief Executive Officer of Littlefeet
Inc., a wireless infrastructure supplier. From September 1999 to July 2002, Mr.
Combs served as Chief Executive Officer of InternetConnect Inc., a broadband
networking solutions provider. Mr. Combs has also held senior management
positions at Nextel Communications, Inc., a wireless digital communications
system provider, L.A. Cellular, a wireless network operator, Mitel Inc., a
manufacturer of private branch exchanges and Fujitsu Business Communication
Systems, Inc., a provider of telecommunications products. Mr. Combs holds a
B.S. in engineering from California Polytechnic State University, San Luis
Obispo. Mr. Combs will be leaving our company as President and Chief Executive
Officer as of September 30, 2010 and will not be standing for reelection as a
Board member.

Donald
J. Girskis has served as our Senior Vice President of
Worldwide Sales since February 2008. Mr. Girskis has been appointed interim
Chief Executive Officer, effective October 1, 2010. From 1993 to 2008, Mr.
Girskis held a variety of executive positions at Sprint-Nextel, a
telecommunications company, most recently as the Senior Vice President and
General Manager of Boost Mobile, a subsidiary of Sprint-Nextel. At Nextel, Mr.
Girskis held the position of Area Vice President of

- 9 -

---



Sales, Area
Vice President of Marketing, Vice President of Engineering, and General
Manager. Prior to Sprint-Nextel, Mr. Girskis held sales management positions
with Businessland, and Los Angeles Cellular Telephone Company. Mr. Girskis
holds a B.A. in business administration from California State University at
Fullerton.

Michael
E. Healy has served as our Chief Financial Officer
since May 2007. From February 2004 to May 2007, he served as Chief Financial
Officer and Senior Vice President of Finance of Genesis Microchip Inc., a
supplier of display image processors. From November 2002 to February 2004, Mr.
Healy served as Chief Financial Officer of Jamcracker, Inc., a software and
application service provider. From September 1997 to June 2002, Mr. Healy held
senior level finance positions at Exodus Communications, Inc., an Internet
infrastructure outsourcing services provider (Exodus Communications sold
substantially all of its assets in January 2002 and changed its name to EXDS,
Inc. in February 2002), including as Senior Vice President of Finance prior to
February 2002, and as its Chief Financial Officer and Corporate Treasurer from
February 2002 to June 2002. From 1987 to 1997, Mr. Healy held various financial
management positions at Apple Computer, Inc., and was an auditor at Deloitte
& Touche LLP from 1983 to 1987. Mr. Healy holds a B.S. in accounting from
Santa Clara University and is a Certified Public Accountant. Mr. Healy is a
member of the American Institute of Certified Public Accountants and the
California Society of Certified Public Accountants.

Edwin
J. Basart co-founded ShoreTel in 1996 and has served
as our Chief Technology Officer and as a director since inception. Prior to
co-founding ShoreTel, Mr. Basart co-founded Network Computing Devices, Inc., a
provider of thin client computing hardware and software, where he served as
Vice President of Engineering, and Ridge Computers, Inc. where he served as
Vice President of Software. Mr. Basart began his career as a software engineer
at Hewlett Packard. Mr. Basart holds a B.S. in English from Iowa State
University and an M.S. in electrical engineering from Stanford University.

Pedro
E. Rump has served as our Vice President of Engineering
and Operations since January 2006. From July 2004 to January 2006, Mr. Rump
served as Vice President of Engineering and Operations at Dust Networks, Inc.,
a developer of embedded wireless sensor networking products. From January 2004
to July 2004, Mr. Rump served as Vice President of Engineering at Sonim
Technologies, Inc., a provider of voice over IP applications. From January 2003
to January 2004, Mr. Rump served as Vice President of Engineering at Littlefeet
Inc. From January 2002 to October 2002, Mr. Rump served as Vice President of
Inviso, a developer of signal transport and display solutions for television
and telecommunications. Mr. Rump holds a B.S. and M.S. in electrical
engineering from the Swiss Federal Institute of Technology.

Ava
M. Hahn has served
as our Vice President, General Counsel and Secretary since May 2009. Ms. Hahn
joined ShoreTel in June 2007 serving in the position of General Counsel and
Secretary. From August 2002 to May 2007, Ms. Hahn served as General Counsel, Assistant
General Counsel and Secretary for Genesis Microchip, Inc., a supplier of
display image processors. From August 2000 to August 2002, Ms. Hahn served as
Director, Legal Affairs for LuxN, Inc., a provider of optical access equipment.
Prior to then, Ms. Hahn was in private practice at Wilson Sonsini Goodrich
& Rosati, P.C. Ms. Hahn holds a J.D. from Columbia Law School and a B.A.
from the University of California, Berkeley.

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

Risks Related to Our Business and Industry

We
may not be able to return to profitability.

We
were not profitable on a GAAP basis in the fiscal years ended June 30, 2010 and
2009, and we had an accumulated deficit of $108.2 million as of June 30, 2010.
If we are not able to grow our revenues or maintain our operating expenses at
appropriate levels based on those revenues, we may not succeed in achieving or
maintaining profitability in future periods. We also incur significant
operating expenses and have recently announced that we plan to increase
operating expenses in order to fund our growth. If our gross profit does not
increase to offset these expected increases in operating expenses, our
operating results will be negatively affected. You should not consider our
historic annual revenue growth rates as indicative of our future growth
particularly in light of the current economic environment. Accordingly, we
cannot assure you that we will be able to return to significant revenue growth
or profitability in the future.

Current
uncertainty in global economic conditions makes it particularly difficult to
predict demand for our products, and makes it more likely that our actual
results could differ materially from expectations.

Our
operations and performance depend on worldwide economic conditions, which have
been depressed in the United States and other countries, and may remain
depressed for the foreseeable future. These conditions make it difficult for
our customers and potential customers to accurately forecast and plan future
business activities, and have caused our customers and potential customers to
slow or reduce spending on capital equipment such as our products. These
economic conditions could also cause our competitors to drastically reduce
prices or take unusual actions to gain a competitive edge, which could force us
to provide similar discounts and thereby reduce our profitability. We cannot
predict the timing, strength or duration of the current economic slowdown or
subsequent economic recovery, worldwide, in the United States, or in our

- 10 -

---



industry.
These and other economic factors could have a material adverse effect on demand
for our products and services, and on our financial condition, including
profitability and operating results.

Our
business could be harmed by adverse economic conditions in our target markets,
reduced spending on information technology and telecommunication products by
customers and potential customers, and the tightening of the credit markets.

Our
business depends on the overall demand for information technology, and in
particular for telecommunications systems. The market we serve is emerging and
the purchase of our products involves significant upfront expenditures. In
addition, the purchase of our products can be discretionary and may involve a
significant commitment of capital and other resources. In many cases, our
resellers and/or end customers procure our products and services on credit. If
credit is not available to them, it may be difficult or impossible for our
resellers and/or end customers to purchase our products. Weak economic
conditions in our target markets, or a reduction in information technology or
telecommunications spending even if economic conditions improve, would likely
adversely impact our business, operating results and financial condition in a
number of ways, including longer sales cycles, lower prices for our products
and reduced unit sales.

We
have had significant executive management turnover, and may not be able to retain
or attract the executives we need to succeed.

We
have had significant turnover in our executive team. Our Chief Executive
Officer John W. Combs, resigned in July 2010 and will continue to serve as our
CEO until September 30, 2010. Though we have commenced a search for his
successor, we cannot predict how long such a search will take. Our Vice
President of Global Services, Walter Weisner, also recently left the company
and we have not yet hired his replacement.

We
cannot assure you that we will be able to attract executives to replace Mr.
Combs or Mr. Weisner in a timely manner, or that we will be able to retain
them. We also cannot assure you that we will be able to retain other key
employees, including senior management and executive positions. If we cannot
attract and retain these executives and key employees, our business would be
harmed, particularly if the departure of any executive or key employee results
in a business interruption, or if we are not successful in preserving material
knowledge of our departing employees.

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

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

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

Substantially
all of our total revenue is generated through indirect channel sales. These
indirect sales channels consist of third-party resellers that market and sell
telecommunications systems and other products and services to customers. We
expect indirect channel sales will continue to generate a substantial majority
of our total revenue in the future. Therefore, our success is highly dependent
upon establishing and maintaining successful relationships with third-party
resellers, and the financial health of these resellers.

Many of the
resellers we recruit never generate significant revenues for us. Recruiting,
launching and retaining qualified channel partners and training them in our
technology and products requires significant time and resources. In order to
develop and expand our distribution channel, we must continue to recruit larger
and more productive channel partners. We must also scale and improve our
processes and procedures that support our channel, including investment in
personnel, systems and training, and those processes and procedures may become
increasingly complex and difficult to manage.

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

- 11 -

---



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

Our
success in expanding our customer base to larger enterprises will depend in
part on our ability to expand our channel to partners that serve those larger
enterprises. In addition, we rely on these entities to provide many of the
installation, implementation and support services for our products.
Accordingly, our success depends in large part on the effective performance of
these channel partners. If a partners performance is ineffective, it may
reflect badly upon ShoreTel or negatively impact our business. For example, if
one of these resellers experiences a work stoppage due to a labor union
dispute, installation of our phone systems could be delayed and our sales and
reputation could suffer. By relying on channel partners, we may in some cases
have little or no contact with the ultimate users of our products, thereby
making it more difficult for us to establish brand awareness, ensure proper
delivery and installation of our products, service ongoing enterprise customer requirements
and respond to evolving enterprise customer needs. This difficulty could be
more pronounced in international markets, where we expect that enterprise
customers will purchase our systems from a channel partner that purchased
through a distributor. Additionally, some of our channel partners are smaller
companies that may not have the same financial resources as other of our larger
channel partners, which exposes us to collections risks.

As
a result of the ongoing credit contraction in the credit markets, our channel
partners may have their credit lines withdrawn or may not be able to procure
financing necessary to purchase our products, or maintain their business.
Additionally, as a result of the current economic downturn, the businesses of
our channel partners are being adversely affected. Our channel partners could
be unable to devote the same level of resources to selling and marketing our
systems, or worse, they could discontinue operations. In such event, we must
find another channel partner to support the failed partners customers, or take
on support of those customers ourselves, even if we have not been paid to do
so. If our resellers cannot continue to purchase our products, or if they cease
operations, our ability to collect receivables, our operating results and our
financial condition will be materially adversely affected.

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

We
plan to further expand our operations, particularly in sales headcount, channel
partnerships, and the number and size of enterprise customers implementing our
systems. We will need to increase our operating expenses in order to fund this
expansion and support larger customers. This growth will place a significant
strain on our management, administrative, operational and financial
infrastructure. Our success will depend upon our ability to manage this growth
effectively. If we do not increase our revenues commensurate to our increased
spending, we will not be profitable. To manage the expected growth of our
operations and personnel, we will need to continue to improve our operational,
financial and management controls and our reporting systems and procedures.
Failure to effectively manage growth could result in difficulty in filling
enterprise customer orders, declines in product quality or customer
satisfaction, increases in costs, production and distribution difficulties, and
any of these difficulties could adversely impact our business performance and
results of operations.

If
we fail to increase our consideration rate, our business could suffer.

We
estimate that we compete for only a fraction of the potential customers in our
market due to our smaller size and lower brand recognition as compared to our
much larger competitors. Many of our potential customers purchase their
communications systems without ever having considered ShoreTel. We have
recently launched a brand recognition campaign in an effort to increase our
rate of consideration by prospective customers. If we do not increase our brand
recognition and public awareness of our products, we may not be able to enter
the sales process for many potential customers and therefore not increase sales
and revenues commensurate with our increased operating expenses, which would
have a negative financial impact on our business.

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

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

We
depend on our contract manufacturers to finance the production of goods ordered
and to maintain adequate manufacturing capacity. Global economic conditions
could adversely impact the financial condition of our contract manufacturers
and their suppliers that could impact our contract manufacturers ability to procure
components or otherwise manufacture our products. Additionally, as a result of
the current economic downturn, the businesses of our contract manufacturers and
other suppliers could be adversely affected and they may be required to slow or
curtail operations. We do

- 12 -

---



not exert
direct control over our contract manufacturers or suppliers of our contract
manufacturers, so we may be unable to procure timely delivery of acceptable
products to our enterprise customers or incur substantially higher product
costs if we move production to other contract manufacturers.

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

In
addition, our contract manufacturers do not have any written contractual
obligation to accept any purchase order that we submit for the manufacture of
any of our products nor do we have any assurance that our contract
manufacturers will agree to manufacture and supply any or all of our
requirements for our products. Furthermore, our contract manufacturers may
unilaterally terminate their relationship with us at any time upon 180 days
notice with respect to the contract manufacturers of our switches and 90 days
notice with respect to the contract manufacturer of our phones or seek to
increase the prices they charge us. As a result, we are not assured that our
current manufacturers will continue to provide us with an uninterrupted supply
of products of at an acceptable price in the future.

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

If
our contract manufacturers are unable or unwilling to continue manufacturing
our products in required volumes and to meet our quality specifications, or if
they significantly increase their prices, whether caused by uncertain global
economic conditions, tightening of the credit markets, their weak financial
condition or otherwise, we will have to procure components on their behalf in
the short term and identify one or more acceptable alternative contract
manufacturers. The process of identifying and qualifying a new contract
manufacturer can be time consuming, and we may not be able to substitute
suitable alternative contract manufacturers in a timely manner or at acceptable
prices. Additionally, transitioning to new contract manufacturers may cause
delays in supply if the new contract manufacturers have difficulty
manufacturing products to our specifications or quality standards and may
result in unexpected costs to our business. Furthermore, we do not own the
electronic design for our IP phones, hence it may be more difficult or costly
for us to change the contract manufacturer of our phones or to arrange for an
alternate of or a replacement for these products in a timely manner should a
transition be required. This could also subject us to the risk that our
competitors could obtain phones containing technology that is the same as or
similar to the technology in our phones.

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

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

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

| |   |                                                                                                  
| | - | -------------------------------------------------------------------------------------------------
| |  | greater
 market presence, name recognition and brand reputation;                                 
| |   |                                                                                                  
| |  | larger
 distribution channels;                                                                   
| |   |                                                                                                  
| |  | a larger
 installed base of telecommunications and networking systems with enterprise
 customers;
| |   |                                                                                                  
| |  | larger and
 more geographically distributed services and support organizations and
 capabilities;
| |   |                                                                                                  
| |  | a broader
 offering of telecommunications and networking products, applications and
 services;   

- 13 -

---



| |   |                                                                                                                                
| | - | -------------------------------------------------------------------------------------------------------------------------------
| |  | a more
 established international presence to address the needs of global
 enterprises;                                        
| |   |                                                                                                                                
| |  | larger
 patent and intellectual property portfolios;                                                                           
| |   |                                                                                                                                
| |  | longer
 operating histories;                                                                                                   
| |   |                                                                                                                                
| |  | a longer
 history of implementing large-scale telecommunications or networking systems;                                        
| |   |                                                                                                                                
| |  | more
 established relationships with industry participants, customers, suppliers,
 distributors and other technology companies;
| |   |                                                                                                                                
| |  | the ability
 to acquire technologies or consolidate with other companies in the industry
 to compete more effectively; and     
| |   |                                                                                                                                
| |  | the ability
 to bundle a broader offering of telecom and networking equipment and services
 into an IP PBX offering.           

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

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

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

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

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

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

The
convergence of voice and data networks and their wider deployment by
enterprises has led information technology and communication applications
deployed on converged networks to become more integrated. This
integration has created an opportunity for the leaders in information
technology, personal and business applications and the software that connects
the network infrastructure to those applications, to enter the
telecommunications market and offer products that compete with our systems,
commonly referred to as Unified Communications. Competition from these
potential market entrants may take many forms, and they may offer products and
applications similar to those we offer. For example, Microsoft Corporation has
announced its unified communications product roadmap. This includes Office
Communicator 2007, which Microsoft states allows end users to control
communications, including voice over IP, through the Office Communicator
application on their PC, which provides functionality that competes with our
ShoreTel Communicator application. Microsoft has also introduced Office
Communications Server 2007, a product that offers competing unified messaging
capabilities. Microsoft has also developed an IP phone and has licensed the
rights to produce such phones to third

- 14 -

---



parties.
Microsoft and other leaders in the information technology, personal and
business applications and software industries, have substantial financial and
other resources that they could devote to this market.

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

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

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

| |   |                                                                                                               
| | - | --------------------------------------------------------------------------------------------------------------
| |  | initial
 costs of implementation for a new system;                                                            
| |   |                                                                                                               
| |  | quality of
 infrastructure;                                                                                   
| |   |                                                                                                               
| |  | security
 concerns;                                                                                           
| |   |                                                                                                               
| |  | equipment,
 software or other technology failures;                                                            
| |   |                                                                                                               
| |  | regulatory
 encroachments;                                                                                    
| |   |                                                                                                               
| |  | inconsistent
 quality of service;                                                                             
| |   |                                                                                                               
| |  | perceived
 unreliability or poor voice quality over IP networks as compared to
 circuit-switched networks; and
| |   |                                                                                                               
| |  | lack of
 availability of cost-effective, high-speed network capacity.                                         

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

Even
if enterprise IP telecommunications systems become more widespread in the
future, we cannot assure you that our products will attain broad market
acceptance. We estimate that our sales represent a very small percentage of the
total available market for enterprise IP telecommunications systems. We must
increase our market penetration in order to maintain and expand our business.

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

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

| |   |                                                                           
| | - | --------------------------------------------------------------------------
| |  | the timing
 of enterprise customers budget cycles and approval processes;
| |   |                                                                           
| |  | a technical
 evaluation or trial by potential enterprise customers;       

- 15 -

---



| |   |                                                                                                                                         
| | - | ----------------------------------------------------------------------------------------------------------------------------------------
| |  | our ability
 to introduce new products, features or functionality in a manner that suits
 the needs of a particular enterprise customer;
| |   |                                                                                                                                         
| |  | the
 announcement or introduction of competing products; and                                                                            
| |   |                                                                                                                                         
| |  | the strength
 of existing relationships between our competitors and potential enterprise
 customers.                                    

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

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

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

| |   |                                
| | - | -------------------------------
| |  | supplier
 capacity constraints;
| |   |                                
| |  | price
 increases;              
| |   |                                
| |  | purchasing
 lead times;        
| |   |                                
| |  | timely
 delivery; and          
| |   |                                
| |  | component
 quality.            

This
reliance is exacerbated by the fact that we maintain a relatively small amount
of inventory and our contract manufacturers typically acquire components only
as needed. As a result, our ability to respond to enterprise customer orders
efficiently may be constrained by the then-current availability or the terms
and pricing of these components. Disruption or termination of the supply of
these components could delay shipments of our products and could materially and
adversely affect our relationships with current and prospective enterprise
customers. Also, from time to time we have experienced component quality issues
with products obtained from our contract manufacturers. In addition, any
increase in the price of these components could reduce our gross margin and
adversely impact our profitability. We may not be able to obtain a sufficient
quantity of these components to meet the demands of enterprise customers in a
timely manner or that prices of these components may increase. In addition,
problems with respect to yield and quality of these components and timeliness
of deliveries could occur. These delays could also materially and adversely
affect our operating results.

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

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

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

- 16 -

---



We
generate forecasts of future demand for our products several months prior to
the scheduled delivery to our prospective customers and typically prior to
receiving a purchase order from our customers. We therefore make significant
investments before our resellers or customers place orders to purchase our
products and before we know if corresponding shipment forecasts will be
changed. Our resellers and customers are not contractually bound by the
forecasts they provide us until they sign a purchase order, and the orders we
ultimately receive often differ from original forecasts. If we underestimate
demand for our products, we will have inadequate inventory, which could result
in delays in shipments, loss of orders and reduced revenues. This is
exacerbated by the fact that lead times for materials and components that we
need can vary significantly and depend on factors such as the specific
supplier, contract terms and demand for each component at a given time. On the
other hand, if we overestimate demand for our products and increase our
inventory in anticipation of customer orders that do not materialize, we will
have excess inventory and we will face a risk of significant inventory
write-downs. Our failure to forecast demand accurately on a timely basis could
result in a decrease in our revenues and gross margins.

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

Our
future growth depends on our ability to develop and introduce new products
successfully. Due to the complexity of the type of products we produce, there
are significant technical risks that may affect our ability to introduce new
products and features successfully. For example, our future success will depend
in part on our ability to introduce new applications such as contact center
systems, which are based on complex software, and our ability to integrate our
products with other business applications, such as Microsoft Office. As another
example, we believe there is increasing demand for communications as a managed
service, either on mobile phones or desk phones, whether ours or another
vendors.

In
addition, we must commit significant resources to developing new products and
features before knowing whether our investments will result in products that
are accepted by the market. The success of new products depends on many
factors, including:

| |   |                                                                                                     
| | - | ----------------------------------------------------------------------------------------------------
| |  | the ability
 of our products to compete with the products and solutions offered by our
 competitors;
| |   |                                                                                                     
| |  | the cost of
 our products;                                                                          
| |   |                                                                                                     
| |  | the
 reliability of our products;                                                                   
| |   |                                                                                                     
| |  | the
 timeliness of the introduction and delivery of our products; and                               
| |   |                                                                                                     
| |  | the market
 acceptance of our products.                                                             

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

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

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

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

- 17 -

---



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

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

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

| |                                                                                               
| | ----------------------------------------------------------------------------------------------
| | We intend to expand our
 international operations, which could expose us to significant risks.

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

| |   |                                                                                                                                                                                                                                     
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | our ability to comply with differing technical and environmental
 standards and certification requirements outside the United States;                                                                                               
| |   |                                                                                                                                                                                                                                     
| |  | difficulties and costs associated with staffing and managing foreign
 operations;                                                                                                                                                   
| |   |                                                                                                                                                                                                                                     
| |  | lower gross margins due to higher discounting;                                                                                                                                                                                      
| |   |                                                                                                                                                                                                                                     
| |  | greater difficulty collecting accounts receivable and longer payment
 cycles;                                                                                                                                                       
| |   |                                                                                                                                                                                                                                     
| |  | the need to adapt our products for specific countries;                                                                                                                                                                              
| |   |                                                                                                                                                                                                                                     
| |  | availability of reliable broadband connectivity and wide area
 networks in targeted areas for expansion;                                                                                                                            
| |   |                                                                                                                                                                                                                                     
| |  | unexpected changes in regulatory requirements;                                                                                                                                                                                      
| |   |                                                                                                                                                                                                                                     
| |  | difficulties in understanding and complying with local laws,
 regulations and customs in foreign jurisdictions;                                                                                                                     
| |   |                                                                                                                                                                                                                                     
| |  | tariffs, export controls and other non-tariff barriers such as quotas
 and local content rules;                                                                                                                                     
| |   |                                                                                                                                                                                                                                     
| |  | more limited protection for intellectual property rights in some
 countries;                                                                                                                                                        
| |   |                                                                                                                                                                                                                                     
| |  | adverse tax consequences;                                                                                                                                                                                                           
| |   |                                                                                                                                                                                                                                     
| |  | fluctuations in currency exchange rates, which could increase the
 price of our products outside of the United States, increase the expenses of
 our international operations and expose us to foreign currency exchange rate
 risk;
| |   |                                                                                                                                                                                                                                     
| |  | restrictions on the transfer of funds;                                                                                                                                                                                              
| |   |                                                                                                                                                                                                                                     
| |  | new and different sources of competition;                                                                                                                                                                                           
| |   |                                                                                                                                                                                                                                     
| |  | less access to the end customer due to our use of two-tier
 distribution internationally.                                                                                                                                           

- 18 -

---



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

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

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

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

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

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

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

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

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

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

Although we
anticipate that our current cash, cash equivalents and short-term investments
on hand will be sufficient to meet our currently anticipated cash needs, if our
cash and cash equivalents balances are not sufficient to meet our future cash
requirements, we will need to seek additional capital, potentially through debt
or equity financings, to fund our operations. We may also need to raise
additional capital to take advantage of new business or acquisition
opportunities. We may seek to raise capital by, among other things:

| |   |                                                            
| | - | -----------------------------------------------------------
| |  | issuing additional common stock or other equity securities;
| |   |                                                            
| |  | issuing debt
 securities; or                               
| |   |                                                            
| |  | borrowing funds under a credit facility.                   

- 19 -

---



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

We
are exposed to fluctuations in the market value of our money market funds and
investments and financial pressure on investment institutions managing our
investments may lead to restrictions on access to our investments which could
harm our financial condition.

We maintain
an investment portfolio of various holdings and maturities. These securities
are recorded on our consolidated balance sheets at fair value. This portfolio
includes money market funds, bonds and commercial paper of various issuers. If
the debt of these issuers is downgraded, the carrying value of these
investments could be impaired. In addition, we could also face default risk
from some of these issuers, which could also cause the carrying value to be
impaired.

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

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

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

Our
success and ability to compete are substantially dependent upon our
intellectual property. We rely on patent, trademark and copyright law, trade
secret protection and confidentiality or license agreements with our employees,
enterprise customers, strategic partners and others to protect our intellectual
proprietary rights. However, the steps we take to protect our intellectual
property rights may be inadequate. We currently have 16 issued U.S. patents and
a 41 patent applications pending in the U.S. and outside the U.S. We cannot
assure you that any additional patents will be issued. Even if patents are
issued, they may not adequately protect our intellectual property rights or our
products against competitors, and third-parties may challenge the scope,
validity and/or enforceability of our issued patents. In addition, other
parties may independently develop similar or competing technologies designed
around any patents that may be issued to us.

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

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

There
is considerable patent and other intellectual property development activity in
our industry. Our success depends, in part, upon our not infringing upon the
intellectual property rights of others. Our competitors, as well as a number of
other entities and individuals, own or claim to own intellectual property relating
to our industry and may have substantially larger and broader patent portfolios
than we do. From time to time, third parties may claim that we are infringing
upon their intellectual property rights, and we may be found to be infringing
upon such rights. Third parties have in the past sent us correspondence
regarding their intellectual property and have filed litigation against us, and
in the future we may receive claims that our products infringe or violate their
intellectual property rights. In this regard, in 2007, Mitel Networks
Corporation, one of our competitors, filed a lawsuit against us, which was
subsequently settled. Furthermore, we may be unaware of the intellectual
property rights of others that may cover some or all of our technology or
products. Any claims or litigation could cause us to incur significant expenses
and, if successfully asserted against us, could require that we pay

- 20 -

---



substantial
damages or ongoing royalty payments, prevent us from selling our products,
damage our reputation, or require that we comply with other unfavorable terms,
any of which could materially harm our business. In addition, we may decide to
pay substantial settlement costs in connection with any claim or litigation,
whether or not successfully asserted against us. Even if we were to prevail,
any litigation regarding our intellectual property could be costly and
time-consuming and divert the attention of our management and key personnel
from our business operations.

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

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

The
Sarbanes-Oxley Act of 2002 requires, among other things, that we establish and
maintain internal control over financial reporting and disclosure controls and
procedures. In particular, under the current rules of the SEC, we must perform
system and process evaluation and testing of our internal control over
financial reporting to allow management to report on the effectiveness of our
internal control over financial reporting, as required by Section 404 of the
Sarbanes-Oxley Act. Our independent registered public accounting firm is also
required to report on our internal control over financing reporting. Our and
our auditors testing may reveal deficiencies in our internal control over
financial reporting that are deemed to be material weaknesses and render our
internal control over financial reporting ineffective. For example, as a result
of an error in the computation of the forfeiture rate used in computing our
stock-based compensation expense, we determined that we had a material weakness
in our internal control over financial reporting as of June 30, 2009. We have
remediated this material weakness as of June 30, 2010. We have incurred and we
expect to continue to incur substantial accounting and auditing expense and
expend significant management time in complying with the requirements of
Section 404. If we are not able to comply with the requirements of Section 404
in a timely manner, or if we and our independent registered public accounting
firm identify deficiencies in our internal control over financial reporting
that are deemed to be material weaknesses, the market price of our stock could
decline and we could be subject to investigations or sanctions by the SEC, The
NASDAQ Stock Market, or NASDAQ, or other regulatory authorities or subject to
litigation. To the extent any material weaknesses in our internal control over
financial reporting are identified in the future, we could be required to
expend significant management time and financial resources to correct such
material weaknesses or to respond to any resulting regulatory investigations or
proceedings.

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

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

- 21 -

---



Risks Related to Ownership of Our Common
Stock

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

Our
stock has been publicly traded for a relatively short period of time, having
first begun trading in July 2007. During that time our stock price has
fluctuated significantly, from a low of approximately $3 per share to a high of
approximately $18 per share. At times the stock price has changed very quickly.
For example, in January 2008, our stock price dropped from approximately $13
per share to approximately $6 per share, and as a result, we were named in the
lawsuits described in Item 3. If investors purchase shares of our common stock,
they may not be able to resell those shares at or above the price at which they
purchased them. The market price of our common stock may fluctuate
significantly in response to numerous factors, many of which are beyond our
control, including:

| |   |                                                                                                                                                                                                     
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | fluctuations
 in the overall stock market;                                                                                                                                                          
| |   |                                                                                                                                                                                                     
| |  | the
 financial projections we may provide to the public, any changes in these
 projections or our failure to meet these projections;                                                                
| |   |                                                                                                                                                                                                     
| |  | actual or
 anticipated fluctuations in our operating results;                                                                                                                                       
| |   |                                                                                                                                                                                                     
| |  | changes in
 operating performance and stock market valuations of other technology
 companies generally, or those that sell enterprise communication products in
 particular;                        
| |   |                                                                                                                                                                                                     
| |  | changes in
 financial estimates by any securities analysts who follow our company, our
 failure to meet these estimates or failure of those analysts to initiate or
 maintain coverage of our stock;
| |   |                                                                                                                                                                                                     
| |  | ratings
 downgrades by any securities analysts who follow our company;                                                                                                                              
| |   |                                                                                                                                                                                                     
| |  | the publics
 response to our press releases or other public announcements, including our
 filings with the SEC;                                                                                    
| |   |                                                                                                                                                                                                     
| |  | announcements
 by us or our competitors of significant technical innovations, customer wins
 or losses, acquisitions, strategic partnerships, joint ventures or capital
 commitments;               
| |   |                                                                                                                                                                                                     
| |  | introduction
 of technologies or product enhancements that reduce the need for our
 products;                                                                                                       
| |   |                                                                                                                                                                                                     
| |  | market
 conditions or trends in our industry or the economy as a whole;                                                                                                                             
| |   |                                                                                                                                                                                                     
| |  | the loss of
 one or more key customers;                                                                                                                                                             
| |   |                                                                                                                                                                                                     
| |  | the loss of
 key personnel;                                                                                                                                                                         
| |   |                                                                                                                                                                                                     
| |  | the
 development and sustainability of an active trading market for our common
 stock;                                                                                                              
| |   |                                                                                                                                                                                                     
| |  | lawsuits
 threatened or filed against us and the outcome of such lawsuits;                                                                                                                          
| |   |                                                                                                                                                                                                     
| |  | shareholder
 activism;                                                                                                                                                                              
| |   |                                                                                                                                                                                                     
| |  | future sales
 of our common stock by our officers, directors and significant stockholders;
 and                                                                                                     
| |   |                                                                                                                                                                                                     
| |  | other events
 or factors, including those resulting from war, incidents of terrorism or
 responses to these events.                                                                                 

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

- 22 -

---



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

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

| |   |                                                                                                                                                                                                                                                                           
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | adverse
 conditions specific to the IP telecommunications market, including decreased
 demand due to overall economic conditions or reduced discretionary spending
 by enterprises, rates of adoption of IP telecommunications systems and
 introduction of new standards;
| |   |                                                                                                                                                                                                                                                                           
| |  | our ability
 to attract and retain larger and more productive channel partners;                                                                                                                                                                                           
| |   |                                                                                                                                                                                                                                                                           
| |  | the
 purchasing and budgeting cycles of enterprise customers;                                                                                                                                                                                                             
| |   |                                                                                                                                                                                                                                                                           
| |  | the timing
 and volume of shipments of our products during a quarter, particularly as we
 experience an increased level of sales occurring towards the end of a
 quarter;                                                                                                 
| |   |                                                                                                                                                                                                                                                                           
| |  | delays in
 purchasing decisions by our customers from one quarter to the next, or later;                                                                                                                                                                                  
| |   |                                                                                                                                                                                                                                                                           
| |  | seasonality
 in our target markets;                                                                                                                                                                                                                                       
| |   |                                                                                                                                                                                                                                                                           
| |  | our ability to attract new
 resellers, retain existing resellers, and their ability to generate revenues;                                                                                                                                                                 
| |   |                                                                                                                                                                                                                                                                           
| |  | the amount and timing of
 operating costs related to the maintenance and expansion of our business
 operations and infrastructure;                                                                                                                                        
| |   |                                                                                                                                                                                                                                                                           
| |  | the timing
 of recognition of revenue from sales to our customers;                                                                                                                                                                                                        
| |   |                                                                                                                                                                                                                                                                           
| |  | changes in
 the mix of our products and services sold during a particular period;                                                                                                                                                                                         
| |   |                                                                                                                                                                                                                                                                           
| |  | our ability
 to control costs, including third-party manufacturing costs and costs of
 components;                                                                                                                                                                        
| |   |                                                                                                                                                                                                                                                                           
| |  | our ability
 to maintain sufficient production volumes for our products from our contract
 manufacturers;                                                                                                                                                                 
| |   |                                                                                                                                                                                                                                                                           
| |  | volatility
 in our stock price, which may lead to higher stock-based compensation
 expenses                                                                                                                                                                               
| |   |                                                                                                                                                                                                                                                                           
| |  | volatility
 and fluctuation in foreign currency exchange rates;                                                                                                                                                                                                           
| |   |                                                                                                                                                                                                                                                                           
| |  | the timing
 of costs related to the development or acquisition of technologies or
 businesses;                                                                                                                                                                            
| |   |                                                                                                                                                                                                                                                                           
| |  | our ability
 to successfully expand our international operations;                                                                                                                                                                                                         
| |   |                                                                                                                                                                                                                                                                           
| |  | general
 economic conditions or economic recession;                                                                                                                                                                                                                       
| |   |                                                                                                                                                                                                                                                                           
| |  | decline in
 interest rates on our investments; and                                                                                                                                                                                                                        
| |   |                                                                                                                                                                                                                                                                           
| |  | publicly-announced
 litigation, and the impact of such litigation on our operating results.                                                                                                                                                                               

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

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

Currently,
more than 40% of our outstanding shares are held by venture capital investors.
If these investors or any existing stockholders sell or distribute a large
number of shares of our common stock or the public market perceives that these
sales may occur, the market price of our common stock could decline. All of our
outstanding shares are freely tradable without restriction or further
registration under the federal securities laws, subject in some cases to the volume,
manner of sale and other limitations under Rule 144. In addition, pursuant to
our investor rights agreement, some of our early investors may require us to
register their shares for public sale which could result in a substantial
volume of shares being sold in a short period of time. Due to these factors,
sales of a substantial number

- 23 -

---



of shares of
our common stock in the public market could occur at any time. These sales, or
the perception in the market that the holders of a large number of shares
intend to sell shares, could reduce the market price of our common stock.

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

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

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

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

|         |                          
|-------- | -------------------------
|ITEM 1B. | UNRESOLVED STAFF COMMENTS

None.

|        |           
|------- | ----------
|ITEM 2. | PROPERTIES

Our
headquarters, which is located in Sunnyvale, California is a 63,781 square
foot leased facility. This lease expires in September 2014. We also occupy
leased facilities in Austin, Texas, and in Europe and Australia.

We
maintain a shipping and warehouse facility in Fremont, California for our
inventory and we rent space as needed at third-party warehouses. Our inventory
is expected to be kept at our facility and at the third party facilities.

We
believe that our current facilities are suitable and adequate to meet our
current needs, and we intend to add new facilities or expand existing
facilities as we add employees. We believe that suitable additional or
substitute space will be available on commercially reasonable terms as needed
to accommodate our operations.

|        |                  
|------- | -----------------
|ITEM 3. | LEGAL PROCEEDINGS

Information
with respect to this item may be found in Note 9 to the Consolidated Financial
Statements in Item 8, is which is incorporated herein by reference.

|        |                                                                                                       
|------- | ------------------------------------------------------------------------------------------------------
|ITEM 4. | RESERVED                                                                                              
|ITEM 5. | MARKET FOR OUR COMMON STOCK AND RELATED
 STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

- 24 -

---



Market Information

Our
common stock has been traded on The NASDAQ Global Market under the symbol
SHOR since July 3, 2007. Prior to then, there was no public market for our
common stock. The following table sets forth for the periods indicated the high
and low sale prices of our common stock, as reported by The NASDAQ Global
Market.

|                          |  |      |      |     |   |      | 
|------------------------- |  | ---- | ---- | --- | - | ---- | 
|Year Ended June 30, 2010  |  | High |      | Low |  
|                          |  |      |      |     |  
|First
 Quarter            |  | $    | 9.22 |     | $ | 5.86 | 
|Second
 Quarter           |  |      | 8.14 |     |   | 5.06 | 
|Third
 Quarter            |  |      | 6.96 |     |   | 5.22 | 
|Fourth
 Quarter           |  |      | 6.79 |     |   | 4.47 | 
|                          |  |      |      |     |   |      | 
|Year Ended
 June 30, 2009 |  | High |      | Low |  
|                          |  |      |      |     |  
|First
 Quarter            |  | $    | 6.50 |     | $ | 3.87 | 
|Second
 Quarter           |  |      | 5.87 |     |   | 2.61 | 
|Third
 Quarter            |  |      | 5.18 |     |   | 3.63 | 
|Fourth
 Quarter           |  |      | 8.52 |     |   | 4.17 | 

In
the past, technology stocks have experienced high levels of volatility. The
trading price of our common stock may fluctuate substantially. These
fluctuations could cause you to lose all or part of your investment in our
common stock. Factors that could cause fluctuations in the trading price of our
common stock include the following:

| |   |                                                                                                            
| | - | -----------------------------------------------------------------------------------------------------------
| |  | price and
 volume fluctuations in the overall stock market from time to time;                              
| |   |                                                                                                            
| |  | significant
 volatility in the market price and trading volume of technology companies;                    
| |   |                                                                                                            
| |  | actual or
 anticipated changes in our results of operations or fluctuations in our
 operating results;     
| |   |                                                                                                            
| |  | actual or
 anticipated changes in the expectations of investors or securities analysts;                    
| |   |                                                                                                            
| |  | actual or
 anticipated developments in our competitors businesses or the competitive
 landscape generally;
| |   |                                                                                                            
| |  | litigation
 involving us, our industry or both;                                                            
| |   |                                                                                                            
| |  | regulatory
 developments in the United States, foreign countries or both;                                  
| |   |                                                                                                            
| |  | economic
 conditions and trends in our industry;                                                           
| |   |                                                                                                            
| |  | major
 catastrophic events;                                                                                
| |   |                                                                                                            
| |  | sales of
 large blocks of our stock;                                                                       
| |   |                                                                                                            
| |  | stock
 buyback programs; or                                                                                
| |   |                                                                                                            
| |  | departures
 of key personnel.                                                                              

In
the past, following periods of volatility in the market price of a companys
securities, securities class action litigation has often been brought against
that company. If our stock price is volatile, we may become the target of
securities litigation. Securities litigation could result in substantial costs
and divert our managements attention and resources from our business.

On
September 1, 2010, the last reported sales price of our common stock on the
Nasdaq Global Market was $4.98 per share.

Holders of Record

As
of September 1, 2010, there were 151 stockholders of record of our common
stock, although we believe there are approximately 2,000 beneficial owners
since many brokers and other institutions hold our common stock on behalf of
stockholders.

Dividend Policy

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

- 25 -

---



Sales of
Unregistered Securities

None.

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 (Registration No. 333-140630). As of June 30, 2010, the
proceeds from our initial public offering were primarily 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.

- 26 -

---



Stock
Performance Graphs and Cumulative Total Return (1)

The following
graph shows the cumulative total stockholder return of an investment of $100 in
cash on July 3, 2007, the date our common stock first started trading on the
NASDAQ National Market through June 30, 2010, for (i) our common stock, (ii)
the S&P Small Cap 500 Index and (iii) the NASDAQ Telecommunications Index.
Pursuant to applicable SEC rules, all values assume reinvestment of the full
amount of all dividends, however no dividends have been declared on our common
stock to date. The stockholder return shown on the graph below is not
necessarily indicative of future performance, and we do not make or endorse any
predictions as to future stockholder returns.

(LINE GRAPH)

$100 invested
on 7/3/08 in stock or index. Fiscal year ending June 30,

|                                |  |          |  |      |       |      |  |       |  |  |       |  | 
|------------------------------- |  | -------- |  | ---- | ----- | ---- |  | ----- |  |  | ----- |  | 
|                                |  | 7/3/2007 |  | 2008 |       | 2009 |  | 2010  | 
|                                |  |          |  |      |       |      |  |       | 
|                                |  |          |  |      |       |      |  |       | 
|ShoreTel, Inc.                  |  | 100.00   |  |      | 36.38 |      |  | 65.84 |  |  | 38.19 |  | 
|                                |  |          |  |      |       |      |  |       |  |  |       |  | 
|S&P Small Cap 500 Index         |  | 100.00   |  |      | 83.94 |      |  | 61.94 |  |  | 70.87 |  | 
|                                |  |          |  |      |       |      |  |       |  |  |       |  | 
|NASDAQ Telecommunications Index |  | 100.00   |  |      | 71.62 |      |  | 52.08 |  |  | 69.02 |  | 

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

- 27 -

---



Equity Compensation Plan Information

The
following table summarizes information about our equity compensation plans as
of June 30, 2010. All outstanding awards relate to our common stock.

|                                                            |  |                                                                                                          |           |                                                                                            |   |                                                                                                                                                               |  |  |           | 
|----------------------------------------------------------- |  | -------------------------------------------------------------------------------------------------------- | --------- | ------------------------------------------------------------------------------------------ | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------- |  |  | --------- | 
|Plan
 Category                                              |  | Number of
 Securities to
 be Issued
 upon
 Exercise of
 Outstanding
 Options,
 Warrants
 and Rights
 (a) |           | Weighted
 Average
 Exercise
 Price of
 Outstanding
 Options,
 Warrants
 and Rights
 (b)(2) |   | Number of
 Securities
 Remaining
 Available for
 Future
 Issuances
 under Equity
 Compensation
 Plans
 (Excluding
 Securities
 Reflected in
 Column (a))
 (c) | 
|                                                            |  |                                                                                                          |           |                                                                                            |   |                                                                                                                                                               | 
|Equity compensation plans approved by
 security holders(1)  |  |                                                                                                          | 8,303,000 |                                                                                            | $ | 4.14                                                                                                                                                          |  |  | 5,152,000 | 
|Equity compensation plans not approved by
 security holders |  |                                                                                                          |          |                                                                                            |   |                                                                                                                                                              |  |  |          | 
|                                                            |  |                                                                                                          |           |                                                                                            |   |                                                                                                                                                               |  |  |           | 
|Total                                                       |  |                                                                                                          | 8,303,000 |                                                                                            | $ | 4.14                                                                                                                                                          |  |  | 5,152,000 | 
|                                                            |  |                                                                                                          |           |                                                                                            |   |                                                                                                                                                               |  |  |           | 

| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       | 
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | 
| |    
| | (1) | The number
 of securities remaining available for future issuance in column (c) includes
 5,152,000 shares of common stock authorized and available for issuance under
 our 2007 Employee Stock Purchase Plan (ESPP) and our 2007 Equity Incentive
 Plan (the 2007 Plan). The number of shares authorized for issuance under
 the ESPP is subject to an annual increase equal to 1% of the outstanding
 shares on the date of the annual increase or an amount determined by the
 Board of Directors and the number of shares authorized for issuance under the
 2007 Plan is subject to an annual increase equal to 5% of the outstanding
 shares on the date of the annual increase or an amount determined by the
 Board of Directors. The number of securities to be issued to participants in
 column (a) does not include shares of common stock to be issued to participants
 in consideration of aggregate participant contributions under the ESPP as of
 June 30, 2010.
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       | 
| | (2) | The weighted
 average exercise price does not reflect shares subject to restricted stock
 awards.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    

- 28 -

---



PART II.

|        |                                     
|------- | ------------------------------------
|ITEM 6. | SELECTED CONSOLIDATED FINANCIAL DATA

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

|                                                                                        |  |                                          |         |      |   |         |   |      |         |      |   |        |   |   |        |  
|--------------------------------------------------------------------------------------- |  | ---------------------------------------- | ------- | ---- | - | ------- | - | ---- | ------- | ---- | - | ------ | - | - | ------ | -
|                                                                                        |  | Year Ended June 30,                      |        
|                                                                                        |  |                                          |        
|                                                                                        |  |                                          |        
|                                                                                        |  | 2010                                     |         | 2009 |   | 2008    |   | 2007 |         | 2006 |  
|                                                                                        |  |                                          |         |      |   |         |   |      |         |      |  
|                                                                                        |  |                                          |        
|                                                                                        |  | (In thousands, except per share amounts) |        
|Revenue:                                                                                |  |                                          |         |      |   |         |   |      |         |      |   |        |   |   |        |  
|Product                                                                                 |  | $                                        | 117,138 |      | $ | 109,555 |   | $    | 110,496 |      | $ | 87,095 |   | $ | 55,300 |  
|Support and services                                                                    |  |                                          | 31,326  |      |   | 25,267  |   |      | 18,233  |      |   | 10,732 |   |   | 6,308  |  
|                                                                                        |  |                                          |         |      |   |         |   |      |         |      |   |        |   |   |        |  
|Total revenue                                                                           |  |                                          | 148,464 |      |   | 134,822 |   |      | 128,729 |      |   | 97,827 |   |   | 61,608 |  
|Cost of revenue:                                                                        |  |                                          |         |      |   |         |   |      |         |      |   |        |   |   |        |  
|Product(1)                                                                              |  |                                          | 40,471  |      |   | 38,149  |   |      | 37,466  |      |   | 29,753 |   |   | 21,855 |  
|Support and services(1)                                                                 |  |                                          | 11,580  |      |   | 11,048  |   |      | 10,036  |      |   | 6,847  |   |   | 5,425  |  
|                                                                                        |  |                                          |         |      |   |         |   |      |         |      |   |        |   |   |        |  
|Total cost of revenue                                                                   |  |                                          | 52,051  |      |   | 49,197  |   |      | 47,502  |      |   | 36,600 |   |   | 27,280 |  
|                                                                                        |  |                                          |         |      |   |         |   |      |         |      |   |        |   |   |        |  
|Gross profit                                                                            |  |                                          | 96,413  |      |   | 85,625  |   |      | 81,227  |      |   | 61,227 |   |   | 34,328 |  
|Operating expenses:                                                                     |  |                                          |         |      |   |         |   |      |         |      |   |        |   |   |        |  
|Research and development(1)                                                             |  |                                          | 33,596  |      |   | 30,724  |   |      | 26,811  |      |   | 17,260 |   |   | 9,720  |  
|Sales and marketing(1)                                                                  |  |                                          | 55,973  |      |   | 44,652  |   |      | 37,869  |      |   | 26,174 |   |   | 15,699 |  
|General and administrative(1)                                                           |  |                                          | 19,888  |      |   | 19,596  |   |      | 17,645  |      |   | 11,674 |   |   | 4,936  |  
|Litigation settlement                                                                   |  |                                          |        |      |   | 4,110   |   |      |        |      |   |       |   |   |       |  
|                                                                                        |  |                                          |         |      |   |         |   |      |         |      |   |        |   |   |        |  
|Total operating expenses                                                                |  |                                          | 109,457 |      |   | 99,082  |   |      | 82,325  |      |   | 55,108 |   |   | 30,355 |  
|                                                                                        |  |                                          |         |      |   |         |   |      |         |      |   |        |   |   |        |  
|Operating income (loss)                                                                 |  |                                          | (13,044 | )    |   | (13,457 | ) |      | (1,098  | )    |   | 6,119  |   |   | 3,973  |  
|Other income  net                                                                      |  |                                          | 84      |      |   | 1,141   |   |      | 4,101   |      |   | 273    |   |   | 248    |  
|                                                                                        |  |                                          |         |      |   |         |   |      |         |      |   |        |   |   |        |  
|Income (loss) before income tax benefit
 (provision)                                    |  |                                          | (12,960 | )    |   | (12,316 | ) |      | 3,003   |      |   | 6,392  |   |   | 4,221  |  
|Income tax benefit (provision)                                                          |  |                                          | 156     |      |   | (343    | ) |      | (861    | )    |   | (408   | ) |   | (219   | )
|                                                                                        |  |                                          |         |      |   |         |   |      |         |      |   |        |   |   |        |  
|Net income (loss)                                                                       |  |                                          | (12,804 | )    |   | (12,659 | ) |      | 2,142   |      |   | 5,984  |   |   | 4,002  |  
|Accretion of preferred stock                                                            |  |                                          |        |      |   |        |   |      |        |      |   | (50    | ) |   | (51    | )
|                                                                                        |  |                                          |         |      |   |         |   |      |         |      |   |        |   |   |        |  
|Net income (loss) available to common
 stockholders                                     |  | $                                        | (12,804 | )    | $ | (12,659 | ) | $    | 2,142   |      | $ | 5,934  |   | $ | 3,951  |  
|                                                                                        |  |                                          |         |      |   |         |   |      |         |      |   |        |   |   |        |  
|Net income (loss) per common share
 available to common stockholders(2):                |  |                                          |         |      |   |         |   |      |         |      |   |        |   |   |        |  
|Basic                                                                                   |  | $                                        | (0.29   | )    | $ | (0.29   | ) | $    | 0.05    |      | $ | 0.69   |   | $ | 0.60   |  
|                                                                                        |  |                                          |         |      |   |         |   |      |         |      |   |        |   |   |        |  
|Diluted                                                                                 |  | $                                        | (0.29   | )    | $ | (0.29   | ) | $    | 0.05    |      | $ | 0.17   |   | $ | 0.12   |  
|                                                                                        |  |                                          |         |      |   |         |   |      |         |      |   |        |   |   |        |  
|Shares used in computing net income (loss)
 per share available to common stockholders: |  |                                          |         |      |   |         |   |      |         |      |   |        |   |   |        |  
|Basic                                                                                   |  |                                          | 44,804  |      |   | 43,714  |   |      | 42,413  |      |   | 8,565  |   |   | 6,609  |  
|Diluted                                                                                 |  |                                          | 44,804  |      |   | 43,714  |   |      | 44,861  |      |   | 35,581 |   |   | 33,431 |  

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

|                                       |  |                     |        |      |   |       |  |      |       |      |   |       |  |   |    | 
|-------------------------------------- |  | ------------------- | ------ | ---- | - | ----- |  | ---- | ----- | ---- | - | ----- |  | - | -- | 
|                                       |  | Year Ended June 30, |       
|                                       |  |                     |       
|                                       |  | 2010                |        | 2009 |   | 2008  |  | 2007 |       | 2006 |  
|                                       |  |                     |        |      |   |       |  |      |       |      |  
|                                       |  |                     |       
|                                       |  | (In thousands)      |       
|Cost of product revenue                |  | $                   | 139    |      | $ | 113   |  | $    | 74    |      | $ | 14    |  | $ |   | 
|Cost of support and services revenue   |  |                     | 838    |      |   | 799   |  |      | 545   |      |   | 109   |  |   | 16 | 
|Research and development               |  |                     | 3,064  |      |   | 2,829 |  |      | 2,005 |      |   | 420   |  |   | 14 | 
|Sales and marketing                    |  |                     | 3,400  |      |   | 3,468 |  |      | 2,447 |      |   | 581   |  |   | 7  | 
|General and administrative             |  |                     | 3,213  |      |   | 2,549 |  |      | 2,360 |      |   | 1,659 |  |   | 45 | 
|                                       |  |                     |        |      |   |       |  |      |       |      |   |       |  |   |    | 
|Total stock-based compensation expense |  | $                   | 10,654 |      | $ | 9,758 |  | $    | 7,431 |      | $ | 2,783 |  | $ | 82 | 
|                                       |  |                     |        |      |   |       |  |      |       |      |   |       |  |   |    | 

|    |                                                                                                                                                                                       
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(2) | See Note 5
 to our consolidated financial statements for a description of the method used
 to compute basic and diluted net income (loss) per share available to common
 stockholders.

- 29 -

---



|                                                      |  |                |         |      |   |         |  |      |         |      |   |         |   |   |         |  
|----------------------------------------------------- |  | -------------- | ------- | ---- | - | ------- |  | ---- | ------- | ---- | - | ------- | - | - | ------- | -
|                                                      |  | As of June 30, |        
|                                                      |  |                |        
|                                                      |  | 2010           |         | 2009 |   | 2008    |  | 2007 |         | 2006 |  
|                                                      |  |                |         |      |   |         |  |      |         |      |  
|                                                      |  |                |         |      |   |         |  |      |         |      |   |         |   |   |         |  
|                                                      |  | (In thousands) |        
|Consolidated balance sheet data:                      |  |                |         |      |   |         |  |      |         |      |   |         |   |   |         |  
|Cash and cash equivalents and short-term
 investments |  | $              | 115,801 |      | $ | 107,666 |  | $    | 102,811 |      | $ | 17,326  |   | $ | 12,333  |  
|Working capital                                       |  |                | 112,836 |      |   | 111,617 |  |      | 111,993 |      |   | 23,018  |   |   | 16,208  |  
|Total assets                                          |  |                | 170,721 |      |   | 155,624 |  |      | 147,797 |      |   | 53,034  |   |   | 30,885  |  
|Redeemable convertible preferred stock                |  |                |        |      |   |        |  |      |        |      |   | 56,341  |   |   | 56,332  |  
|Total stockholders equity (deficit)                  |  |                | 114,466 |      |   | 113,772 |  |      | 113,213 |      |   | (31,829 | ) |   | (41,168 | )

|        |                                                                                       
|------- | --------------------------------------------------------------------------------------
|ITEM 7. | MANAGEMENTS DISCUSSION AND ANALYSIS OF
 FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The
following discussion and analysis of our financial condition and results of
operations should be read in conjunction with the consolidated financial
statements and related notes included elsewhere in this document. This
discussion contains forward-looking statements that involve risks and
uncertainties. Our actual results could differ materially from those discussed
below. Factors that could cause or contribute to such differences include, but
are not limited to, those identified below, and those discussed above in the
section entitled Risk Factors. We report results on a fiscal year ending June
30. For ease of reference within this section, 2010 refers to the fiscal year
ended June 30, 2010, 2009 refers to the fiscal year ended June 30, 2009, and
2008 refers to the fiscal year ended June 30, 2008.

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

- 30 -

---



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 have a customer support, finance
and engineering office in Austin, Texas. The majority of our personnel work at
these two locations. 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 was
approximately 10% of our total revenue for 2010 and approximately 7% for 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.

We
have experienced some growth despite the economic recession and contraction in
the IT telephony market, with our total revenue growing to $148.5 million for
2010 from $134.8 million for 2009. This growth in revenue has been driven by
increased revenue from both support and services and product revenue. Our
operating expenses have increased significantly to $109.5 million for 2010 from
$99.1 million for 2009. This increase in operating expenses is primarily a
result of increases in compensation expenses related to growth in headcount,
increases in advertising and promotion expense, facilities expenses, and
research and development expenses. Compensation expense included increases in
stock-based compensation and commissions. We increased headcount from 375 at
June 30, 2009 to 479 at June 30, 2010, with the growth driven by the Companys
strategic investment plan focused on growing our sales channel, enhancing our
product and increasing our branding activities. We expect to continue to add
personnel primarily in our sales, engineering, and customer support areas.

Key Business Metrics

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

Initial
and repeat sales orders. Our goal is to attract a
significant number of new enterprise customers and to encourage existing
enterprise customers to purchase additional products and support. Many
enterprise customers make an initial purchase and deploy additional sites at a
later date, and also buy additional products and support as their businesses
expand. As our installed enterprise customer base has grown we have experienced
an increase in orders attributable to existing enterprise customers, which
currently represents a significant portion of our total revenue. For fiscal
year 2010 order volume from existing enterprise customers represented approximately
56% of total order volume, while in fiscal year 2009 and 2008 it has been
approximately 54% and 50%, respectively.

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 our
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 our
renewal rates on these contracts have been high historically. We recognize
support revenue on a ratable basis over the term of the support contract. Since
we receive payment for support in advance of our recognizing the related
revenue, we carry a deferred revenue balance on our consolidated balance sheet.
This deferred revenue helps provide predictability to our future support and services
revenue. Accordingly, the level of purchases of post-contractual support with
our product sales is an important metric for us along with the renewal rates
for these services. Our deferred revenue balance at June 30, 2010 was $28.7
million, of which $19.5 million is expected to be recognized within one year.

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

Gross
margin for support and services is slightly lower than gross margin for
products, and is impacted primarily by personnel costs and labor related
expenses. The primary goal of our support and services function is to ensure a
high level of

- 31 -

---



customer
satisfaction and our investments in support personnel and infrastructure are
made with this goal in mind. We expect that as our installed enterprise
customer base grows, we will be able to improve gross margin for support and
services through economies of scale. However, the timing of additional
investments in our support and services infrastructure could materially affect
our cost of support and services revenue, both in absolute dollars and as a
percentage of support and services revenue and total revenue, in any particular
period.

Operating
expense management. 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
increase in our headcount. We intend to expand our workforce to support our
anticipated growth, and therefore our ability to forecast revenue is critical
to managing our operating expenses.

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
levels, as well as our own strategic considerations. In circumstances where we
sell directly to the enterprise customer in transactions that have been
assisted by channel partners, we report our revenue net of any associated
payment to the channel partners that assisted in such sales. This results in recognized
revenue from a direct sale approximating the revenue that would have been
recognized from a sale of a comparable system through a channel partner.
Product revenue has accounted for 79%, 81%, and 86% of our total revenue for
2010, 2009 and 2008, respectively.

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

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

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 capitalize software development costs incurred from determination
of technological feasibility through general release of the product to
customers. Software development costs capitalized and shown under other assets
was $0.7 million, $0.5 million and zero in fiscal 2010, 2009, and 2008,
respectively.

We
are devoting substantial resources to the development of additional
functionality for existing products and the development of new products and
related software applications. We intend to continue to make significant
investments in our research and development efforts because we believe they are
essential to maintaining and improving our competitive position. Accordingly,
we expect research and development expenses to continue to increase in absolute
dollars.

Sales
and marketing expenses. Sales and marketing expenses
primarily include personnel costs, sales commissions, travel, marketing
promotional and lead generation programs, branding and 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, recruiting expense, software amortization costs,
depreciation expense and facilities expenses. In addition, as we expand our
business, we expect to increase our general and administrative expenses.

Other
income (expense). Other income (expense) primarily
consists of interest earned on cash and short-term investments, gains and
losses on foreign currency transactions, and other miscellaneous income
(expenses).

Income
tax benefit (provision). Income tax benefit
(provision) includes federal, state and foreign tax on our income. From
inception through 2005, we accumulated substantial net operating loss and tax
credit carryforwards. We account for

- 32 -

---



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 current enacted tax laws. Valuation allowances are
provided when necessary to reduce deferred tax assets to an amount that is more
likely than not to be realized.

We believe we
have had multiple ownership changes, as defined under Section 382 of the
Internal Revenue Code, due to significant stock transactions in previous years,
which had limited the realization of our net operating losses and tax credit
carryforwards under Section 382 of the Internal Revenue Code in future
periods. During fiscal 2010, the Company received a favorable tax ruling from
the Internal Revenue Service related to Section 382. As a result of the
ruling, at least $25 million of net operating losses that were previously
limited by Section 382 of the Internal Revenue Code are now available to
the Company to offset future taxable income and to recapture previously paid
taxes. The increase in the deferred tax assets associated with this ruling was
offset by an increase in valuation allowance. As a result, in the fourth
quarter of fiscal 2010, the Company filed an amended fiscal 2008 federal income
tax return utilizing the available net operating losses to request a tax refund
for approximately $1.7 million, which the Company has not received as of June
30, 2010.

SHORETEL,
INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands, except per share amounts)

|                                                                               |                                                                                                                                                                                                                                                                                                                                                 |   |                       |        |      |         |       | 
|------------------------------------------------------------------------------ | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | - | --------------------- | ------ | ---- | ------- | ----- | 
|                                                                               |                                                                                                                                                                                                                                                                                                                                                 |   | (Unaudited)           |       
|                                                                               |                                                                                                                                                                                                                                                                                                                                                 |   | Year
 Ended
 June 30, |       
|                                                                               |                                                                                                                                                                                                                                                                                                                                                 |   |                       |       
|                                                                               |                                                                                                                                                                                                                                                                                                                                                 |   |                       |        |      |         |       | 
|                                                                               |                                                                                                                                                                                                                                                                                                                                                 |   | 2010                  |        | 2009 |        
|                                                                               |                                                                                                                                                                                                                                                                                                                                                 |   |                       |        |      |        
|                                                                               |                                                                                                                                                                                                                                                                                                                                                 |   |                       |        |      |         |       | 
|Revenue:                                                                       |                                                                                                                                                                                                                                                                                                                                                 |   |                       |        |      |         |      
|Product                                                                        |                                                                                                                                                                                                                                                                                                                                                 | $ | 117,138               |        | $    | 109,555 |      
|Support
 and services                                                          |                                                                                                                                                                                                                                                                                                                                                 |   | 31,326                |        |      | 25,267  |      
|                                                                               |                                                                                                                                                                                                                                                                                                                                                 |   |                       |        |      |         |      
|Total
 revenues                                                                |                                                                                                                                                                                                                                                                                                                                                 |   | 148,464               |        |      | 134,822 |      
|Cost of revenue                                                                |                                                                                                                                                                                                                                                                                                                                                 |   |                       |        |      |         |      
|Product
 (1)                                                                   |                                                                                                                                                                                                                                                                                                                                                 |   | 40,471                |        |      | 38,149  |      
|Support
 and services (1)                                                      |                                                                                                                                                                                                                                                                                                                                                 |   | 11,580                |        |      | 11,048  |      
|                                                                               |                                                                                                                                                                                                                                                                                                                                                 |   |                       |        |      |         |      
|Total
 cost of revenue                                                         |                                                                                                                                                                                                                                                                                                                                                 |   | 52,051                |        |      | 49,197  |      
|                                                                               |                                                                                                                                                                                                                                                                                                                                                 |   |                       |        |      |         |      
|Gross profit                                                                   |                                                                                                                                                                                                                                                                                                                                                 |   | 96,413                |        |      | 85,625  |      
|Gross
 profit %                                                                |                                                                                                                                                                                                                                                                                                                                                 |   | 64.9                  | %      |      | 63.5    | %    
|                                                                               |                                                                                                                                                                                                                                                                                                                                                 |   |                       |        |      |         |      
|Operating expenses:                                                            |                                                                                                                                                                                                                                                                                                                                                 |   |                       |        |      |         |      
|Research
 and development (1,2)                                                |                                                                                                                                                                                                                                                                                                                                                 |   | 33,596                |        |      | 30,724  |      
|Sales and
 marketing (1,2)                                                     |                                                                                                                                                                                                                                                                                                                                                 |   | 55,973                |        |      | 44,652  |      
|General
 and administrative (1,2)                                              |                                                                                                                                                                                                                                                                                                                                                 |   | 19,888                |        |      | 19,596  |      
|Litigation
 Settlement                                                         |                                                                                                                                                                                                                                                                                                                                                 |   |                      |        |      | 4,110   |      
|                                                                               |                                                                                                                                                                                                                                                                                                                                                 |   |                       |        |      |         |      
|Total
 operating expenses                                                      |                                                                                                                                                                                                                                                                                                                                                 |   | 109,457               |        |      | 99,082  |      
|                                                                               |                                                                                                                                                                                                                                                                                                                                                 |   |                       |        |      |         |      
|Loss from operations                                                           |                                                                                                                                                                                                                                                                                                                                                 |   | (13,044               | )      |      | (13,457 | )    
|Other income (expense), net                                                    |                                                                                                                                                                                                                                                                                                                                                 |   | 84                    |        |      | 1,141   |      
|                                                                               |                                                                                                                                                                                                                                                                                                                                                 |   |                       |        |      |         |      
|Loss before provision for income taxes                                         |                                                                                                                                                                                                                                                                                                                                                 |   | (12,960               | )      |      | (12,316 | )    
|Benefit from (provision for) income
 taxes                                     |                                                                                                                                                                                                                                                                                                                                                 |   | 156                   |        |      | (343    | )    
|                                                                               |                                                                                                                                                                                                                                                                                                                                                 |   |                       |        |      |         |      
|Net loss                                                                       |                                                                                                                                                                                                                                                                                                                                                 | $ | (12,804               | )      | $    | (12,659 | )    
|                                                                               |                                                                                                                                                                                                                                                                                                                                                 |   |                       |        |      |         |      
|Net loss per share available to common
 stockholders:                          |                                                                                                                                                                                                                                                                                                                                                 |   |                       |        |      |         |      
|Basic                                                                          |                                                                                                                                                                                                                                                                                                                                                 | $ | (0.29                 | )      | $    | (0.29   | )    
|Diluted
 (3)                                                                   |                                                                                                                                                                                                                                                                                                                                                 | $ | (0.29                 | )      | $    | (0.29   | )    
|                                                                               |                                                                                                                                                                                                                                                                                                                                                 |   |                       |        |      |         |      
|Shares used in computing net loss per
 share available to common stockholders: |                                                                                                                                                                                                                                                                                                                                                 |   |                       |        |      |         |      
|Basic                                                                          |                                                                                                                                                                                                                                                                                                                                                 |   | 44,804                |        |      | 43,714  |      
|Diluted
 (3)                                                                   |                                                                                                                                                                                                                                                                                                                                                 |   | 44,804                |        |      | 43,714  |      
|                                                                               |                                                                                                                                                                                                                                                                                                                                                 |   |                       |        |      |         |       | 
|(1)                                                                            | Includes stock-based compensation as
 follows:                                                                                                                                                                                                                                                                                                  |   |                       |        |      |         |       | 
|                                                                               | Cost of product revenue                                                                                                                                                                                                                                                                                                                         |   | $                     | 139    |      | $       | 113   | 
|                                                                               | Cost of support and services revenue                                                                                                                                                                                                                                                                                                            |   |                       | 838    |      |         | 799   | 
|                                                                               | Research and development                                                                                                                                                                                                                                                                                                                        |   |                       | 3,064  |      |         | 2,829 | 
|                                                                               | Sales and marketing                                                                                                                                                                                                                                                                                                                             |   |                       | 3,400  |      |         | 3,468 | 
|                                                                               | General and administrative                                                                                                                                                                                                                                                                                                                      |   |                       | 3,213  |      |         | 2,549 | 
|                                                                               |                                                                                                                                                                                                                                                                                                                                                 |   |                       |        |      |         |       | 
|                                                                               |                                                                                                                                                                                                                                                                                                                                                 |   | $                     | 10,654 |      | $       | 9,758 | 
|                                                                               |                                                                                                                                                                                                                                                                                                                                                 |   |                       |        |      |         |       | 
|                                                                               |                                                                                                                                                                                                                                                                                                                                                 |   |                       |        |      |         |       | 
|(2)                                                                            | Includes restructuring charge as
 follows:                                                                                                                                                                                                                                                                                                      |   |                       |        |      |         |       | 
|                                                                               | Research and development                                                                                                                                                                                                                                                                                                                        |   |                       |       |      |         | 98    | 
|                                                                               | Sales and marketing                                                                                                                                                                                                                                                                                                                             |   |                       | (27    | )    |         | 235   | 
|                                                                               | General and administrative                                                                                                                                                                                                                                                                                                                      |   |                       |       |      |         | 83    | 
|                                                                               |                                                                                                                                                                                                                                                                                                                                                 |   |                       |        |      |         |       | 
|                                                                               |                                                                                                                                                                                                                                                                                                                                                 |   | $                     | (27    | )    | $       | 416   | 
|                                                                               |                                                                                                                                                                                                                                                                                                                                                 |   |                       |        |      |         |       | 
|                                                                               |                                                                                                                                                                                                                                                                                                                                                
|(3)                                                                            | Diluted net
 loss per share and share count reflect the weighted average number of common
 shares used in the basic net loss per
 share calculation. Potentially dilutive securities were not included in the
 compilation of diluted net loss per
 share for the periods which had a net loss because to do so would have been
 anti-dilutive.

- 33 -

---



Use of Non-GAAP Financial Measures

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

- 34 -

---



RECONCILIATION OF GAAP TO NON-GAAP FINANCIAL
MEASURES
(Amounts in thousands, except per share amounts)
(Unaudited)

|                                                       |                                                                         |                      |         |        |   |         |        |  
|------------------------------------------------------ | ----------------------------------------------------------------------- | -------------------- | ------- | ------ | - | ------- | ------ | -
|                                                       |                                                                         | Year Ended
 June 30, |        
|                                                       |                                                                         |                      |        
|                                                       |                                                                         | 2010                 |         | 2009   |  
|                                                       |                                                                         |                      |         |        |  
|                                                       |                                                                         |                      |         |        |   |         |       
|GAAP net loss available to stockholders:               |                                                                         | $                    | (12,804 | )      | $ | (12,659 | )     
|                                                       |                                                                         |                      |         |        |   |         |       
|                                                       | Adjustments for non-GAAP items (1)                                      |                      |         | 10,627 |   |         | 14,557 |  
|                                                       |                                                                         |                      |         |        |   |         |        |  
|                                                       | Tax effect of non-GAAP adjustments                                      |                      |         | (195   | ) |         | (675   | )
|                                                       |                                                                         |                      |         |        |   |         |        |  
|                                                       |                                                                         |                      |         |        |   |         |        |  
|Non-GAAP net income (loss) available to
 stockholders  |                                                                         | $                    | (2,372  | )      | $ | 1,223   |       
|                                                       |                                                                         |                      |         |        |   |         |       
|                                                       |                                                                         |                      |         |        |   |         |        |  
|GAAP diluted net loss per share:                       |                                                                         | $                    | (0.29   | )      | $ | (0.29   | )     
|                                                       |                                                                         |                      |         |        |   |         |       
|                                                       | Adjustments for non-GAAP items                                          |                      |         | 0.24   |   |         | 0.32   |  
|                                                       |                                                                         |                      |         |        |   |         |        |  
|                                                       | Tax effect of non-GAAP adjustments                                      |                      |         | 0.00   |   |         | 0.00   |  
|                                                       |                                                                         |                      |         |        |   |         |        |  
|                                                       |                                                                         |                      |         |        |   |         |        |  
|Non-GAAP diluted net income (loss) per
 share:         |                                                                         | $                    | (0.05   | )      | $ | 0.03    |       
|                                                       |                                                                         |                      |         |        |   |         |       
|                                                       |                                                                         |                      |         |        |   |         |        |  
|Shares Used in Non-GAAP diluted per share
 calculation |                                                                         |                      | 44,804  |        |   | 44,994  |       
|                                                       |                                                                         |                      |         |        |   |         |        |  
|                                                       |                                                                         |                      |         |        |   |         |       
|(1)                                                    | Adjustments for non-GAAP items include:                                 |                      |         |        |   |         |        |  
|                                                       | Stock-based compensation                                                |                      | $       | 10,654 |   | $       | 9,758  |  
|                                                       |                                                                         |                      |         |        |   |         |        |  
|                                                       | Litigation settlement                                                   |                      |         |       |   |         | 4,110  |  
|                                                       |                                                                         |                      |         |        |   |         |        |  
|                                                       | Restructuring charge (benefit)                                          |                      |         | (27    | ) |         | 416    |  
|                                                       |                                                                         |                      |         |        |   |         |        |  
|                                                       | Cancellation of contractual obligation
 included in sales and marketing |                      |         |       |   |         | 273    |  
|                                                       |                                                                         |                      |         |        |   |         |        |  
|                                                       |                                                                         |                      |         |        |   |         |        |  
|                                                       | Adjustments for non-GAAP items                                          |                      | $       | 10,627 |   | $       | 14,557 |  
|                                                       |                                                                         |                      |         |        |   |         |        |  

Results of Operations

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

|                                                              |  |                     |     |      |  |      |    |  |     |   
|------------------------------------------------------------- |  | ------------------- | --- | ---- |  | ---- | -- |  | --- | --
|                                                              |  | Year Ended June 30, |    
|                                                              |  |                     |    
|                                                              |  | 2010                |     | 2009 |  | 2008 |   
|                                                              |  |                     |     |      |  |      |   
|Revenue:                                                      |  |                     |     |      |  |      |    |  |     |   
|Product                                                       |  |                     | 79  | %    |  | 81   | %  |  | 86  | % 
|Support and services                                          |  |                     | 21  | %    |  | 19   | %  |  | 14  | % 
|                                                              |  |                     |     |      |  |      |    |  |     |   
|Total revenue                                                 |  |                     | 100 | %    |  | 100  | %  |  | 100 | % 
|Cost of
 revenue:                                             |  |                     |     |      |  |      |    |  |     |   
|Product                                                       |  |                     | 27  | %    |  | 28   | %  |  | 29  | % 
|Support and services                                          |  |                     | 8   | %    |  | 8    | %  |  | 8   | % 
|                                                              |  |                     |     |      |  |      |    |  |     |   
|Total cost of revenue                                         |  |                     | 35  | %    |  | 36   | %  |  | 37  | % 
|                                                              |  |                     |     |      |  |      |    |  |     |   
|Gross profit                                                  |  |                     | 65  | %    |  | 64   | %  |  | 63  | % 
|Operating
 expenses:                                          |  |                     |     |      |  |      |    |  |     |   
|Research and development                                      |  |                     | 23  | %    |  | 23   | %  |  | 21  | % 
|Sales and marketing                                           |  |                     | 38  | %    |  | 33   | %  |  | 29  | % 
|General and administrative                                    |  |                     | 13  | %    |  | 14   | %  |  | 13  | % 
|Litigation settlement                                         |  |                     |    |      |  | 3    | %  |  |    |   
|                                                              |  |                     |     |      |  |      |    |  |     |   
|Total operating expenses                                      |  |                     | 74  | %    |  | 73   | %  |  | 63  | % 
|                                                              |  |                     |     |      |  |      |    |  |     |   
|Operating
 income (loss)                                      |  |                     | (9  | )%   |  | (9   | )% |  |    |   
|Other
 income, net                                            |  |                     |    |      |  | 1    | %  |  | 3   | % 
|                                                              |  |                     |     |      |  |      |    |  |     |   
|Income (loss) before benefit from
 (provision for) income tax |  |                     | (9  | )%   |  | (8   | )% |  | 3   | % 
|Income tax benefit (provision)                                |  |                     |    |      |  | (1   | )% |  | (1  | )%
|                                                              |  |                     |     |      |  |      |    |  |     |   
|Net income
 (loss)                                            |  |                     | (9  | )%   |  | (9   | )% |  | 2   | % 
|                                                              |  |                     |     |      |  |      |    |  |     |   

- 35 -

---



Fiscal 2010 compared
to Fiscal 2009

Revenue.

|        |  |                                    |         |                |   |         |  |   |        |  |  |    |  
|------- |  | ---------------------------------- | ------- | -------------- | - | ------- |  | - | ------ |  |  | -- | -
|        |  | Year ended                         |         | Change         |  
|        |  |                                    |         |                |  
|        |  | June 30,
 2010                     |         | June 30,
 2009 |   | $       |  | % |       
|        |  |                                    |         |                |   |         |  |   |       
|        |  | (in thousands, except percentages) |        
|Revenue |  | $                                  | 148,464 |                | $ | 134,822 |  | $ | 13,642 |  |  | 10 | %

The
increase was due to increases in both product revenue and support and services
revenue. Product revenue was $117.1 million in 2010, an increase of $7.5
million or 7%, from $109.6 million in 2009, as a result of higher sales volumes
of $12.5 million primarily from our U.S. telecom carrier resellers, partially
offset by a slight decline in average selling prices of approximately $5
million. Support and services revenue was $31.3 million in 2010, an increase of
$6.0 million, or 24%, from $25.3 million in 2009, as a result of a $4.5 million
increase in revenue associated with post-contractual support contracts, an
increase of $0.5 million in professional services, $0.3 million increase in
installations revenue and a $0.7 million increase in training revenue.

Gross
margin.

|                 |  |                                    |        |                |   |        |   |   |        |  |  |    |  
|---------------- |  | ---------------------------------- | ------ | -------------- | - | ------ | - | - | ------ |  |  | -- | -
|                 |  | Year ended                         |        | Change         |  
|                 |  |                                    |        |                |  
|                 |  | June 30,
 2010                     |        | June 30,
 2009 |   | $      |   | % |       
|                 |  |                                    |        |                |   |        |   |   |       
|                 |  | (in thousands, except percentages) |       
|Cost of
 revenue |  | $                                  | 52,051 |                | $ | 49,197 |   | $ | 2,854  |  |  | 6  | %
|Gross profit     |  | $                                  | 96,413 |                | $ | 85,625 |   | $ | 10,788 |  |  | 13 | %
|Gross margin     |  |                                    | 65     | %              |   | 64     | % |   | n/a    |  |  | 1  | %

The
increase in gross margin was attributable to an increase in support and
services gross margin from 56% in 2009 to 63% in 2010. The product gross margin
remained unchanged at 65% in 2009 and 2010. Support and services gross margin
increased due to support and services revenue increasing by 24% and service
costs only increasing by 5%, compared to the same period in 2009. The service
costs increase was limited to 5% as we deployed employee resources to a lower
cost region outside of our California headquarters office. The increase in the
gross profit for support and services was primarily due to the ability to
support a larger customer base with similar number of employees in 2010.

Operating expenses.

|                            |  |                                    |        |                |   |        |  |   |        |   |  |      |   
|--------------------------- |  | ---------------------------------- | ------ | -------------- | - | ------ |  | - | ------ | - |  | ---- | --
|                            |  | Year ended                         |        | Change         |  
|                            |  |                                    |        |                |  
|                            |  | June 30,
 2010                     |        | June 30,
 2009 |   | $      |  | % |       
|                            |  |                                    |        |                |   |        |  |   |       
|                            |  | (in thousands, except percentages) |       
|Operating
 expenses:        |  |                                    |        |                |   |        |  |   |        |   |  |      |   
|Research and
 development   |  | $                                  | 33,596 |                | $ | 30,724 |  | $ | 2,872  |   |  | 9    | % 
|Sales and
 marketing        |  | $                                  | 55,973 |                | $ | 44,652 |  | $ | 11,321 |   |  | 25   | % 
|General and
 administrative |  | $                                  | 19,888 |                | $ | 19,596 |  | $ | 292    |   |  | 1    | % 
|Litigation
 settlement      |  | $                                  |       |                | $ | 4,110  |  | $ | (4,110 | ) |  | (100 | )%

Research and development. These expenses
represented 23% of total revenue in both 2010 and 2009. Compensation, including
stock-based compensation, for research and development employees accounted for
$2.3 million of the increase, primarily as a result of increased headcount
during the year. The increase in research and development expenses also

- 36 -

---



included $0.8 million in consulting and outside services, $0.2 million
in incentive compensation expense and $0.1 million each in legal expenses
associated with trademark and patent costs.. These increases were primarily
offset by a decrease of $0.4 million in non-recurring engineering expenses and
decrease of $0.1 million in issued equipment expenses related to usage in beta
programs.

Sales and marketing. These expenses
represented 38% and 33% of total revenue in 2010 and 2009, respectively. The
increase in sales and marketing expense included increases of $3.8 million in
advertising and promotional expenses, $2.7 million in labor costs due to growth
in headcount, and $2.6 million in commissions. Additional increase in sales and
marketing expenses included increases of $1.0 million in consulting expenses,
$0.9 million in travel expenses. The increase in headcount from 128 in 2009 to
158 in 2010 was to augment the sales force with the objective to generate
future revenues.

General and administrative. These expenses
represented 13% and 14% of total revenue in 2010 and 2009, respectively.
Compensation for general and administrative employees, including stock-based
compensation, accounted for $1.7 million of the increase. Additional increases
in general and administrative expenses included $1.1 million in
consulting/outside services, $0.2 million in travel expense. These increases
were partially offset by a decrease of $1.3 million in legal expenses due to
the resolution of the litigation with Mitel, $1.1 million in bad debt expense
and $0.4 million in restructuring expense.

Litigation Settlement. We recorded a
charge of $4.1 million as a result of the agreement to settle our litigation
with Mitel in April 2009. There was no such charge in fiscal 2010.

Other income

|                   |  |                                    |    |                |   |       |  |   |        |   |  |     |   
|------------------ |  | ---------------------------------- | -- | -------------- | - | ----- |  | - | ------ | - |  | --- | --
|                   |  | Year ended                         |    | Change         |  
|                   |  |                                    |    |                |  
|                   |  | June 30,
 2010                     |    | June 30,
 2009 |   | $     |  | % |       
|                   |  |                                    |    |                |   |       |  |   |       
|                   |  | (in thousands, except percentages) |   
|Other
 Income, net |  | $                                  | 84 |                | $ | 1,141 |  | $ | (1,057 | ) |  | (93 | )%

Other income. Other income primarily
consists of interest earned on our cash and cash equivalents and short-term
investments and foreign currency translation gains and losses. The decrease in
other income is primarily attributable to significantly reduced interest rates
earned on relatively stable cash and investment balances.

Income tax provision (benefit).

|                                |  |                                    |      |                |   |     |  |   |      |   |  |      |   
|------------------------------- |  | ---------------------------------- | ---- | -------------- | - | --- |  | - | ---- | - |  | ---- | --
|                                |  | Year ended                         |      | Change         |  
|                                |  |                                    |      |                |  
|                                |  | June 30,
 2010                     |      | June 30,
 2009 |   | $   |  | % |     
|                                |  |                                    |      |                |   |     |  |   |     
|                                |  | (in thousands, except percentages) |     
|Income tax
 provision (benefit) |  | $                                  | (156 | )              | $ | 343 |  | $ | (499 | ) |  | (145 | )%

Income tax provision (benefit).
The income tax benefit was $(0.2) million in 2010 compared to an income tax
provision of approximately $0.3 million in 2009. The $(0.2) million income tax
benefit primarily relates to estimated benefit related to carrying back the
FY10 losses to FY06-FY08 to claim a tax refund of approximately $0.4 million
offset by $0.2 million foreign and minimum state taxes. In 2009, we incurred a
loss before provision for income tax; however, due to differences related to
book vs. tax, we generated taxable income in 2009. Accordingly, we recorded an
income tax benefit in 2010 and an income tax expense in 2009.

Fiscal 2009 compared to Fiscal 2008

Revenue.

|        |  |                                    |         |          |   |         |  |   |       |  |  |   |  
|------- |  | ---------------------------------- | ------- | -------- | - | ------- |  | - | ----- |  |  | - | -
|        |  | Year ended                         |         |          |  
|        |  |                                    |         | Change   |  
|        |  | June 30,                           |         | June 30, |   |         | 
|        |  | 2009                               |         | 2008     |   | $       |  | % |      
|        |  |                                    |         |          |   |         |  |   |      
|        |  | (in thousands, except percentages) |        
|Revenue |  | $                                  | 134,822 |          | $ | 128,729 |  | $ | 6,093 |  |  | 5 | %

- 37 -

---



The
increase was primarily attributable to increased support and services revenue.
Support and services revenue was $25.3 million in 2009, an increase of
$7.1 million, or 39%, from $18.2 million in 2008, as a result of a
$5.5 million increase in revenue associated with post-contractual support
contracts accompanying new system sales, post-contractual support contract
renewals, a $0.7 million increase in installations revenue and a $0.6 million
increase in training services revenue. Product revenue declined marginally to
$109.6 million in 2009 from $110.5 million in 2008 due to a decrease
in revenue from ShoreGear switches, IP phones and software licenses, all of
which had slight decline in average selling prices, partially offset by higher
volumes. The average selling price decline was primarily driven by increased
discounting due to the world wide economic recession that reduced the level of
IT capital spending at enterprises and specifically impacted the IP Telephony
market which has declined significantly in the last year.

Gross margin.

|                 |  |                                    |        |          |   |        |   |   |       |  |  |   |  
|---------------- |  | ---------------------------------- | ------ | -------- | - | ------ | - | - | ----- |  |  | - | -
|                 |  | Year ended                         |        |          |  
|                 |  |                                    |        | Change   |  
|                 |  | June 30,                           |        | June 30, |   |        |  
|                 |  | 2009                               |        | 2008     |   | $      |   | % |      
|                 |  |                                    |        |          |   |        |   |   |      
|                 |  | (in thousands, except percentages) |       
|Cost of
 revenue |  | $                                  | 49,197 |          | $ | 47,502 |   | $ | 1,695 |  |  | 4 | %
|Gross profit     |  | $                                  | 85,625 |          | $ | 81,227 |   | $ | 4,398 |  |  | 5 | %
|Gross margin     |  |                                    | 63.5   | %        |   | 63.1   | % |   | n/a   |  |  | 1 | %

The
increase in gross margin was attributable to an increase in support and
services gross margin from 45% in 2008 to 56% in 2009. This increase was
partially offset by a decline in product gross margin from 66% in 2008 to 65%
in 2009 due to a decline in average selling price of our ShoreGear Switches of
10% and a decline in our IP Phones of 2%. Support and services gross margin
increased due to support and services revenue increasing by 39% and service
costs only increasing by 10%, compared to the same period in 2008. The service
costs increase was limited to 10% 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, increased 16% in 2009, primarily due to an increase in stock-based
compensation and an increase in headcount from 52 employees at
June 30, 2008 to 55 employees at June 30, 2009.

Operating expenses.

|                            |  |                                    |        |          |   |        |  |   |       |  |  |     |  
|--------------------------- |  | ---------------------------------- | ------ | -------- | - | ------ |  | - | ----- |  |  | --- | -
|                            |  | Year ended                         |        |          |  
|                            |  |                                    |        | Change   |  
|                            |  | June 30,                           |        | June 30, |   |        | 
|                            |  | 2009                               |        | 2008     |   | $      |  | % |      
|                            |  |                                    |        |          |   |        |  |   |      
|                            |  | (in thousands, except percentages) |       
|Operating
 expenses:        |  |                                    |        |          |   |        |  |   |       |  |  |     |  
|Research and
 development   |  | $                                  | 30,724 |          | $ | 26,811 |  | $ | 3,913 |  |  | 15  | %
|Sales and
 marketing        |  | $                                  | 44,652 |          | $ | 37,869 |  | $ | 6,783 |  |  | 18  | %
|General and
 administrative |  | $                                  | 19,596 |          | $ | 17,645 |  | $ | 1,951 |  |  | 11  | %
|Litigation
 settlement      |  | $                                  | 4,110  |          | $ |       |  | $ | 4,110 |  |  | n/a |  

Research and development. These expenses
represented 23% and 21% of total revenue in 2009 and 2008, respectively.
Compensation, including stock-based compensation, for research and development
employees accounted for $4.1 million of the increase, primarily as a result of
increased headcount during the year. The increase in research and development
expenses also included $0.2 million each in legal expenses associated with
trademark and patent costs and in depreciation, $0.5 million in facilities,
$0.3 million corporate bonus and $0.1 million each in travel and software
expenses. These increases were primarily offset by a decrease of $1.1 million
in non-recurring engineering expenses, and decreases of $0.3 million each in
issued equipment expenses related to usage in beta programs and in consulting
and professional services.

Sales and marketing. These expenses
represented 33% and 29% of total revenue in 2009 and 2008, respectively.
Compensation, including stock-based compensation for sales and marketing
employees represented $4.9 million of the increase. The increase in sales and
marketing compensation included increases of $1.0 million in stock-based
compensation, $1.5 million in commissions and $2.4 million due to increased
headcount during the year. Additional increase in sales and

- 38 -

---



marketing expenses included increases of $0.2 million each in
restructuring expenses, consulting expenses, facilities expenses, and in travel
expenses, and $1.1 million in promotional expenses.

General and administrative. These expenses
represented 14% and 13% of total revenue in 2009 and 2008, respectively.
Compensation for general and administrative employees, including stock-based
compensation, accounted for $0.6 million of the increase. Additional
increases in general and administrative expenses included $0.8 million in the
provision for doubtful accounts, $0.1 million each in depreciation expense,
employee relations expenses, equipment expenses and restructuring expenses,
$0.3 million in sales tax expense and $0.2 million each in telecom and in legal
expenses. These increases were partially offset by a decrease of $0.3 million
in facilities expenses and $0.2 million in corporate bonus expense.

Litigation Settlement. We recorded a
charge of $4.1 million as a result of the agreement to settle our litigation
with Mitel in April 2009.

Other income

|                   |  |                                    |       |          |   |       |  |   |        |   |  |     |   
|------------------ |  | ---------------------------------- | ----- | -------- | - | ----- |  | - | ------ | - |  | --- | --
|                   |  | Year ended                         |       |          |  
|                   |  |                                    |       | Change   |  
|                   |  | June 30,                           |       | June 30, |   |       | 
|                   |  | 2009                               |       | 2008     |   | $     |  | % |       
|                   |  |                                    |       |          |   |       |  |   |       
|                   |  | (in thousands, except percentages) |      
|Other
 Income, net |  | $                                  | 1,141 |          | $ | 4,101 |  | $ | (2,960 | ) |  | (72 | )%

Other
income. Other income is primarily composed of interest
earned on our cash and cash equivalents and short-term investments and foreign
currency translation gains and losses. The decrease in other income is
primarily attributable to reduced interest rates earned on relatively stable
cash and investment balances. Interest income decreased $2.8 million, or 66%,
from 2008 to 2009 due to substantially lower interest rates. In addition,
foreign currency translation losses increased $0.2 million in 2009 compared to
2008.

Income tax provision.

|               |  |                                    |     |          |   |     |  |   |      |   |  |     |   
|-------------- |  | ---------------------------------- | --- | -------- | - | --- |  | - | ---- | - |  | --- | --
|               |  | Year ended                         |     |          |  
|               |  |                                    |     | Change   |  
|               |  | June 30,                           |     | June 30, |   |     | 
|               |  | 2009                               |     | 2008     |   | $   |  | % |     
|               |  |                                    |     |          |   |     |  |   |     
|               |  | (in thousands, except percentages) |    
|Tax
 provision |  | $                                  | 343 |          | $ | 861 |  | $ | (518 | ) |  | (60 | )%

Income tax provision. The income tax
provision was $0.3 million in 2009, a decrease of $0.6 million, from
approximately $0.9 million in 2008. We incurred a loss before provision for
income tax in 2009; however, due to differences related to book vs. tax, we
generated taxable income in 2009 and accordingly, we recorded an income tax
provision in 2009. We were profitable in 2008 and had an effective tax rate of
approximately 28.7% as a result of utilizing portions of the deferred tax asset
and reducing the related valuation allowance.

Liquidity and Capital Resources

Cash and Cash Equivalents and Investments.

|                                                                                                        |  |                     |         |      |   |         |  |   |         | 
|------------------------------------------------------------------------------------------------------- |  | ------------------- | ------- | ---- | - | ------- |  | - | ------- | 
|The
following table summarizes our cash and cash equivalents and short-term
investments (in thousands):
|                                                                                                       
|                                                                                                        |  | Year ended June 30, |        
|                                                                                                        |  |                     |        
|                                                                                                        |  | 2010                |         | 2009 |   | 2008    | 
|                                                                                                        |  |                     |         |      |   |         | 
|Cash and
 cash equivalents                                                                              |  | $                   | 68,426  |      | $ | 73,819  |  | $ | 68,672  | 
|Short-term
 investments                                                                                 |  |                     | 47,375  |      |   | 33,847  |  |   | 34,139  | 
|                                                                                                        |  |                     |         |      |   |         |  |   |         | 
|Total                                                                                                   |  | $                   | 115,801 |      | $ | 107,666 |  | $ | 102,811 | 
|                                                                                                        |  |                     |         |      |   |         |  |   |         | 

As
of June 30, 2010, our principal sources of liquidity consisted of cash and cash
equivalents and short-term investments of $115.8 million and net accounts
receivable of $24.6 million.

- 39 -

---



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 $115.8 million of cash and cash equivalents and short-term
investments at June 30, 2010, together with cash flows from our operations will
be sufficient to fund our operating requirements for at least the next 12 months.
Our future capital requirements will depend on many factors, including our rate
of revenue growth, the expansion of our sales and marketing activities, the
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 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:

|                                       |  |                     |         |      |   |        |   |   |         |  
|-------------------------------------- |  | ------------------- | ------- | ---- | - | ------ | - | - | ------- | -
|                                       |  | Year Ended June 30, |        
|                                       |  |                     |        
|                                       |  | 2010                |         | 2009 |   | 2008   |  
|                                       |  |                     |         |      |   |        |  
|                                       |  | (In thousands)      |        
|Cash
 provided by operating activities |  | $                   | 11,181  |      | $ | 7,447  |   | $ | 8,153   |  
|Cash used in
 investing activities     |  | $                   | (19,743 | )    | $ | (5,494 | ) | $ | (36,519 | )
|Cash
 provided by financing activities |  | $                   | 3,169   |      | $ | 3,194  |   | $ | 79,712  |  

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 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 assets and liabilities. We procure finished goods inventory from our
contract manufacturers and typically pay them in 30 days. We extend credit to
our channel partners and typically collect in 30 to 60 days, although these time
periods can vary and can be longer. In some cases we prepay for license rights
to third-party products in advance of sales.

Cash
provided by operating activities is generated by net income (loss) adjusted for
certain non-cash items and changes in assets and liabilities. Cash provided by
operating activities was $11.2 million for 2010 as compared to cash provided by
operations of $7.4 million for 2009 and $8.2 million for 2008. The increase in
cash provided by operations in fiscal year 2010 compared to fiscal year 2009
resulted primarily from the period-to-period change in cash flows relating to
operating activities. Deferred revenue increased by $6.2 million, primarily due
to the deferral of revenue from sales of post contractual support contracts exceeding
the revenue recognized from post contractual support contracts, increases in
accrued liabilities and other of $5.1 million and in accrued employee
compensation of $3.4 million, decreases in inventories of $1.9 million and
other assets of $1.2 million. These sources of cash were partially offset by
uses of cash associated with an increase in accounts receivable of $3.1 million
due to increased sales in 2010 compared to 2009 and increase in prepaid and
other current assets of $4.0 million. Further, noncash adjustments were higher
in 2010 compared to 2009 by $0.9 million.

Net
cash provided by operating activities in 2009 partly consisted of net loss of
$12.7 million. Noncash adjustments were higher in 2009 compared to 2008,
including stock-based compensation expense, which was higher in 2009 by $2.3
million. Noncash adjustments included $9.8 million in stock-based compensation,
$1.1 million in provision for doubtful accounts, $0.2 million loss on disposal
of property and equipment and $2.0 million in depreciation expense. These were
partially offset by $0.2 million in excess tax benefits from stock options
exercised. In addition, the period-to-period change in cash flows relating to
operating activities is composed of increases in deferred revenue of $3.8
million, primarily due to the deferral of revenue from sales of post
contractual support contracts exceeding the revenue recognized from post
contractual support contracts, and increases in accrued liabilities and other
of $2.3 million and in accounts payable of $1.8 million, decreases in prepaid
expenses and other current assets of $0.5 million, and inventory of $0.2
million. These sources of cash were partially offset by uses of cash associated
with an increase in accounts receivable of $0.6 million due to increased sales
in 2009 compared to 2008.

Net
cash provided by operating activities in 2008 partly consisted of net income of
$2.1 million. Noncash adjustments were higher in 2008 compared to 2007,
including stock-based compensation expense, which was higher in 2008 by $4.6
million. This was partially offset by a higher deferred tax benefit of $1.7
million in 2008. In addition, the period-to-period change in cash flows
relating to operating activities was also affected by an increase in deferred
revenue of $4.7 million, primarily due to the deferral of revenue from sales of
post contractual support contracts exceeding the revenue

- 40 -

---



recognized
from post contractual support contracts, and an increase in accrued liabilities
and other of $2.3 million, accrued employee compensation of $1.8 million,
primarily attributable to increased headcount. These sources of cash were
partially offset by uses of cash associated with an increase in accounts
receivable of $2.7 million due to increased sales in 2008 compared to 2007, an
increase in inventories of $5.0 million primarily due to business growth and an
increase in other assets of $1.9 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 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.
Because we invest only in investment securities that are highly liquid with a
ready market, we believe that the purchase, maturity or sale of our investments
has no material impact to our overall liquidity.

Net
cash used in investing activities was $19.7 million, $5.5 million, and $36.5
million in 2010, 2009 and 2008, respectively. Net cash used in investing
activities in 2010 was primarily related to investments made in U.S. government
sponsored securities and corporate bonds and commercial paper of $23.8 million,
partially offset by the net amount of sales and maturities of $10.1 million.
Also, $1.4 million was used to purchase technology licenses and patents and
$4.7 million was used to purchase property and equipment. Net cash used in
investing activities in 2009 was primarily related to $4.1 million used to
purchase technology licenses and patents and $1.8 million used to purchase
property and equipment. This was partially offset by sale/maturities of
investments made in U.S. government sponsored securities and corporate bonds
and commercial paper. Net cash used in investing activities in 2008 was
primarily related to investments made in U.S. government sponsored securities
and corporate bonds and commercial paper. Our requirements for additional
capital expenditures are subject to change depending upon several factors,
including our needs based on our changing business and industry and market
conditions.

Cash
flows from financing activities

Net
cash provided by financing activities was $3.2 million, $3.2 million and $79.7
million, in 2010, 2009 and 2008, respectively. In 2010, we generated proceeds
of $3.0 million from the sale of employee stock purchase plan shares and the
exercise of common stock options and $0.2 million from tax benefit of stock
options exercised. In 2009, we generated proceeds of $3.0 million from the sale
of employee stock purchase plan shares and the exercise of common stock options
and $0.2 million from tax benefit of stock options exercised. In 2008, we
generated proceeds of $78.6 million from our initial public offering including
payment of other offering costs, $0.8 million from exercise of common stock
options and received tax benefit of stock options exercised of $0.3 million.

Contractual Obligations

The
following is a summary of our contractual obligations as of June 30, 2010:

|                                                         |  |                        |        |                   |   |           |  |           |       |            |   |       |  |   |   | 
|-------------------------------------------------------- |  | ---------------------- | ------ | ----------------- | - | --------- |  | --------- | ----- | ---------- | - | ----- |  | - | - | 
|                                                         |  | Payments Due by Period |       
|                                                         |  |                        |       
|                                                         |  | Total                  |        | Less Than
 1 Year |   | 1-3 Years |  | 3-5 Years |       | Thereafter |  
|                                                         |  | (In thousands)         |       
|Operating lease obligations                              |  | $                      | 6,262  |                   | $ | 1,926     |  | $         | 2,944 |            | $ | 1,392 |  | $ |  | 
|Non-cancellable purchase commitments for
 finished goods |  |                        | 20,106 |                   |   | 20,106    |  |           |      |            |   |      |  |   |  | 
|Software license commitments                             |  |                        | 2,750  |                   |   | 1,250     |  |           | 1,500 |            |   |      |  |   |  | 
|                                                         |  |                        |        |                   |   |           |  |           |       |            |   |       |  |   |   | 
|Total                                                    |  | $                      | 29,118 |                   | $ | 23,282    |  | $         | 4,444 |            | $ | 1,392 |  | $ |  | 
|                                                         |  |                        |        |                   |   |           |  |           |       |            |   |       |  |   |   | 

Off-Balance Sheet Arrangements

We
do not have any material off-balance sheet arrangements (Other than those
disclosed above within Contractual Obligations) 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.

Critical Accounting Policies and Estimates

Our
consolidated financial statements are prepared in accordance with accounting
principles generally accepted in the United States of America, or GAAP. These
accounting principles require us to make certain estimates and judgments that
can affect the reported amounts of assets and liabilities as of the dates of
the consolidated financial statements, the disclosure

- 41 -

---



of
contingencies as of the dates of the consolidated financial statements, and the
reported amounts of revenue and expenses during the periods presented. Although
we believe that our judgments and estimates are reasonable under the circumstances,
actual results may differ from those estimates.

We
believe the following to be our critical accounting policies because they are
important to the portrayal of our financial condition and results of operations
and they require critical management judgments and estimates about matters that
are uncertain:

| |   |                                  
| | - | ---------------------------------
| |  | Revenue
 recognition;            
| |   |                                  
| |  | Allowance
 for doubtful accounts;
| |   |                                  
| |  | Stock-based
 compensation;       
| |   |                                  
| |  | Inventory
 valuation; and        
| |   |                                  
| |  | Accounting
 for income taxes.    

If
actual results or events differ materially from those contemplated by us in
making these estimates, our reported financial condition and results of
operations for future periods could be materially affected. See Risk Factors
for certain matters that may affect our future financial condition or results
of operations.

Revenue
Recognition

Product
Revenue. Our software is integrated with our hardware
and is essential to the functionality of the integrated system product. Product
sales typically include a perpetual license to our software, except in limited
circumstances such as sales of spare or replacement handsets, back-up switches
and additional business applications. We recognize revenue, depending on
whether the hardware is sold in a multiple-element arrangement with software
and post-contractual support or on a standalone basis if the enterprise
customer purchases hardware, software, or maintenance support separately. For
the initial sale, we generally bundle together the hardware, software, and
post-contractual support contracts with terms of up to five years. Thereafter,
if the enterprise customer increases the number of end user deployments and/or
functionality, it may add more hardware, software, and related post-contractual
support by purchasing them separately. We evaluate existence of vendor-specific
objective evidence, or VSOE, of fair value for post-contractual support and,
installation and services and training, as noted below.

We
recognize product revenue when persuasive evidence of an arrangement exists,
product has shipped or delivery has occurred (depending on when title passes),
the sales price is fixed or determinable and free of contingencies and
significant uncertainties, and collection is probable. Our fee is considered
fixed or determinable at the execution of an agreement, based on specific
products and quantities to be delivered at specified prices. Our agreements
generally do not include rights of return or acceptance provisions. To the
extent that our agreements contain acceptance terms, we recognize revenue upon
product acceptance, unless the acceptance provision is deemed to be
perfunctory. We maintain a reserve for sales returns based on historical
experience. Payment terms generally range from net 30 to net 60 days. In the
event payment terms are extended materially from our standard business
practices, the fees are deemed to not be fixed or determinable and revenue is
recognized when the payments become due. We assess the ability to collect from
channel partners based on a number of factors, including creditworthiness and
past transaction history. If the channel partner is not deemed creditworthy, we
defer all revenue from the arrangement until payment is received and all other
revenue recognition criteria have been met. Shipping charges are included in
product revenue and the related shipping costs are included in cost of product
revenue.

We
monitor and analyze the accuracy of sales returns estimates by reviewing actual
returns and adjust it for future expectations to determine the adequacy of our
current and future reserve needs. If actual future returns and allowances
differ from past experience and expectation, additional allowances may be
required.

We
have arrangements with channel partners to reimburse the channel partners for
cooperative marketing costs meeting specified criteria. The reimbursements are
limited to 50% of the actual costs charged to the channel partners by
third-party vendors for advertising, trade shows and other related sales and
marketing activities for which we receive an identifiable benefit, subject to a
limit of the total cooperative marketing allowance earned by each channel
partner. Moreover, we record the reimbursements to the channel partners meeting
such specified criteria within sales and marketing expenses in the accompanying
consolidated statements of operations.

Post-Contractual
Support. Our support and services revenue is primarily
derived from post-contractual support. We account for post-contractual support
revenue based on VSOE of fair value, regardless of any separate prices stated
within the contract for each element. VSOE of fair value is limited to the
price charged when the same element is sold separately. VSOE of fair value is
established for support through prior renewals of post-contractual support
contracts, which establishes a price which is based on a standalone sale. To
determine the fair value of the price charged, we analyze both the selling
prices when

- 42 -

---



elements are
sold separately as well as the concentrations of those prices. We believe those
concentrations have been sufficient to enable us to establish VSOE of fair
value for the post-contract support revenues.

We
currently use the residual method to determine the amount of product revenue to
be recognized. Under the residual method, the fair value of the undelivered
elements, such as post-contractual support, installation services and training,
are deferred and the remaining portion of the sales amount is recognized as
product revenue. The fair value of the post-contractual support is recognized
as support and services revenue on a straight-line basis over the term of the
related support period, which can be up to five years in length.

Installation
and training. Installation services are sold on an
elective basis. Channel partners or enterprise customers generally perform
installations without our involvement, so we do not recognize substantial
revenue from installation services. As installation is typically performed by
the channel partner or enterprise customer, it is not considered essential to
the functionality of the delivered elements. Installation is generally priced
at established rates based on estimated hours to install our systems. Training
services are also sold on an elective basis, both to channel partners and to
enterprise customers, and is purchased both with system orders and on a
standalone basis. VSOE of fair value has been established for training. We
recognize revenue related to installation services and training upon delivery
of the service. If VSOE of fair value does not exist for installation, training
or commitments to provide specified upgrades, services or additional products
to customers in the future, as has been the case from time to time in the past,
we defer all revenue from the arrangement until the earlier of the point at
which VSOE of fair value does exist or all such elements from the arrangement
have been delivered.

Allowance
for Doubtful Accounts

We
review our allowance for doubtful accounts on a quarterly basis by assessing
individual accounts receivable that materially exceed due dates. Risk
assessment for these accounts includes historical collections experience with
the specific account and with our similarly situated accounts coupled with
other related credit factors that may evidence a risk of default and loss to
us. Accordingly, the amount of this allowance will fluctuate based upon changes
in revenue levels, collection of specific balances in accounts receivable and
estimated changes in channel partner credit quality or likelihood of
collection. If the financial condition of our channel partners were to
deteriorate, resulting in an impairment of their ability to make payments,
additional allowances may be required. The allowance for doubtful accounts
represents managements best estimate, but changes in circumstances, including
unforeseen declines in market conditions and collection rates, may result in
additional allowances in the future or reductions in allowances due to future
recoveries.

Stock-Based
Compensation

Stock-Based
Compensation The Company amortizes stock-based
compensation expense based upon the fair value of stock-based awards on a
straight-line basis over the requisite vesting period as defined in the
applicable plan documents. Corporate income tax benefits realized upon exercise
or vesting of an award in excess of that previously recognized in earnings,
referred to as an excess tax benefit, are presented in the consolidated
statements of cash flows as a financing activity. Realized excess tax benefits
are credited to additional paid-in capital in the consolidated balance sheets.

Stock-based
compensation expense recognized in the Consolidated Statements of Operations
has been reduced for forfeitures since it is based on awards ultimately
expected to vest, it. If factors change and we employ different assumptions in
the application of our option-pricing model in future periods or if we experience
different forfeiture rates, the compensation expense that is derived may differ
significantly from what we have recorded in the current year.

Inventory
Valuation

Inventories
consist principally of finished goods and are stated at the lower of cost or
market value, with cost being determined under a standard cost method that
approximates first-in, first out. Inventory valuation reserves are established
to reduce the carrying amounts of our inventories to their net estimated
realizable values. Inventory valuation reserves are generally based on
historical usage and expected demand. If future demand or market conditions are
less favorable than our projections, additional inventory valuation reserves
could be required and would be reflected in cost of product revenue in the
period in which the reserves are taken. Inventory valuation reserves were $0.5
million and $0.6 million as of June 30, 2010 and 2009, respectively. Once a
reserve is established, it is maintained until the unit to which it relates is
sold or scrapped.

Accounting
for Income Taxes

The
Company accounts for income taxes using the asset and liability method as
prescribed by Statement of Financial Accounting Standards (SFAS) No. 109,
Accounting for Income Taxes. Deferred income taxes are recognized by applying
enacted statutory tax rates applicable to future years to differences between
the financial statement carrying amounts of existing assets and liabilities and
their respective tax bases and operating loss and tax credit carryforwards. The
effect on deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment

- 43 -

---



date. The
measurement of deferred tax assets is reduced, if necessary, by a valuation
allowance for any tax benefit of which future realization is uncertain.

During
the year ended June 30, 2010, the increase in total deferred tax assets of $9.7
million and related increase in the valuation allowance of $11.4 million was
primarily related to the increase in gross net operating loss and tax credit
carryforwards due to the favorable tax ruling from the Internal Revenue Service
related to Section 382. In assessing the realizability of deferred tax assets,
management considers whether it is more likely than not that some portion or
all of deferred tax assets will not be realized. The realization of deferred
tax assets is based on several factors, including the Companys past earnings
and the scheduling of deferred taxes and projected income from operating
activities. As of June 30, 2010, management does not believe it is more likely
than not that the deferred tax assets relating to U.S. federal and state
operations are realizable. The Company intends to maintain the valuation
allowance until sufficient positive evidence exists to support reversal of some
or all of the valuation allowance. The Companys income tax expense (benefit)
recorded in the future will be reduced or increased in the event changes to the
valuation allowance are required.

Recent Accounting Pronouncements

Refer
to Note 1 of Notes to Consolidated Financial Statements in this Form 10-K for a
discussion of the expected impact of recently issued accounting pronouncements.

|         |                                                            
|-------- | -----------------------------------------------------------
|ITEM 7A. | QUANTITATIVE AND QUALITATIVE DISCLOSURES
 ABOUT MARKET RISK

Market Risk

We
are exposed to various market risks, including changes in foreign currency
exchange rates. Market risk is the potential loss arising from adverse changes
in market rates and prices, such as foreign currency exchange and interest
rates. We do not enter into derivatives or other financial instruments for
trading or speculative purposes. We may enter into financial instrument
contracts with major financial institutions to manage and reduce the impact of
changes in foreign currency exchange rates in the future. We had no forward
exchange contracts outstanding as of June 30, 2010.

In
addition, we currently hold our investment portfolio in accounts with three
financial firms. While we do not invest our cash in obligations of these firms,
if these firms were to experience financial or other regulatory difficulties,
it might be difficult for us to access our investments in a timely manner.

Interest Rate Risk

We
maintain an investment portfolio of various holdings, types, and maturities.
These securities are generally classified as available for sale and
consequently, are recorded on the balance sheet at fair value with unrealized
gains and losses reported as a separate component of accumulated other
comprehensive income (loss). At any time, a sharp rise in interest rates could
have a material adverse impact on the fair value of our investment portfolio.
Conversely, declines in interest rates could have a material positive impact on
interest earnings for our portfolio. We do not currently hedge these interest
rate exposures.

The
following table presents the hypothetical change in fair values in the
financial instruments we held at June 30, 2010 that are sensitive to
changes in interest rates. The modeling technique used measures the change in
fair values arising from selected potential changes in interest rates on our
investment portfolio, which had a fair value of $47.4 million at June 30,
2010. Market changes reflect immediate hypothetical parallel shifts in the
yield curve of plus or minus 100, 50 and 25 basis points (BPS).

|                              |  |                            |        |                            |   |         |   |        |        |        |   |         |    |   |        |    |   |        |   
|----------------------------- |  | -------------------------- | ------ | -------------------------- | - | ------- | - | ------ | ------ | ------ | - | ------- | -- | - | ------ | -- | - | ------ | --
|                              |  | Decrease in interest rates |        | Increase in interest rates |  
|                              |  |                            |        |                            |  
|(in
 thousands)               |  | -100 BPS                   |        | -50 BPS                    |   | -25 BPS |   | 25 BPS |        | 50 BPS |   | 100 BPS |   
|Total Fair
 Market Value      |  | $                          | 47,803 |                            | $ | 47,589  |   | $      | 47,482 |        | $ | 47,268  |    | $ | 47,161 |    | $ | 46,947 |   
|Percent
 Change in Fair Value |  |                            | 0.90   | %                          |   | 0.45    | % |        | 0.23   | %      |   | (0.23   | )% |   | (0.45  | )% |   | (0.90  | )%

- 44 -

---



|        |                                              | 
|------- | -------------------------------------------- | 
|ITEM 8. | FINANCIAL
 STATEMENTS AND SUPPLEMENTARY DATA | 
|        | SHORETEL, INC. AND SUBSIDIARIES              | 

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

|                                                                                                                             |  |     
|---------------------------------------------------------------------------------------------------------------------------- |  | ----
|                                                                                                                             |  | Page
|                                                                                                                             |  |     
|Report of Independent Registered Public Accounting Firm                                                                      |  | 46  
|Consolidated Balance Sheets                                                                                                  |  | 47  
|Consolidated Statements of Operations                                                                                        |  | 48  
|Consolidated
 Statements of Redeemable Convertible Preferred Stock and Stockholders Equity
 and Comprehensive Income (Loss) |  | 49  
|Consolidated Statements of Cash Flows                                                                                        |  | 50  
|Notes to Consolidated Financial Statements                                                                                   |  | 51  

- 45 -

---



REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors
and Stockholders of 
ShoreTel, Inc.
Sunnyvale, California

We
have audited the accompanying consolidated balance sheets of ShoreTel, Inc. and
subsidiaries (the Company) as of June 30, 2010 and 2009, and the related
consolidated statements of operations, redeemable convertible preferred stock
and stockholders equity and comprehensive income (loss), and cash flows for
each of the three years in the period ended June 30, 2010. These financial
statements are the responsibility of the Companys management. Our
responsibility is to express an opinion on the financial statements based on
our audits.

We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

In
our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of ShoreTel, Inc. and subsidiaries as
of June 30, 2010 and 2009, and the results of their operations and their
cash flows for each of the three years in the period ended June 30, 2010,
in conformity with accounting principles generally accepted in the United
States of America.

We
have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the Companys internal control over
financial reporting as of June 30, 2010, based on the criteria established
in Internal ControlIntegrated Frameworkissued
by the Committee of Sponsoring Organizations of the Treadway Commission and our
report dated September 10, 2010 expressed an unqualified opinion on the
Companys internal control over financial reporting.

/s/ DELOITTE & TOUCHE
LLP

San Jose, California 
September 10, 2010

- 46 -

---



SHORETEL, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS 
(Amounts in thousands except per share amounts)

|                                                                                                                                                                                                    |  |          |          |      |   |         |  
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------- | -------- | ---- | - | ------- | -
|                                                                                                                                                                                                    |  | June 30, |         
|                                                                                                                                                                                                    |  |          |         
|                                                                                                                                                                                                    |  | 2010     |          | 2009 |  
|                                                                                                                                                                                                    |  |          |          |      |  
|ASSETS                                                                                                                                                                                             
|CURRENT ASSETS:                                                                                                                                                                                     |  |          |          |      |   |         |  
|Cash and cash equivalents                                                                                                                                                                           |  | $        | 68,426   |      | $ | 73,819  |  
|Short-term investments                                                                                                                                                                              |  |          | 47,375   |      |   | 33,847  |  
|Accounts receivable, net of allowances of
 $876 and $1,330 as of June 30, 2010 and June 30, 2009, respectively                                                                                      |  |          | 24,596   |      |   | 21,454  |  
|Inventories                                                                                                                                                                                         |  |          | 9,954    |      |   | 11,805  |  
|Prepaid expenses and other current assets                                                                                                                                                           |  |          | 8,125    |      |   | 3,110   |  
|                                                                                                                                                                                                    |  |          |          |      |   |         |  
|Total current assets                                                                                                                                                                                |  |          | 158,476  |      |   | 144,035 |  
|PROPERTY AND EQUIPMENT - Net                                                                                                                                                                        |  |          | 6,019    |      |   | 3,475   |  
|OTHER ASSETS                                                                                                                                                                                        |  |          | 6,226    |      |   | 8,114   |  
|                                                                                                                                                                                                    |  |          |          |      |   |         |  
|TOTAL                                                                                                                                                                                               |  | $        | 170,721  |      | $ | 155,624 |  
|                                                                                                                                                                                                    |  |          |          |      |   |         |  
|                                                                                                                                                                                                    |  |          |          |      |   |         |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                                                               
|                                                                                                                                                                                                    |  |          |          |      |   |         |  
|CURRENT LIABILITIES:                                                                                                                                                                                |  |          |          |      |   |         |  
|Accounts payable                                                                                                                                                                                    |  | $        | 7,868    |      | $ | 7,774   |  
|Accrued liabilities and other                                                                                                                                                                       |  |          | 10,061   |      |   | 4,494   |  
|Accrued employee compensation                                                                                                                                                                       |  |          | 8,261    |      |   | 4,895   |  
|Deferred revenue                                                                                                                                                                                    |  |          | 19,450   |      |   | 15,255  |  
|                                                                                                                                                                                                    |  |          |          |      |   |         |  
|Total current liabilities                                                                                                                                                                           |  |          | 45,640   |      |   | 32,418  |  
|LONG-TERM LIABILITIES:                                                                                                                                                                              |  |          |          |      |   |         |  
|Long-term deferred revenue                                                                                                                                                                          |  |          | 9,269    |      |   | 7,236   |  
|Other long-term liabilities                                                                                                                                                                         |  |          | 1,346    |      |   | 2,198   |  
|                                                                                                                                                                                                    |  |          |          |      |   |         |  
|Total liabilities                                                                                                                                                                                   |  |          | 56,255   |      |   | 41,852  |  
|                                                                                                                                                                                                    |  |          |          |      |   |         |  
|                                                                                                                                                                                                    |  |          |          |      |   |         |  
|COMMITMENTS AND CONTINGENCIES (Note 9)                                                                                                                                                              |  |          |          |      |   |         |  
|                                                                                                                                                                                                    |  |          |          |      |   |         |  
|STOCKHOLDERS EQUITY:                                                                                                                                                                               |  |          |          |      |   |         |  
|Preferred stock, par value $.001 per share,
 authorized 5,000 shares; none issued and outstanding                                                                                                   |  |          |         |      |   |        |  
|                                                                                                                                                                                                    |  |          |          |      |   |         |  
|Common stock and additional paid-in
 capital, par value $.001 per share, authorized 500,000; issued and
 outstanding, 45,370 and 44,362 shares as of June 30, 2010 and June 30, 2009,
 respectively |  |          | 222,491  |      |   | 209,102 |  
|Deferred compensation                                                                                                                                                                               |  |          |         |      |   | (54     | )
|Accumulated other comprehensive income                                                                                                                                                              |  |          | 191      |      |   | 136     |  
|Accumulated deficit                                                                                                                                                                                 |  |          | (108,216 | )    |   | (95,412 | )
|                                                                                                                                                                                                    |  |          |          |      |   |         |  
|Total stockholders equity                                                                                                                                                                          |  |          | 114,466  |      |   | 113,772 |  
|                                                                                                                                                                                                    |  |          |          |      |   |         |  
|TOTAL                                                                                                                                                                                               |  | $        | 170,721  |      | $ | 155,624 |  
|                                                                                                                                                                                                    |  |          |          |      |   |         |  

See notes to consolidated financial
statements

- 47 -

---



SHORETEL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS

|                                                                                                         |  |                                                  |         |      |   |         |   |   |         |  
|-------------------------------------------------------------------------------------------------------- |  | ------------------------------------------------ | ------- | ---- | - | ------- | - | - | ------- | -
|                                                                                                         |  | Year Ended June 30,                              |        
|                                                                                                         |  |                                                  |        
|                                                                                                         |  | 2010                                             |         | 2009 |   | 2008    |  
|                                                                                                         |  |                                                  |         |      |   |         |  
|                                                                                                         |  |                                                  |        
|                                                                                                         |  | (Amounts in thousands, except per share amounts) |        
|REVENUE:                                                                                                 |  |                                                  |         |      |   |         |   |   |         |  
|Product                                                                                                  |  | $                                                | 117,138 |      | $ | 109,555 |   | $ | 110,496 |  
|Support and services                                                                                     |  |                                                  | 31,326  |      |   | 25,267  |   |   | 18,233  |  
|                                                                                                         |  |                                                  |         |      |   |         |   |   |         |  
|Total revenue                                                                                            |  |                                                  | 148,464 |      |   | 134,822 |   |   | 128,729 |  
|COST OF REVENUE:                                                                                         |  |                                                  |         |      |   |         |   |   |         |  
|Product                                                                                                  |  |                                                  | 40,471  |      |   | 38,149  |   |   | 37,466  |  
|Support and services                                                                                     |  |                                                  | 11,580  |      |   | 11,048  |   |   | 10,036  |  
|                                                                                                         |  |                                                  |         |      |   |         |   |   |         |  
|Total cost of revenue                                                                                    |  |                                                  | 52,051  |      |   | 49,197  |   |   | 47,502  |  
|GROSS PROFIT                                                                                             |  |                                                  | 96,413  |      |   | 85,625  |   |   | 81,227  |  
|OPERATING EXPENSES:                                                                                      |  |                                                  |         |      |   |         |   |   |         |  
|Research and development                                                                                 |  |                                                  | 33,596  |      |   | 30,724  |   |   | 26,811  |  
|Sales and marketing                                                                                      |  |                                                  | 55,973  |      |   | 44,652  |   |   | 37,869  |  
|General and administrative                                                                               |  |                                                  | 19,888  |      |   | 19,596  |   |   | 17,645  |  
|Litigation settlement                                                                                    |  |                                                  |        |      |   | 4,110   |   |   |        |  
|                                                                                                         |  |                                                  |         |      |   |         |   |   |         |  
|Total operating expenses                                                                                 |  |                                                  | 109,457 |      |   | 99,082  |   |   | 82,325  |  
|                                                                                                         |  |                                                  |         |      |   |         |   |   |         |  
|LOSS FROM OPERATIONS                                                                                     |  |                                                  | (13,044 | )    |   | (13,457 | ) |   | (1,098  | )
|OTHER INCOME (EXPENSE):                                                                                  |  |                                                  |         |      |   |         |   |   |         |  
|Interest income                                                                                          |  |                                                  | 408     |      |   | 1,399   |   |   | 4,141   |  
|Other                                                                                                    |  |                                                  | (324    | )    |   | (258    | ) |   | (40     | )
|                                                                                                         |  |                                                  |         |      |   |         |   |   |         |  
|Total other income                                                                                       |  |                                                  | 84      |      |   | 1,141   |   |   | 4,101   |  
|                                                                                                         |  |                                                  |         |      |   |         |   |   |         |  
|INCOME (LOSS) BEFORE INCOME TAX BENEFIT
 (PROVISION)                                                     |  |                                                  | (12,960 | )    |   | (12,316 | ) |   | 3,003   |  
|Income tax benefit (provision)                                                                           |  |                                                  | 156     |      |   | (343    | ) |   | (861    | )
|                                                                                                         |  |                                                  |         |      |   |         |   |   |         |  
|NET INCOME (LOSS)                                                                                        |  | $                                                | (12,804 | )    | $ | (12,659 | ) | $ | 2,142   |  
|                                                                                                         |  |                                                  |         |      |   |         |   |   |         |  
|Net income (loss) per common share
 available to common stockholders:                                    |  |                                                  |         |      |   |         |   |   |         |  
|Basic                                                                                                    |  | $                                                | (0.29   | )    | $ | (0.29   | ) | $ | 0.05    |  
|                                                                                                         |  |                                                  |         |      |   |         |   |   |         |  
|Diluted                                                                                                  |  | $                                                | (0.29   | )    | $ | (0.29   | ) | $ | 0.05    |  
|                                                                                                         |  |                                                  |         |      |   |         |   |   |         |  
|Weighted average shares used in computing
 net income (loss) per share available to common stockholders: |  |                                                  |         |      |   |         |   |   |         |  
|Basic                                                                                                    |  |                                                  | 44,804  |      |   | 43,714  |   |   | 42,413  |  
|Diluted                                                                                                  |  |                                                  | 44,804  |      |   | 43,714  |   |   | 44,861  |  

|                                              
|----------------------------------------------
|                                              
|See notes to consolidated financial statements

- 48 -

---



SHORETEL, INC. AND SUBSIDIARIES

CONSOLIDATED
STATEMENTS OF REDEEMABLE CONVERTIBLEPREFERRED STOCK AND STOCKHOLDERS EQUITY AND COMPREHENSIVE INCOME (LOSS)

|                                                                  |  |                                      |         |                           |   |                                             |   |        |                                           |                          |   |         |   |   |      |   |   |   |  |   |     |   |   |          |   |   |         |  
|----------------------------------------------------------------- |  | ------------------------------------ | ------- | ------------------------- | - | ------------------------------------------- | - | ------ | ----------------------------------------- | ------------------------ | - | ------- | - | - | ---- | - | - | - |  | - | --- | - | - | -------- | - | - | ------- | -
|                                                                  |  |                                      |         |                           |   | Common Stock
 andAdditional Paid-In-Capital |   |        |                                           |                          |   |         |   |   |      |   |  
|                                                                  |  | RedeemableConvertiblePreferred Stock |         |                           |   |                                             |   |        | AccumulatedOtherComprehensiveIncome(Loss) |                          |   |         |   |  
|                                                                  |  |                                      |         |                           |   | NoteReceivablefromStockholders              |   |        |                                           |                          |   |        
|                                                                  |  |                                      |         | DeferredStockCompensation |   |                                             |   |        |                                           | TotalStockholdersEquity |  
|                                                                  |  |                                      |         |                           |   |                                             |   |        | AccumulatedDeficit                        |                          |  
|                                                                  |  | Shares                               |         | Amount                    |   | Shares                                      |   | Amount |                                           |                          |   |         |   |  
|                                                                  |  |                                      |         |                           |   |                                             |   |        |                                           |                          |   |         |   |   |      |   |   |   | 
|                                                                  |  | (Amounts in thousands)               |        
|                                                                  |  |                                      |         |                           |   |                                             |   |        |                                           |                          |   |         |   |   |      |   |   |   | 
|                                                                  |  |                                      |         |                           |   |                                             |   |        |                                           |                          |   |         |   |   |      |   |   |   | 
|BALANCE - July 1, 2007                                            |  |                                      | 23,316  |                           | $ | 56,341                                      |   |        | 10,132                                    |                          | $ | 53,303  |   | $ | (237 | ) | $ |  |  | $ |    |   | $ | (84,895  | ) | $ | (31,829 | )
|Proceeds from initial public offering, net of offering costs      |  |                                      |         |                           |   |                                             |   |        | 9,085                                     |                          |   | 77,328  |   |   |      |   |   |   |  |   |     |   |   |          |   |   | 77,328  |  
|Preferred stock warrants converted to common stock warrants       |  |                                      |         |                           |   |                                             |   |        |                                           |                          |   | 549     |   |   |      |   |   |   |  |   |     |   |   |          |   |   | 549     |  
|Conversion of preferred stock to common stock                     |  |                                      | (23,316 | )                         |   | (56,341                                     | ) |        | 23,316                                    |                          |   | 56,341  |   |   |      |   |   |   |  |   |     |   |   |          |   |   | 56,341  |  
|Exercise of warrants                                              |  |                                      |         |                           |   |                                             |   |        | 61                                        |                          |   |         |   |   |      |   |   |   |  |   |     |   |   |          |   |   |         |  
|Common stock issued under stock-based compensation plans          |  |                                      |         |                           |   |                                             |   |        | 747                                       |                          |   | 857     |   |   |      |   |   |   |  |   |     |   |   |          |   |   | 857     |  
|Stock-based compensation expense                                  |  |                                      |         |                           |   |                                             |   |        |                                           |                          |   | 7,336   |   |   | 95   |   |   |   |  |   |     |   |   |          |   |   | 7,431   |  
|Vesting of accrued early exercised stock options                  |  |                                      |         |                           |   |                                             |   |        |                                           |                          |   | 220     |   |   |      |   |   |   |  |   |     |   |   |          |   |   | 220     |  
|Income tax benefit related to stock option exercises              |  |                                      |         |                           |   |                                             |   |        |                                           |                          |   | 250     |   |   |      |   |   |   |  |   |     |   |   |          |   |   | 250     |  
|Components of comprehensive income:                               |  |                                      |         |                           |   |                                             |   |        |                                           |                          |   |         |   |   |      |   |   |   |  |   |     |   |   |          |   |   |         |  
|Unrealized loss on short-term investments                         |  |                                      |         |                           |   |                                             |   |        |                                           |                          |   |         |   |   |      |   |   |   |  |   | (76 | ) |   |          |   |   | (76     | )
|Net income                                                        |  |                                      |         |                           |   |                                             |   |        |                                           |                          |   |         |   |   |      |   |   |   |  |   |     |   |   | 2,142    |   |   | 2,142   |  
|                                                                  |  |                                      |         |                           |   |                                             |   |        |                                           |                          |   |         |   |   |      |   |   |   |  |   |     |   |   |          |   |   |         |  
|Comprehensive income                                              |  |                                      |         |                           |   |                                             |   |        |                                           |                          |   |         |   |   |      |   |   |   |  |   |     |   |   |          |   |   | 2,066   |  
|                                                                  |  |                                      |         |                           |   |                                             |   |        |                                           |                          |   |         |   |   |      |   |   |   |  |   |     |   |   |          |   |   |         |  
|                                                                  |  |                                      |         |                           |   |                                             |   |        |                                           |                          |   |         |   |   |      |   |   |   |  |   |     |   |   |          |   |   |         |  
|BALANCE  June 30, 2008                                           |  |                                      |        |                           |   |                                            |   |        | 43,341                                    |                          |   | 196,184 |   |   | (142 | ) |   |  |  |   | (76 | ) |   | (82,753  | ) |   | 113,213 |  
|Common stock issued under stock-based compensation plans          |  |                                      |         |                           |   |                                             |   |        | 1,021                                     |                          |   | 3,004   |   |   |      |   |   |   |  |   |     |   |   |          |   |   | 3,004   |  
|Stock-based compensation expense                                  |  |                                      |         |                           |   |                                             |   |        |                                           |                          |   | 9,670   |   |   | 88   |   |   |   |  |   |     |   |   |          |   |   | 9,758   |  
|Vesting of accrued early exercised stock options                  |  |                                      |         |                           |   |                                             |   |        |                                           |                          |   | 54      |   |   |      |   |   |   |  |   |     |   |   |          |   |   | 54      |  
|Income tax benefit related to stock option exercises              |  |                                      |         |                           |   |                                             |   |        |                                           |                          |   | 190     |   |   |      |   |   |   |  |   |     |   |   |          |   |   | 190     |  
|Components of comprehensive income:                               |  |                                      |         |                           |   |                                             |   |        |                                           |                          |   |         |   |   |      |   |   |   |  |   |     |   |   |          |   |   |         |  
|Unrealized gain on short-term investments                         |  |                                      |         |                           |   |                                             |   |        |                                           |                          |   |         |   |   |      |   |   |   |  |   | 212 |   |   |          |   |   | 212     |  
|Net loss                                                          |  |                                      |         |                           |   |                                             |   |        |                                           |                          |   |         |   |   |      |   |   |   |  |   |     |   |   | (12,659  | ) |   | (12,659 | )
|                                                                  |  |                                      |         |                           |   |                                             |   |        |                                           |                          |   |         |   |   |      |   |   |   |  |   |     |   |   |          |   |   |         |  
|Comprehensive loss                                                |  |                                      |         |                           |   |                                             |   |        |                                           |                          |   |         |   |   |      |   |   |   |  |   |     |   |   |          |   |   | (12,447 | )
|                                                                  |  |                                      |         |                           |   |                                             |   |        |                                           |                          |   |         |   |   |      |   |   |   |  |   |     |   |   |          |   |   |         |  
|                                                                  |  |                                      |         |                           |   |                                             |   |        |                                           |                          |   |         |   |   |      |   |   |   |  |   |     |   |   |          |   |   |         |  
|BALANCE - June 30, 2009                                           |  |                                      |        |                           |   |                                            |   |        | 44,362                                    |                          |   | 209,102 |   |   | (54  | ) |   |  |  |   | 136 |   |   | (95,412  | ) |   | 113,772 |  
|                                                                  |  |                                      |         |                           |   |                                             |   |        |                                           |                          |   |         |   |   |      |   |   |   |  |   |     |   |   |          |   |   |         |  
|Common stock issued under stock-based compensation plans          |  |                                      |         |                           |   |                                             |   |        | 1,008                                     |                          |   | 2,978   |   |   |      |   |   |   |  |   |     |   |   |          |   |   | 2,978   |  
|Stock-based compensation expense                                  |  |                                      |         |                           |   |                                             |   |        |                                           |                          |   | 10,600  |   |   | 54   |   |   |   |  |   |     |   |   |          |   |   | 10,654  |  
|Vesting of accrued early exercised stock options                  |  |                                      |         |                           |   |                                             |   |        |                                           |                          |   | 18      |   |   |      |   |   |   |  |   |     |   |   |          |   |   | 18      |  
|Income tax benefit (deficiency) related to stock option exercises |  |                                      |         |                           |   |                                             |   |        |                                           |                          |   | (207    | ) |   |      |   |   |   |  |   |     |   |   |          |   |   | (207    | )
|Components of comprehensive income:                               |  |                                      |         |                           |   |                                             |   |        |                                           |                          |   |         |   |   |      |   |   |   |  |   |     |   |   |          |   |   |         |  
|Unrealized gain on short-term investments                         |  |                                      |         |                           |   |                                             |   |        |                                           |                          |   |         |   |   |      |   |   |   |  |   | 55  |   |   |          |   |   | 55      |  
|Net loss                                                          |  |                                      |         |                           |   |                                             |   |        |                                           |                          |   |         |   |   |      |   |   |   |  |   |     |   |   | (12,804  | ) |   | (12,804 | )
|                                                                  |  |                                      |         |                           |   |                                             |   |        |                                           |                          |   |         |   |   |      |   |   |   |  |   |     |   |   |          |   |   |         |  
|Comprehensive loss                                                |  |                                      |         |                           |   |                                             |   |        |                                           |                          |   |         |   |   |      |   |   |   |  |   |     |   |   |          |   |   | (12,749 | )
|                                                                  |  |                                      |         |                           |   |                                             |   |        |                                           |                          |   |         |   |   |      |   |   |   |  |   |     |   |   |          |   |   |         |  
|                                                                  |  |                                      |         |                           |   |                                             |   |        |                                           |                          |   |         |   |   |      |   |   |   |  |   |     |   |   |          |   |   |         |  
|BALANCE - June 30, 2010                                           |  |                                      |        |                           | $ |                                            |   |        | 45,370                                    |                          | $ | 222,491 |   | $ |     |   | $ |  |  | $ | 191 |   | $ | (108,216 | ) |   | 114,466 |  
|                                                                  |  |                                      |         |                           |   |                                             |   |        |                                           |                          |   |         |   |   |      |   |   |   |  |   |     |   |   |          |   |   |         |  

See notes to consolidated financial
statements

- 49 -

---



SHORETEL, INC. AND SUBSIDIARIES

CONSOLIDATED
STATEMENTS OF CASH FLOWS

|                                                                                                             |  |                     |         |      |   |         |   |   |         |  
|------------------------------------------------------------------------------------------------------------ |  | ------------------- | ------- | ---- | - | ------- | - | - | ------- | -
|                                                                                                             |  | Year Ended June 30, |        
|                                                                                                             |  |                     |        
|                                                                                                             |  | 2010                |         | 2009 |   | 2008    |  
|                                                                                                             |  |                     |         |      |   |         |  
|                                                                                                             |  | (In thousands)      |        
|CASH FLOWS FROM OPERATING ACTIVITIES:                                                                        |  |                     |         |      |   |         |   |   |         |  
|Net income (loss)                                                                                            |  | $                   | (12,804 | )    | $ | (12,659 | ) | $ | 2,142   |  
|Adjustments to reconcile net income (loss)
 to net cash provided by operating activities:                    |  |                     |         |      |   |         |   |   |         |  
|Depreciation and amortization                                                                                |  |                     | 2,804   |      |   | 1,965   |   |   | 1,606   |  
|Amortization (accretion) of premium
 (discount) on investments                                               |  |                     | 217     |      |   | 27      |   |   | (198    | )
|Stock-based compensation expense                                                                             |  |                     | 10,654  |      |   | 9,758   |   |   | 7,431   |  
|Excess tax benefit from stock options
 exercised                                                             |  |                     | (191    | )    |   | (190    | ) |   | (250    | )
|Loss on disposal of property and equipment
 and other assets                                                 |  |                     | 340     |      |   | 191     |   |   | 270     |  
|Deferred tax benefit                                                                                         |  |                     | (26     | )    |   |        |   |   | (1,748  | )
|Provision (benefit) for doubtful accounts
 receivable                                                        |  |                     | (83     | )    |   | 1,066   |   |   | 245     |  
|Changes in assets and liabilities:                                                                           |  |                     |         |      |   |         |   |   |         |  
|Accounts receivable                                                                                          |  |                     | (3,059  | )    |   | (611    | ) |   | (2,743  | )
|Inventories                                                                                                  |  |                     | 1,851   |      |   | 203     |   |   | (4,951  | )
|Prepaid expenses and other current assets                                                                    |  |                     | (4,022  | )    |   | 480     |   |   | 57      |  
|Other assets                                                                                                 |  |                     | 1,179   |      |   | (85     | ) |   | (1,880  | )
|Accounts payable                                                                                             |  |                     | (325    | )    |   | 1,796   |   |   | (586    | )
|Accrued liabilities and other                                                                                |  |                     | 5,052   |      |   | 2,332   |   |   | 2,283   |  
|Accrued employee compensation                                                                                |  |                     | 3,366   |      |   | (652    | ) |   | 1,761   |  
|Deferred revenue                                                                                             |  |                     | 6,228   |      |   | 3,826   |   |   | 4,714   |  
|                                                                                                             |  |                     |         |      |   |         |   |   |         |  
|Net cash provided by operating activities                                                                    |  |                     | 11,181  |      |   | 7,447   |   |   | 8,153   |  
|                                                                                                             |  |                     |         |      |   |         |   |   |         |  
|                                                                                                             |  |                     |         |      |   |         |   |   |         |  
|CASH FLOWS FROM INVESTING ACTIVITIES:                                                                        |  |                     |         |      |   |         |   |   |         |  
|Purchases of property and equipment                                                                          |  |                     | (4,650  | )    |   | (1,842  | ) |   | (2,407  | )
|Purchases of investments                                                                                     |  |                     | (23,835 | )    |   | (35,087 | ) |   | (51,267 | )
|Proceeds from sale/maturities of
 investments                                                                |  |                     | 10,145  |      |   | 35,558  |   |   | 17,250  |  
|Purchase of software licenses and other                                                                      |  |                     | (1,403  | )    |   | (4,123  | ) |   |        |  
|Long-term deposit on operating facility                                                                      |  |                     |        |      |   |        |   |   | (95     | )
|                                                                                                             |  |                     |         |      |   |         |   |   |         |  
|Net cash used in investing activities                                                                        |  |                     | (19,743 | )    |   | (5,494  | ) |   | (36,519 | )
|                                                                                                             |  |                     |         |      |   |         |   |   |         |  
|                                                                                                             |  |                     |         |      |   |         |   |   |         |  
|CASH FLOWS FROM FINANCING ACTIVITIES:                                                                        |  |                     |         |      |   |         |   |   |         |  
|Proceeds from initial public offering,
 received net of underwriting discounts                               |  |                     |        |      |   |        |   |   | 80,265  |  
|Initial public offering costs                                                                                |  |                     |        |      |   |        |   |   | (1,660  | )
|Proceeds from issuance of common stock                                                                       |  |                     | 3,103   |      |   | 3,004   |   |   | 857     |  
|Taxes paid on vested and released stock
 awards                                                              |  |                     | (125    | )    |   |        |   |   |        |  
|Excess tax benefit from stock options
 exercised                                                             |  |                     | 191     |      |   | 190     |   |   | 250     |  
|                                                                                                             |  |                     |         |      |   |         |   |   |         |  
|Net cash provided by financing activities                                                                    |  |                     | 3,169   |      |   | 3,194   |   |   | 79,712  |  
|                                                                                                             |  |                     |         |      |   |         |   |   |         |  
|                                                                                                             |  |                     |         |      |   |         |   |   |         |  
|NET INCREASE (DECREASE) IN CASH AND CASH
 EQUIVALENTS                                                        |  |                     | (5,393  | )    |   | 5,147   |   |   | 51,346  |  
|CASH AND CASH EQUIVALENTS - Beginning of
 the year                                                           |  |                     | 73,819  |      |   | 68,672  |   |   | 17,326  |  
|                                                                                                             |  |                     |         |      |   |         |   |   |         |  
|CASH AND CASH EQUIVALENTS - End of the year                                                                  |  | $                   | 68,426  |      | $ | 73,819  |   | $ | 68,672  |  
|                                                                                                             |  |                     |         |      |   |         |   |   |         |  
|                                                                                                             |  |                     |         |      |   |         |   |   |         |  
|SUPPLEMENTAL DISCLOSURES OF CASH FLOW
 INFORMATION:                                                          |  |                     |         |      |   |         |   |   |         |  
|Cash paid (refunds) for taxes, net of
 refunds                                                               |  | $                   | (156    | )    | $ | 1,196   |   | $ | 1,398   |  
|                                                                                                             |  |                     |         |      |   |         |   |   |         |  
|NONCASH FINANCING AND INVESTING ACTIVITIES:                                                                  |  |                     |         |      |   |         |   |   |         |  
|Conversion of redeemable convertible
 preferred stock to common stock                                        |  | $                   |        |      | $ |        |   | $ | 56,341  |  
|Reclassification of initial public offering
 costs from other assets to common stock                         |  | $                   |        |      | $ |        |   | $ | 2,752   |  
|Reclassification of preferred stock warrant
 liability to common stock                                       |  | $                   |        |      | $ |        |   | $ | 549     |  
|Unpaid portion of property and equipment
 purchases included in period-end accounts payable                  |  | $                   | 647     |      | $ | 196     |   | $ | 185     |  
|Vesting of accrued early exercised stock
 options                                                            |  | $                   | 18      |      | $ | 54      |   | $ | 220     |  
|Unpaid portion of purchases of other assets
 included in period-end accounts payable and accrued liabilities |  | $                   |        |      | $ | 215     |   | $ | 200     |  

See notes to consolidated financial statements

- 50 -

---



SHORETEL, INC. AND SUBSIDIARIES

NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS

1. THE COMPANY AND SIGNIFICANT ACCOUNTING
POLICIES

The
Company - ShoreTel,
Inc. was incorporated in California on September 17, 1996 and reincorporated in
Delaware on June 22, 2007. 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.

Fiscal
Year End - The Company operates on a fiscal year
ending June 30.

Principles
of Consolidation - The accompanying consolidated
financial statements include the accounts of the Companys wholly owned
subsidiaries located in Germany, the United Kingdom and Australia. All
transactions and balances between the parent and the subsidiaries have been
eliminated in consolidation. The functional currency of the subsidiaries is the
U.S. dollar. Functional currency monetary assets and liabilities are translated
at the rates of exchange on the balance sheet date, and local currency revenues
and expenses are translated at average rates of exchange during the period.
Gains and losses resulting from the process of remeasuring foreign currency
financial statements into U.S. dollars are included in other income (expense).

Use
of Estimates - The preparation of financial statements
in conformity with accounting principles generally accepted in the United
States of America requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
reported amounts of revenues and expenses during the reporting period. The use
of estimates are included in certain areas including revenue recognition,
allowance for doubtful accounts, stock-based compensation, inventory and other
assets valuation, and accounting for income taxes. Actual results could differ
from those estimates.

Certain
Significant Risks and Uncertainties - The Company
participates in a dynamic high-technology industry. Changes in any of the
following areas could have a material adverse effect on the Companys future
financial position, results of operations, or cash flows: reliance on
sole-source suppliers; general economic conditions; advances and trends in new
technologies; competitive pressures; changes in the overall demand for its future
products; acceptance of the Companys products; litigation or claims against
the Company based on intellectual property, patent, regulatory, or other
factors; and the Companys ability to attract and retain employees necessary to
support its growth.

Concentration
of Credit Risk - Financial instruments, which
potentially subject the Company to concentrations of credit risk, consist
principally of cash and cash equivalents, short-term investments and accounts
receivable. As of June 30, 2010, substantially all of the Companys cash and
cash equivalents and short-term investments were managed by multiple financial
institutions. Accounts receivable are typically unsecured and are derived from
revenue earned from the customers. The Company performs ongoing credit
evaluations of its customers and maintains allowances for potential credit
losses. At June 30, 2010 and 2009, no enterprise customer or channel partner
comprised more than 10% of total accounts receivable. For the year ended June
30, 2010, 2009 and 2008, no enterprise customer or channel partner comprised
more than 10% of total revenue.

Fair
Value of Financial Instruments The carrying amounts of
the Companys financial instruments, including cash and cash equivalents,
accounts receivable, accounts payable, and accrued liabilities, approximate
their respective fair market values due to the short maturities of these
financial instruments. The fair values of short-term investments are determined
using quoted market prices for those securities or similar financial
instruments.

Dependence
on Suppliers - The Company depends in part upon
contractors to manufacture, assemble, and deliver items in a timely and
satisfactory manner. The Company obtains certain components and subsystems from
a single or a limited number of sources. A significant interruption in the
delivery of such items or the demise of a supplier could have a material
adverse effect on the Companys operations.

Cash
and Cash Equivalents - The Company considers all
highly liquid investments purchased with an original or remaining maturity of
less than three months at the date of purchase to be cash equivalents. Cash and
cash equivalents are maintained with various financial institutions.

- 51 -

---



Investments
- The Companys short-term investments are comprised of U.S. Government agency
securities, corporate notes and commercial paper. These investments are held in
the custody of three major financial institutions. The specific identification
method is used to determine the cost basis of disposed fixed income securities.
At June 30, 2010 and 2009, the Companys investments were classified as
available-for-sale. These investments are recorded in the Consolidated Balance
Sheets at fair value with unrealized gains or losses reported as a separate
component of accumulated other comprehensive income (loss), net of tax.

The
Company recognizes an impairment charge when a decline in the fair value of its
investments below the cost basis is judged to be other-than-temporary. The
Company considers various factors in determining whether to recognize an
impairment charge, including the length of time and extent to which the fair
value has been less than the Companys cost basis, the financial condition and
near-term prospects of the investee, and the Companys intent and ability to
hold the investment for a period of time sufficient to allow for any
anticipated recovery in market value.

Allowance
for Doubtful Accounts. The Company records its allowance
for doubtful accounts based upon its assessment of various factors. The Company
considers historical experience, the age of the accounts receivable balances,
the credit quality of its customers, current economic conditions and other
factors that may affect customers ability to pay to determine the level of
allowance required.

The change
in allowance for doubtful accounts is summarized as follows (in thousands):

|                                                     |  |          |       |      |   |       |   |   |      |  
|---------------------------------------------------- |  | -------- | ----- | ---- | - | ----- | - | - | ---- | -
|                                                     |  | June 30, |      
|                                                     |  |          |      
|                                                     |  | 2010     |       | 2009 |   | 2008  |  
|                                                     |  |          |       |      |   |       |  
|Allowance for
 doubtful accounts - beginning         |  | $        | 1,330 |      | $ | 414   |   | $ | 320  |  
|Current
 period provision (benefit)                  |  |          | (83   | )    |   | 1,066 |   |   | 245  |  
|Write-offs
 charged to allowance (net of recoveries) |  |          | (371  | )    |   | (150  | ) |   | (151 | )
|                                                     |  |          |       |      |   |       |   |   |      |  
|Allowance
 for doubtful accounts - ending            |  | $        | 876   |      | $ | 1,330 |   | $ | 414  |  
|                                                     |  |          |       |      |   |       |   |   |      |  

Inventories
- Inventories, which consist principally of raw materials, finished goods and
inventory in process/transit, are stated at the lower of cost or market, with
cost being determined under a standard cost method that approximates first-in,
first-out.

Property
and Equipment - Property and equipment are stated at
cost. Depreciation is computed using the straight-line method over the
estimated useful lives of the assets, which range from two to five years.
Leasehold improvements are amortized over the shorter of the estimated useful
lives of the asset or the lease term.

Long-Lived
Assets  The
Company evaluates the carrying value of long-lived assets to be held and used
including intangible assets, when events or circumstances warrant such a
review. The carrying value of a long-lived asset to be held and used is
considered impaired when the anticipated separately identifiable undiscounted
cash flows from such an asset are less than the carrying value of the asset. In
that event, an impairment loss is recognized based on the amount by which the
carrying value exceeds the fair value of the long-lived asset. Fair value is
determined primarily using the anticipated cash flows discounted at a rate
commensurate with the risk involved.

Revenue
Recognition - The Companys revenue is related to the
sale of enterprise IP telecommunications systems, which include hardware,
primarily phones and voice switches, and software components and may also
include training, installation and post-contractual support for the products.
The Companys business strategy is centered on selling to enterprise customers
through channel partners, rather than directly. Hence, sales transactions are
generally made to a channel partner. Certain larger enterprise customers prefer
to purchase directly from the Company. Many of these large account sales are
channel partner-assisted and the Company compensates the channel partner in
much the same way as if the channel partner had made the sale directly. The
compensation to the channel partner is recorded as an offset to the revenues
associated with the direct sale to the enterprise customer.

Product
Revenue - The
Companys software is integrated with hardware and is essential to the
functionality of the integrated system product. Revenue is recognized depending
on whether the hardware is sold in a multiple-element arrangement with software
and post-contractual support or on a standalone basis if the customer purchases
hardware, software, or post- contractual support separately. At the initial
purchase, the customer generally bundles together the hardware, software
components and up to five years of post-contractual support. Thereafter, if the
enterprise customer increases end users and functionality, it may add more
hardware, software, and related post-contractual support by purchasing them
separately. The Company evaluates vendor-specific objective evidence (VSOE) of
fair value for post-contractual support, installation services and training,
and other undelivered elements as noted below.

- 52 -

---



Product
revenue is recognized when persuasive evidence of an arrangement exists,
product has shipped or delivery has occurred (depending on when title passes),
the sales price is fixed or determinable and free of contingencies and
significant uncertainties, and collection is probable. The fee is considered
fixed or determinable at the execution of an agreement, based on specific
products and quantities to be delivered at specified prices. The agreements
with customers generally do not include rights of return or acceptance
provisions. To the extent that the Companys agreements contain acceptance
terms, the Company recognizes revenue upon product acceptance, unless the
acceptance provision is deemed to be perfunctory. Even though substantially all
of the contractual agreements do not provide return privileges, there are
circumstances for which the Company will accept a return. The Company maintains
a reserve for such returns based on historical experience. Payment terms to
customers generally range from net 30 to net 60 days. In the event payment
terms are extended materially from the Companys standard business practices,
the fees are deemed to not be fixed or determinable and revenue is recognized
when the payment becomes due. The Company assesses the ability to collect from
its customers based on a number of factors, including credit worthiness and
past transaction history of the customer. If the customer is not deemed credit
worthy, the Company defers all revenue from the arrangement until payment is
received and all other revenue recognition criteria have been met. Shipping
charges billed to customers are included in product revenue and the related shipping
costs are included in cost of product revenue.

Provisions
for return allowances and product warranties are recorded at the time revenue
is recognized based on the Companys historical experience. The provision for
return allowances is recorded as a reduction to revenues on the statement of
operations and is included as a reduction to account receivables on the balance
sheet.

The Company
has arrangements with resellers of their products to reimburse the resellers
for cooperative marketing costs meeting specified criteria. The reimbursements
are limited to 50% of the actual costs charged to the channel partners by
third-party vendors for advertising, trade show activities and other related
sales and marketing activities for which the Company receives an identifiable
benefit (goods and services that the Company could have purchased directly from
third-party vendors), subject to a limit of the total cooperative marketing
allowance earned by each channel partner. The Company records the reimbursements
to the channel partners meeting such specified criteria within sales and
marketing expenses in the accompanying consolidated statements of operations.

Post-Contractual
Support - The
Companys support and service revenues are primarily derived from
post-contractual support. The Company accounts for post-contractual support
revenues based on the nature of the arrangement. If an arrangement includes
multiple elements, the fee is allocated to the various elements based on VSOE
of fair value, regardless of any separate prices stated within the contract for
each element. VSOE of fair value is limited to the price charged when the same
element is sold separately. VSOE of fair value is established for
post-contractual support through prior renewals of post-contractual support
from existing customers, which establishes a price based on a standalone sale.
To determine the fair value of the price charged, the Company analyzes both the
selling prices when elements are sold separately as well as the concentrations
of those prices. The Company believes those concentrations have been sufficient
to enable us to establish VSOE of fair value for the post-contract support
revenues.

The Company
offers one, three and five year post-contractual support contracts. The
decision to procure support is elected by the enterprise customer, but most
channel partners and their enterprise customers desire post-contractual support
so an initial system sale usually includes post-contractual support. The majority
of post-contractual support contracts are sold to channel partners, under which
the channel partner provides first level support to the enterprise customer and
the Company provides support, as needed, to the channel partner. In a lesser
number of cases, the Company provides support directly to the enterprise
customer.

The Company
uses the residual method to determine the amount of product revenue to be
recognized. Under the residual method, the fair value of the undelivered
elements, such as post-contractual support installation services and training,
is deferred and the remaining portion of the sales amount is recognized as
product revenue. The fair value of the post-contractual support is recognized
on a straight-line basis over the term of the related support period, which is
typically one to five years.

Installation
and Training- Installation is sold on an elective
basis. As installation is typically performed by the channel partner or
enterprise customer, and it is not considered essential to the functionality of
the delivered elements. Installation, when performed by the Company, is by its
nature sold only with an accompanying system order. Installation is generally
priced at established rates based on estimated hours required to install the
accompanying system.

The
Company recognizes revenue related to installation services and training upon
delivery of the service.

If
VSOE of fair value does not exist for installation, training or commitments to
provide specified upgrades, services or additional products to customers in the
future, as has been the case from time to time in the past, the Company defers
all revenue from the arrangement until the earlier of the point at which VSOE
of fair value does exist or all such elements from the arrangement have been
delivered.

Warranties
- The majority of the Companys products are covered by a one-year limited
manufacturers warranty. Estimated contractual warranty obligations are
recorded when related sales are recognized based on historical experience.

- 53 -

---



The
determination of such provision requires the Company to make estimates of
product return rates and expected costs to repair or replace the product under
warranty. If actual costs differ significantly from these estimates, additional
amounts are recorded when such costs are probable and can be reasonably
estimated. The provision for product warranties are recorded within cost of
goods sold on the statement of operations and included within accrued liabilities
and other on the balance sheet.

The
change in accrued warranty expense is summarized as follows (in thousands):

|                                          |  |          |      |      |   |      |   |   |      |  
|----------------------------------------- |  | -------- | ---- | ---- | - | ---- | - | - | ---- | -
|                                          |  | June 30, |     
|                                          |  |          |     
|                                          |  | 2010     |      | 2009 |   | 2008 |  
|                                          |  |          |      |      |   |      |  
|Accrued
 warranty balance - beginning     |  | $        | 261  |      | $ | 239  |   | $ | 167  |  
|Current
 period accrual                   |  |          | 330  |      |   | 292  |   |   | 313  |  
|Warranty
 expenditures charged to accrual |  |          | (276 | )    |   | (270 | ) |   | (241 | )
|                                          |  |          |      |      |   |      |   |   |      |  
|Accrued
 warranty balance - ending        |  | $        | 315  |      | $ | 261  |   | $ | 239  |  
|                                          |  |          |      |      |   |      |   |   |      |  

Research
and Development Costs - Research and development
expenditures, which include software development costs, are expensed as
incurred. Software development costs incurred subsequent to the time a
products technological feasibility has been established through the time the
product is available for general release to customers are subject to
capitalization.

Income
Taxes  The
Company utilizes the asset and liability method of accounting for income taxes.
Deferred income taxes are recognized by applying enacted statutory tax
rates applicable to future years to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases and operating loss and tax credit carryforwards. The effect on deferred
tax assets and liabilities of a change in tax rates is recognized in income in
the period that includes the enactment date. The measurement of deferred tax
assets is reduced, if necessary, by a valuation allowance for any tax benefit
of which future realization is uncertain.

Stock-Based
Compensation  The Company measures the cost of
employee services received in exchange for an award of equity instruments based
on the grant date fair value of the award. The Company elected to use the
Prospective Transition method to new awards and to awards modified, repurchased
or canceled after the effective date of July 1, 2006. The Company has a
stock-based employee compensation plan (Option Plan). Generally, stock options
granted to employees vest 25% one year or 50% two years from the grant date and
1/48 each month thereafter, and have a term of ten years.

The
following table shows total stock-based compensation expense included in the
accompanying Consolidated Statements of Operations for the years ended June 30,
2010, 2009 and 2008 (in thousands):

|                                       |  |                     |        |      |   |       |  |   |       | 
|-------------------------------------- |  | ------------------- | ------ | ---- | - | ----- |  | - | ----- | 
|                                       |  | Year Ended June 30, |       
|                                       |  |                     |       
|                                       |  | 2010                |        | 2009 |   | 2008  | 
|                                       |  |                     |        |      |   |       | 
|Cost of
 product revenue               |  | $                   | 139    |      | $ | 113   |  | $ | 74    | 
|Cost of
 support and services revenue  |  |                     | 838    |      |   | 799   |  |   | 545   | 
|Research and
 development              |  |                     | 3,064  |      |   | 2,829 |  |   | 2,005 | 
|Sales and
 marketing                   |  |                     | 3,400  |      |   | 3,468 |  |   | 2,447 | 
|General and
 administrative            |  |                     | 3,213  |      |   | 2,549 |  |   | 2,360 | 
|                                       |  |                     |        |      |   |       |  |   |       | 
|Total stock-based compensation expense |  | $                   | 10,654 |      | $ | 9,758 |  | $ | 7,431 | 
|                                       |  |                     |        |      |   |       |  |   |       | 

Compensation
expense related to equity instruments issued to nonemployees is recognized as
the equity instruments vest. At each reporting date, the Company revalues the
compensation. As a result, stock-based compensation expense related to unvested
equity instruments issued to nonemployees fluctuates as the fair value of the
Companys common stock fluctuates. The Company uses the Black-Scholes
option-pricing model to value options granted to non-employees. The related
expense is recorded over the period in which the related services are received.

Foreign
currency translation - The Companys foreign
operations are subject to exchange rate fluctuations and foreign currency
transaction costs, however, the majority of sales transactions are denominated
in U.S. dollars. Foreign currency denominated sales, costs and expenses are
recorded at the average exchange rates during the year. Gains or losses
resulting from foreign currency transactions are included in other income in
the consolidated statements of operations.

Comprehensive
income (loss) - Comprehensive income (loss) is defined
as the change in equity during a period from nonowner sources. Comprehensive
income (loss) consists of net income (loss) and other comprehensive income
(loss), which is a separate component of stockholders equity. Other
comprehensive income (loss) includes unrealized gains and losses on the
Companys available-for-sale securities. Other comprehensive income (loss) for
fiscal years 2010, 2009 and 2008 has

- 54 -

---



been disclosed
within the consolidated statements of redeemable convertible preferred stock
and stockholders equity and comprehensive income (loss).

Recent
Accounting Pronouncements 

During
the first quarter of fiscal year 2010, the Company adopted the new Accounting
Standards Codification (ASC) as issued by the FASB. The ASC has become the
source of authoritative GAAP recognized by the FASB to be applied by
nongovernmental entities. The ASC is not intended to change or alter existing
GAAP. The adoption of the ASC did not have a material impact on the Companys
consolidated financial statements.

In
October 2009, the Financial Accounting Standards Board (FASB) issued an
accounting standards update that revises accounting and reporting requirements
for arrangements with multiple deliverables that are excluded from the scope of
existing software revenue guidance. This update requires the use of an
estimated selling price to determine the selling price of a deliverable in
cases where neither vendor-specific objective evidence nor third-party evidence
is available, which is expected to increase the ability for entities to
separate deliverables in multiple-deliverable arrangements and, accordingly, to
decrease the amount of revenue deferred in these cases. Additionally, this
update requires the total selling price of a multiple-deliverable arrangement
to be allocated at the inception of the arrangement to all deliverables based
on relative selling prices. This update is to be applied prospectively for
revenue arrangements entered into or materially modified in fiscal years
beginning on or after June 15, 2010, which for the Company is July 1,
2010. The Company is currently evaluating the impact of adoption of this update
on our financial position, results of operations and cash flows and the impact
of adoption is not expected to be material.

In
October 2009, the FASB issued an accounting standards update that
clarifies which revenue allocation and measurement guidance should be used for
arrangements that contain both tangible products and software, in cases where
the software is more than incidental to the tangible product as a whole. More
specifically, if the software sold with or embedded within the tangible product
is essential to the functionality of the tangible product, then this software
as well as undelivered software elements that relate to this software is
excluded from the scope of existing software revenue guidance, which is
expected to decrease the amount of revenue deferred in these cases. This update
is to be applied prospectively for revenue arrangements entered into or
materially modified in fiscal years beginning on or after June 15, 2010,
which for the Company is July 1, 2010. The Company is currently evaluating
the impact of adoption of this update on our financial position, results of
operations and cash flows and the impact of adoption is not expected to be
material.

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

2. BALANCE SHEET COMPONENTS

Balance
sheet components consisted of the following:

|                                                 |  |                        |        |      |   |        |  
|------------------------------------------------ |  | ---------------------- | ------ | ---- | - | ------ | -
|                                                 |  | As of June 30,         |       
|                                                 |  |                        |       
|                                                 |  | 2010                   |        | 2009 |  
|                                                 |  |                        |        |      |  
|                                                 |  | (Amounts in thousands) |       
|Inventories:                                     |  |                        |        |      |   |        |  
|Raw materials                                    |  | $                      | 335    |      | $ | 398    |  
|Inventory in process/transit                     |  |                        | 526    |      |   | 962    |  
|Finished goods                                   |  |                        | 9,093  |      |   | 10,445 |  
|                                                 |  |                        |        |      |   |        |  
|Total
 inventories                               |  | $                      | 9,954  |      | $ | 11,805 |  
|                                                 |  |                        |        |      |   |        |  
|                                                 |  |                        |        |      |   |        |  
|Prepaid
 expenses and other current assets:      |  |                        |        |      |   |        |  
|Prepaid expenses and other receivables           |  | $                      | 7,778  |      | $ | 2,435  |  
|Deferred cost of revenue                         |  |                        | 347    |      |   | 315    |  
|Deferred taxes                                   |  |                        |       |      |   | 360    |  
|                                                 |  |                        |        |      |   |        |  
|Total
 prepaid expenses and other current assets |  | $                      | 8,125  |      | $ | 3,110  |  
|                                                 |  |                        |        |      |   |        |  
|                                                 |  |                        |        |      |   |        |  
|Property and
 equipment:                         |  |                        |        |      |   |        |  
|Computer equipment and tooling                   |  | $                      | 9,559  |      | $ | 5,281  |  
|Software                                         |  |                        | 1,354  |      |   | 1,086  |  
|Furniture and fixtures                           |  |                        | 1,196  |      |   | 1,064  |  
|Leasehold improvements & others                  |  |                        | 583    |      |   | 387    |  
|                                                 |  |                        |        |      |   |        |  
|Total
 property and equipment                    |  | $                      | 12,692 |      | $ | 7,818  |  
|Less
 accumulated depreciation and amortization  |  |                        | (6,673 | )    |   | (4,343 | )
|                                                 |  |                        |        |      |   |        |  
|Property and
 equipment  Net                    |  | $                      | 6,019  |      | $ | 3,475  |  
|                                                 |  |                        |        |      |   |        |  
|                                                 |  |                        |        |      |   |        |  
|Deferred
 revenue:                               |  |                        |        |      |   |        |  
|Product                                          |  | $                      | 966    |      | $ | 988    |  
|Support and services                             |  |                        | 27,753 |      |   | 21,503 |  
|                                                 |  |                        |        |      |   |        |  
|Total
 deferred revenue                          |  | $                      | 28,719 |      | $ | 22,491 |  
|                                                 |  |                        |        |      |   |        |  

- 55 -

---



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

|                                  |  |                         |       |                           |   |                      |   |                         |       |                           |   |                      |  |   |      |   |   |       | 
|--------------------------------- |  | ----------------------- | ----- | ------------------------- | - | -------------------- | - | ----------------------- | ----- | ------------------------- | - | -------------------- |  | - | ---- | - | - | ----- | 
|                                  |  | June 30, 2010           |       | June 30, 2009             |  
|                                  |  |                         |       |                           |  
|                                  |  | Gross
 Carrying
 Amount |       | Accumulated
 Amortization |   | Net Carrying
 Amount |   | Gross
 Carrying
 Amount |       | Accumulated
 Amortization |   | Net Carrying
 Amount | 
|                                  |  |                         |       |                           |   |                      |   |                         |       |                           |   |                      | 
|Licensed
 technology              |  | $                       | 2,310 |                           | $ | (532                 | ) | $                       | 1,778 |                           | $ | 1,860                |  | $ | (131 | ) | $ | 1,729 | 
|Intangible
 assets in pre-release |  |                         | 3,247 |                           |   |                     |   |                         | 3,247 |                           |   | 2,478                |  |   |     |   |   | 2,478 | 
|                                  |  |                         |       |                           |   |                      |   |                         |       |                           |   |                      |  |   |      |   |   |       | 
|Other
 intangible assets          |  | $                       | 5,557 |                           | $ | (532                 | ) |                         | 5,025 |                           | $ | 4,338                |  | $ | (131 | ) |   | 4,207 | 
|                                  |  |                         |       |                           |   |                      |   |                         |       |                           |   |                      |  |   |      |   |   |       | 
|Prepaid
 royalties                |  |                         |       |                           |   |                      |   |                         | 914   |                           |   |                      |  |   |      |   |   | 2,285 | 
|Deferred tax
 asset               |  |                         |       |                           |   |                      |   |                         | 53    |                           |   |                      |  |   |      |   |   | 1,388 | 
|Deposits and
 other               |  |                         |       |                           |   |                      |   |                         | 234   |                           |   |                      |  |   |      |   |   | 234   | 
|                                  |  |                         |       |                           |   |                      |   |                         |       |                           |   |                      |  |   |      |   |   |       | 
|Total other
 assets               |  |                         |       |                           |   |                      |   | $                       | 6,226 |                           |   |                      |  |   |      |   | $ | 8,114 | 
|                                  |  |                         |       |                           |   |                      |   |                         |       |                           |   |                      |  |   |      |   |   |       | 

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

The
intangible assets are all amortizable and have original estimated useful lives
of three to six years.

Amortization
of intangible assets for fiscal 2010, 2009 and 2008 was $0.4 million, $0.1
million and zero, respectively.

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

|                       |  |   |       | 
|---------------------- |  | - | ----- | 
|Years
 Ending June 30, |  |   |       | 
|                       |  |   |       | 
|2011                   |  | $ | 453   | 
|2012                   |  |   | 453   | 
|2013                   |  |   | 453   | 
|2014                   |  |   | 338   | 
|2015                   |  |   | 81    | 
|Thereafter             |  |   |      | 
|                       |  |   |       | 
|Total                  |  | $ | 1,778 | 
|                       |  |   |       | 

3. SHORT-TERM INVESTMENTS

The
following is a summary of the Companys short-term investments (in thousands):

|                                      |  |                |        |                         |   |                          |  |            |     |   |   |        | 
|------------------------------------- |  | -------------- | ------ | ----------------------- | - | ------------------------ |  | ---------- | --- | - | - | ------ | 
|                                      |  | June 30, 2010  |       
|                                      |  |                |       
|                                      |  | Amortized Cost |        | Gross Unrealized
 Gains |   | Gross Unrealized
 Losses |  | Fair Value |    
|                                      |  |                |        |                         |   |                          |  |            |    
|                                      | 
|Corporate notes
 and commercial paper |  | $              | 33,280 |                         | $ | 142                      |  | $          | (50 | ) | $ | 33,372 | 
|U.S.
 Government agency securities    |  |                | 13,904 |                         |   | 99                       |  |            |    |   |   | 14,003 | 
|                                      |  |                |        |                         |   |                          |  |            |     |   |   |        | 
|Total
 short-term investments         |  | $              | 47,184 |                         | $ | 241                      |  | $          | (50 | ) | $ | 47,375 | 
|                                      |  |                |        |                         |   |                          |  |            |     |   |   |        | 

- 56 -

---



|                                      |  |                |        |                         |   |                          |  |            |   |  |   |        | 
|------------------------------------- |  | -------------- | ------ | ----------------------- | - | ------------------------ |  | ---------- | - |  | - | ------ | 
|                                      |  | June 30, 2009  |       
|                                      |  |                |       
|                                      |  | Amortized Cost |        | Gross Unrealized
 Gains |   | Gross Unrealized
 Losses |  | Fair Value |  
|                                      |  |                |        |                         |   |                          |  |            |  
|                                      | 
|Corporate
 notes and commercial paper |  | $              | 24,209 |                         | $ | 111                      |  |            |  |  | $ | 24,320 | 
|U.S.
 Government agency securities    |  |                | 9,502  |                         |   | 25                       |  |            |  |  |   | 9,527  | 
|                                      |  |                |        |                         |   |                          |  |            |   |  |   |        | 
|Total
 short-term investments         |  | $              | 33,711 |                         | $ | 136                      |  |            |  |  | $ | 33,847 | 
|                                      |  |                |        |                         |   |                          |  |            |   |  |   |        | 

The
following table summarizes the maturities of the Companys short-term
investments by contractual maturity at June 30, 2010 (in thousands):

|                     |  |                |        |            |   |        | 
|-------------------- |  | -------------- | ------ | ---------- | - | ------ | 
|                     |  | Amortized Cost |        | Fair Value |  
|                     |  |                |        |            |  
|Less than 1
 year    |  | $              | 33,956 |            | $ | 34,133 | 
|Due in 1 to
 3 years |  |                | 13,228 |            |   | 13,242 | 
|                     |  |                |        |            |   |        | 
|                     |  | $              | 47,184 |            | $ | 47,375 | 
|                     |  |                |        |            |   |        | 

The
following table summarizes the maturities of the Companys short-term
investments at June 30, 2009 (in thousands):

|                     |  |                |        |            |   |        | 
|-------------------- |  | -------------- | ------ | ---------- | - | ------ | 
|                     |  | Amortized Cost |        | Fair Value |  
|                     |  |                |        |            |  
|Less than 1
 year    |  | $              | 6,646  |            | $ | 6,677  | 
|Due in 1 to
 3 years |  |                | 27,065 |            |   | 27,170 | 
|                     |  |                |        |            |   |        | 
|                     |  | $              | 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.                                                                            

- 57 -

---



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 June 30, 2010 |       
|                                                                 |  |                     |       
|                                                                 |  | FairValue           |        | Level 1 |   | Level 2 |  | Level 3 |       
|                                                                 |  |                     |        |         |   |         |  |         |       
|Assets:                                                          |  |                     |        |         |   |         |  |         |        |  |   |   | 
|Cash and cash equivalents:                                       |  |                     |        |         |   |         |  |         |        |  |   |   | 
|Money market funds                                               |  | $                   | 51,660 |         | $ | 51,660  |  | $       |       |  | $ |  | 
|                                                                 |  |                     |        |         |   |         |  |         |        |  |   |   | 
|Short-term investments:                                          |  |                     |        |         |   |         |  |         |        |  |   |   | 
|Corporate notes and commercial paper                             |  |                     | 33,372 |         |   |        |  |         | 33,372 |  |   |   | 
|U.S. Government agency securities                                |  |                     | 14,003 |         |   |        |  |         | 14,003 |  |   |  | 
|                                                                 |  |                     |        |         |   |         |  |         |        |  |   |   | 
|Total
 financial instruments measured and recorded at fair value |  | $                   | 99,035 |         | $ | 51,660  |  | $       | 47,375 |  | $ |  | 
|                                                                 |  |                     |        |         |   |         |  |         |        |  |   |   | 

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

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

5. NET INCOME (LOSS) PER COMMON SHARE

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

The
following table is a reconciliation of the numerators and denominators used in
computing basic and diluted net income (loss) per common share available to
common stockholders:

|                                                                      |  |                                          |         |      |   |         |   |   |        |  
|--------------------------------------------------------------------- |  | ---------------------------------------- | ------- | ---- | - | ------- | - | - | ------ | -
|                                                                      |  | Year Ended June 30,                      |        
|                                                                      |  |                                          |        
|                                                                      |  | 2010                                     |         | 2009 |   | 2008    |  
|                                                                      |  |                                          |         |      |   |         |  
|                                                                      |  | (In thousands, except per share amounts) |        
|Numerator:                                                            |  |                                          |         |      |   |         |   |   |        |  
|Net income (loss) available to common
 stockholders                   |  | $                                        | (12,804 | )    | $ | (12,659 | ) | $ | 2,142  |  
|                                                                      |  |                                          |         |      |   |         |   |   |        |  
|Denominator:                                                          |  |                                          |         |      |   |         |   |   |        |  
|Weighted average common shares outstanding                            |  |                                          | 44,811  |      |   | 43,756  |   |   | 42,852 |  
|Weighted average common shares subject to
 repurchase                 |  |                                          | (7      | )    |   | (42     | ) |   | (439   | )
|                                                                      |  |                                          |         |      |   |         |   |   |        |  
|Weighted average common shares outstanding
 (basic)                   |  |                                          | 44,804  |      |   | 43,714  |   |   | 42,413 |  
|Effect of dilutive securities:                                        |  |                                          |         |      |   |         |   |   |        |  
|Weighted average common shares subject to
 repurchase                 |  |                                          |        |      |   |        |   |   | 439    |  
|Common equivalent shares from employee
 stock plans                   |  |                                          |        |      |   |        |   |   | 2,009  |  
|                                                                      |  |                                          |         |      |   |         |   |   |        |  
|Weighted average common shares outstanding
 (diluted)                 |  |                                          | 44,804  |      |   | 43,714  |   |   | 44,861 |  
|Net income
 (loss) per common share available to common stockholders: |  |                                          |         |      |   |         |   |   |        |  
|Basic                                                                 |  | $                                        | (0.29   | )    | $ | (0.29   | ) | $ | 0.05   |  
|                                                                      |  |                                          |         |      |   |         |   |   |        |  
|Diluted                                                               |  | $                                        | (0.29   | )    | $ | (0.29   | ) | $ | 0.05   |  
|                                                                      |  |                                          |         |      |   |         |   |   |        |  

Anti-dilutive
common equivalent shares related to stock options excluded from the calculation
of diluted shares were approximately 8.3 million, 7.7 million, and 3.1 million
for the years ended June 30, 2010, 2009 and 2008 respectively.

6. INCOME TAXES

The
components of income (loss) before income taxes consist of the following for
the years ended June 30 (in thousands):

|         |  |          |         |      |   |         |   |   |       | 
|-------- |  | -------- | ------- | ---- | - | ------- | - | - | ----- | 
|         |  | June 30, |        
|         |  |          |        
|         |  | 2010     |         | 2009 |   | 2008    |  
|         |  |          |         |      |   |         |  
|Domestic |  | $        | (13,196 | )    | $ | (12,462 | ) | $ | 2,928 | 
|Foreign  |  |          | 236     |      |   | 146     |   |   | 75    | 
|         |  |          |         |      |   |         |   |   |       | 
|Total    |  | $        | (12,960 | )    | $ | (12,316 | ) | $ | 3,003 | 
|         |  |          |         |      |   |         |   |   |       | 

- 58 -

---



The
income tax provision (benefit) consists of the following for the years ended
June 30 (in thousands):

|                                |  |          |      |      |   |      |  |   |        |  
|------------------------------- |  | -------- | ---- | ---- | - | ---- |  | - | ------ | -
|                                |  | June 30, |     
|                                |  |          |     
|                                |  | 2010     |      | 2009 |   | 2008 | 
|                                |  |          |      |      |   |      | 
|Current:                        |  |          |      |      |   |      |  |   |        |  
|Federal                         |  | $        | (392 | )    | $ | 100  |  | $ | 2,430  |  
|State                           |  |          | 125  |      |   | 165  |  |   | 207    |  
|Foreign                         |  |          | 137  |      |   | 78   |  |   | (28    | )
|                                |  |          |      |      |   |      |  |   |        |  
|                                |  |          | (130 | )    |   | 343  |  |   | 2,609  |  
|                                |  |          |      |      |   |      |  |   |        |  
|                                |  |          |      |      |   |      |  |   |        |  
|Deferred:                       |  |          |      |      |   |      |  |   |        |  
|Federal                         |  |          |     |      |   |     |  |   | (1,667 | )
|State                           |  |          |     |      |   |     |  |   |       |  
|Foreign                         |  |          | (26  | )    |   |     |  |   | (81    | )
|                                |  |          |      |      |   |      |  |   |        |  
|                                |  |          | (26  | )    |   |     |  |   | (1,748 | )
|                                |  |          |      |      |   |      |  |   |        |  
|Income tax
 provision (benefit) |  | $        | (156 | )    | $ | 343  |  | $ | 861    |  
|                                |  |          |      |      |   |      |  |   |        |  

The
difference between the income tax provision (benefit) and the amount computed
by applying the federal statutory income tax rate to income (loss) before
income taxes is as follows for the years ended June 30 (in thousands):

|                                                     |  |          |        |      |   |        |   |   |         |  
|---------------------------------------------------- |  | -------- | ------ | ---- | - | ------ | - | - | ------- | -
|                                                     |  | June 30, |       
|                                                     |  |          |       
|                                                     |  | 2010     |        | 2009 |   | 2008   |  
|                                                     |  |          |        |      |   |        |  
|Income tax
 provision at federal statutory rate      |  | $        | (4,415 | )    | $ | (4,187 | ) | $ | 1,021   |  
|Elimination
 of NOL and R&D tax credit carryforwards |  |          |       |      |   |       |   |   | 26,939  |  
|Stock-based
 compensation                            |  |          | 471    |      |   | 71     |   |   | 1,326   |  
|Credits                                              |  |          | (3,032 | )    |   | (2,162 | ) |   | (1,032  | )
|State taxes                                          |  |          | 112    |      |   | 118    |   |   | 206     |  
|NOL
 carryback                                       |  |          | (5,348 | )    |   |       |   |   |        |  
|Other                                                |  |          | 648    |      |   | (15    | ) |   | (49     | )
|Increase
 (decrease) in valuation allowance          |  |          | 11,408 |      |   | 6,518  |   |   | (27,550 | )
|                                                     |  |          |        |      |   |        |   |   |         |  
|Total                                                |  | $        | (156   | )    | $ | 343    |   | $ | 861     |  
|                                                     |  |          |        |      |   |        |   |   |         |  

Significant
components of deferred tax assets consist of the following as of June 30 (in
thousands):

|                                  |  |          |         |      |   |         |  
|--------------------------------- |  | -------- | ------- | ---- | - | ------- | -
|                                  |  | June 30, |        
|                                  |  |          |        
|                                  |  | 2010     |         | 2009 |  
|                                  |  |          |         |      |  
|Net
 operating loss carryforwards |  | $        | 4,777   |      | $ | 31      |  
|Tax credit
 carryforwards         |  |          | 5,653   |      |   | 2,615   |  
|Other                             |  |          | 12,986  |      |   | 11,057  |  
|                                  |  |          |         |      |   |         |  
|Total
 deferred tax assets        |  |          | 23,416  |      |   | 13,703  |  
|Less
 valuation allowance         |  |          | (23,363 | )    |   | (11,955 | )
|                                  |  |          |         |      |   |         |  
|Net deferred
 tax assets          |  | $        | 53      |      | $ | 1,748   |  
|                                  |  |          |         |      |   |         |  

During
the year ended June 30, 2010, the increase in total deferred tax assets of $9.7
million and related increase in the valuation allowance of $11.4 million was
primarily related to the increase in gross net operating loss and tax credit
carryforwards due to the favorable tax ruling discussed below from the Internal
Revenue Service related to Section 382. In assessing the realizability of
deferred tax assets, management considers whether it is more likely than not
that some portion or all of deferred tax assets will not be realized. The realization
of deferred tax assets is based on several factors, including the Companys
past earnings and the scheduling of deferred tax liabilities and projected
income from operating activities. As of June 30, 2010, management does not
believe it is more likely than not that the net deferred tax assets relating to
U.S. federal and state operations are realizable. The Company intends to
maintain the valuation allowance until sufficient positive evidence exists to
support reversal of some or all of the allowance. The Companys income tax
expense (benefit) recorded in the future will be reduced or increased in the
event changes to the valuation allowance are required.

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

- 59 -

---



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.

As
of June 30, 2010, the Company had federal and California tax credit carryforwards
of $3.2 million and $3.4 million, respectively. The federal tax credit
carryfowards expire at various dates between 2023 and 2030. The federal
Alternative Minimum Tax and the California tax credits may be carryforward
indefinitely. The Company also had other state net operating loss carryforwards
of $6.7 million which expire at various dates between 2015 and 2022.

The
undistributed earnings from the foreign subsidiaries are not subject to a U.S.
tax provision because it is Companys intention to permanently reinvest such
undistributed earnings outside of the United States. The Company evaluates its
circumstances and reassesses this determination on a periodic basis. As of June
30, 2010, the determination of the unrecorded deferred tax liability related to
these earnings is not practicable. If circumstances change and it becomes
apparent that some or all of the undistributed earnings of the Companys
foreign subsidiaries will be remitted in the foreseeable future, the Company
will be required to recognize a deferred tax liability on those amounts.

During
the year ended June 30, 2008, management completed its analysis of the
Companys multiple equity transactions since inception and determined that
changes in ownership had occurred as defined by Section 382 of the Internal
Revenue Code. As a result of the ownership changes, management has determined
that substantially all of the Companys federal and state net operating loss
carryforwards could not be utilized. Consequently, approximately $26.2 million
of the deferred tax asset associated with net operating loss carryforwards and
$0.7 million of California research and development tax credit carryforwards as
of June 30, 2007 were eliminated in fiscal 2008 with a corresponding reduction
in the valuation allowance.

During
the quarter ended March 31, 2010, the Company received a favorable tax ruling
from the Internal Revenue Service related to Section 382. As a result of the
ruling, at least $25million of net operating losses that were previously
limited by Section 382 of the Internal Revenue Code are now available to the
Company to offset future taxable income and to recapture previously paid taxes.
As a result, the Company filed an amended fiscal 2008 federal income tax return
utilizing the available net operating losses to request a tax refund for
approximately $1.7 million which the Company has not received as of June 30,
2010. As of June 30, 2010, the Company had federal net operating loss
carryforwards of approximately $13.4 million. The federal net operating loss
carryforwards expire at various dates between 2023 and 2025.

The
Worker, Homeownership and Business Assistance Act of 2009 was enacted on
November 6, 2009. Under the Act, businesses with net operating losses for 2008
and 2009 may carry back those losses for up to five years. The Company intends
to carry back losses incurred in fiscal year 2010 to offset AMT taxes paid in
prior years. The tax benefit of $0.3 million for carrying back net operating
loss has been reflected in the tax provision.

The
Company maintains liabilities for uncertain tax positions. These liabilities
involve considerable judgment and estimation and are continuously monitored by
management based on the best information available, including changes in tax
regulations, the outcome of relevant court cases, and other information. As of
June 30, 2010 and June 30, 2009, the Companys total amount of unrecognized tax
benefit was approximately $2.1 million and $1.5 million, respectively. These
amounts are primarily related to the Companys research and development tax
credits and tax accruals.

A
reconciliation of the beginning and ending balances of the total amounts of
unrecognized tax benefits for 2010 and 2009 is as follows (in thousands):

|                                            |  |          |       |      |   |       |  
|------------------------------------------- |  | -------- | ----- | ---- | - | ----- | -
|                                            |  | June 30, |      
|                                            |  |          |      
|                                            |  | 2010     |       | 2009 |  
|                                            |  |          |       |      |  
|Beginning
 balance                          |  | $        | 1,540 |      | $ | 1,525 |  
|Decrease in
 tax positions for prior years  |  |          |      |      |   | (435  | )
|Increase in
 tax positions for current year |  |          | 551   |      |   | 450   |  
|                                            |  |          |       |      |   |       |  
|Ending
 balance                             |  | $        | 2,091 |      | $ | 1,540 |  
|                                            |  |          |       |      |   |       |  

As
of June 30, 2010, the Companys total amount of unrecognized tax benefit was
approximately $2.1 million of which only $0.3 million, if recognized, would
impact the effective tax rate. The Company does not expect its unrecognized tax
benefits to change materially over the next 12 months.

- 60 -

---



The
Companys policy is to include interest and penalties related to unrecognized
tax benefits within the provision for taxes on the consolidated statements of
operations. Management determined that no accrual for interest and penalties
was required as of June 30, 2010.

While
Management believes that the Company has adequately provided for all tax
positions, amounts asserted by tax authorities could be greater or less than
the recorded position. Accordingly, the Companys provisions on federal, state
and foreign tax-related matters to be recorded in the future may change as
revised estimates are made or the underlying matters are settled or otherwise
resolved.

The
Companys primary tax jurisdiction is in the United States. For federal and
state tax purposes, the tax years 2000 through 2010 remain open and subject to
tax examination by the appropriate federal or state taxing authorities.

7. COMMON STOCK

Common Shares
Subject to Repurchase

| |                                                                                                                                                                                                                     
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Shares of
 common stock subject to repurchase in connection with the early exercise of
 incentive stock options under the Companys stock option plan were zero and
 20,626 at June 30, 2010 and 2009, respectively.

Common Shares
Reserved for Issuance

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

|                                             |  |       
|-------------------------------------------- |  | ------
|Reserved
 under stock option plans           |  | 12,812
|Reserved
 under employee stock purchase plan |  | 642   
|Conversion
 of warrants                      |  | 2     
|                                             |  |       
|Total                                        |  | 13,456
|                                             |  |       

8. EMPLOYEE BENEFIT
PLANS

Equity Stock
Incentive Plans

The
Company grants nonqualified (NSO) and incentive stock options (ISOs),
restricted stock awards, and restricted stock units to officers, directors,
employees and consultants. As of June 30, 2010, the Company made awards under
two equity incentive plans: the 2007 Equity Incentive Plan (the 2007 Plan)
and the 1997 Stock Option Plan (the 1997 Plan).

The 1997 Plan, as amended, provides for granting
ISOs and NSOs for shares of common stock to employees, directors, and
consultants of the Company. 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. During
2010 and 2009, zero and 1,167 unvested shares were repurchased, respectively.
The Companys repurchase right for such options lapses as the options vest,
generally over four years from the date of grant.

Class Two
options granted to certain executive officers and non-employee directors in
fiscal years 2007 and prior 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 June 30, 2010 and 2009, there were zero
and 20,626 shares subject to repurchase, respectively, of the Companys common
stock outstanding and zero and $19,000, respectively, of related recorded
liability, which is included in accrued liabilities.

The
2007 Plan, as amended, provides for grants of ISOs and NSOs to employees,
directors and consultants of the Company. This plan serves as the successor to
the 1997 Plan, which terminated in January 2007. Five million shares of common
stock are reserved for future issuance in the form of stock options, restricted
stock awards or units, stock appreciation rights and stock bonuses. In 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

- 61 -

---



2.2 million
and 2.2 million in fiscal 2010 and 2009, respectively. In accordance with the
2007 Plan, the stated exercise price of ISOs and NSOs shall not be less than
100% and 85%, respectively, of the estimated fair market value of common stock
on the date of grant, as determined by the Board of Directors. Additionally,
the 2007 Plan provides for automatic annual increases of shares available for
issuance of up to 5% of the number of common shares then outstanding. The 2007
Plan provides that the options shall be exercisable over a period not to exceed
ten years. During fiscal 2010 and 2009, the Company granted options for
1,431,000 and 4,889,000 shares of common stock, respectively, under its 2007
Plan. The 4,889,000 options granted during fiscal 2009 include 3,215,000 shares
issued under a Tender Offer.

Tender Offer

On
January 2, 2009, the Company filed with the SEC a Schedule TO with respect to
the proposed stock option exchange program under which U.S. employees holding
stock options with exercise prices greater than $9.50 per share could tender
their options in exchange for an equivalent number of new stock options to be
granted under the 2007 Equity Incentive Plan (Tender Offer).

The
new stock options vest on a four-year schedule, with either (1) 25% of the
shares subject to the option vesting on the first anniversary of the date of
grant, and the remainder vesting ratably on a monthly basis over the next three
years or (2) 50% of the shares subject to the option vesting on the second
anniversary of the date of grant, and the remainder vesting ratably on a
monthly basis
over the next two years. The vesting schedule was determined based on the
vesting schedule of the surrendered option.

The
Tender Offer expired on February 2, 2009. The Tender Offer was subject to
approval by the Companys stockholders and such approval was obtained at a
Special Meeting of Stockholders held on February 2, 2009.

The
Company accepted for exchange, options to purchase an aggregate of 3,215,000
shares of the Companys common stock from 212 eligible participants,
representing 99% of the shares subject to options that were eligible to be
exchanged in the Tender Offer. Upon the terms and subject to the conditions set
forth in the Tender Offer, the Company issued new options to purchase an
aggregate of 3,215,000 shares of the Companys common stock at an exercise
price of $4.82 in exchange for the options surrendered in the Tender Offer. The
fair value of the new options was measured as the total of the unrecognized
compensation cost of the original options tendered and the incremental compensation
cost of the new options awarded on February 2, 2009, the date of cancellation.
The incremental compensation cost was measured as the excess of the fair value
of the old options over the fair value of the options immediately before
cancellation based on the share price and other pertinent factors at that date.
The incremental cost of the 3,215,000 options was $3.0 million, net of
estimated forfeitures. The $14.8 million remaining unamortized expense of the
original options and the $3.0 million incremental compensation cost for the new
options will be recognized as stock-based compensation expense ratably over the
vesting period of the new options. As would be the case with eligible options,
in the event that any of the new options are forfeited prior to their vesting
due to termination of service, the stock-based compensation cost for the
forfeited new options will not be recorded. In the event that any of the new
options are forfeited, due to termination of service, prior to vesting under
the terms of the new grants, stock-based compensation costs will not be
recorded for the unvested incremental portion of the option.

The
following table summarizes the Companys stock option activities for the fiscal
years ended June 30, 2008, 2009, and 2010 under the Companys 1997 and 2007
Option Plans as presented below:

|                                                                                                           |  |                               |        |                                          |  |                                     |   |   |       | 
|---------------------------------------------------------------------------------------------------------- |  | ----------------------------- | ------ | ---------------------------------------- |  | ----------------------------------- | - | - | ----- | 
|                                                                                                           |  | Shares
 Available
 for
 Grant |        | Shares
 Subject to
 Options
 Outstanding |  | Weighted-
 Average
 Exercise
 Price |  
|Outstanding - July 1, 2007                                                                                 |  |                               | 4,504  |                                          |  | 4,626                               |   |   | 4.57  | 
|                                                                                                           |  |                               |        |                                          |  |                                     |   |   |       | 
|Shares authorized                                                                                          |  |                               | 2,137  |                                          |  |                                    |   |   |      | 
|Termination of remaining shares available
 for grant under the 1997 Option Plan and other non-plan options |  |                               | (1,192 | )                                        |  |                                    |   |   |      | 
|Options granted (weighted average fair
 value of $7.00 per share)                                          |  |                               | (3,518 | )                                        |  | 3,518                               |   |   | 11.56 | 
|Options exercised                                                                                          |  |                               |       |                                          |  | (597                                | ) |   | 0.62  | 
|Options cancelled/forfeited                                                                                |  |                               | 372    |                                          |  | (372                                | ) |   | 7.47  | 
|Restricted stock awards                                                                                    |  |                               | (101   | )                                        |  |                                    |   |   |      | 
|                                                                                                           |  |                               |        |                                          |  |                                     |   |   |       | 
|Outstanding - June 30, 2008                                                                                |  |                               | 2,202  |                                          |  | 7,175                               |   |   | 8.18  | 
|                                                                                                           |  |                               |        |                                          |  |                                     |   |   |       | 
|Shares authorized                                                                                          |  |                               | 2,190  |                                          |  |                                    |   |   |      | 
|Cancelled shares under the 1997 Option Plan                                                                |  |                               | (65    | )                                        |  |                                    |   |   |      | 
|Options granted (weighted average fair
 value of $5.72 per share)                                          |  |                               | (4,327 | )                                        |  | 4,327                               |   |   | 4.87  | 
|Options exercised                                                                                          |  |                               |       |                                          |  | (395                                | ) |   | 1.55  | 
|Options repurchased                                                                                        |  |                               | 1      |                                          |  |                                    |   |   |      | 
|Options cancelled/forfeited                                                                                |  |                               | 3,851  |                                          |  | (3,851                              | ) |   | 12.66 | 
|Restricted stock awards                                                                                    |  |                               | (562   | )                                        |  |                                    |   |   |      | 
|Restricted stock cancelled                                                                                 |  |                               | 69     |                                          |  |                                    |   |   |      | 
|                                                                                                           |  |                               |        |                                          |  |                                     |   |   |       | 
|Outstanding - June 30, 2009                                                                                |  |                               | 3,359  |                                          |  | 7,256                               |   | $ | 4.19  | 
|                                                                                                           |  |                               |        |                                          |  |                                     |   |   |       | 
|Shares authorized                                                                                          |  |                               | 2,246  |                                          |  |                                    |   |   |      | 
|Cancelled shares under the 1997 Option Plan                                                                |  |                               | (32    | )                                        |  |                                    |   |   |      | 
|Options granted (weighted average fair
 value of $3.55 per share)                                          |  |                               | (980   | )                                        |  | 980                                 |   |   | 6.33  | 
|Options exercised                                                                                          |  |                               |       |                                          |  | (438                                | ) |   | 1.50  | 
|Options cancelled/forfeited                                                                                |  |                               | 306    |                                          |  | (306                                | ) |   | 4.92  | 
|Restricted stock awards                                                                                    |  |                               | (451   | )                                        |  |                                    |   |   |      | 
|Restricted stock cancelled/forfeited                                                                       |  |                               | 62     |                                          |  |                                    |   |   |      | 
|                                                                                                           |  |                               |        |                                          |  |                                     |   |   |       | 
|Outstanding - June 30, 2010                                                                                |  |                               | 4,510  |                                          |  | 7,492                               |   | $ | 4.59  | 
|                                                                                                           |  |                               |        |                                          |  |                                     |   |   |       | 
|Options exercisable at June 30, 2010                                                                       |  |                               |        |                                          |  | 2,766                               |   | $ | 3.49  | 
|                                                                                                           |  |                               |        |                                          |  |                                     |   |   |       | 
|Vested and expected to vest at June 30,
 2010                                                              |  |                               |        |                                          |  | 7,146                               |   | $ | 4.56  | 
|                                                                                                           |  |                               |        |                                          |  |                                     |   |   |       | 

- 62 -

---



The
total intrinsic value for options exercised in the years ended June 30, 2010,
2009 and 2008 was $2.1 million, $1.5 million and $4.1 million, respectively,
representing the difference between the fair values of the Companys common
stock underlying these options at the dates of exercise and the exercise prices
paid. There were 1,192,000 unissued options that expired under the 1997 Option
Plan upon the termination of that plan. These unissued, expired options have
been included in the option activity for the year ended June 30, 2008. There
were 32,000 and 65,000 cancelled options that expired under the 1997 Plan in
2010 and 2009, respectively, due to the termination of that plan. These
cancelled, expired options have been included in the option activity for the
years ended June 30, 2010 and 2009.

The
following table summarizes information about outstanding and exercisable
options at June 30, 2010:

|                            |  |                                               |       |                                                         |  |                                    |  |                             |       |  |   |       | 
|--------------------------- |  | --------------------------------------------- | ----- | ------------------------------------------------------- |  | ---------------------------------- |  | --------------------------- | ----- |  | - | ----- | 
|                            |  |                                               |       |                                                         |  |                                    |  |                             |      
|Exercise
 Prices            |  | Options
 Outstanding                          |       | Weighted
 Average
 Remaining
 Contractual
 Life (Years) |  | Weighted
 Average
 Exercise
 Price |  | Aggregate
 Intrinsic
 Value |      
|                            |  |                                               |       |                                                         |  |                                    |  |                             |      
|                            |  | (Amounts in thousands, except per share data) |      
|$0.10  0.40                |  |                                               | 503   |                                                         |  | 3.91                               |  | $                           | 0.28  |  |   |       | 
|$0.80  1.00                |  |                                               | 406   |                                                         |  | 5.43                               |  |                             | 0.87  |  |   |       | 
|$2.50  3.20                |  |                                               | 511   |                                                         |  | 6.24                               |  |                             | 3.12  |  |   |       | 
|$3.50  4.80                |  |                                               | 479   |                                                         |  | 8.15                               |  |                             | 3.99  |  |   |       | 
|$4.82                       |  |                                               | 2,910 |                                                         |  | 5.61                               |  |                             | 4.82  |  |   |       | 
|$4.93  5.08                |  |                                               | 810   |                                                         |  | 7.68                               |  |                             | 4.96  |  |   |       | 
|$5.25 - 6.08                |  |                                               | 1,115 |                                                         |  | 8.53                               |  |                             | 5.68  |  |   |       | 
|$6.21 - 8.29                |  |                                               | 568   |                                                         |  | 9.22                               |  |                             | 6.70  |  |   |       | 
|$11.30 - 11.40              |  |                                               | 169   |                                                         |  | 6.85                               |  |                             | 11.36 |  |   |       | 
|$12.55  15.41              |  |                                               | 21    |                                                         |  | 7.21                               |  |                             | 13.49 |  |   |       | 
|                            |  |                                               |       |                                                         |  |                                    |  |                             |       |  |   |       | 
|Total Outstanding           |  |                                               | 7,492 |                                                         |  | 6.66                               |  | $                           | 4.59  |  | $ | 4,817 | 
|                            |  |                                               |       |                                                         |  |                                    |  |                             |       |  |   |       | 
|                            |  |                                               |       |                                                         |  |                                    |  |                             |       |  |   |       | 
|Exercisable                 |  |                                               | 2,766 |                                                         |  | 6.07                               |  |                             | 3.49  |  |   | 4,637 | 
|Vested and expected to vest |  |                                               | 7,146 |                                                         |  | 6.46                               |  | $                           | 4.56  |  | $ | 4,809 | 
|                            |  |                                               |       |                                                         |  |                                    |  |                             |       |  |   |       | 

Determining Fair Value of Stock-based
Compensation

Valuation
and amortization method - The Company estimates the
fair value of stock options granted using the Black-Scholes option-pricing
formula and a single option award approach. This fair value is then amortized
on a straight-line basis over the requisite service periods of the awards,
which is generally the vesting period.

- 63 -

---



Expected
Term - The expected term represents the period that
the Companys stock-based awards are expected to be outstanding. The Company
has elected to use the simplified method as prescribed by authoritative
guidance to compute expected term. The Companys stock plan provides for a 10
year term to expiration. Prior to and during fiscal year 2007, the Company
categorized option grants into two classes. Class One includes all options
issued with standard four year vesting and no ability to exercise prior to
vesting. Class Two includes options granted that have the same four year
vesting provision but allow for early exercisability. The Company discontinued
granting Class Two options as of June 30, 2007. The options in Class One vest
over four years with a one or two year cliff. Based on the above, the Company
computed an expected term of 6.08 years for the one year cliff and 6.26 for the
two year cliff under the simplified method. The options in Class Two are
early exercisable at the discretion of the option holder and vest over 4 years
with a one or two year cliff. For Class Two, the Company assumed an expected
term of 4 years based, in part, on the history of prior exercises for this
class of optionees.

Expected
Volatility - The
Company estimates volatility for option grants by evaluating the average historical
volatility of its peer group for the period immediately preceding the option
grant for a term that is approximately equal to the options expected term. The
Company has estimated future volatility based on its peer group, as it does not
have enough history to calculate its own volatility. Management believes
historical volatility to be the best estimate of future volatility. Volatility
will be analyzed on an annual basis unless management becomes aware of events
that would indicate more frequent analysis is necessary.

Risk-Free
Interest Rate - The risk-free interest rate used in
the Black-Scholes valuation method is based on the implied yield currently
available on U.S. Treasury zero-coupon issues with an equivalent remaining
term.

Expected
Dividend - The Company has not issued dividends to
date and does not anticipate issuing dividends.

The
fair value of each option is estimated on the date of grant using the
Black-Scholes option valuation method, with the following assumptions:

|                                                                                                                                                                                                    |  |                    |  |                           |  |               
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------ |  | ------------------------- |  | --------------
|                                                                                                                                                                                                    |  | June 30,
 2010     |  | Year Ended
 June 30, 2009 |  | June 30,
 2008
|                                                                                                                                                                                                    |  |                    |  |                           |  |               
|                                                                                                                                                                                                    | 
|Expected
 life from grant date of option                                                                                                                                                            |  | 6.08  6.50
 years |  | 4.58-6.46 years           |  | 6.08 years    
|Risk-free
 interest rate                                                                                                                                                                            |  | 2.26-2.47%         |  | 1.76-3.11%                |  | 2.42-4.50%    
|Expected volatility                                                                                                                                                                                 |  | 57-58%             |  | 58-59%                    |  | 62%           
|Expected
 dividend yield                                                                                                                                                                            |  | 0%                 |  | 0%                        |  | 0%            
|                                                                                                                                                                                                    |  |                    |  |                           |  |               
|The
 fair value of each stock purchase right granted for the Employee Stock
 Purchase Plan (ESPP) is estimated using the Black-Scholes option valuation
 method, using the following assumptions:
|                                                                                                                                                                                                    |  |                    |  |                           |  |               
|                                                                                                                                                                                                    |  | June 30, 2010      |  | Year EndedJune 30, 2009   |  | June 30, 2008 
|                                                                                                                                                                                                    |  |                    |  |                           |  |               
|Expected
 life from grant date of ESPP                                                                                                                                                              |  | 0.50 years         |  | 0.50 years                |  | 0.50 years    
|Risk-free
 interest rate                                                                                                                                                                            |  | 0.16-0.26%         |  | 0.31-1.81%                |  | 2.03-2.49%    
|Expected
 volatility                                                                                                                                                                                |  | 46-138%            |  | 92-138%                   |  | 47-136%       
|Expected
 dividend yield                                                                                                                                                                            |  | 0%                 |  | 0%                        |  | 0%            

Compensation
expense is recognized 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 expected
forfeiture rates.

As of June
30, 2010 total unrecognized compensation cost related to stock-based awards
granted to employees and non-employee directors was $20.8 million, net of
estimated forfeitures. This cost will be amortized on a straight-line basis
over a weighted average period of approximately three years.

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 the Company
stock at a discount through payroll deductions. The ESPP consists of six-month
offering periods commencing on May 1st and 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.

- 64 -

---



In
February of fiscal 2010 and 2009, pursuant to the automatic increase provisions
of the ESPP, the Companys Board of Directors approved increases to the number
of shares authorized and reserved for issuance under the ESPP by 449,000 and
438,000 shares, respectively, pursuant to the terms of that plan. The Company
issued 484,721 shares and 571,000 shares under the ESPP in fiscal 2010 and
2009, respectively, at a weighted average price per share of $5.05 and $4.19 in
fiscal 2010 and 2009, respectively.

As
of June 30, 2010, 642,000 shares had been reserved for future issuance under
the ESPP.

Restricted Stock
Awards and Restricted Stock Units

Under
the 2007 Plan, during the year ended June 30, 2010, 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 year ended June 30, 2010
is as follows (in thousands):

|                                              |  |        |      |                                                          |  |                             |  |   |       | 
|--------------------------------------------- |  | ------ | ---- | -------------------------------------------------------- |  | --------------------------- |  | - | ----- | 
|                                              |  | Shares |      | Weighted-
 Average
 Remaining
 Contractual Life
 (Years) |  | Aggregate
 Intrinsic
 Value | 
|                                              |  |        |      |                                                          |  |                             | 
|Outstanding
 - July 1, 2009                   |  |        | 507  |                                                          |  |                             |  |   |       | 
|Awarded                                       |  |        | 451  |                                                          |  |                             |  |   |       | 
|Released                                      |  |        | (107 | )                                                        |  |                             |  |   |       | 
|Forfeited                                     |  |        | (42  | )                                                        |  |                             |  |   |       | 
|                                              |  |        |      |                                                          |  |                             |  |   |       | 
|Outstanding
 - June 30, 2010                  |  |        | 809  |                                                          |  | 1.59                        |  | $ | 3,754 | 
|                                              |  |        |      |                                                          |  |                             |  |   |       | 
|Vested and
 expected to vest at June 30, 2010 |  |        | 726  |                                                          |  | 1.56                        |  | $ | 3,369 | 
|                                              |  |        |      |                                                          |  |                             |  |   |       | 

Restricted
stock award and restricted stock unit activity for the year ended June 30, 2009
is as follows (in thousands):

|                                              |  |        |     |                                                          |  |                             |  |   |       | 
|--------------------------------------------- |  | ------ | --- | -------------------------------------------------------- |  | --------------------------- |  | - | ----- | 
|                                              |  | Shares |     | Weighted-
 Average
 Remaining
 Contractual Life
 (Years) |  | Aggregate
 Intrinsic
 Value | 
|                                              |  |        |     |                                                          |  |                             | 
|Outstanding
 - July 1, 2008                   |  |        | 70  |                                                          |  |                             |  |   |       | 
|Awarded                                       |  |        | 562 |                                                          |  |                             |  |   |       | 
|Released                                      |  |        | (56 | )                                                        |  |                             |  |   |       | 
|Forfeited                                     |  |        | (69 | )                                                        |  |                             |  |   |       | 
|                                              |  |        |     |                                                          |  |                             |  |   |       | 
|Outstanding
 - June 30, 2009                  |  |        | 507 |                                                          |  | 1.87                        |  | $ | 4,053 | 
|                                              |  |        |     |                                                          |  |                             |  |   |       | 
|Vested and
 expected to vest at June 30, 2009 |  |        | 405 |                                                          |  | 1.76                        |  | $ | 3,240 | 
|                                              |  |        |     |                                                          |  |                             |  |   |       | 

Restricted
stock award and restricted stock unit activity for the year ended June 30, 2008
is as follows (in thousands):

|                                              |  |        |     |                                                          |  |                         |  |   |     | 
|--------------------------------------------- |  | ------ | --- | -------------------------------------------------------- |  | ----------------------- |  | - | --- | 
|                                              |  | Shares |     | Weighted-
 Average
 Remaining
 Contractual Life
 (Years) |  | AggregateIntrinsicValue | 
|                                              |  |        |     |                                                          |  |                         | 
|Outstanding
 - July 1, 2007                   |  |        |    |                                                          |  |                         |  |   |     | 
|Awarded                                       |  |        | 101 |                                                          |  |                         |  |   |     | 
|Released                                      |  |        | (31 | )                                                        |  |                         |  |   |     | 
|Forfeited                                     |  |        |    |                                                          |  |                         |  |   |     | 
|                                              |  |        |     |                                                          |  |                         |  |   |     | 
|Outstanding
 - June 30, 2008                  |  |        | 70  |                                                          |  | 2.42                    |  | $ | 309 | 
|                                              |  |        |     |                                                          |  |                         |  |   |     | 
|Vested and
 expected to vest at June 30, 2008 |  |        | 53  |                                                          |  | 2.35                    |  | $ | 236 | 
|                                              |  |        |     |                                                          |  |                         |  |   |     | 

- 65 -

---



The
weighted average grant-date fair value of restricted stock awards granted
during fiscal 2010, 2009 and 2008 was $2.8 million, $3.0 million, and $0.5
million, respectively. As of June 30, 2010, total unrecognized compensation
cost related to restricted stock units granted to employees and directors was
$3.1 million, net of estimated forfeitures. The Company expects to recognize
the expense related to restricted stock units on a straight-line basis over a
weighted-average vesting period of approximately 3 years.

Employee 401(k) Plan

The
Company adopted a defined contribution retirement plan which has been
determined by the Internal Revenue Service (IRS) to be qualified as a 401(k)
plan (the Plan). The Plan covers substantially all employees. The Plan
provides for voluntary tax deferred contributions of 1 -20% of gross
compensation, subject to certain IRS limitations. Based on approval by the
Board of Directors, the Company may make matching contributions to the Plan. No
matching contributions have been made since inception of the Plan.

9. LITIGATION, COMMITMENTS AND CONTINGENCIES

Litigation
- The Company is or was a party to the following material litigation:

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

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

Mitel Litigation.
   On June 27, 2007, a lawsuit was filed against us by Mitel Networks Corporation in the United States District Court for the Eastern
District of Texas. Mitel initially alleged that the Company infringed four of its U.S. patents and later amended it complaint to add
two additional patents.   On July 31, 2007 the Company filed a lawsuit against Mitel Networks Corporation in Ontario Superior Court
in Canada for making false or misleading statements about the Company.      On April 24, 2009, the Company and Mitel entered into a
confidential definitive agreement to settle the litigation between them. Under the terms of the agreement, the parties agreed to
dismiss the patent litigation and trade libel litigation. Both matters were dismissed with prejudice on May 8, 2009. The agreement
calls for the Company to make payments totaling $5.0 million over four years. The present value of the payments was calculated to
be $4.6 million, of which $0.5 million was estimated to be the value of the future right to use the technology covered by such
patents and was recorded as a long term prepaid royalty asset that will be amortized to cost of revenue over approximately six years,
which is the life of the patents. The remaining amount of $4.1 million was recorded as litigation settlement cost in the Companys
consolidated statements of operations for the year ended June 30, 2009. As of June 30, 2010, the remaining liability relating to
this settlement was $2.3 million.

General
  - The Company is 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.

- 66 -

---



Leases - The Company
leases its facilities under non-cancelable 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
non-cancelable leases as of June 30, 2010, are as follows (in thousands):

|                       |  |   |       | 
|---------------------- |  | - | ----- | 
|Years
 Ending June 30, |  |   |       | 
|                       |  |   |       | 
|2011                   |  | $ | 1,926 | 
|2012                   |  |   | 1,724 | 
|2013                   |  |   | 1,220 | 
|2014                   |  |   | 1,112 | 
|2015                   |  |   | 280   | 
|                       |  |   |       | 
|Total                  |  | $ | 6,262 | 
|                       |  |   |       | 

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

Rent
expense for the years ended June 30, 2010, 2009, and 2008, was $1.4 million,
$1.9 million, and $1.6 million, respectively.

Purchase
commitments - As of June 30, 2010, the Company had
purchase commitments with contract manufacturers for inventory and with
technology firms for usage of software licenses totaling approximately $22.9
million.

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

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

10. 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 on 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):

|                          |  |                     |         |      |  |         |  |   |         | 
|------------------------- |  | ------------------- | ------- | ---- |  | ------- |  | - | ------- | 
|                          |  | Year Ended June 30, |        
|                          |  |                     |        
|                          |  | 2010                |         | 2009 |  | 2008    | 
|                          |  |                     |         |      |  |         | 
|United
 States of America |  | $                   | 133,248 |      |  | 125,321 |  | $ | 120,170 | 
|International             |  |                     | 15,216  |      |  | 9,501   |  |   | 8,559   | 
|                          |  |                     |         |      |  |         |  |   |         | 
|Total                     |  | $                   | 148,464 |      |  | 134,822 |  | $ | 128,729 | 
|                          |  |                     |         |      |  |         |  |   |         | 

11. QUARTERLY FINANCIAL DATA (Unaudited)

The
following table summarizes the Companys information on total revenue, gross
profit, net loss and earnings per share by quarter for the years ended June 30,
2010 and 2009. This data was derived from the Companys unaudited consolidated
financial statements.

- 67 -

---



|                                                            |  |                                           |        |                |   |                 |   |                  |        |                 |   |                 |   |                 |        |                 |   |        |   |   |        |   |   |        |  
|----------------------------------------------------------- |  | ----------------------------------------- | ------ | -------------- | - | --------------- | - | ---------------- | ------ | --------------- | - | --------------- | - | --------------- | ------ | --------------- | - | ------ | - | - | ------ | - | - | ------ | -
|                                                            |  | Three
 Months Ended                       |       
|                                                            |  |                                           |       
|                                                            |  | Jun.
 30, 
 2010                          |        | Mar.
 31, 2010 |   | Dec.
 31,
 2009 |   | Sept.
 30,
 2009 |        | Jun.
 30,
 2009 |   | Mar.
 31,
 2009 |   | Dec.
 31,
 2008 |        | Sep.
 30,
 2008 |  
|                                                            |  |                                           |        |                |   |                 |   |                  |        |                 |   |                 |   |                 |        |                 |  
|                                                            |  | (In
 thousands, except per share amounts) |       
|Total revenue                                               |  | $                                         | 42,223 |                | $ | 37,034          |   | $                | 35,457 |                 | $ | 33,750          |   | $               | 32,390 |                 | $ | 31,237 |   | $ | 35,335 |   | $ | 35,860 |  
|                                                            |  |                                           |        |                |   |                 |   |                  |        |                 |   |                 |   |                 |        |                 |   |        |   |   |        |   |   |        |  
|Gross profit                                                |  |                                           | 27,864 |                |   | 24,052          |   |                  | 22,864 |                 |   | 21,633          |   |                 | 20,508 |                 |   | 19,883 |   |   | 22,282 |   |   | 22,952 |  
|                                                            |  |                                           |        |                |   |                 |   |                  |        |                 |   |                 |   |                 |        |                 |   |        |   |   |        |   |   |        |  
|Net loss                                                    |  |                                           | (3,693 | )              |   | (4,489          | ) |                  | (2,496 | )               |   | (2,126          | ) |                 | (735   | )               |   | (7,347 | ) |   | (2,339 | ) |   | (2,238 | )
|                                                            |  |                                           |        |                |   |                 |   |                  |        |                 |   |                 |   |                 |        |                 |   |        |   |   |        |   |   |        |  
|Basic net loss per share available to common stockholders   |  | $                                         | (0.08  | )              | $ | (0.10           | ) | $                | (0.06  | )               | $ | (0.05           | ) | $               | (0.02  | )               | $ | (0.17  | ) | $ | (0.05  | ) | $ | (0.05  | )
|                                                            |  |                                           |        |                |   |                 |   |                  |        |                 |   |                 |   |                 |        |                 |   |        |   |   |        |   |   |        |  
|Diluted net loss per share available to common stockholders |  | $                                         | (0.08  | )              | $ | (0.10           | ) | $                | (0.06  | )               | $ | (0.05           | ) | $               | (0.02  | )               | $ | (0.17  | ) | $ | (0.05  | ) | $ | (0.05  | )

ITEM 9.     CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE

None.

ITEM 9A.     CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and
Procedures

Under
the supervision and with the participation of our management, including our
Chief Executive Officer (CEO) and our Chief Financial Officer (CFO), we
conducted an evaluation of our disclosure controls and procedures (as defined
in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934
(Exchange Act), as of the end of the period covered by this Annual Report on
Form 10-K. Based upon that evaluation, our CEO and our CFO have concluded that
the design and operation of our disclosure controls and procedures were
effective to ensure that information required to be disclosed by us in reports
that we file or submit under the Exchange Act (i) is recorded, processed,
summarized and reported within the time periods specified in Securities and
Exchange Commission rules and forms and (ii) is accumulated and communicated to
our management, including our CEO and CFO, as appropriate to allow timely
decisions regarding required disclosure.

Changes in Internal Control over Financial
Reporting

As
required by Rule 13a-15(d) of the Exchange Act, our management, including our
Chief Executive Officer and Chief Financial Officer, conducted an evaluation of
our internal control over financial reporting as defined in Exchange Act Rule
13a-15(f) to determine whether any changes in our internal control over
financial reporting occurred during the fourth quarter of fiscal 2010 that
materially affected, or are reasonably likely to materially affect, our
internal control over financial reporting. Based on that evaluation, there have
been no such changes during the fourth quarter of fiscal 2010.

Managements Report on Internal Control Over
Financial Reporting

Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f)
under the Securities Exchange Act of 1934). Our internal control over financial
reporting is designed to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles.

Under
the supervision and with the participation of our management, including our
principal executive officer and principal financial officer, we conducted an
evaluation of the effectiveness of our internal control over financial
reporting based on the framework set forth in Internal Control  Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission. Based on our evaluation under the framework set forth in Internal
Control  Integrated Framework, our management concluded that our internal
control over financial reporting was effective as of June 30, 2010.

The
effectiveness of our internal control over financial reporting as of June 30,
2010 has been audited by Deloitte & Touche LLP, an independent registered
public accounting firm, as stated in its report which appears below.

- 68 -

---



Inherent Limitations on Effectiveness of
Controls

Our
management, including our CEO and CFO, does not expect that our disclosure
controls and procedures or our internal controls will prevent all errors and
all fraud. A control system, no matter how well conceived and operated, can
provide only reasonable, not absolute, assurance that the objectives of the
control system are met. Further, the design of a control system must reflect
the fact that there are resource constraints, and the benefits of controls must
be considered relative to their costs. Our disclosure controls and procedures
and our internal controls over financial reporting have been designed to
provide reasonable assurance of achieving their objectives. Because of the
inherent limitations in all control systems, no evaluation of controls can
provide absolute assurance that all control issues and instances of fraud, if
any, have been detected.

- 69 -

---



REPORT OF INDEPENDENT REGISTERED PUBLIC
ACCOUNTING FIRM

To the Board
of Directors and Stockholders of 
ShoreTel, Inc.
Sunnyvale, California

We
have audited the internal control over financial reporting of ShoreTel, Inc.
and subsidiaries (the Company) as of June 30, 2010, based on criteria
established in Internal ControlIntegrated
Frameworkissued by the Committee of Sponsoring Organizations of the
Treadway Commission. The Companys management is responsible for maintaining
effective internal control over financial reporting and for its assessment of
the effectiveness of internal control over financial reporting, included in the
accompanying Managements Report on Internal Control over Financial Reporting.
Our responsibility is to express an opinion on the Companys internal control
over financial reporting based on our audit.

We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether
effective internal control over financial reporting was maintained in all
material respects. Our audit included obtaining an understanding of internal
control over financial reporting, assessing the risk that a material weakness
exists, testing and evaluating the design and operating effectiveness of
internal control based on that assessed risk, and performing such other
procedures as we considered necessary in the circumstances. We believe that our
audit provides a reasonable basis for our opinion.

A
companys internal control over financial reporting is a process designed by,
or under the supervision of, the companys principal executive and principal
financial officers, or persons performing similar functions, and effected by
the companys board of directors, management, and other personnel to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
generally accepted accounting principles. A companys internal control over
financial reporting includes those policies and procedures that
(1) pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions of the assets
of the company; (2) provide reasonable assurance that transactions are
recorded as necessary to permit preparation of financial statements in
accordance with generally accepted accounting principles, and that receipts and
expenditures of the company are being made only in accordance with
authorizations of management and directors of the company; and (3) provide
reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the companys assets that could have a
material effect on the financial statements.

Because
of the inherent limitations of internal control over financial reporting,
including the possibility of collusion or improper management override of
controls, material misstatements due to error or fraud may not be prevented or
detected on a timely basis. Also, projections of any evaluation of the
effectiveness of the internal control over financial reporting to future
periods are subject to the risk that the controls may become inadequate because
of changes in conditions, or that the degree of compliance with the policies or
procedures may deteriorate.

In
our opinion, the Company maintained, in all material respects, effective
internal control over financial reporting as of June 30, 2010, based on
the criteria established in Internal
ControlIntegrated Frameworkissued by the Committee of Sponsoring
Organizations of the Treadway Commission.

We
have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States),the
consolidated financial statements as of and for the year ended June 30,
2010 of the Company and our report dated September 10, 2010, expressed an
unqualified opinion on those financial statements.

/s/ DELOITTE
& TOUCHE LLP

San Jose,
California 
September 10, 2010

- 70 -

---



|         |                  
|-------- | -----------------
|ITEM 9B. | OTHER INFORMATION

None.

PART III

|         |                                                                             
|-------- | ----------------------------------------------------------------------------
|ITEM 10. | DIRECTORS AND EXECUTIVE OFFICERS OF THE
 REGISTRANT AND CORPORATE GOVERNANCE

The
information required by this item is incorporated by reference to our
definitive Proxy Statement for the 2010 Annual Meeting of Stockholders to be
filed with the SEC within 120 days after the end of our fiscal year ended June
30, 2010.

|         |                       
|-------- | ----------------------
|ITEM 11. | EXECUTIVE COMPENSATION

The
information required by this item is incorporated by reference to our
definitive Proxy Statement for the 2010 Annual Meeting of Stockholders to be
filed with the SEC within 120 days after the end of our fiscal year ended June
30, 2010.

|         |                                                                                                
|-------- | -----------------------------------------------------------------------------------------------
|ITEM 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
 AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The
information required by this item is incorporated by reference to our
definitive Proxy Statement for the 2010 Annual Meeting of Stockholders to be
filed with the SEC within 120 days after the end of our fiscal year ended June
30, 2010.

|         |                                                                       
|-------- | ----------------------------------------------------------------------
|ITEM 13. | CERTAIN RELATIONSHIPS AND RELATED
 TRANSACTIONS, DIRECTOR INDEPENDENCE

The
information required by this item is incorporated by reference to our
definitive Proxy Statement for the 2010 Annual Meeting of Stockholders to be
filed with the SEC within 120 days after the end of our fiscal year ended June
30, 2010.

|         |                                       
|-------- | --------------------------------------
|ITEM 14. | PRINCIPAL ACCOUNTING FEES AND SERVICES

The
information required by this item is incorporated by reference to our
definitive Proxy Statement for the 2010 Annual Meeting of Stockholders to be
filed with the SEC within 120 days after the end of our fiscal year ended June
30, 2010.

PART IV

|         |                                            
|-------- | -------------------------------------------
|ITEM 15. | EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.

(a)
(1) Financial Statements - See
Index to Financial Statements at page 73 of this Report.

(2)
Financial Statement Schedule -
Financial statement schedules have been omitted because the required
information is not present or not present in amounts sufficient to require
submission of the schedule, or because the information required is included in
the financial statements or the notes to those financial statements.

(3)
Exhibits - See Exhibit Index at page 74 of this Report.

- 71 -

---



SIGNATURES

Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the registrant has duly caused this Annual Report on Form 10-Kto be
signed on its behalf by the undersigned, thereunto duly authorized, on this 10th
day of September 2010.

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

POWER OF ATTORNEY

KNOW
ALL PERSONS BY THESE PRESENTS that each individual whose signature appears
below constitutes and appoints Ava M. Hahn and Michael E. Healy, his or her
true and lawful attorney-in-fact and agent with full power of substitution, for
him or her and in his or her name, place and stead, in any and all capacities,
to sign any and all amendments to this Annual Report on Form 10-K, with all
exhibits thereto and all documents in connection therewith, with the Securities
and Exchange Commission, granting unto said attorney-in-fact and agent, full
power and authority to do and perform each and every act and thing requisite
and necessary to be done in and about the premises, as fully to all intents and
purposes as he or she might or could do in person, hereby ratifying and
confirming all that said attorney-in-fact and agent, or his or her substitute
or substitutes, may lawfully do or cause to be done by virtue hereof.

Pursuant
to the requirements of the Securities Exchange Act of 1934, this Annual Report
on Form 10-K has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.

|                       |  |                                      |  |                   
|---------------------- |  | ------------------------------------ |  | ------------------
|Name                   |  | Title                                |  | Date              
|                       |  |                                      |  |                   
|                      
|/s/ JOHN W. COMBS      |  | President and                        |  | September 10, 2010
|                       |  | Chief Executive Officer and Director |  |                   
|John W. Combs          |  | (Principal Executive Officer)        |  |                   
|                       |  |                                      |  |                   
|/s/ MICHAEL E. HEALY   |  | Chief Financial Officer              |  | September 10, 2010
|                       |  | (Principal Financial Officer and     |  |                   
|Michael E. Healy       |  | Principal Accounting Officer)        |  |                   
|                       |  |                                      |  |                   
|/s/ GARY J. DAICHENDT  |  | Chairman of the Board                |  | September 10, 2010
|                       |  |                                      |  |                   
|Gary J. Daichendt      |  |                                      |  |                   
|                       |  |                                      |  |                   
|/s/ EDWIN J. BASART    |  | Director                             |  | September 10, 2010
|                       |  |                                      |  |                   
|Edwin J. Basart        |  |                                      |  |                   
|                       |  |                                      |  |                   
|/s/ MARK F. BREGMAN    |  | Director                             |  | September 10, 2010
|                       |  |                                      |  |                   
|Mark F. Bregman        |  |                                      |  |                   
|                       |  |                                      |  |                   
|/s/ KENNETH DENMAN     |  | Director                             |  | September 10, 2010
|                       |  |                                      |  |                   
|Kenneth Denman         |  |                                      |  |                   
|                       |  |                                      |  |                   
|/s/ MICHAEL GREGOIRE   |  | Director                             |  | September 10, 2010
|                       |  |                                      |  |                   
|Michael Gregoire       |  |                                      |  |                   
|                       |  |                                      |  |                   
|/s/ CHARLES D. KISSNER |  | Director                             |  | September 10, 2010
|                       |  |                                      |  |                   
|Charles D. Kissner     |  |                                      |  |                   
|                       |  |                                      |  |                   
|/s/ EDWARD F. THOMPSON |  | Director                             |  | September 10, 2010
|                       |  |                                      |  |                   
|Edward F. Thompson     |  |                                      |  |                   

- 72 -

---



INDEX TO FINANCIAL STATEMENT SCHEDULES

FINANCIAL
STATEMENT SCHEDULE

Schedule II -
Valuation and Qualifying Accounts and Reserves

All
required schedules associated with Valuation and Qualifying Accounts and
Reserves are omitted because they are not required, are not applicable or the
information is included in the consolidated financial statements or notes
thereto.

- 73 -

---



EXHIBIT INDEX

|                |  |                                                                                                                                                                                                     
|--------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit
 Number |  | Exhibit Title                                                                                                                                                                                       
|                |  |                                                                                                                                                                                                     
|3.1(1)          |  | Third
 Restated Certificate of Incorporation of the Registrant                                                                                                                                      
|                |  |                                                                                                                                                                                                     
|3.2(9)          |  | Third
 Amended and Restated Bylaws of the Registrant.                                                                                                                                               
|                |  |                                                                                                                                                                                                     
|4.1(1)          |  | Form of
 Registrants Common Stock certificate.                                                                                                                                                     
|                |  |                                                                                                                                                                                                     
|4.2(1)          |  | Seventh
 Amended and Restated Rights Agreement dated October 20, 2004 by and among the
 Registrant and certain of its equity holders.                                                               
|                |  |                                                                                                                                                                                                     
|10.1(1)         |  | Form of
 Indemnity Agreement between the Registrant and each of its directors and
 executive officers.                                                                                              
|                |  |                                                                                                                                                                                                     
|10.2(1) +       |  | 1997 Stock
 Option Plan and forms of stock option agreement and stock option exercise
 agreement.                                                                                                   
|                |  |                                                                                                                                                                                                     
|10.3(1) +       |  | 2007 Equity
 Incentive Plan and forms of stock option agreement and stock option exercise
 agreement.                                                                                               
|                |  |                                                                                                                                                                                                     
|10.4(2)+        |  | 2007
 Employee Stock Purchase Plan.                                                                                                                                                                 
|                |  |                                                                                                                                                                                                     
|10.5(4)+        |  | ShoreTel FY
 2009 Executive Bonus Plan.                                                                                                                                                             
|                |  |                                                                                                                                                                                                     
|10.6(8)+        |  | Executive
 Employment Agreement dated February 22, 2010, by the Registrant and John W.
 Combs.                                                                                                      
|                |  |                                                                                                                                                                                                     
|10.7(1) +       |  | Offer
 Letter, dated as of April 13, 2005, by the Registrant and Walter Weisner.                                                                                                                    
|                |  |                                                                                                                                                                                                     
|10.8(1)+        |  | Offer
 Letter, dated April 22, 2007, by the Registrant and Michael E. Healy.                                                                                                                        
|                |  |                                                                                                                                                                                                     
|10.9(3)+        |  | Employment
 Agreement, dated as of January 23, 2008, between the Registrant and Donald
 Girskis.                                                                                                    
|                |  |                                                                                                                                                                                                     
|10.10(1)        |  | Manufacturing
 Services Agreement, dated October 28, 2005, between Registrant and Jabil
 Circuit, Inc.                                                                                              
|                |  |                                                                                                                                                                                                     
|10.11(7)        |  | Office Lease
 Oakmead West, dated April 20, 2007, between Registrant and Carr NP
 Properties, L.L.C.(1), and Amendment No. 1 thereto.                                                               
|                |  |                                                                                                                                                                                                     
|10.12(5)+       |  | Non-employee
 director compensation guidelines.                                                                                                                                                     
|                |  |                                                                                                                                                                                                     
|10.13(6)+       |  | Form of
 Retention Incentive Agreement for the Chief Executive Officer, Form of
 Retention Agreement for the Chief Financial Officer, Form of Retention
 Agreement for the Other Executive Officers.
|                |  |                                                                                                                                                                                                     
|21(7)           |  | Subsidiaries.                                                                                                                                                                                       
|                |  |                                                                                                                                                                                                     
|23.1            |  | Consent of
 Deloitte & Touche LLP, independent registered public accounting firm.                                                                                                                   
|                |  |                                                                                                                                                                                                     
|24.1(7)         |  | Power of
 Attorney (included on the signature page).                                                                                                                                                
|                |  |                                                                                                                                                                                                     
|31.1            |  | Rule
 13a-14(a)/15d-14(a) Certification of Chief Executive Officer.                                                                                                                                 
|                |  |                                                                                                                                                                                                     
|31.2            |  | Rule
 13a-14(a)/15d-14(a) Certification of Chief Financial Officer.                                                                                                                                 
|                |  |                                                                                                                                                                                                     
|32.1            |  | Section 1350
 Certification of Chief Executive Officer.                                                                                                                                             
|                |  |                                                                                                                                                                                                     
|32.2            |  | Section 1350
 Certification of Chief Financial Officer.                                                                                                                                             

|    |  |                                                                                                                                         
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------
|(1) |  | Incorporated
 by reference to the Registrants Registration Statement on Form S-1 filed on
 February 12, 2007.                          
|    |  |                                                                                                                                         
|(2) |  | Incorporated
 by reference to the Registrants Annual Report on Form 10-K for the year
 ended June 30, 2007 filed on September 27, 2007.

- 74 -

---



|    |  |                                                                                                                                                   
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------
|(3) |  | Incorporated
 by reference to the Registrants Quarterly Report on Form 10-Q for the
 quarter ended March 31, 2008 filed on May 13, 2008.         
|    |  |                                                                                                                                                   
|(4) |  | Incorporated
 by reference to the Registrants Annual Report on Form 10-K for the year
 ended June 30, 2008 filed on September 12, 2008.          
|    |  |                                                                                                                                                   
|(5) |  | Incorporated
 by reference to the Registrants Form 8-K filed on February 12, 2008.                                                               
|    |  |                                                                                                                                                   
|(6) |  | Incorporated
 by reference to the Registrants Form 8-K filed on February 9, 2009.                                                                
|    |  |                                                                                                                                                   
|(7) |  | Incorporated
 by reference to the Registrants Annual Report on Form 10-K for the year
 ended June 30, 2009 filed on September 10, 2009.          
|    |  |                                                                                                                                                   
|(8) |  | Incorporated
 by reference to the Registrants Quarterly Report on Form 10-Q for the
 quarter ended March 31, 2010, filed on May 6, 2010.         
|    |  |                                                                                                                                                   
|(9) |  | 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.
|    |  |                                                                                                                                                   
|+   |  | Management
 Compensatory Plan or Arrangement                                                                                                      
|    |  |                                                                                                                                                   
|   |  | Confidential
 treatment has been granted with respect to selected portions of this
 agreement has been filed with the Commission.                 
|    |  |                                                                                                                                                   
|    |  | (b) Financial Statement Schedules.                                                                                                                

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

- 75 -

---