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UNITED STATES SECURITIES AND EXCHANGE
COMMISSION

Washington, D.C. 20549





Form 10-K







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



| |  | For the year ended June 30, 2008
| |  | --------------------------------

or



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

Commission file number: 001-33506

SHORETEL, INC.

(Exact name of Registrant as specified in its charter)



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

960 Stewart Drive

Sunnyvale, CA 94085-3913

(408) 331-3300

(Address, including zip code, and telephone number, including area code, of Registrants principal executive offices)

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

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   ̈    No  þ

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   ̈    No  þ

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  þ    No   ̈

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.    þ

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



|                                              |  |                             
|--------------------------------------------- |  | ----------------------------
|Large accelerated filer   ̈                    |  | Accelerated Filer  þ        
|Non-accelerated filer   ̈                      |  | Smaller reporting company   ̈
|(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   ̈    No  þ

The aggregate market value of the voting stock held by non-affiliates of the registrant as of December 31, 2007 was approximately $207.8 million based on the number of shares held by non-affiliates of the
registrant as of December 31, 2007 and based on the reported last sale price of common stock on December 31, 2007. 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 2, 2008 was 43,403,974.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement for the Annual Meeting of Stockholders (the Proxy Statement) to be held on November 12, 2008, and to be
filed pursuant to Regulation 14A within 120 days after registrants fiscal year ended June 30, 2008 are incorporated by reference into Part III of this Report.









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TABLE OF CONTENTS



|           |  |                                                                                                |  |     
|---------- |  | ---------------------------------------------------------------------------------------------- |  | ----
|           |  |                                                                                                |  | Page
|PART I    
|Item 1     |  | Business                                                                                       |  | 4   
|Item 1A    |  | Risk Factors                                                                                   |  | 12  
|Item 1B    |  | Unresolved Staff Comments                                                                      |  | 26  
|Item 2     |  | Properties                                                                                     |  | 26  
|Item 3     |  | Legal Proceedings                                                                              |  | 27  
|Item 4     |  | Submission of Matters to a Vote of Security Holders                                            |  | 27  
|          
|PART II   
|Item 5     |  | Market for Our Common Stock and Related Stockholder Matters                                    |  | 28  
|Item 6     |  | Selected Consolidated Financial Data                                                           |  | 31  
|Item 7     |  | Managements Discussion and Analysis of Financial Condition and Results of Operations          |  | 32  
|Item 7A    |  | Quantitative and Qualitative Disclosures About Market Risk                                     |  | 46  
|Item 8     |  | Financial Statements and Supplementary Data                                                    |  | 47  
|Item 9     |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure           |  | 75  
|Item 9A    |  | Controls and Procedures                                                                        |  | 75  
|Item 9B    |  | Other Information                                                                              |  | 78  
|          
|PART III  
|Item 10    |  | Directors and Executive Officers of the Registrant and Corporate Governance                    |  | 78  
|Item 11    |  | Executive Compensation                                                                         |  | 78  
|Item 12    |  | Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters |  | 78  
|Item 13    |  | Certain Relationships and Related Transactions, Director Independence                          |  | 78  
|Item 14    |  | Principal Accountant Fees and Services                                                         |  | 78  
|          
|PART IV   
|Item 15    |  | Exhibits and Financial Statement Schedules                                                     |  | 78  
|Signatures |  | 79                                                                                            



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TRADEMARKS

The ShoreTel logo, ShoreTel, ShoreCare, ShoreGear and ShoreWare are registered trademarks of ShoreTel, Inc. in the United States and/or other countries.
ShorePhone is a trademark of ShoreTel, Inc. in the United States and/or other countries. All other trademarks, tradenames 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.

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



|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 ShoreGear switches, ShorePhone IP telephones and ShoreWare software
applications. We provide our systems to enterprises across all industries, including to small, medium and large companies and public institutions. Our enterprise customers include multi-site Fortune 500 companies. As of June 30, 2008, we
had sold our IP unified communications systems to close to 8,000 enterprise customers. We sell our systems through our extensive network of over 600 channel partners.

We have achieved broad industry recognition for our technology and high customer satisfaction. Our enterprise IP unified communications systems have been voted Best in Show for the last two years at the
industrys flagship tradeshow, VoiceCon. For the last five 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 have increased our total revenue over the last four fiscal years, from $35.5 million in fiscal 2005 to $128.7
million in fiscal 2008, and we generated net income available to common stockholders of $2.6 million in fiscal 2008. As of June 30, 2008, we had an accumulated deficit of $82.2 million and total stockholders equity of $113.2 million.

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

Products

We provide a
switch-based IP unified communications system for enterprises. Our systems are based on our distributed software architecture and switch-based hardware platform that enable a single system to serve multi-site enterprises. This architecture provides
high network reliability and allows for a single point of management and administration of a system 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 ShoreGear switches, ShorePhone IP phones and ShoreWare 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.



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ShoreGear
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 each site within the system can be further improved by adding a single
additional switch to that site 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 thirteen 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.

ShorePhone 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 eleven phones that vary by size, display features, line capacity and Gigabit Ethernet support. ShorePhone IP phones are designed to function without any configuration, simplifying installation. Our systems also
support Wi-Fi phones for mobile workers.

ShoreWare software applications.    Our ShoreWare 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 improved functionality and 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 entirely on ShoreGear switches. Our ShoreWare software consists of our proprietary software
as well as third-party applications and includes



| |  |  | ShoreWare desktop applications and features.    ShoreWare desktop applications and features for end users include the following primary
offerings: Personal Call Manager, Unified Messaging, Office Anywhere, Automated Attendant and a softphone.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Personal Call Manager.    Personal Call Manager is an application that allows end users to manage their communications from their
desktops. With the click of a mouse, end users can initiate, manage, terminate, and receive calls, convene and manage conference calls, and see the availability of others on the network. This functionality is enhanced by the integration of our
Personal Call Manager application with Microsoft Outlook, which allows the end user to initiate calls from a contact list. An enhanced version of this application, Professional Call Manager, adds desktop video, instant messaging (IM) and softphone
capabilities.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 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.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Office Anywhere.    The Office Anywhere feature enables end users outside the office to manage calls with Personal Call Manager 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.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Softphone.    ShoreTels softphone application allows an end user to turn a PC into an IP phone by simply connecting a headset to
the PC and activating the application.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 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.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  |  | Workgroup.    Workgroup is an entry-level contact center application that provides real-time handling of incoming calls to enterprises,
with call routing, queuing and reporting tools.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | ShoreWare system management.    Our browser-based system management applications consist of ShoreWare Director and ShoreWare System
Monitor.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | ShoreWare Director.    ShoreWare Director provides enterprises with a single point of system management, enabling IT administrators to
view and manage the entire unified communications system of the enterprise from any location using a single application. A new end users extension, mailbox and automated attendant profile can be added from a single management screen, avoiding
the additional work required with most PBXs, voice mail systems and automated attendants.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | ShoreWare System Monitor.    ShoreWare System Monitor is an IP voice management tool that is designed to continuously measure the
performance of every link in the network, enabling an enterprise to identify and address voice quality issues.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | ShoreTel Contact Center.ShoreTel Contact Center allows enterprises to efficiently manage significant inbound or outbound call
activities.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Additional business applications.    We offer other business applications, such as ShoreTel Converged Conferencing and integration with
third party applications. ShoreTel Converged Conferencing enables enterprises to conduct large audio conferences and provides collaboration tools for application sharing, desktop sharing, instant messaging and end user availability information. Our
third party applications integrations include several customer relationship management (CRM) solutions (Salesforce.com, Microsoft Dynamics, Netsuite and RightNow) as well as cost recovery applications (Equitrak and Copitrak) These integrations are
designed to improve the productivity of end users that use these application by seamlessly integrating communications capabilities into their data driven workflow.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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.



| |  |  | 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 ShoreGear switches within our systems and provide our systems with the properties that distinguish them from
alternative IP systems.



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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 switches and allows calls to be distributed among switches instead of using a single centralized switch;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | software that enables ShoreGear 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 ShoreGear switches, and enables integration of ShoreTel and third-party applications;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------



| |  |  | software that coordinates the functions of all servers 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 switch to communicate with the application server, and receive system configuration information;
| | - |  | --------------------------------------------------------------------------------------------------------------------------



| |  |  | software that allows each switch to maintain a comprehensive view of the system; and
| | - |  | ------------------------------------------------------------------------------------



| |  |  | software that provides a graphical user interface for our phones.
| | - |  | -----------------------------------------------------------------

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

ShoreGear switches are comprised of off-the-shelf, embedded microprocessors and networking components, such as Ethernet controllers, and customized
integrated circuits. These switches run on an embedded operating system, and use random access memory and flash memory and our switch call management software for application processing. ShorePhone IP phones are comprised of enterprise IP phone
chips manufactured by Broadcom Corporation and customized LCD displays, microphones and speaker circuitry.

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 organization, and technology industries. As of June 30, 2008, we had sold our IP unified communications systems to close to 8,000
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.

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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, 2008, we had over 600 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. 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 our channel partners in selling to and providing support for large enterprise customer accounts. No single channel partner accounted for
10% or more of our total revenue in fiscal 2008.

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, 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 news letters, direct mail campaigns, web postings, press releases and web-based training.

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. 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 $26.7 million, $17.2 million and $9.7 million in fiscal 2008, 2007
and 2006, 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 a
contract manufacturer located in China. Our reliance on contract manufacturers involves a number of potential risks, including the absence of adequate capacity, ownership of certain elements of electronic designs, and reduced control over delivery
schedules. 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 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.



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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. 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. 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

For financial information about geographic areas, refer to Note 13 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 3Com and Cisco Systems; and
| | - |  | --------------------------------------------------------------



| |  |  | Providers of hybrid and IP systems, including Avaya, Alcatel-Lucent, Mitel Networks and Nortel Networks.
| | - |  | --------------------------------------------------------------------------------------------------------

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. 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, such as Microsoft. 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 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:



| |  |  | price of products and services and total cost of ownership;
| | - |  | -----------------------------------------------------------



| |  |  | system reliability;
| | - |  | -------------------



| |  |  | voice, video, and messaging quality and product features;
| | - |  | ---------------------------------------------------------



| |  |  | ease of administration and installation, including system scalability;
| | - |  | ----------------------------------------------------------------------



| |  |  | customer service and technical support;
| | - |  | ---------------------------------------

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| |  |  | relationships with buyers and decision makers;
| | - |  | ----------------------------------------------



| |  |  | the ability to integrate various products into an enterprise customers existing networks, including the ability of a providers products to interoperate
with other providers communications products; and
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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 five patents issued in the United States, which expire in 2019,
2023, 2023, 2025 and 2025, and have 19 patent applications in the United States. We also have one foreign patent application relating to one of our U.S. 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, 2008, we had 365 employees in North America, Europe, Asia
and Australia, of which 125 were in sales and marketing, 120 were in engineering, 59 were in global support services, 42 were in general and administrative functions and 19 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 2, 2008:



|                  |  |             |  |                                                
|----------------- |  | ----------- |  | -----------------------------------------------
|Name              |  | Age (Years) |  | Position                                       
|John W. Combs     |  | 61          |  | Chairman, President and Chief Executive Officer
|Edwin J. Basart   |  | 59          |  | Founder, Chief Technology Officer and Director 
|Michael E. Healy  |  | 47          |  | Chief Financial Officer                        
|Donald J. Girskis |  | 48          |  | Senior Vice President, Worldwide Sales         
|Pedro E. Rump     |  | 52          |  | Vice President, Engineering and Operations     
|Walter Weisner    |  | 52          |  | Vice President, Global Services                
|William P. Garvey |  | 43          |  | Vice President, General Counsel and Secretary  

John W. Combshas served as our President and Chief Executive Officer and as a director
since July 2004 and as our Chairman since February 2007. 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.



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Edwin J. Basartco-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.

Michael E. Healyhas 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.

Donald J. Girskis has served as our Senior Vice President of Worldwide Sales since February
2008. From 1993 to 2008, Mr. Girksis 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 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.

Pedro E. Rumphas 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.

Walter Weisnerhas served as our Vice President of Global Services since July 2005. From April 2002 to June 2005, Mr. Weisner served as Vice
President, Global Support Services for Webex Communications, Inc., a web communications services provider. From October 1999 to March 2002, Mr. Weisner served as Executive Vice President of Operations and Support for InternetConnect. Prior to
joining InternetConnect, Mr. Weisner served as Senior Director of Customer Operations and Support for Nextel Communications, Southwest region, and also held positions in product management and product development with Nextel. Mr. Weisner
holds a B.A. in business administration from Cleveland State University.

William P. Garveyhas served as our Vice President, General
Counsel and Secretary since April 2008. From January 2005 to September 2007, Mr. Garvey served as General Counsel, Vice President of Corporate Development, and Secretary of Rackable Systems, Inc., a publicly traded computer server
manufacturer. From September 1997 to December 2004, Mr. Garvey served as General Counsel, Vice President of Corporate Development and Secretary for Actuate Corporation, a publicly traded software company. Mr. Garvey holds a B.S. in
applied sciences and engineering from the United States Military Academy and a J.D. from Stanford Law School.

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

Risks Related to Our Business and
Industry

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. For example, in response to our announcement regarding our preliminary financial results for the quarter ended December 31, 2007
our stock price declined substantially. 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:



| |  |  | the purchasing and budgeting cycles of enterprise customers;
| | - |  | ------------------------------------------------------------



| |  |  | the timing and volume of shipments of our products during a quarter, particularly as we have recently begun to 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;
| | - |  | ---------------------------------------------------------------------------------------



| |  |  | 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;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the timing and success of new product introductions by us or our competitors;
| | - |  | -----------------------------------------------------------------------------



| |  |  | the timing of recognition of revenue from sales to our customers;
| | - |  | -----------------------------------------------------------------



| |  |  | changes in our or our competitors pricing policies or sales terms;
| | - |  | -------------------------------------------------------------------



| |  |  | changes in the mix of our products and services sold during a particular period;
| | - |  | --------------------------------------------------------------------------------



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



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



| |  |  | our ability to obtain sufficient supplies of components;
| | - |  | --------------------------------------------------------



| |  |  | our ability to maintain sufficient production volumes for our products;
| | - |  | -----------------------------------------------------------------------



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



| |  |  | publicly-announced litigation, such as the lawsuit by Mitel or stockholder litigation, and the impact of such litigation on our operating expenses and sales;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the timing of costs related to the development or acquisition of technologies or businesses;
| | - |  | --------------------------------------------------------------------------------------------



| |  |  | changes in domestic and international regulatory environments affecting the Internet and telecommunications industries;
| | - |  | -----------------------------------------------------------------------------------------------------------------------



| |  |  | our ability to successfully expand our international operations;
| | - |  | ----------------------------------------------------------------



| |  |  | seasonality in our target markets; and
| | - |  | --------------------------------------



| |  |  | general economic conditions or economic recession.
| | - |  | --------------------------------------------------

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.



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We may not be
profitable in future periods and our past growth rates may not be indicative of our future growth, and we may not be able to continue to maintain or increase our growth.

We have not been profitable in some prior periods and we had an accumulated deficit of $82.2 million as of June 30, 2008. We may not succeed in
sustaining profitability in future periods. We incur significant operating expenses associated with being a public company. We also expect that our operating expenses will continue to increase in all areas as we seek to grow our business. If our
gross profit does not increase to offset these expected increases in operating expenses, our operating results will be negatively affected. You should not consider our historic revenue growth rates as indicative of our future growth. Accordingly we
cannot assure you that we will be able to maintain or grow our revenue in the future.

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, 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.

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

Our business depends
on the overall demand for information technology, and in particular for telecommunications systems. The market we serve is emerging and the purchase of our products involves significant upfront expenditures. In addition, the purchase of our products
can be discretionary and may involve a significant commitment of capital and other resources. Weak economic conditions in our target markets, or a reduction in information technology or telecommunications spending even if economic conditions
improve, would likely adversely impact our business, operating results and financial condition in a number of ways, including longer sales cycles, lower prices for our products and reduced unit sales. For example, we estimate that a significant
percentage of our sales in the year ended June 30, 2008 were derived from the financial services market, which is experiencing a downturn related to the sub-prime mortgage market defaults and conditions in the credit markets.

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

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



| |  |  | greater market presence, name recognition and brand reputation;
| | - |  | ---------------------------------------------------------------



| |  |  | a larger installed base of telecommunications and networking systems with enterprise customers;
| | - |  | -----------------------------------------------------------------------------------------------



| |  |  | larger and more geographically distributed services and support organizations and capabilities;
| | - |  | -----------------------------------------------------------------------------------------------



| |  |  | a broader offering of telecommunications and networking products, applications and services;
| | - |  | --------------------------------------------------------------------------------------------



| |  |  | a more established international presence to address the needs of global enterprises;
| | - |  | -------------------------------------------------------------------------------------



| |  |  | substantially larger patent and intellectual property portfolios;
| | - |  | -----------------------------------------------------------------

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| |  |  | longer operating histories;
| | - |  | ---------------------------



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



| |  |  | more established relationships with industry participants, customers, suppliers, distributors and other technology companies; and
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------



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

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

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

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

As voice and data networks converge, we are likely to face increased competition from 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 recently announced its unified communications product roadmap. This includes its
recently introduced Office Communicator 2007, which Microsoft stated will allow end users to control communications, including voice over IP, through the Office Communicator application on their PC, which we expect will provide
functionality similar to that offered by our Personal Call Manager application. Microsoft has also introduced Office Communications Server 2007, a product that offers competing unified messaging capabilities. Microsoft has also developed
an IP phone and has licensed the rights to produce such phones to third parties. In addition, Microsoft has also entered into alliances with several of our competitors, and in July 2007 announced an extensive relationship with Nortel for the
production of IP-based communications equipment that will be integrated with the Microsoft systems and Office Communicator Microsoft and other leaders in the information technology, personal and business applications and software industries, have
substantial financial and other resources that they could devote to this market.

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



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



| |  |  | initial costs of implementation for a new system;
| | - |  | -------------------------------------------------



| |  |  | quality of infrastructure;
| | - |  | --------------------------



| |  |  | security concerns;
| | - |  | ------------------



| |  |  | equipment, software or other technology failures;
| | - |  | -------------------------------------------------



| |  |  | regulatory encroachments;
| | - |  | -------------------------



| |  |  | inconsistent quality of service;
| | - |  | --------------------------------



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



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

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

Even if enterprise IP telecommunications systems become more widespread in the future, we
cannot assure you that our products will attain broad market acceptance. 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.

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

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. Our future success is highly dependent upon establishing and maintaining successful relationships with a
variety of third-party resellers of telecommunications products and services. 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. By relying on
channel partners, we may in some

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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.

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

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

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



| |  |  | the timing of enterprise customers budget cycles and approval processes;
| | - |  | -------------------------------------------------------------------------



| |  |  | a technical evaluation or trial by potential enterprise customers;
| | - |  | ------------------------------------------------------------------



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



| |  |  | the announcement or introduction of competing products; and
| | - |  | -----------------------------------------------------------



| |  |  | the strength of existing relationships between our competitors and potential enterprise customers.
| | - |  | --------------------------------------------------------------------------------------------------

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

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. In addition, we must commit significant resources to developing new products and
features before knowing whether our invest-



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

We incorporate certain third-party technologies, such as our contact center, collaboration bridge and network monitoring software, into our products, and intend to utilize additional third-party technologies in the
future. However, licenses to relevant third-party technology or updates to those technologies may not continue to be available to us on commercially reasonable terms, or at all. Furthermore, we do not own the electronic design for our phones, 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 a very small number of issued U.S. patents and a small number of 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.

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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, on June 27, 2007, Mitel Networks Corporation, one of our competitors, filed a lawsuit alleging that we infringed six of its patents. See Business 
Legal Proceedings for a further discussion of this lawsuit. Furthermore, we may be unaware of the intellectual property rights of others that may cover some or all of our technology or products. Any claims or litigation could cause us to incur
significant expenses and, if successfully asserted against us, could require that we pay substantial damages or ongoing royalty payments, prevent us from selling our products, damage our reputation, or require that we comply with other unfavorable
terms, any of which could materially harm our business. In addition, we may decide to pay substantial settlement costs in connection with any claim or litigation, whether or not successfully asserted against us. Even if we were to prevail, any
litigation regarding our intellectual property could be costly and time-consuming and divert the attention of our management and key personnel from our business operations.

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

Our products 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 enter-



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prise 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 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.

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 a contract manufacturer located in China. Our reliance on contract manufacturers involves
a number of potential risks, including the absence of adequate capacity, ownership of certain elements of electronic designs, and reduced control over delivery schedules.

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

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

In addition, our contract manufacturers do not have any written contractual obligation to accept any purchase order that we submit for the
manufacture of any of our products nor do we have any assurance that our contract manufacturers will agree to manufacture and supply any or all of our requirements for our products. Furthermore, either of our contract manufacturers may unilaterally
terminate their relationship with us at any time upon 180 days notice with respect to the contract manufacturer of our switches and 120 days notice with respect to the contract manufacturer of our phones or seek to increase the prices they charge
us. 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.

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

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

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.

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 are contractually obligated 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.

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.

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



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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.

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

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

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

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

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;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------

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| |  |  | difficulties and costs associated with staffing and managing foreign operations;
| | - |  | --------------------------------------------------------------------------------



| |  |  | greater difficulty collecting accounts receivable and longer payment cycles;
| | - |  | ----------------------------------------------------------------------------



| |  |  | the need to adapt our products for specific countries;
| | - |  | ------------------------------------------------------



| |  |  | availability of reliable broadband connectivity and wide area networks in targeted areas for expansion;
| | - |  | -------------------------------------------------------------------------------------------------------



| |  |  | unexpected changes in regulatory requirements;
| | - |  | ----------------------------------------------



| |  |  | difficulties in understanding and complying with local laws, regulations and customs in foreign jurisdictions;
| | - |  | --------------------------------------------------------------------------------------------------------------



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



| |  |  | more limited protection for intellectual property rights in some countries;
| | - |  | ---------------------------------------------------------------------------



| |  |  | adverse tax consequences;
| | - |  | -------------------------



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



| |  |  | restrictions on the transfer of funds; and
| | - |  | ------------------------------------------



| |  |  | new and different sources of competition.
| | - |  | -----------------------------------------

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

We face certain litigation risks.

We are a party to certain lawsuits. Litigation can be lengthy, time-consuming,
expensive, disruptive to normal business operations and may divert management time and resources. The results of complex legal proceedings are difficult to predict. An unfavorable resolution of a particular lawsuit could have a material adverse
effect on our business, results of operations or financial condition. In addition, we may incur higher general and administrative expenses than we have in the past in order to defend and prosecute this litigation, which could adversely affects our
operating results. For additional information regarding the material lawsuits in which we are involved, see Item 3 Legal Proceedings.

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, equip-



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ment 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 on hand and the
proceeds from our initial public offering, which was completed in July 2007, will be sufficient to meet our currently anticipated cash needs through fiscal 2009, if our cash and cash equivalents balances and any cash generated from operations and
from our initial public offering are not sufficient to meet our future cash requirements, we will need to seek additional capital, potentially through debt or equity financings, to fund our operations. We may also need to raise additional capital to
take advantage of new business or acquisition opportunities. We may seek to raise capital by, among other things:



| |  |  | issuing additional common stock or other equity securities;
| | - |  | -----------------------------------------------------------



| |  |  | issuing debt securities; or
| | - |  | ---------------------------



| |  |  | borrowing funds under a credit facility.
| | - |  | ----------------------------------------

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.

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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 which have some exposure to asset-backed structured investment vehicles (SIVs). If the SIVs incur significant losses, we may recognize a decline in fair value of our money market funds below our cost basis
which could negatively impact our earnings. We also hold notes, 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. In addition, financial institutions have been under significant pressure over the past several quarters. Should one or more of the financial
institutions managing our invested funds experience increased financial pressure resulting in bankruptcy or the threat of bankruptcy access to our funds may be restricted for a period of time and may also result in losses on those funds.

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, beginning with the year ended June 30, 2008, 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. 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 or our independent registered public accounting firm identify deficiencies in our internal control over financial reporting that are deemed to be
material weaknesses, the market price of our stock could decline and we could be subject to investigations or sanctions by the SEC, The NASDAQ Stock Market, or NASDAQ, or other regulatory authorities or subject to litigation. To the extent any
material weaknesses in our internal control over financial reporting are identified in the future, we could be required to expend significant management time and financial resources to correct such material weaknesses or to respond to any resulting
regulatory investigations or proceedings.

Our current level of net income as reported on our financial statements could increase the
likelihood of identifying a material weakness in our internal controls.

The threshold for determining whether or not we have a
material weakness in our internal controls and procedures as defined by the Sarbanes-Oxley Act is, in part, based on our net income. If our net income should remain at its current level or decrease, the materiality threshold associated with
deficiencies discovered in our internal controls and procedures would remain relatively low or decrease, increasing our risk of identifying and having to disclose material control weaknesses, which negatively impact the price of our stock.

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 dis-



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asters 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.

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 $4 per share to a high of approximately $20 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;
| | - |  | -------------------------------------------------------------------------



| |  |  | 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.

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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 50% our shares
are held by our venture capital investors. If these investors or any of our existing stockholders sell a large number of shares of our common stock or the public market perceives that these sales may occur, the market price of our common stock could
decline. 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 and 701. 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 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;
| | - |  | -----------------------------------------------------



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



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



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



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



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



| |  |  | set limitations on the removal of directors.
| | - |  | --------------------------------------------

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



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

None.



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

Our headquarters
is located in Sunnyvale, California in a 63,781 square foot facility that we lease through October 2009. In June 2008, we entered into an office space lease for 10,683 square foot in Austin, Texas which commences in September 2008. We also
maintain leased sales offices in Europe and Australia.



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We do not maintain a
dedicated warehouse facility for our inventory, rather we rent space as needed at a third-party warehouse. In May 2007, we entered into a lease for a shipping and receiving facility with warehouse capacity and occupied it in July 2007. The lease
expires in September 2009. Our inventory is expected to be kept at our facility and at the third party facility.

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 11 to the Consolidated Financial Statements in Item 8, which is incorporated herein by reference.



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

None.

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PART II



|ITEM 5. | MARKET FOR OUR COMMON STOCK AND RELATED STOCKHOLDER MATTERS
|------- | -----------------------------------------------------------

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 Ending June 30, 2008   |  | High |       | Low
|First Quarter (from July 3) |  | $    | 16.50 |     | $ | 12.15
|Second Quarter              |  |      | 18.32 |     |   | 13.25
|Third Quarter               |  |      | 13.69 |     |   | 4.75 
|Fourth Quarter              |  |      | 5.64  |     |   | 4.42 

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; 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

Holders of Record

As of September 2, 2008, there were 195 stockholders of record of our common stock, although
we believe there are approximately 2,100 beneficial owners since many brokers and other institutions hold our common stock on behalf of stockholders. On September 2, 2008, the last reported sales price of our common stock on the Nasdaq Global
Market was $5.72 per share.

Dividend Policy

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



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Sales of Unregistered Securities

None.

Performance Graph (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, 2008, for (i) our common stock, (ii) the S&P 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.

Comparison of 1 Year Cumulative Total Return

Assumes Initial Investment of $100

June 2008

LOGO



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

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Equity Compensation Plan Information

The following table summarizes information about our equity compensation plans as of June 30, 2008. All outstanding awards relate to our common stock.



|                                                           |  |                                                                                        |  |                                                                         |      |                                                                                                                                     |          
|---------------------------------------------------------- |  | -------------------------------------------------------------------------------------- |  | ----------------------------------------------------------------------- | ---- | ----------------------------------------------------------------------------------------------------------------------------------- | ---------
|Plan Category                                              |  | Number ofSecurities tobe IssueduponExercise ofOutstandingOptions,Warrantsand
Rights(a) |  | WeightedAverageExercisePrice ofOutstandingOptions,Warrantsand Rights(b) |      | Number ofSecuritiesRemainingAvailable forFutureIssuancesunder EquityCompensationPlans(ExcludingSecuritiesReflected inColumn (a))(c)
|Equity compensation plans approved by security holders(1)  |  | 7,245,000                                                                              |  | $                                                                       | 8.10 |                                                                                                                                     | 2,903,000
|Equity compensation plans not approved by security holders |  |                                                                                       |  |                                                                         |     |                                                                                                                                     |         
|                                                           |  |                                                                                        |  |                                                                         |      |                                                                                                                                     |          
|Total                                                      |  | 7,245,000                                                                              |  | $                                                                       | 8.10 |                                                                                                                                     | 2,903,000
|                                                           |  |                                                                                        |  |                                                                         |      |                                                                                                                                     |          



|(1) | The number of securities remaining available for future issuance in column (c) includes 2,903,000 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, 2008.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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|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,                      |        
|                                                                                       |  | 2008                                     |         |   | 2007 |   |        | 2006 |  |   | 2005   |   |  | 2004 |       
|                                                                                       |  | (In thousands, except per share amounts) |        
|Revenue:                                                                               |  |                                          |         |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Product                                                                                |  | $                                        | 110,496 |   |      | $ | 87,095 |      |  | $ | 55,300 |   |  | $    | 31,970 |   |  | $ | 16,587 |  
|Support and services                                                                   |  |                                          | 18,233  |   |      |   | 10,732 |      |  |   | 6,308  |   |  |      | 3,512  |   |  |   | 2,241  |  
|                                                                                       |  |                                          |         |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Total revenue                                                                          |  |                                          | 128,729 |   |      |   | 97,827 |      |  |   | 61,608 |   |  |      | 35,482 |   |  |   | 18,828 |  
|Cost of revenue:                                                                       |  |                                          |         |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Product(1)                                                                             |  |                                          | 37,451  |   |      |   | 29,751 |      |  |   | 21,855 |   |  |      | 13,961 |   |  |   | 7,725  |  
|Support and services(1)                                                                |  |                                          | 9,994   |   |      |   | 6,837  |      |  |   | 5,425  |   |  |      | 2,907  |   |  |   | 1,660  |  
|                                                                                       |  |                                          |         |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Total cost of revenue                                                                  |  |                                          | 47,445  |   |      |   | 36,588 |      |  |   | 27,280 |   |  |      | 16,868 |   |  |   | 9,385  |  
|                                                                                       |  |                                          |         |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Gross profit                                                                           |  |                                          | 81,284  |   |      |   | 61,239 |      |  |   | 34,328 |   |  |      | 18,614 |   |  |   | 9,443  |  
|Operating expenses:                                                                    |  |                                          |         |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Research and development(1)                                                            |  |                                          | 26,691  |   |      |   | 17,224 |      |  |   | 9,720  |   |  |      | 7,034  |   |  |   | 5,517  |  
|Sales and marketing(1)                                                                 |  |                                          | 37,780  |   |      |   | 26,126 |      |  |   | 15,699 |   |  |      | 10,050 |   |  |   | 8,004  |  
|General and administrative(1)                                                          |  |                                          | 17,420  |   |      |   | 11,673 |      |  |   | 4,936  |   |  |      | 3,045  |   |  |   | 2,166  |  
|                                                                                       |  |                                          |         |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Total operating expenses                                                               |  |                                          | 81,891  |   |      |   | 55,023 |      |  |   | 30,355 |   |  |      | 20,129 |   |  |   | 15,687 |  
|                                                                                       |  |                                          |         |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Operating income (loss)                                                                |  |                                          | (607    | ) |      |   | 6,216  |      |  |   | 3,973  |   |  |      | (1,515 | ) |  |   | (6,244 | )
|Other income  net                                                                     |  |                                          | 4,101   |   |      |   | 273    |      |  |   | 248    |   |  |      | 124    |   |  |   | (7     | )
|                                                                                       |  |                                          |         |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Income (loss) before provision for income tax                                          |  |                                          | 3,494   |   |      |   | 6,489  |      |  |   | 4,221  |   |  |      | (1,391 | ) |  |   | (6,251 | )
|Income tax provision                                                                   |  |                                          | (861    | ) |      |   | (408   | )    |  |   | (219   | ) |  |      | (11    | ) |  |   |       |  
|                                                                                       |  |                                          |         |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Net income (loss)                                                                      |  |                                          | 2,633   |   |      |   | 6,081  |      |  |   | 4,002  |   |  |      | (1,402 | ) |  |   | (6,251 | )
|Accretion of preferred stock                                                           |  |                                          |        |   |      |   | (50    | )    |  |   | (51    | ) |  |      | (32    | ) |  |   | (26    | )
|                                                                                       |  |                                          |         |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Net income (loss) available to common stockholders                                     |  | $                                        | 2,633   |   |      | $ | 6,031  |      |  | $ | 3,951  |   |  | $    | (1,434 | ) |  | $ | (6,277 | )
|                                                                                       |  |                                          |         |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Net income (loss) per common share available to common stockholders(2):                |  |                                          |         |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Basic                                                                                  |  | $                                        | 0.06    |   |      | $ | 0.70   |      |  | $ | 0.60   |   |  | $    | (0.27  | ) |  | $ | (1.27  | )
|                                                                                       |  |                                          |         |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Diluted                                                                                |  | $                                        | 0.06    |   |      | $ | 0.17   |      |  | $ | 0.12   |   |  | $    | (0.27  | ) |  | $ | (1.27  | )
|                                                                                       |  |                                          |         |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Shares used in computing net income (loss) per share available to common stockholders: |  |                                          |         |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Basic                                                                                  |  |                                          | 42,413  |   |      |   | 8,565  |      |  |   | 6,609  |   |  |      | 5,352  |   |  |   | 4,935  |  
|Diluted                                                                                |  |                                          | 44,861  |   |      |   | 35,581 |      |  |   | 33,431 |   |  |      | 5,352  |   |  |   | 4,935  |  



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



|                                       |  |                     |       |      |   |       |  |      |    |      |   |    |  |   |   
|-------------------------------------- |  | ------------------- | ----- | ---- | - | ----- |  | ---- | -- | ---- | - | -- |  | - | --
|                                       |  | Year Ended June 30,
|                                       |  | 2008                |       | 2007 |   | 2006  |  | 2005 |    | 2004
|                                       |  | (In thousands)     
|Cost of product revenue                |  | $                   | 59    |      | $ | 12    |  | $    |   |      | $ |   |  | $ |  
|Cost of support and services revenue   |  |                     | 503   |      |   | 99    |  |      | 16 |      |   |   |  |   |  
|Research and development               |  |                     | 1,885 |      |   | 384   |  |      | 14 |      |   |   |  |   |  
|Sales and marketing                    |  |                     | 2,358 |      |   | 533   |  |      | 7  |      |   |   |  |   |  
|General and administrative             |  |                     | 2,135 |      |   | 1,658 |  |      | 45 |      |   | 82 |  |   | 45
|                                       |  |                     |       |      |   |       |  |      |    |      |   |    |  |   |   
|Total stock-based compensation expense |  | $                   | 6,940 |      | $ | 2,686 |  | $    | 82 |      | $ | 82 |  | $ | 45
|                                       |  |                     |       |      |   |       |  |      |    |      |   |    |  |   |   

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|(2) | See Note 3 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, which gives effect to the 1-for-10 reverse split of our outstanding common stock on June 22, 2007.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Effective July 1, 2006, we adopted SFAS 123(R) Share-Based Payment. Stock-based compensation expense for years prior to fiscal 2007 was calculated based on provisions of APB 25 Accounting for Stock
Issued to Employees.



|                                                     |  |                |         |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|---------------------------------------------------- |  | -------------- | ------- | ---- | - | ------- | ---- |  | - | ------- | - |  | ---- | ------- | - |  | - | ------- | -
|                                                     |  | As of June 30, |        
|                                                     |  | 2008           |         | 2007 |   |         | 2006 |  |   | 2005    |   |  | 2004 |        
|                                                     |  | (In thousands) |        
|Consolidated balance sheet data:                     |  |                |         |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Cash and cash equivalents and short-term investments |  | $              | 102,811 |      | $ | 17,326  |      |  | $ | 12,333  |   |  | $    | 5,373   |   |  | $ | 723     |  
|Working capital                                      |  |                | 111,993 |      |   | 23,018  |      |  |   | 16,208  |   |  |      | 10,741  |   |  |   | 1,320   |  
|Total assets                                         |  |                | 147,797 |      |   | 53,034  |      |  |   | 30,885  |   |  |      | 20,960  |   |  |   | 7,962   |  
|Redeemable convertible preferred stock               |  |                |        |      |   | 56,341  |      |  |   | 56,332  |   |  |      | 56,281  |   |  |   | 46,300  |  
|Total stockholders equity (deficit)                 |  |                | 113,213 |      |   | (31,829 | )    |  |   | (41,168 | ) |  |      | (45,713 | ) |  |   | (44,596 | )



|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, 2008 refers to the fiscal year ended June 30, 2008, 2007 refers to the fiscal year ended June 30, 2007, and 2006 refers to the fiscal year ended June 30, 2006.

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 600 as of June 30, 2008. 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 two



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

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

We are headquartered in Sunnyvale, California and the majority of our personnel work at this location. Sales and support
personnel are located throughout the United States and, to a lesser extent, in the United Kingdom, Germany, Belgium, Spain, Hong Kong, Singapore and Australia. While we expanded our operations to Europe in 2005 and to the Asia Pacific region in
2006, most of our enterprise customers are located in the United States. Revenue from international sales has been 5% or less of our total revenue for 2008, 2007, and 2006, respectively. Although we intend to focus on increasing international sales,
we expect that sales to enterprise customers in the United States will continue to comprise the significant majority of our sales.

We have
experienced significant growth in past two years, with our total revenue growing to $128.7 million for 2008 from $61.6 million for 2006. This growth in revenue has largely been driven by increased demand for IP telecommunications systems
from new enterprise customers, as well as sales of additional products to our installed enterprise customer base. Our operating expenses have also increased significantly to $81.9 million for 2008 from $30.4 million for 2006. This growth
in operating expenses has primarily been driven by our growth in headcount, to 365 employees at June 30, 2008, as compared with 174 employees at June 30, 2006. We expect to continue to add personnel in all functional areas.

Key Business Metrics

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

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

Deferred revenue.    Nearly all system sales include the purchase of post-contractual support contracts with terms of up to five years, and our renewal rates on these contracts have been high historically. We
recognize support revenue on a ratable basis over the term of the support contract. Since we receive payment for support in advance of our recognizing the related revenue, we carry a deferred revenue balance on our consolidated balance sheet. This
deferred revenue helps provide predictability to our future support and services revenue. Accordingly, the level of purchases of post-contractual support with our product sales is an important metric for us along with the renewal rates for these
services. Our deferred revenue balance at June 30, 2008 was $18.7 million, of which $13.9 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,

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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 significantly lower than gross
margin for products, and is impacted primarily by personnel costs and labor related expenses. The primary goal of our support and services function is to ensure a high level of 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 metrics, as well as our own
strategic considerations. In circumstances where we sell directly to the enterprise customer in transactions that have been assisted by channel partners, we report our revenue net of any associated payment to the channel partners that assisted in
such sales. This results in recognized revenue from a direct sale approximating the revenue that would have been recognized from a sale of a comparable system through a channel partner. Product revenue has accounted for 86%, 89%, and 90% of our
total revenue for 2008, 2007 and 2006, respectively.

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

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

Research and development expenses.    Research and development expenses primarily include personnel costs, outside engineering costs, professional services, prototype costs, test equipment,
software usage fees and facilities expenses. Research and development expenses are recognized when incurred. We are devoting substantial resources to the development of additional functionality for existing products and the development of new
products and related software applications. We intend to continue to make significant investments in our research and development efforts because we believe they are essential to maintaining and improving our competitive position. Accordingly, we
expect research and development expenses to continue to increase in absolute dollars.

Sales and marketing
expenses.    Sales and marketing expenses primarily include personnel costs, sales commissions, travel, marketing promotional and lead generation programs, advertising, trade shows, professional services fees and facilities
expenses. We plan to continue to invest in development of our distribution channel by



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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. We also expect to incur additional general and administrative expenses related to our securities litigation matters and litigation with Mitel. 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 investments and other miscellaneous income (expenses).

Income tax provision.    Income tax provision includes federal, state and foreign tax on our income. From inception through 2005 we accumulated substantial net operating loss and tax credit
carryforwards. We fully reserved the deferred tax asset from these losses and tax credits on our financial statements. We were profitable in 2008, 2007 and 2006 and had an effective tax rate of approximately 24.6%, 6.3% and 5.2%, respectively, as a
result of utilizing portions of the deferred tax asset and reducing the related valuation allowance. The increase in the effective tax rate from 2007 to 2008 is primarily driven by the increase in non-deductible stock based compensation, the usage
of available net operating losses in earlier years as well as the decrease in deferred tax assets available to offset taxable income.

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 may limit the future realization of our net operating losses and tax
credit carryforwards under Sections 382 and 383 of the Internal Revenue Code in future periods. Based on our final analysis, we believe the provisions of Section 382 will result in the forfeiture of federal and California net operating
loss carryforwards of $71.5 million and $19.7 million, respectively, and federal and California research and development tax credit carryforwards of $1.5 million and $0.7 million, respectively.

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Results of Operations

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



|                                       |  |                     |    |  |      |   |  |      |  
|-------------------------------------- |  | ------------------- | -- |  | ---- | - |  | ---- | -
|                                       |  | Year Ended June 30, |   
|                                       |  | 2008                |    |  | 2007 |   |  | 2006 |  
|Revenue:                               |  |                     |    |  |      |   |  |      |  
|Product                                |  | 86                  | %  |  | 89   | % |  | 90   | %
|Support and services                   |  | 14                  | %  |  | 11   | % |  | 10   | %
|                                       |  |                     |    |  |      |   |  |      |  
|Total revenue                          |  | 100                 | %  |  | 100  | % |  | 100  | %
|Cost of revenue:                       |  |                     |    |  |      |   |  |      |  
|Product                                |  | 29                  | %  |  | 30   | % |  | 35   | %
|Support and services                   |  | 8                   | %  |  | 7    | % |  | 9    | %
|                                       |  |                     |    |  |      |   |  |      |  
|Total cost of revenue                  |  | 37                  | %  |  | 37   | % |  | 44   | %
|                                       |  |                     |    |  |      |   |  |      |  
|Gross profit                           |  | 63                  | %  |  | 63   | % |  | 56   | %
|Operating expenses:                    |  |                     |    |  |      |   |  |      |  
|Research and development               |  | 21                  | %  |  | 18   | % |  | 16   | %
|Sales and marketing                    |  | 29                  | %  |  | 27   | % |  | 26   | %
|General and administrative             |  | 13                  | %  |  | 12   | % |  | 8    | %
|                                       |  |                     |    |  |      |   |  |      |  
|Total operating expenses               |  | 63                  | %  |  | 57   | % |  | 50   | %
|                                       |  |                     |    |  |      |   |  |      |  
|Operating income (loss)                |  |                    |    |  | 6    | % |  | 6    | %
|Other income, net                      |  | 3                   | %  |  |     |   |  |     |  
|                                       |  |                     |    |  |      |   |  |      |  
|Income before provision for income tax |  | 3                   | %  |  | 6    | % |  | 6    | %
|Provision for income taxes             |  | (1                  | )% |  |     |   |  |     |  
|                                       |  |                     |    |  |      |   |  |      |  
|Net income                             |  | 2                   | %  |  | 6    | % |  | 6    | %
|                                       |  |                     |    |  |      |   |  |      |  

Fiscal 2008 compared to Fiscal 2007

Revenue.



|        |  |                                    |         |              |   |        |  |   |        |  |    |  
|------- |  | ---------------------------------- | ------- | ------------ | - | ------ |  | - | ------ |  | -- | -
|        |  | Year ended                         |         | Change       |  
|        |  | June 30,2008                       |         | June 30,2007 |  
|        |  |                                    | $       |              | % |       
|        |  | (in thousands, except percentages) |        
|Revenue |  | $                                  | 128,729 |              | $ | 97,827 |  | $ | 30,902 |  | 32 | %

The increase was primarily attributable to increased sales of our products and services. Product
revenue was $110.5 million in 2008, an increase of $23.4 million, or 27%, from $87.1 million in 2007. Support and services revenue was $18.2 million in 2008, an increase of $7.5 million, or 70%, from $10.7 million in
2007, as a result of increased revenue associated with post-contractual support contracts accompanying new system sales, post-contractual support contract renewals and increased revenue from training services and installations.

Gross margin.



|                |  |                                    |        |   |              |   |        |   |  |   |        |  |    |  
|--------------- |  | ---------------------------------- | ------ | - | ------------ | - | ------ | - |  | - | ------ |  | -- | -
|                |  | Year ended                         |        |   | Change       |  
|                |  | June 30,2008                       |        |   | June 30,2007 |   |       
|                |  |                                    | $      |   | %            |  
|                |  | (in thousands, except percentages) |       
|Cost of revenue |  | $                                  | 47,445 |   |              | $ | 36,588 |   |  | $ | 10,857 |  | 30 | %
|Gross profit    |  | $                                  | 81,284 |   |              | $ | 61,239 |   |  | $ | 20,045 |  | 33 | %
|Gross margin    |  |                                    | 63.1   | % |              |   | 62.6   | % |  |   | n/a    |  | 1  | %

The increase in gross margin was attributable to an increase in support and services gross margin
from 36% in 2007 to 45% in 2008. Support and services gross margin increased due to support and services revenue



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increasing by 70% and service costs only increasing 46%, compared to the same period in 2007. Compensation for support and services employees, the largest
category of support and service costs, increased 33% in 2008, as headcount increased from 42 employees at June 30, 2007 to 52 employees at June 30, 2008. The product gross margin remained at 66% in 2008 and 2007.

Operating expenses



|                           |  |                                    |        |              |   |        |  |   |        |  |    |  
|-------------------------- |  | ---------------------------------- | ------ | ------------ | - | ------ |  | - | ------ |  | -- | -
|                           |  | Year ended                         |        | Change       |  
|                           |  | June 30,2008                       |        | June 30,2007 |  
|                           |  |                                    | $      |              | % |       
|                           |  | (in thousands, except percentages) |       
|OPERATING EXPENSES:        |  |                                    |        |              |   |        |  |   |        |  |    |  
|Research and development   |  | $                                  | 26,691 |              | $ | 17,224 |  | $ | 9,467  |  | 55 | %
|Sales and marketing        |  | $                                  | 37,780 |              | $ | 26,126 |  | $ | 11,654 |  | 45 | %
|General and administrative |  | $                                  | 17,420 |              | $ | 11,673 |  | $ | 5,747  |  | 49 | %

Research and development.    These expenses represented 21% and 18% of
total revenue in 2008 and 2007, respectively. Compensation, including stock based compensation, for research and development employees accounted for $6.3 million of the increase, primarily as a result of an increase in headcount to
125 employees at June 30, 2008, from 102 employees at June 30, 2007. Additionally, outside engineering charges, facilities costs and consulting and professional services, accounted for $1.6 million, $0.8 million and $0.3 million,
respectively, of the increase.

Sales and marketing.    These expenses represented 29% and 27% of total revenue
in 2008 and 2007, respectively. Compensation, including stock based compensation for sales and marketing employees represented $7.9 million of the increase, primarily as a result of an increase in headcount, to 127 employees at
June 30, 2008 from 94 employees at June 30, 2007. Additionally, travel and entertainment, consulting and temporary labor costs, public relations, trade shows, marketing cooperative advertising, issued equipment, depreciation and
facilities expense accounted for $1.0 million, $0.4 million, $0.3 million, $0.2 million, $0.2 million, $0.3 million $0.2 million and $0.3 million, respectively, of the increase.

General and administrative.    These expenses represented 13% and 12% of total revenue in 2008 and 2007, respectively.
Compensation for general and administrative employees, including stock based compensation, accounted for $3.3 million of the increase, primarily as a result of an increase in headcount, to 42 employees at June 30, 2008 from
33 employees at June 30, 2007. Legal expenses including litigation expenses, office rent, insurance, and depreciation accounted for $1.5 million, $0.8 million, $0.4 million and $0.3 million, respectively, of the increase. These increases
were partially offset by decreases in recruiting costs and software license and maintenance fees by $0.4 million and $0.1 million, respectively.

Other income



|                  |  |                                    |       |              |   |     |  |   |       |  |      |  
|----------------- |  | ---------------------------------- | ----- | ------------ | - | --- |  | - | ----- |  | ---- | -
|                  |  | Year ended                         |       | Change       |  
|                  |  | June 30,2008                       |       | June 30,2007 |  
|                  |  |                                    | $     |              | % |    
|                  |  | (in thousands, except percentages) |      
|Other Income, net |  | $                                  | 4,101 |              | $ | 273 |  | $ | 3,828 |  | 1402 | %

Other income.    The increase is primarily attributable to increase in
interest income by $3.3 million on account of higher cash and investment balances in 2008 as compared to 2007. Additionally, in 2007 there were expenses of $0.5 million associated with an increase in fair value of preferred stock warrants that were
converted in connection with our initial public offering that were partially offset against other income.

Income tax provision.



|              |  |                                    |     |              |   |     |  |   |     |  |     |  
|------------- |  | ---------------------------------- | --- | ------------ | - | --- |  | - | --- |  | --- | -
|              |  | Year ended                         |     | Change       |  
|              |  | June 30,2008                       |     | June 30,2007 |  
|              |  |                                    | $   |              | % |    
|              |  | (in thousands, except percentages) |    
|Tax provision |  | $                                  | 861 |              | $ | 408 |  | $ | 453 |  | 111 | %

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The income tax provision was $861,000 in 2008, an increase of $453,000, from $408,000 in 2007, primarily
due to an increase in our effective tax rate from 6.3% to 24.6%.

Fiscal 2007 compared to Fiscal 2006

Revenue.



|        |  |                                    |        |              |   |        |  |   |        |  |    |  
|------- |  | ---------------------------------- | ------ | ------------ | - | ------ |  | - | ------ |  | -- | -
|        |  | Year ended                         |        | Change       |  
|        |  | June 30,2007                       |        | June 30,2006 |  
|        |  |                                    |        | $            |   | %      | 
|        |  | (in thousands, except percentages) |       
|Revenue |  | $                                  | 97,827 |              | $ | 61,608 |  | $ | 36,219 |  | 59 | %

The revenue growth in 2007 was primarily attributable to increased sales of our products and
services. Product revenue was $87.1 million in 2007, an increase of $31.8 million, or 57%, from $55.3 million in 2006. Support and services revenue was $10.7 million in 2007, an increase of $4.4 million, or 70%, from
$6.3 million in 2006, as a result of increased revenue associated with post-contractual support contracts accompanying new system sales, post-contractual support contract renewals and increased revenue from training services and installations.

Gross margin.



|                |  |                                    |        |   |              |   |        |   |  |   |        |  |    |  
|--------------- |  | ---------------------------------- | ------ | - | ------------ | - | ------ | - |  | - | ------ |  | -- | -
|                |  | Year ended                         |        |   | Change       |  
|                |  | June 30,2007                       |        |   | June 30,2006 |   |       
|                |  |                                    | $      |   | %            |  
|                |  | (in thousands, except percentages) |       
|Cost of revenue |  | $                                  | 36,588 |   |              | $ | 27,280 |   |  | $ | 9,308  |  | 34 | %
|Gross profit    |  | $                                  | 61,239 |   |              | $ | 34,328 |   |  | $ | 26,911 |  | 78 | %
|Gross margin    |  |                                    | 62.6   | % |              |   | 55.7   | % |  |   | n/a    |  | 12 | %

In 2007, the increase in total gross margin was attributable to product gross margin of 66%
compared to 60% in 2006. The increase in product gross margin was due to improved margins on hardware products as a result of sales of hardware products introduced in April 2006 that have higher margins than the hardware products that they replaced.
Support and services gross margin increased to 36% in 2007 from 14% in 2006. The increase in support and services gross margin was due to support and service revenue increasing by 70% and service costs only increasing 26%, compared to the same
period in 2006. Compensation for support and services employees, the largest category of support and service costs, increased 41% in 2007, as headcount increased from 31 employees at June 30, 2006 to 42 employees at June 30,
2007.

Operating expenses



|                           |  |                                    |        |              |   |        |  |   |        |  |     |  
|-------------------------- |  | ---------------------------------- | ------ | ------------ | - | ------ |  | - | ------ |  | --- | -
|                           |  | Year ended                         |        | Change       |  
|                           |  | June 30,2007                       |        | June 30,2006 |  
|                           |  |                                    | $      |              | % |       
|                           |  | (in thousands, except percentages) |       
|OPERATING EXPENSES:        |  |                                    |        |              |   |        |  |   |        |  |     |  
|Research and development   |  | $                                  | 17,224 |              | $ | 9,720  |  | $ | 7,504  |  | 77  | %
|Sales and marketing        |  | $                                  | 26,126 |              | $ | 15,699 |  | $ | 10,427 |  | 66  | %
|General and administrative |  | $                                  | 11,673 |              | $ | 4,936  |  | $ | 6,737  |  | 136 | %

Research and development.    Compensation, including stock based
compensation, for research and development employees accounted for $5.1 million of the increase in 2007 compared to 2006, primarily as a result of an increase in headcount to 102 employees at June 30, 2007, from 48 employees at
June 30, 2006. Additionally, consulting and professional services, non-recurring engineering charges, software license and maintenance fees and equipment costs accounted for $0.8 million, $0.5 million, $0.3 million and $0.2 million,
respectively, of the increase.

Sales and marketing.    Compensation, including stock based compensation for
sales and marketing employees represented $7.2 million of the increase in 2007 compared to 2006, primarily as a result of an increase



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in headcount, to 94 employees at June 30, 2007 from 66 employees at June 30, 2006. Additionally, travel, promotional and lead generation
programs, marketing shows and events and advertising and public relations accounted for $1.0 million, $1.0 million, $0.7 million and $0.6 million, respectively, of the increase.

General and administrative.    Compensation for general and administrative employees accounted for $2.6 million of the
increase in 2007 compared to 2006, primarily as a result of an increase in headcount, to 33 employees at June 30, 2007 from 18 employees at June 30, 2006. General and administrative compensation expense in 2007 also included
$1.7 million of stock-based compensation expense most of which is associated with an outstanding option granted prior to the adoption of SFAS 123(R) that was subject to variable accounting. Variable accounting on this outstanding option
ceased in March 2007 upon the repayment of the related note receivable in exchange for the surrender of shares of our common stock having a value equal to the amounts outstanding under the note. Audit, legal and professional services accounted for
$1.5 million and $1.5 million, respectively, of the increase. The remainder of the increase was primarily attributable to various expenses including travel expenses, software license and maintenance, training, and facility expenses.

Other income/(expense).



|                  |  |                                    |     |              |   |     |  |   |    |  |    |  
|----------------- |  | ---------------------------------- | --- | ------------ | - | --- |  | - | -- |  | -- | -
|                  |  | Year ended                         |     | Change       |  
|                  |  | June 30,2007                       |     | June 30,2006 |  
|                  |  |                                    | $   |              | % |    
|                  |  | (in thousands, except percentages) |    
|Other Income, net |  | $                                  | 273 |              | $ | 248 |  | $ | 25 |  | 10 | %

Other income (expense).    The increase in 2007 compared to 2006 was due
to increased interest income of $0.5 million associated with higher average cash balances and interest rates in 2007 as compared to 2006. The increase was partially offset by an expense of $0.5 million associated with the increase in fair value of
preferred stock warrants issued in 2001 and 2003 in conjunction with a line of credit.

Income tax provision.



|              |  |                                    |     |              |   |     |  |   |     |  |    |  
|------------- |  | ---------------------------------- | --- | ------------ | - | --- |  | - | --- |  | -- | -
|              |  | Year ended                         |     | Change       |  
|              |  | June 30,2007                       |     | June 30,2006 |  
|              |  |                                    | $   |              | % |    
|              |  | (in thousands, except percentages) |    
|Tax provision |  | $                                  | 408 |              | $ | 219 |  | $ | 189 |  | 86 | %

The increase in 2007 compared to 2006 was primarily due to an increase in our taxable income and in
our effective tax rate from 5.2% to 6.3%.

Liquidity and Capital Resources

Cash and Cash Equivalents and Investments

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



|                          |  |              |         |              |   |              |  |   |       
|------------------------- |  | ------------ | ------- | ------------ | - | ------------ |  | - | ------
|                          |  | June 30,2008 |         | June 30,2007 |   | June 30,2006
|Cash and cash equivalents |  | $            | 68,672  |              | $ | 17,326       |  | $ | 12,333
|Short-term investments    |  |              | 34,139  |              |   |             |  |   |      
|                          |  |              |         |              |   |              |  |   |       
|Total                     |  | $            | 102,811 |              | $ | 17,326       |  | $ | 12,333
|                          |  |              |         |              |   |              |  |   |       

As of June 30, 2008, our principal sources of liquidity consisted of cash and cash equivalents
and short-term investments of $102.8 million and accounts receivable (net) of $21.9 million. We do not hold any auction rate securities in our cash and cash equivalents and short-term investments portfolio. On July 9, 2007, we closed our
initial public offering of 9,085,000 shares of common stock at a price of $9.50 per share, resulting in net proceeds to us of approximately $77 million.

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

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We believe that our $102.8 million of cash and cash equivalents and short-term investments at
June 30, 2008, together with cash flows from our operations will be sufficient to fund our operating requirements for at least 12 months. Our future capital requirements will depend on many factors, including our rate of revenue growth, the
expansion of our sales and marketing activities, the 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, |        
|                                                |  | 2008                |         |   | 2007 |   |        | 2006 | 
|                                                |  | (In thousands)      |        
|Cash provided by operating activities           |  | $                   | 8,153   |   |      | $ | 7,910  |      |  | $ | 7,266  |  
|Cash (used in) investing activities             |  |                     | (36,519 | ) |      |   | (2,224 | )    |  |   | (1,293 | )
|Cash provided by (used in) financing activities |  |                     | 79,712  |   |      |   | (693   | )    |  |   | 987    |  

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. We also prepay for license
rights to third-party products in advance of sales.

Net cash provided by operating activities was $8.2 million, $7.9 million, and
$7.3 million in 2008, 2007 and 2006, respectively. Net cash provided by operating activities in 2008 partly consisted of net income of $2.6 million. Noncash adjustments were higher in 2008 compared to 2007, including stock-based
compensation expense, which was higher in 2008 by $4.3 million. This was partially off set 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 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.

Net cash provided by operating activities in 2007 primarily consisted of net income of $6.1 million. Noncash adjustments were higher in 2007 compared
to 2006, including stock-based compensation expense, which was higher in 2007 by $2.7 million due to $1.4 million of stock-based compensation expense associated with an award that was subject to variable accounting and the adoption of
SFAS 123(R) on July 1, 2006, and an increase in fair value of the preferred stock warrants by $0.5 million. In addition to the higher net income and non-cash adjustments, the period-to-period change in cash flows relating to operating
activities was also affected by an increase in deferred revenue of $7.4 million, due primarily to the deferral of revenue from sales of post contractual support contracts exceeding the revenue recognized from post contractual support contracts,
and an increase in accounts payable of $2.0 million, primarily attributable to increased purchasing activity required to support our business growth and increased headcount. These sources of cash were partially offset by uses of cash associated
with an increase in accounts receivable of $8.2 million due to increased sales in 2007 compared to 2006, an increase in prepaid expenses and other current assets of $2.5 million and an increase in inventory of $2.4 million.



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Net cash provided by
operating activities in 2006 primarily consisted of net income of $4.0 million, depreciation and amortization expense of $0.7 million and an increase of $2.3 million related to net changes in working capital. Of this $2.3 million, the
primary sources of cash were a $1.9 million increase to accrued employee compensation, largely employee bonuses relating to company performance, increased deferred revenue relating to support contracts of $1.5 million and increased
accounts payable of $809,000, which was partially offset by increases to accounts receivable of $2.4 million.

Cash flows from
investing activities

We have classified our investment portfolio as available for sale and our investments are made
with a policy of capital preservation and liquidity as the primary objectives. We may hold investments in corporate bonds to maturity; however, we may sell an investment at any time if the quality rating of the investment declines, the yield on the
investment is no longer attractive or we are in need of cash. 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 $36.5 million, $2.2 million, and $1.3 million in 2008, 2007 and
2006, respectively. Net cash used in investing activities in 2008 was primarily related to investments made in US government sponsored securities and corporate bonds and commercial paper and in 2007 was primarily for capital expenditures related to
manufacturing tooling for the production of our hardware products, computer equipment for our research and development lab and to support our growth in headcount. Net cash used in investing activities in 2006 was for capital expenditures, primarily
related to computer and lab equipment to support our growth in headcount and manufacturing tooling for production of our hardware products. 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 (used in) financing activities was $79.7 million, ($0.7) million and $1.0 million, in 2008, 2007 and 2006,
respectively. In 2008, we generated proceeds of $78.6 million from our initial public offering including payment of other offering costs, $0.9 million from exercise of common stock options and received tax benefit of stock options exercised of $0.3
million. In 2007, we incurred $1.3 million of costs related to our initial public offering and generated $0.6 million of net proceeds from the exercise of common stock options. In 2006, we generated $1.0 million of net proceeds from the
exercise of common stock options.

Contractual Obligations

The following is a summary of our contractual obligations as of June 30, 2008:



|                                                        |  |                        |        |                 |   |           |  |           |       |            |   |     |  |   |  
|------------------------------------------------------- |  | ---------------------- | ------ | --------------- | - | --------- |  | --------- | ----- | ---------- | - | --- |  | - | -
|                                                        |  | Payments Due by Period
|                                                        |  | Total                  |        | Less Than1 Year |   | 1-3 Years |  | 3-5 Years |       | Thereafter
|                                                        |  | (In thousands)        
|Operating lease obligations                             |  | $                      | 3,488  |                 | $ | 1,771     |  | $         | 1,307 |            | $ | 410 |  | $ | 
|Non-cancellable purchase commitments for finished goods |  |                        | 6,857  |                 |   | 6,857     |  |           |      |            |   |    |  |   | 
|Purchase commitments for software license use           |  |                        | 3,544  |                 |   | 1,995     |  |           | 1,549 |            |   |    |  |   | 
|                                                        |  |                        |        |                 |   |           |  |           |       |            |   |     |  |   |  
|Total                                                   |  | $                      | 13,889 |                 | $ | 10,623    |  | $         | 2,856 |            | $ | 410 |  | $ | 
|                                                        |  |                        |        |                 |   |           |  |           |       |            |   |     |  |   |  

Off-Balance Sheet Arrangements

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

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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 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 for these sales
in accordance with Statement of Position (SOP) No. 97-2, Software Revenue Recognition, or Staff Accounting Bulletin (SAB) No. 104, Revenue Recognition in Financial Statements, as applicable, 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 such terms, we recognize revenue once the acceptance provisions have been
met or the right of return lapses. 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.



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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. In accordance with EITF Issue No. 01-9, Accounting for Consideration Given by a Vendor to a
Customer (including a Reseller of the Vendors Products), 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 SOP 97-2, which states that if an arrangement includes multiple elements, the fee should be 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 support through prior renewals of post-contractual
support contracts, which establishes a price which is based on a standalone sale.

We use the residual method, as allowed by
SOP No. 98-9, Modification of SOP 97-2, Software Revenue Recognition With Respect to Certain Transactions, 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.

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Stock-Based Compensation

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

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

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



|                                                     |  |                         |  |                         |  |          
|---------------------------------------------------- |  | ----------------------- |  | ----------------------- |  | ---------
|                                                     |  | Year EndedJune 30, 2008 |  | Year EndedJune 30, 2007
|                                                     |  | Class One               |  | Class Two              
|Expected life of option plan                         |  | 6.08 years              |  | 6.08 years              |  | 4.0 years
|Expected life of Employee Stock Purchase Plan (ESPP) |  | 0.50 years              |  |                        |  |         
|Risk-free interest rate range for option plan        |  | 2.42-4.50%              |  | 4.6-4.8%                |  | 4.6-4.8% 
|Risk-free interest rate for ESPP                     |  | 2.03-2.49%              |  |                        |  |         
|Volatility for option plan                           |  | 62%                     |  | 71%                     |  | 55%      
|Volatility for ESPP                                  |  | 47-136%                 |  |                        |  |         
|Dividend yield                                       |  | 0%                      |  | 0%                      |  | 0%       

During 2008, we recorded non-cash stock-based compensation expense of $6.9 million under
SFAS 123(R). In future periods, stock-based compensation expense is expected to increase as we issue additional equity-based awards to continue to attract and retain key employees. Additionally, SFAS 123(R) requires that we recognize
compensation expense only for the portion of stock options that are expected to vest, assuming an expected forfeiture rate in determining stock-based compensation expense, which could affect the stock-based compensation expense recorded if there is
a significant difference between actual and estimated forfeiture rates. Our estimated forfeiture rate in the year ended June 30, 2008 was 10.7%. As of June 30, 2008, total unrecognized compensation cost related to stock-based awards
granted to employees and non-employee directors was $23.6 million, net of estimated forfeitures of $6.7 million. This cost will be amortized on a straight-line basis over a weighted-average vesting period of approximately three years.

Estimation of Fair Value of Warrants to Purchase Preferred Stock

FASB Staff Position No. 150-5, Issuers Accounting under FASB Statement No. 150 for Freestanding Warrants and Other Similar Instruments
on Shares That Are Redeemable, or FSP 150-5, provides that the warrants we have issued to purchase shares of Series E and Series F preferred stock are subject to the requirements in FSP 150-5, which requires us to classify
these warrants as current liabilities and to adjust the value of these warrants to their fair value at the end of each reporting period. We recorded $508,000 of expense in other income



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(expense) for 2007, to reflect increase in the estimated fair value of the warrants. We estimated the fair value of these warrants at June 30, 2007
using the Black-Scholes option valuation model. This model utilizes the estimated fair value of the underlying preferred stock at the valuation measurement date, the remaining term of the warrant, risk-free interest rates, and expected dividends and
expected volatility of the price of the underlying convertible preferred stock.

Upon our initial public offering, subsequent to
June 30, 2007, these warrants converted into warrants to purchase shares of our common stock and, as a result, are no longer subject to FSP 150-5. At that time, the then-current aggregate fair value of these warrants was reclassified from
liabilities to common stock, a component of stockholders deficit, and we ceased to record any related periodic fair value adjustments.

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. A small portion of our inventory also relates to evaluation units located at enterprise customer locations and service inventory. Inventory
valuation reserves are established to reduce the carrying amounts of our inventories to their net estimated realizable values. Inventory valuation reserves are based on historical usage, expected demand and, with respect to evaluation units,
conversion rate and age. Inherent in our estimates of market value in determining inventory valuation reserves are estimates related to economic trends, future demand for our products and technological obsolescence of our products. 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 $0.3 million and $0.4 million as of June 30, 2008 and 2007, respectively. Once a reserve is established, it is maintained until the unit to which it relates is sold or scrapped. The reduced costs associated with the revenue from this unit
results in an increase in gross profit and gross margin.

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 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. See Note 5 regarding the adoption of Accounting Standards Board Interpretation No. 48 (FIN 48), Accounting for
Uncertainty in Income Taxes  an interpretation of FASB Statement No. 109, effective July 1, 2007.

The total valuation
allowance decreased by approximately $28.8 million in 2008, primarily due to a reduction of deferred tax assets associated with net operating loss and tax credit carryforwards that management determined could not be utilized, based on a final
analysis of the Companys multiple ownership changes since inception as a result of significant stock transactions, as defined by Section 382 of the Internal Revenue Code, 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, 2008, management does not believe it is more likely than not that $5.4 million of the $7.1 million 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. In addition, the occurrence of negative evidence with respect to
deferred tax assets which currently have no valuation allowance could result in an increase in the valuation allowance in a future period. 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.

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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, 2008.

In addition, we currently hold our investment portfolio in accounts with two financial firms. While we do not invest our cash in obligations of these
firms, if either one or both of these firms were to experience financial or other regulatory difficulties, it might be difficult for us to access our investments in a timely manner. We intend to place our investment portfolio with additional firms
in an effort to spread our investment holdings with a number of different firms.

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, 2008 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 $34.1 million at June 30, 2008. Market
changes reflect immediate hypothetical parallel shifts in the yield curve of plus or minus 100, 75 and 50 basis points (BPS).



|                             |  |                            |        |   |                            |   |        |         |  |   |        |   |  |        |        |    |         |   |        |    |  |   |        |   
|---------------------------- |  | -------------------------- | ------ | - | -------------------------- | - | ------ | ------- |  | - | ------ | - |  | ------ | ------ | -- | ------- | - | ------ | -- |  | - | ------ | --
|                             |  | Decrease in interest rates |        |   | Increase in interest rates |  
|(in thousands)               |  | -100 BPS                   |        |   | -75 BPS                    |   |        | -50 BPS |  |   | 50 BPS |   |  | 75 BPS |        |    | 100 BPS |  
|Total Fair Market Value      |  | $                          | 34,401 |   |                            | $ | 34,336 |         |  | $ | 34,270 |   |  | $      | 34,008 |    |         | $ | 33,942 |    |  | $ | 33,877 |   
|Percent Change in Fair Value |  |                            | 0.77   | % |                            |   | 0.58   | %       |  |   | 0.38   | % |  |        | (0.38  | )% |         |   | (0.58  | )% |  |   | (0.77  | )%



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|ITEM 8. | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
|------- | -------------------------------------------

SHORETEL, INC. AND SUBSIDIARIES

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS



|                                                                                                                               |  |     
|------------------------------------------------------------------------------------------------------------------------------ |  | ----
|                                                                                                                               |  | Page
|Report of Independent Registered Public Accounting Firm                                                                        |  | 48  
|Consolidated Balance Sheets                                                                                                    |  | 49  
|Consolidated Statements of Operations                                                                                          |  | 50  
|Consolidated Statements of Redeemable Convertible Preferred Stock and Stockholders Equity (Deficit) and Comprehensive
 Income |  | 51  
|Consolidated Statements of Cash Flows                                                                                          |  | 52  
|Notes to Consolidated Financial Statements                                                                                     |  | 53  

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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 (collectively, the Company) as of June 30, 2008 and 2007, and the related consolidated statements of income, redeemable convertible preferred stock and
stockholders equity (deficit) and comprehensive income, and cash flows for each of the three years in the period ended June 30, 2008. These financial statements are the responsibility of the Companys management. Our responsibility
is to express an opinion on these consolidated 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, 2008 and 2007, and the results of their operations and their cash flows for each of the three
years in the period ended June 30, 2008, in conformity with accounting principles generally accepted in the United States of America.

As discussed in Note 5 to the consolidated financial statements, on July 1, 2007 the Company adopted the provisions of Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes
 an interpretation of FASB Statement No. 109. In addition, as discussed in Note 1 to the consolidated financial statements, effective July 1, 2006, the Company changed its method of accounting for stock-based compensation in
accordance with guidance provided in Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Companys internal control over financial reporting as of June 30, 2008, 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 12, 2008, expressed an unqualified opinion on the
Companys internal control over financial reporting.

/s/    DELOITTE & TOUCHE LLP

San Jose, California

September 12, 2008



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SHORETEL, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS



|                                                                                                                                                                                                                                                              |  |                        |         |   |      |   |         |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------------- | ------- | - | ---- | - | ------- | -
|                                                                                                                                                                                                                                                              |  | June 30,               |        
|                                                                                                                                                                                                                                                              |  | 2008                   |         |   | 2007 |  
|                                                                                                                                                                                                                                                              |  | (Amounts in thousands) |        
|ASSETS                                                                                                                                                                                                                                                        | 
|CURRENT ASSETS:                                                                                                                                                                                                                                               |  |                        |         |   |      |   |         |  
|Cash and cash equivalents                                                                                                                                                                                                                                     |  | $                      | 68,672  |   |      | $ | 17,326  |  
|Short-term investments                                                                                                                                                                                                                                        |  |                        | 34,139  |   |      |   |        |  
|Accounts receivable, net of allowances of $414 and $320 as of June 30, 2008 and June 30, 2007, respectively                                                                                                                                                   |  |                        | 21,909  |   |      |   | 19,411  |  
|Inventories                                                                                                                                                                                                                                                   |  |                        | 12,008  |   |      |   | 7,057   |  
|Prepaid expenses and other current assets                                                                                                                                                                                                                     |  |                        | 5,063   |   |      |   | 3,372   |  
|                                                                                                                                                                                                                                                              |  |                        |         |   |      |   |         |  
|Total current assets                                                                                                                                                                                                                                          |  |                        | 141,791 |   |      |   | 47,166  |  
|PROPERTY AND EQUIPMENT  Net                                                                                                                                                                                                                                  |  |                        | 3,649   |   |      |   | 2,933   |  
|OTHER ASSETS                                                                                                                                                                                                                                                  |  |                        | 2,357   |   |      |   | 2,935   |  
|                                                                                                                                                                                                                                                              |  |                        |         |   |      |   |         |  
|TOTAL                                                                                                                                                                                                                                                         |  | $                      | 147,797 |   |      | $ | 53,034  |  
|                                                                                                                                                                                                                                                              |  |                        |         |   |      |   |         |  
|                                                                                                                                                                                                                                                             
|LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK, AND STOCKHOLDERS EQUITY (DEFICIT)                                                                                                                                                                       | 
|CURRENT LIABILITIES:                                                                                                                                                                                                                                          |  |                        |         |   |      |   |         |  
|Accounts payable                                                                                                                                                                                                                                              |  | $                      | 5,952   |   |      | $ | 7,433   |  
|Accrued liabilities and other                                                                                                                                                                                                                                 |  |                        | 4,420   |   |      |   | 2,807   |  
|Accrued employee compensation                                                                                                                                                                                                                                 |  |                        | 5,547   |   |      |   | 3,782   |  
|Deferred revenue                                                                                                                                                                                                                                              |  |                        | 13,879  |   |      |   | 10,126  |  
|                                                                                                                                                                                                                                                              |  |                        |         |   |      |   |         |  
|Total current liabilities                                                                                                                                                                                                                                     |  |                        | 29,798  |   |      |   | 24,148  |  
|LONG-TERM LIABILITIES:                                                                                                                                                                                                                                        |  |                        |         |   |      |   |         |  
|Preferred stock warrant liability                                                                                                                                                                                                                             |  |                        |        |   |      |   | 549     |  
|Long-term deferred revenue                                                                                                                                                                                                                                    |  |                        | 4,786   |   |      |   | 3,825   |  
|                                                                                                                                                                                                                                                              |  |                        |         |   |      |   |         |  
|Total long-term liabilities                                                                                                                                                                                                                                   |  |                        | 4,786   |   |      |   | 4,374   |  
|                                                                                                                                                                                                                                                              |  |                        |         |   |      |   |         |  
|Total liabilities                                                                                                                                                                                                                                             |  |                        | 34,584  |   |      |   | 28,522  |  
|                                                                                                                                                                                                                                                              |  |                        |         |   |      |   |         |  
|COMMITMENTS AND CONTINGENCIES (Note 11)                                                                                                                                                                                                                       |  |                        |         |   |      |   |         |  
|REDEEMABLE CONVERTIBLE PREFERRED STOCK, authorized 0 and 23,586 shares as of June 30, 2008 and June 30, 2007; issued and
outstanding 0 and 23,316 shares as of June 30, 2008 and June 30, 2007 (aggregate liquidation preference of $44,250 at June 30, 2007) |  |                        |        |   |      |   | 56,341  |  
|                                                                                                                                                                                                                                                              |  |                        |         |   |      |   |         |  
|STOCKHOLDERS EQUITY (DEFICIT):                                                                                                                                                                                                                               |  |                        |         |   |      |   |         |  
|Preferred stock, par value $.001 per share, authorized 5,000 and 0 shares as of June 30, 2008 and June 30, 2007, respectively; none
issued and outstanding                                                                                                    |  |                        |        |   |      |   |        |  
|Common stock and additional paid-in capital, par value $.001 per share, authorized 500,000 shares as of June 30, 2008 and June 30,
2007, respectively; issued and outstanding, 43,341 and 10,132 shares as of June 30, 2008 and June 30, 2007, respectively   |  |                        | 195,596 |   |      |   | 53,206  |  
|Deferred compensation                                                                                                                                                                                                                                         |  |                        | (142    | ) |      |   | (237    | )
|Accumulated other comprehensive loss                                                                                                                                                                                                                          |  |                        | (76     | ) |      |   |        |  
|Accumulated deficit                                                                                                                                                                                                                                           |  |                        | (82,165 | ) |      |   | (84,798 | )
|                                                                                                                                                                                                                                                              |  |                        |         |   |      |   |         |  
|Total stockholders equity (deficit)                                                                                                                                                                                                                          |  |                        | 113,213 |   |      |   | (31,829 | )
|                                                                                                                                                                                                                                                              |  |                        |         |   |      |   |         |  
|TOTAL                                                                                                                                                                                                                                                         |  | $                      | 147,797 |   |      | $ | 53,034  |  
|                                                                                                                                                                                                                                                              |  |                        |         |   |      |   |         |  

See notes to consolidated financial statements

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SHORETEL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS



|                                                                                                 |  |                                                 |         |   |      |   |        |      |  |   |        |  
|------------------------------------------------------------------------------------------------ |  | ----------------------------------------------- | ------- | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                                                                                 |  | Year Ended June 30,                             |        
|                                                                                                 |  | 2008                                            |         |   | 2007 |   |        | 2006 | 
|                                                                                                 |  | (Amounts in thousands, except pershare amounts) |        
|REVENUE:                                                                                         |  |                                                 |         |   |      |   |        |      |  |   |        |  
|Product                                                                                          |  | $                                               | 110,496 |   |      | $ | 87,095 |      |  | $ | 55,300 |  
|Support and services                                                                             |  |                                                 | 18,233  |   |      |   | 10,732 |      |  |   | 6,308  |  
|                                                                                                 |  |                                                 |         |   |      |   |        |      |  |   |        |  
|Total revenue                                                                                    |  |                                                 | 128,729 |   |      |   | 97,827 |      |  |   | 61,608 |  
|COST OF REVENUE:                                                                                 |  |                                                 |         |   |      |   |        |      |  |   |        |  
|Product                                                                                          |  |                                                 | 37,451  |   |      |   | 29,751 |      |  |   | 21,855 |  
|Support and services                                                                             |  |                                                 | 9,994   |   |      |   | 6,837  |      |  |   | 5,425  |  
|                                                                                                 |  |                                                 |         |   |      |   |        |      |  |   |        |  
|Total cost of revenue                                                                            |  |                                                 | 47,445  |   |      |   | 36,588 |      |  |   | 27,280 |  
|GROSS PROFIT                                                                                     |  |                                                 | 81,284  |   |      |   | 61,239 |      |  |   | 34,328 |  
|                                                                                                 |  |                                                 |         |   |      |   |        |      |  |   |        |  
|OPERATING EXPENSES:                                                                              |  |                                                 |         |   |      |   |        |      |  |   |        |  
|Research and development                                                                         |  |                                                 | 26,691  |   |      |   | 17,224 |      |  |   | 9,720  |  
|Sales and marketing                                                                              |  |                                                 | 37,780  |   |      |   | 26,126 |      |  |   | 15,699 |  
|General and administrative                                                                       |  |                                                 | 17,420  |   |      |   | 11,673 |      |  |   | 4,936  |  
|                                                                                                 |  |                                                 |         |   |      |   |        |      |  |   |        |  
|Total operating expenses                                                                         |  |                                                 | 81,891  |   |      |   | 55,023 |      |  |   | 30,355 |  
|                                                                                                 |  |                                                 |         |   |      |   |        |      |  |   |        |  
|INCOME (LOSS) FROM OPERATIONS                                                                    |  |                                                 | (607    | ) |      |   | 6,216  |      |  |   | 3,973  |  
|OTHER INCOME:                                                                                    |  |                                                 |         |   |      |   |        |      |  |   |        |  
|Interest income                                                                                  |  |                                                 | 4,141   |   |      |   | 803    |      |  |   | 292    |  
|Interest expense                                                                                 |  |                                                 |        |   |      |   |       |      |  |   | (31    | )
|Change in fair value of warrants                                                                 |  |                                                 |        |   |      |   | (508   | )    |  |   |       |  
|Other                                                                                            |  |                                                 | (40     | ) |      |   | (22    | )    |  |   | (13    | )
|                                                                                                 |  |                                                 |         |   |      |   |        |      |  |   |        |  
|Total other income                                                                               |  |                                                 | 4,101   |   |      |   | 273    |      |  |   | 248    |  
|                                                                                                 |  |                                                 |         |   |      |   |        |      |  |   |        |  
|INCOME BEFORE PROVISION FOR INCOME TAXES                                                         |  |                                                 | 3,494   |   |      |   | 6,489  |      |  |   | 4,221  |  
|PROVISION FOR INCOME TAXES                                                                       |  |                                                 | (861    | ) |      |   | (408   | )    |  |   | (219   | )
|                                                                                                 |  |                                                 |         |   |      |   |        |      |  |   |        |  
|NET INCOME                                                                                       |  |                                                 | 2,633   |   |      |   | 6,081  |      |  |   | 4,002  |  
|ACCRETION OF PREFERRED STOCK                                                                     |  |                                                 |        |   |      |   | (50    | )    |  |   | (51    | )
|                                                                                                 |  |                                                 |         |   |      |   |        |      |  |   |        |  
|NET INCOME AVAILABLE TO COMMON STOCKHOLDERS                                                      |  | $                                               | 2,633   |   |      | $ | 6,031  |      |  | $ | 3,951  |  
|                                                                                                 |  |                                                 |         |   |      |   |        |      |  |   |        |  
|Net income per common share available to common stockholders:                                    |  |                                                 |         |   |      |   |        |      |  |   |        |  
|Basic                                                                                            |  | $                                               | 0.06    |   |      | $ | 0.70   |      |  | $ | 0.60   |  
|                                                                                                 |  |                                                 |         |   |      |   |        |      |  |   |        |  
|Diluted                                                                                          |  | $                                               | 0.06    |   |      | $ | 0.17   |      |  | $ | 0.12   |  
|                                                                                                 |  |                                                 |         |   |      |   |        |      |  |   |        |  
|Weighted average shares used in computing net income per share available to common stockholders: |  |                                                 |         |   |      |   |        |      |  |   |        |  
|Basic                                                                                            |  |                                                 | 42,413  |   |      |   | 8,565  |      |  |   | 6,609  |  
|Diluted                                                                                          |  |                                                 | 44,861  |   |      |   | 35,581 |      |  |   | 33,431 |  

See notes to consolidated financial statements



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SHORETEL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF REDEEMABLE CONVERTIBLE

PREFERRED STOCK AND STOCKHOLDERS EQUITY ( DEFICIT) AND COMPREHENSIVE INCOME



|                                                                      |  |                                      |   |  |                                            |         |   |                           |        |   |                                 |   |         |                                   |  |   |                    |   |  |                           |      |   |  |   |     |   |  |   |         |   |  |   |         |  
|--------------------------------------------------------------------- |  | ------------------------------------ | - |  | ------------------------------------------ | ------- | - | ------------------------- | ------ | - | ------------------------------- | - | ------- | --------------------------------- |  | - | ------------------ | - |  | ------------------------- | ---- | - |  | - | --- | - |  | - | ------- | - |  | - | ------- | -
|                                                                      |  | RedeemableConvertiblePreferred Stock |   |  | Common Stockand AdditionalPaid- In-Capital |         |   | DeferredStockCompensation |        |   | NotesReceivableFromStockholders |   |         | AccumulatedOtherComprehensiveLoss |  |   | AccumulatedDeficit |   |  | TotalStockholdersDeficit |     
|                                                                      |  | Shares                               |   |  | Amount                                     |         |   | Shares                    |        |   | Amount                          |   |         |                                   |  |   |                   
|                                                                      |  | (Amounts in thousands)               |   |  |                                            |        
|BALANCE  July 1, 2005                                                |  | 23,316                               |   |  | $                                          | 56,281  |   |                           | 5,993  |   |                                 | $ | 49,576  |                                   |  | $ | (36                | ) |  | $                         | (372 | ) |  | $ |    |   |  | $ | (94,881 | ) |  | $ | (45,713 | )
|Accretion of preferred stock                                          |  |                                      |   |  |                                            | 51      |   |                           |        |   |                                 |   | (51     | )                                 |  |   |                    |   |  |                           |      |   |  |   |     |   |  |   |         |   |  |   | (51     | )
|Exercise of common stock options                                      |  |                                      |   |  |                                            |         |   |                           | 3,429  |   |                                 |   | 521     |                                   |  |   |                    |   |  |                           |      |   |  |   |     |   |  |   |         |   |  |   | 521     |  
|Stock-based compensation expense                                      |  |                                      |   |  |                                            |         |   |                           |        |   |                                 |   | 381     |                                   |  |   | (299               | ) |  |                           |      |   |  |   |     |   |  |   |         |   |  |   | 82      |  
|Repurchase of shares exercised under note receivable                  |  |                                      |   |  |                                            |         |   |                           | (46    | ) |                                 |   | (141    | )                                 |  |   |                    |   |  |                           | 141  |   |  |   |     |   |  |   |         |   |  |   |         |  
|Repurchase of shares early exercised                                  |  |                                      |   |  |                                            |         |   |                           | (87    | ) |                                 |   | (9      | )                                 |  |   |                    |   |  |                           |      |   |  |   |     |   |  |   |         |   |  |   | (9      | )
|Net income and comprehensive income                                   |  |                                      |   |  |                                            |         |   |                           |        |   |                                 |   |         |                                   |  |   |                    |   |  |                           |      |   |  |   |     |   |  |   | 4,002   |   |  |   | 4,002   |  
|                                                                      |  |                                      |   |  |                                            |         |   |                           |        |   |                                 |   |         |                                   |  |   |                    |   |  |                           |      |   |  |   |     |   |  |   |         |   |  |   |         |  
|BALANCE  June 30, 2006                                               |  | 23,316                               |   |  |                                            | 56,332  |   |                           | 9,289  |   |                                 |   | 50,277  |                                   |  |   | (335               | ) |  |                           | (231 | ) |  |   |    |   |  |   | (90,879 | ) |  |   | (41,168 | )
|Accretion of preferred stock                                          |  |                                      |   |  |                                            | 50      |   |                           |        |   |                                 |   | (50     | )                                 |  |   |                    |   |  |                           |      |   |  |   |     |   |  |   |         |   |  |   | (50     | )
|Exercise of common stock options                                      |  |                                      |   |  |                                            |         |   |                           | 901    |   |                                 |   | 573     |                                   |  |   |                    |   |  |                           |      |   |  |   |     |   |  |   |         |   |  |   | 573     |  
|Stock-based compensation expense                                      |  |                                      |   |  |                                            |         |   |                           |        |   |                                 |   | 2,588   |                                   |  |   | 98                 |   |  |                           |      |   |  |   |     |   |  |   |         |   |  |   | 2,686   |  
|Repayment of note receivable from shareholder                         |  |                                      |   |  |                                            |         |   |                           |        |   |                                 |   |         |                                   |  |   |                    |   |  |                           | 12   |   |  |   |     |   |  |   |         |   |  |   | 12      |  
|Vesting of accrued early exercised stock options                      |  |                                      |   |  |                                            |         |   |                           |        |   |                                 |   | 228     |                                   |  |   |                    |   |  |                           |      |   |  |   |     |   |  |   |         |   |  |   | 228     |  
|Warrants reclassified to liabilities                                  |  |                                      |   |  |                                            | (41     | ) |                           |        |   |                                 |   |         |                                   |  |   |                    |   |  |                           |      |   |  |   |     |   |  |   |         |   |  |   |         |  
|Surrender of common stock for settlement of notes receivable (Note 4) |  |                                      |   |  |                                            |         |   |                           | (58    | ) |                                 |   | (410    | )                                 |  |   |                    |   |  |                           | 219  |   |  |   |     |   |  |   |         |   |  |   | (191    | )
|Net income and comprehensive income                                   |  |                                      |   |  |                                            |         |   |                           |        |   |                                 |   |         |                                   |  |   |                    |   |  |                           |      |   |  |   |     |   |  |   | 6,081   |   |  |   | 6,081   |  
|                                                                      |  |                                      |   |  |                                            |         |   |                           |        |   |                                 |   |         |                                   |  |   |                    |   |  |                           |      |   |  |   |     |   |  |   |         |   |  |   |         |  
|BALANCE  June 30, 2007                                               |  | 23,316                               |   |  |                                            | 56,341  |   |                           | 10,132 |   |                                 |   | 53,206  |                                   |  |   | (237               | ) |  |                           |     |   |  |   |    |   |  |   | (84,798 | ) |  |   | (31,829 | )
|Proceeds from initial public offering, net of offering costs          |  |                                      |   |  |                                            |         |   |                           | 9,085  |   |                                 |   | 77,328  |                                   |  |   |                    |   |  |                           |      |   |  |   |     |   |  |   |         |   |  |   | 77,328  |  
|Conversion of preferred stock to common stock                         |  | (23,316                              | ) |  |                                            | (56,341 | ) |                           | 23,316 |   |                                 |   | 56,341  |                                   |  |   |                    |   |  |                           |      |   |  |   |     |   |  |   |         |   |  |   | 56,341  |  
|Preferred stock warrants converted to common stock warrants           |  |                                      |   |  |                                            |         |   |                           |        |   |                                 |   | 549     |                                   |  |   |                    |   |  |                           |      |   |  |   |     |   |  |   |         |   |  |   | 549     |  
|Exercise of warrants                                                  |  |                                      |   |  |                                            |         |   |                           | 61     |   |                                 |   |         |                                   |  |   |                    |   |  |                           |      |   |  |   |     |   |  |   |         |   |  |   |         |  
|Common stock issued under stock based compensation plans              |  |                                      |   |  |                                            |         |   |                           | 747    |   |                                 |   | 857     |                                   |  |   |                    |   |  |                           |      |   |  |   |     |   |  |   |         |   |  |   | 857     |  
|Stock-based compensation expense                                      |  |                                      |   |  |                                            |         |   |                           |        |   |                                 |   | 6,845   |                                   |  |   | 95                 |   |  |                           |      |   |  |   |     |   |  |   |         |   |  |   | 6,940   |  
|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                                                            |  |                                      |   |  |                                            |         |   |                           |        |   |                                 |   |         |                                   |  |   |                    |   |  |                           |      |   |  |   |     |   |  |   | 2,633   |   |  |   | 2,633   |  
|                                                                      |  |                                      |   |  |                                            |         |   |                           |        |   |                                 |   |         |                                   |  |   |                    |   |  |                           |      |   |  |   |     |   |  |   |         |   |  |   |         |  
|Comprehensive income                                                  |  |                                      |   |  |                                            |         |   |                           |        |   |                                 |   |         |                                   |  |   |                    |   |  |                           |      |   |  |   |     |   |  |   |         |   |  |   | 2,557   |  
|                                                                      |  |                                      |   |  |                                            |         |   |                           |        |   |                                 |   |         |                                   |  |   |                    |   |  |                           |      |   |  |   |     |   |  |   |         |   |  |   |         |  
|BALANCE  June 30, 2008                                               |  |                                     |   |  | $                                          |        |   |                           | 43,341 |   |                                 | $ | 195,596 |                                   |  | $ | (142               | ) |  | $                         |     |   |  | $ | (76 | ) |  | $ | (82,165 | ) |  | $ | 113,213 |  
|                                                                      |  |                                      |   |  |                                            |         |   |                           |        |   |                                 |   |         |                                   |  |   |                    |   |  |                           |      |   |  |   |     |   |  |   |         |   |  |   |         |  

See notes to consolidated financial statements

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SHORETEL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS



|                                                                                                       |  |                     |         |   |      |   |        |      |  |   |        |  
|------------------------------------------------------------------------------------------------------ |  | ------------------- | ------- | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                                                                                       |  | Year Ended June 30, |        
|                                                                                                       |  | 2008                |         |   | 2007 |   |        | 2006 | 
|                                                                                                       |  | (In thousands)      |        
|CASH FLOWS FROM OPERATING ACTIVITIES:                                                                  |  |                     |         |   |      |   |        |      |  |   |        |  
|Net income                                                                                             |  | $                   | 2,633   |   |      | $ | 6,081  |      |  | $ | 4,002  |  
|Adjustments to reconcile net income to net cash provided by operating activities:                      |  |                     |         |   |      |   |        |      |  |   |        |  
|Depreciation and amortization                                                                          |  |                     | 1,606   |   |      |   | 956    |      |  |   | 716    |  
|Accretion of discount on investments                                                                   |  |                     | (198    | ) |      |   |       |      |  |   |       |  
|Stock compensation expense                                                                             |  |                     | 6,940   |   |      |   | 2,686  |      |  |   | 82     |  
|Excess tax benefit from stock options exercised                                                        |  |                     | (250    | ) |      |   |       |      |  |   |       |  
|Loss on disposal of property and equipment                                                             |  |                     | 270     |   |      |   | 38     |      |  |   | 160    |  
|Increase in fair value of warrants                                                                     |  |                     |        |   |      |   | 508    |      |  |   |       |  
|Deferred tax benefit                                                                                   |  |                     | (1,748  | ) |      |   |       |      |  |   |       |  
|Recovery from settlement of note receivable                                                            |  |                     |        |   |      |   | (191   | )    |  |   |       |  
|Provision for doubtful accounts receivable                                                             |  |                     | 245     |   |      |   | 238    |      |  |   | 250    |  
|Changes in assets and liabilities:                                                                     |  |                     |         |   |      |   |        |      |  |   |        |  
|Accounts receivable                                                                                    |  |                     | (2,743  | ) |      |   | (8,170 | )    |  |   | (2,395 | )
|Inventories                                                                                            |  |                     | (4,951  | ) |      |   | (2,401 | )    |  |   | 7      |  
|Prepaid expenses and other current assets                                                              |  |                     | 57      |   |      |   | (2,520 | )    |  |   | (335   | )
|Other assets                                                                                           |  |                     | (1,880  | ) |      |   | (55    | )    |  |   | 4      |  
|Accounts payable                                                                                       |  |                     | (586    | ) |      |   | 2,034  |      |  |   | 809    |  
|Accrued liabilities and other                                                                          |  |                     | 2,283   |   |      |   | 463    |      |  |   | 605    |  
|Accrued employee compensation                                                                          |  |                     | 1,761   |   |      |   | 864    |      |  |   | 1,856  |  
|Deferred revenue                                                                                       |  |                     | 4,714   |   |      |   | 7,379  |      |  |   | 1,505  |  
|                                                                                                       |  |                     |         |   |      |   |        |      |  |   |        |  
|Net cash provided by operating activities                                                              |  |                     | 8,153   |   |      |   | 7,910  |      |  |   | 7,266  |  
|                                                                                                       |  |                     |         |   |      |   |        |      |  |   |        |  
|CASH FLOWS FROM INVESTING ACTIVITIES:                                                                  |  |                     |         |   |      |   |        |      |  |   |        |  
|Purchases of property and equipment                                                                    |  |                     | (2,407  | ) |      |   | (2,106 | )    |  |   | (1,308 | )
|Purchase of investments                                                                                |  |                     | (51,267 | ) |      |   |       |      |  |   |       |  
|Proceeds from sale/maturities of investments                                                           |  |                     | 17,250  |   |      |   |       |      |  |   |       |  
|Decrease in restricted cash                                                                            |  |                     |        |   |      |   |       |      |  |   | 15     |  
|Long-term deposit on operating facility                                                                |  |                     | (95     | ) |      |   | (118   | )    |  |   |       |  
|                                                                                                       |  |                     |         |   |      |   |        |      |  |   |        |  
|Net cash used in investing activities                                                                  |  |                     | (36,519 | ) |      |   | (2,224 | )    |  |   | (1,293 | )
|                                                                                                       |  |                     |         |   |      |   |        |      |  |   |        |  
|CASH FLOWS FROM FINANCING ACTIVITIES:                                                                  |  |                     |         |   |      |   |        |      |  |   |        |  
|Proceeds from initial public offering, received net of underwriting discounts                          |  |                     | 80,265  |   |      |   |       |      |  |   |       |  
|Initial public offering costs                                                                          |  |                     | (1,660  | ) |      |   | (1,277 | )    |  |   |       |  
|Borrowings under line of credit agreement                                                              |  |                     |        |   |      |   |       |      |  |   | 1,000  |  
|Repayments under line of credit agreement                                                              |  |                     |        |   |      |   |       |      |  |   | (1,000 | )
|Repayment of capital leases                                                                            |  |                     |        |   |      |   | (1     | )    |  |   | (7     | )
|Exercise of common stock options (including proceeds from unvested shares)                             |  |                     | 857     |   |      |   | 573    |      |  |   | 1,003  |  
|Repurchase of shares early exercised                                                                   |  |                     |        |   |      |   |       |      |  |   | (9     | )
|Repayment of shareholder notes issued in connection with stock option exercises                        |  |                     |        |   |      |   | 12     |      |  |   |       |  
|Excess tax benefit from stock options exercised                                                        |  |                     | 250     |   |      |   |       |      |  |   |       |  
|                                                                                                       |  |                     |         |   |      |   |        |      |  |   |        |  
|Net cash provided by (used in) financing activities                                                    |  |                     | 79,712  |   |      |   | (693   | )    |  |   | 987    |  
|                                                                                                       |  |                     |         |   |      |   |        |      |  |   |        |  
|NET INCREASE IN CASH AND CASH EQUIVALENTS                                                              |  |                     | 51,346  |   |      |   | 4,993  |      |  |   | 6,960  |  
|CASH AND CASH EQUIVALENTS  Beginning of period                                                        |  |                     | 17,326  |   |      |   | 12,333 |      |  |   | 5,373  |  
|                                                                                                       |  |                     |         |   |      |   |        |      |  |   |        |  
|CASH AND CASH EQUIVALENTS  End of period                                                              |  | $                   | 68,672  |   |      | $ | 17,326 |      |  | $ | 12,333 |  
|                                                                                                       |  |                     |         |   |      |   |        |      |  |   |        |  
|SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:                                                     |  |                     |         |   |      |   |        |      |  |   |        |  
|Cash paid during the period for interest                                                               |  | $                   |        |   |      | $ |       |      |  | $ | 31     |  
|Cash paid during the period for income taxes                                                           |  |                     | 1,398   |   |      |   | 697    |      |  |   | 82     |  
|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     |   |      |   |       |      |  |   |       |  
|Accretion of preferred stock                                                                           |  |                     |        |   |      |   | 50     |      |  |   | 51     |  
|Surrender of common stock for settlement of notes receivable                                           |  |                     |        |   |      |   | 536    |      |  |   |       |  
|Repurchase of shares exercised under notes receivable                                                  |  |                     |        |   |      |   |       |      |  |   | 141    |  
|Purchase of property and equipment included in period-end accounts payable                             |  |                     | 185     |   |      |   | 265    |      |  |   | 79     |  
|Deferred initial public offering costs included in period-end accounts payable and accrued liabilities |  |                     |        |   |      |   | 1,476  |      |  |   |       |  
|Warrants reclassified to liabilities                                                                   |  |                     |        |   |      |   | 41     |      |  |   |       |  
|Vesting of accrued early exercised stock options                                                       |  |                     | 220     |   |      |   | 228    |      |  |   |       |  
|Other assets included in accounts payable and accrued liabilities                                      |  |                     | 200     |   |      |   |       |      |  |   |       |  

See notes to consolidated financial statements



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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. In April 2004, the Companys Board of Directors
approved the change in the Companys name from Shoreline Communications, Inc to ShoreTel, Inc. ShoreTel, Inc. and its subsidiaries (collectively, the Company) provide enterprise internet protocol (IP) telecommunications
systems. The Company sells systems that generally include hardware, software licenses, post-contractual customer support and, in some cases, additional elements, such as training, installation and other professional services.

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

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

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 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.

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;
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 equivalent, short-term investments and accounts receivable.
As of June 30, 2008, substantially all of the Companys cash and cash equivalents and short-term investments were managed by two 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, 2008 and 2007, no enterprise customer or channel partner comprised more than 10% of total accounts
receivable.

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

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SHORETEL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



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 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.

Investments  The Companys short-term investments are comprised of US government sponsored securities, corporate notes and commercial paper. These investments are held in the custody of two major
financial institutions. The specific identification method is used to determine the cost basis of fixed income securities disposed of. At June 30, 2008, 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 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, |     
|                                                    |  | 2008     |      |   | 2007 |   |      | 2006 | 
|Allowance for doubtful accounts  beginning         |  | $        | 320  |   |      | $ | 378  |      |  | $ | 200 |  
|Current period provision                            |  |          | 245  |   |      |   | 238  |      |  |   | 250 |  
|Write-offs charged to allowance (net of recoveries) |  |          | (151 | ) |      |   | (296 | )    |  |   | (72 | )
|                                                    |  |          |      |   |      |   |      |      |  |   |     |  
|Allowance for doubtful accounts  ending            |  | $        | 414  |   |      | $ | 320  |      |  | $ | 378 |  
|                                                    |  |          |      |   |      |   |      |      |  |   |     |  

Inventories  Inventories, which consist principally of 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



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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 for these sales in accordance with Statement of Position (SOP) No. 97-2, Software Revenue Recognition, as amended, and Securities and Exchange
Commission Staff Accounting Bulletin (SAB) No. 104, Revenue Recognition, as applicable, depending on whether the hardware is sold in a multiple-element arrangement with software and post-contractual support or on a stand alone 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.

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 shows 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. In accordance with EITF Issue No. 01-9,
Accounting for

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Consideration Given by a Vendor to a Customer (including a Reseller of the Vendors Products), 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 SOP 97-2,
which states that If an arrangement includes multiple elements, the fee should be allocated to the various elements based on vendor-specific objective evidence 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 stand alone sale.

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, as allowed by
SOP 98-9, Modification of SOP 97-2 Software Revenue Recognition With Respect to Certain Transactions, 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.

Training is also sold on an elective basis both to channel partners and to their enterprise customers and is purchased both with system orders and on a
standalone basis. VSOE of fair value has been established for training.

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, 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.

Warranties  In November 2002, the Financial Accounting Standard Board
(FASB) issued Financial Interpretation (FIN) No. 45 (FIN 45), Guarantors Accounting and Disclosure Requirements for Guarantee, Including Indirect Guarantees of Indebtedness of Others.FIN 45 requires a guarantor to
include disclosures of certain obligations, and if applicable, at the inception of the guarantee, recognize a liability for the fair value of other obligations undertaken in issuing a guarantee.

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. 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



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provision for product warranties are recorded within cost of goods sold on the statement of operations and included within accrued liabilities on the balance
sheet.

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



|                                         |  |          |      |   |      |   |      |      |  |   |      |  
|---------------------------------------- |  | -------- | ---- | - | ---- | - | ---- | ---- |  | - | ---- | -
|                                         |  | June 30, |     
|                                         |  | 2008     |      |   | 2007 |   |      | 2006 | 
|Accrued warranty balance  beginning     |  | $        | 167  |   |      | $ | 206  |      |  | $ | 100  |  
|Current period accrual                   |  |          | 313  |   |      |   | 512  |      |  |   | 646  |  
|Warranty expenditures charged to accrual |  |          | (241 | ) |      |   | (416 | )    |  |   | (540 | )
|Adjustment to estimate                   |  |          |     |   |      |   | (135 | )    |  |   |     |  
|                                         |  |          |      |   |      |   |      |      |  |   |      |  
|Accrued warranty balance  end           |  | $        | 239  |   |      | $ | 167  |      |  | $ | 206  |  
|                                         |  |          |      |   |      |   |      |      |  |   |      |  

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 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 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. See Note 5 for
adoption of the provisions of FIN 48, Accounting for Uncertainty in Income Taxes  an interpretation of FASB Statement No. 109.

Stock-Based Compensation  On July 1, 2006, the Company adopted SFAS No. 123 (revised 2004) (SFAS 123R), Share-Based Payment, which requires companies to measure 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 such that SFAS 123R applies to new awards and to awards modified, repurchased
or canceled after the effective date. 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.

Prior to July 1, 2006, the Company accounted for these plans using the intrinsic value method in accordance
with Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and FIN No. 44, Accounting for Certain Transactions involving Stock Compensation  an interpretation of APB Opinion
No. 25.Accordingly, no compensation expense was recognized for employee stock options granted with exercise prices greater than or equal to the fair value of the underlying common stock at date of grant. If the exercise price is less than
the market value at the date of grant, the difference is recognized as deferred compensation expense, which is amortized over the vesting period. Compensation costs for the portion of awards for which the required service period has not been
rendered (such as unvested options) that were outstanding as of July 1, 2006 are recognized as the remaining required services are rendered.

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The following table shows total stock-based compensation expense included in the accompanying
Consolidated Statements of Operations for the years ended June 30, 2008, 2007 and 2006 (in thousands):



|                                       |  |                     |       |      |   |       |  |   |   
|-------------------------------------- |  | ------------------- | ----- | ---- | - | ----- |  | - | --
|                                       |  | Year Ended June 30,
|                                       |  | 2008                |       | 2007 |   | 2006 
|Cost of product revenue                |  | $                   | 59    |      | $ | 12    |  | $ |  
|Cost of support and services revenue   |  |                     | 503   |      |   | 99    |  |   | 16
|Research and development               |  |                     | 1,885 |      |   | 384   |  |   | 14
|Sales and marketing                    |  |                     | 2,358 |      |   | 533   |  |   | 7 
|General and administrative             |  |                     | 2,135 |      |   | 1,658 |  |   | 45
|                                       |  |                     |       |      |   |       |  |   |   
|Total stock-based compensation expense |  | $                   | 6,940 |      | $ | 2,686 |  | $ | 82
|                                       |  |                     |       |      |   |       |  |   |   

The income tax benefit associated with stock-based compensation expense for the year ended
June 30, 2008 was $1.4 million. The income tax benefit for years ended June 30, 2007 and 2006 was not significant.

The Company
accounts for stock issued to non-employees in accordance with the provisions of EITF Issue No. 96-18, Accounting for Equity Instruments that are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling Goods or Services.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.

Other
income  Other income includes net foreign currency transaction gains (losses) of ($34,000), $13,000, ($19,000), in the years ended June 30, 2008, 2007 and 2006, respectively.

Comprehensive Income (Loss)  Comprehensive income (loss) consists of two components, net income (loss) and other comprehensive loss. Other
comprehensive loss refers to losses that under generally accepted accounting principals are recorded as an element of stockholders equity (deficit). The Companys other comprehensive loss is comprised of unrealized losses on marketable
securities categorized as available-for-sale.

Recent Accounting Pronouncements  In June 2008, the FASB ratified FSP
No. EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities(FSP No. EITF 03-6-1), which addresses whether instruments granted in share-based payment awards are
participating securities prior to vesting and, therefore, must be included in the earnings allocation in calculating earnings per share under the two-class method described in SFAS No. 128, Earnings per Share(SFAS No. 128). FSP
No. EITF 03-6-1 requires that unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend- equivalents be treated as participating securities in calculating earnings per share. FSP No. EITF 03-6-1 is
effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years, and shall be applied retrospectively to all prior periods. The Company is currently evaluating the
impact of adopting FSP EITF 03-6-1 on its consolidated results of operations.

In May 2008, the FASB issued SFAS No. 162,
The Hierarchy of Generally Accepted Accounting Principles, (SFAS No. 162), which becomes effective 60 days following the SECs approval of the Public Company Accounting Oversight Board (PCAOB) amendments to US Auditing
Standards (AU) Section 411, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles. SFAS No. 162 identifies the sources of accounting principles and the framework for selecting the principles to
be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with US GAAP. This standard is not expected to have an impact on the Companys financial position, results of operations or cash
flow.



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In April 2008, the FASB released FASB Staff Position 142-3, Determination of the Useful Life
of Intangible Assets (SFAS No.142-3), which amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, Goodwill and
Other Intangible Assets. The intent of the statement is to improve the consistency between the useful life of a recognized intangible asset under SFAS No. 142 and the period of expected cash flows used to measure the fair value of the asset
under SFAS No. 141 (revised 2007) and other U.S. generally accepted accounting principles. SFAS No. 142-3 is effective as of the beginning of an entitys fiscal year that begins after December 15, 2008, which will be the
Companys fiscal year beginning July 1, 2009. The Company is currently evaluating the potential impact, if any, of the adoption of SFAS No. 142-3 on its consolidated financial position, cash flows, and results of operations.

In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations(SFAS No. 141R), which replaces FASB
Statement No. 141. SFAS No. 141R establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any non controlling interest in the
acquiree and the goodwill acquired. The Statement also establishes disclosure requirements which will enable users to evaluate the nature and financial effects of the business combination. SFAS No. 141R is effective as of the beginning of an
entitys fiscal year that begins after December 15, 2008, which will be the Companys fiscal year beginning July 1, 2009. Early adoption and retroactive application of SFAS No. 141R to fiscal years preceding the effective
date are not permitted. The Company is currently evaluating the potential impact, if any, of the adoption of SFAS No. 141R on the Companys consolidated financial position, results of operations and cash flows.

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

In September 2006, the FASB issued SFAS No. 157 (SFAS 157), Fair Value Measurements. This Statement
defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This Statement applies under other accounting pronouncements that require or
permit fair value measurements, the Board having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, this Statement does not require any new fair value measurements. Originally,
this Statement was effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. However, in February 2008, the FASB released FASB Staff Position 157-2, Effective
Date of FASB Statement No. 157which delayed the effective date of FAS 157 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring
basis (at least annually) until years beginning after November 15, 2008, which will be the Companys fiscal year beginning July 1, 2009. The Company does not expect the adoption of SFAS 157 to have a material impact on its
consolidated financial statements. The Company is currently evaluating the potential impact, if any, of the adoption of FSP SFAS 157-2 on the Companys consolidated financial position, results of operations and cash flows.

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2.    BALANCE SHEET COMPONENTS

Balance sheet components consist of the following:



|                                                |  |                        |        |      |   |       
|----------------------------------------------- |  | ---------------------- | ------ | ---- | - | ------
|                                                |  | As of June 30,        
|                                                |  | 2008                   |        | 2007
|                                                |  | (Amounts in thousands)
|Inventories:                                    |  |                        |        |      |   |       
|Raw materials                                   |  | $                      |       |      | $ | 47    
|Inventory in process/transit                    |  |                        | 253    |      |   | 325   
|Finished goods                                  |  |                        | 11,755 |      |   | 6,685 
|                                                |  |                        |        |      |   |       
|Total inventories                               |  | $                      | 12,008 |      | $ | 7,057 
|                                                |  |                        |        |      |   |       
|Prepaid expenses and other current assets:      |  |                        |        |      |   |       
|Prepaid expenses                                |  | $                      | 2,614  |      | $ | 2,600 
|Deferred cost of revenue                        |  |                        | 701    |      |   | 772   
|Deferred taxes                                  |  |                        | 1,748  |      |   |      
|                                                |  |                        |        |      |   |       
|Total prepaid expenses and other current assets |  | $                      | 5,063  |      | $ | 3,372 
|                                                |  |                        |        |      |   |       
|Property and equipment:                         |  |                        |        |      |   |       
|Computer equipment and tooling                  |  | $                      | 4,656  |      | $ | 3,573 
|Software                                        |  |                        | 943    |      |   | 982   
|Furniture and fixtures                          |  |                        | 759    |      |   | 403   
|Leasehold improvements                          |  |                        | 298    |      |   | 203   
|                                                |  |                        |        |      |   |       
|Total property and equipment                    |  |                        | 6,656  |      |   | 5,161 
|Less accumulated depreciation and amortization  |  |                        | 3,007  |      |   | 2,228 
|                                                |  |                        |        |      |   |       
|Property and equipment  Net                    |  | $                      | 3,649  |      | $ | 2,933 
|                                                |  |                        |        |      |   |       
|Deferred revenue:                               |  |                        |        |      |   |       
|Product                                         |  | $                      | 2,410  |      | $ | 2,618 
|Support and services                            |  |                        | 16,255 |      |   | 11,333
|                                                |  |                        |        |      |   |       
|                                                |  | $                      | 18,665 |      | $ | 13,951
|                                                |  |                        |        |      |   |       

As of June 30, 2008 and 2007, computer equipment and tooling included $0.4 million and $0.1
million, respectively, of inventory items held within various departments of the Company for demonstration, testing and development purposes, net of accumulated depreciation.

As of June 30, 2008 and 2007, deferred revenue includes $1.1 million and $0, respectively, of revenue deferred due to lack of VSOE of fair value of
installation and services on a select class of customer.

Short-term Investments:

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



|                                     |  |               |        |                      |   |                       |  |   |           |   |  |   |       
|------------------------------------ |  | ------------- | ------ | -------------------- | - | --------------------- |  | - | --------- | - |  | - | ------
|June 30, 2008                        |  | AmortizedCost |        | GrossUnrealizedGains |   | GrossUnrealizedLosses |  |   | FairValue
|Corporate notes and commercial paper |  | $             | 15,607 |                      | $ | 5                     |  | $ | (58       | ) |  | $ | 15,554
|US Govt. sponsored entity securities |  |               | 18,608 |                      |   | 2                     |  |   | (25       | ) |  |   | 18,585
|                                     |  |               |        |                      |   |                       |  |   |           |   |  |   |       
|Total                                |  | $             | 34,215 |                      | $ | 7                     |  | $ | (83       | ) |  | $ | 34,139
|                                     |  |               |        |                      |   |                       |  |   |           |   |  |   |       



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The following table summarizes the maturities of the Companys fixed income securities at
June 30, 2008 (in thousands):



|                    |  |                |        |            |   |       
|------------------- |  | -------------- | ------ | ---------- | - | ------
|                    |  | Amortized Cost |        | Fair Value
|Less than 1 year    |  | $              | 27,490 |            | $ | 27,472
|Due in 1 to 2 years |  |                | 6,725  |            |   | 6,667 
|Due in 2 to 5 years |  |                |       |            |   |      
|Due after 5 years   |  |                |       |            |   |      
|                    |  |                |        |            |   |       
|Total               |  | $              | 34,215 |            | $ | 34,139
|                    |  |                |        |            |   |       

Actual maturities may differ from the contractual maturities because borrowers may have the right
to call or prepay certain obligations. The Company did not have any short-term investments at June 30, 2007.

Other assets:

In January 2008, the Company entered into an agreement with a third party software vendor to acquire non-exclusive license rights to an
upgraded version of software that is currently incorporated into the Companys products. Under the agreement, an initial payment of $2.25 million was made in January 2008 and development milestone payments aggregating $1.6 million are required
over an estimated period of 12 months, along with $0.4 million to be paid in twenty equal monthly installments commencing in January 2009 through August 2010, subject to satisfactory completion of the milestones by the vendor. Payments made to the
vendor under this arrangement are applied towards royalty payments that the Company would have otherwise paid to the vendor for the use of the current version of the software that is incorporated into the Companys products. Consequently, the
payments to the vendor under the arrangement are treated as a long-term prepaid royalty and expensed to cost of sales based on usage. In fiscal 2008, $0.8 million of prepaid royalties were expensed to cost of sales. The carrying amount of the
prepaid royalties, included within Other long-term assets at June 30, 2008 was approximately $1.8 million.

Other assets also includes
long term deposit on office facilities of $0.2 million and $0.1 million at June 30, 2008 and 2007, respectively.

Other assets at
June 30, 2007 included approximately $2.8 million of deferred initial public offering costs that were reclassified to common stock upon the completion of the initial public offering in July 2007.

3.    NET INCOME PER COMMON SHARE

Basic net income per common share available to common stockholders is determined by dividing net income available to common stockholders by the weighted average number of common shares during the period. Diluted net income per common share
available to common stockholders is determined by dividing net income available to common stockholders by the weighted average number of common shares used in the basic net income per common share calculation, plus the number of common shares that
would be issued assuming conversion of all potentially dilutive securities outstanding under the treasury stock method.

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SHORETEL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



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



|                                                              |  |                                                 |        |   |      |   |        |      |  |   |        |  
|------------------------------------------------------------- |  | ----------------------------------------------- | ------ | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                                              |  | Year Ended June 30,                             |       
|                                                              |  | 2008                                            |        |   | 2007 |   |        | 2006 | 
|                                                              |  | (Amounts in thousands, exceptper share amounts) |       
|Numerator:                                                    |  |                                                 |        |   |      |   |        |      |  |   |        |  
|Net income available to common stockholders                   |  | $                                               | 2,633  |   |      | $ | 6,031  |      |  | $ | 3,951  |  
|                                                              |  |                                                 |        |   |      |   |        |      |  |   |        |  
|Denominator:                                                  |  |                                                 |        |   |      |   |        |      |  |   |        |  
|Weighted average common shares outstanding                    |  |                                                 | 42,852 |   |      |   | 9,713  |      |  |   | 7,402  |  
|Weighted average common shares subject to repurchase          |  |                                                 | (439   | ) |      |   | (1,148 | )    |  |   | (793   | )
|                                                              |  |                                                 |        |   |      |   |        |      |  |   |        |  
|Weighted average common shares outstanding (basic)            |  |                                                 | 42,413 |   |      |   | 8,565  |      |  |   | 6,609  |  
|Effect of dilutive securities:                                |  |                                                 |        |   |      |   |        |      |  |   |        |  
|Weighted average common shares subject to repurchase          |  |                                                 | 439    |   |      |   | 1,148  |      |  |   | 793    |  
|Common equivalent shares from employee stock plans            |  |                                                 | 2,009  |   |      |   | 2,484  |      |  |   | 2,650  |  
|Common equivalent shares from common stock warrants           |  |                                                 |       |   |      |   | 68     |      |  |   | 63     |  
|Conversion of redeemable convertible preferred stock          |  |                                                 |       |   |      |   | 23,316 |      |  |   | 23,316 |  
|                                                              |  |                                                 |        |   |      |   |        |      |  |   |        |  
|Weighted average common shares outstanding (diluted)          |  |                                                 | 44,861 |   |      |   | 35,581 |      |  |   | 33,431 |  
|Net income per common share available to common stockholders: |  |                                                 |        |   |      |   |        |      |  |   |        |  
|Basic                                                         |  | $                                               | 0.06   |   |      | $ | 0.70   |      |  | $ | 0.60   |  
|                                                              |  |                                                 |        |   |      |   |        |      |  |   |        |  
|Diluted                                                       |  | $                                               | 0.06   |   |      | $ | 0.17   |      |  | $ | 0.12   |  
|                                                              |  |                                                 |        |   |      |   |        |      |  |   |        |  

Anti-dilutive common equivalent shares related to stock options excluded from the calculation of
diluted shares were approximately 3.1 million, 0.4 million and 0.3 million for the years ended June 30, 2008, 2007 and 2006, respectively. Anti-dilutive common equivalent shares from common stock warrants were approximately 1,909
for the year ended June 30, 2008, 3,180 for the year ended June 30, 2007, and 8,516 for the year ended June 30, 2006.

4.    RELATED-PARTY TRANSACTIONS

Unsecured Promissory Note  In October 1997, the
Company issued an unsecured promissory note in the principal amount of $350,000 to an officer and shareholder. The note bears interest at 6.34% per annum. The principal and any accrued but unpaid interest were due on the earlier of
(a) October 27, 2004 or (b) two years after the termination of the officers employment, the Companys initial public offering or a merger or acquisition of the Company. In January 2002, the officer was terminated and in
connection therewith, the Company forgave $230,000 plus related accrued interest and reserved the remaining principal balance of $120,000 plus related accrued interest. In March 2007, the Company entered into a Note Repayment Agreement whereby the
borrower surrendered 57,671 shares of the Companys common stock (with an estimated fair value of $536,000) to repay in full the outstanding principal and interest balances due under this note (resulting in a recovery of $191,000 recorded
as a reduction of general and administrative expense of $120,000 and interest income of $71,000 in the accompanying statement of operations for the year ended June 30, 2007) and under notes issued for stock purchases (see Note 8).



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



5.    INCOME TAXES

The provision for income taxes consists of the following for the years ended June 30, 2008, 2007, and 2006 (in thousands):



|          |  |                     |        |   |      |   |      |  |   |    
|--------- |  | ------------------- | ------ | - | ---- | - | ---- |  | - | ---
|          |  | Year Ended June 30,
|          |  | 2008                |        |   | 2007 |   | 2006
|Current:  |  |                     |        |   |      |   |      |  |   |    
|Federal   |  | $                   | 2,430  |   |      | $ | 178  |  | $ | 114
|State     |  |                     | 207    |   |      |   | 199  |  |   | 99 
|Foreign   |  |                     | (28    | ) |      |   | 31   |  |   | 6  
|          |  |                     |        |   |      |   |      |  |   |    
|          |  |                     | 2,609  |   |      |   | 408  |  |   | 219
|          |  |                     |        |   |      |   |      |  |   |    
|Deferred: |  |                     |        |   |      |   |      |  |   |    
|Federal   |  |                     | (1,667 | ) |      |   |     |  |   |   
|State     |  |                     |       |   |      |   |     |  |   |   
|Foreign   |  |                     | (81    | ) |      |   |     |  |   |   
|          |  |                     |        |   |      |   |      |  |   |    
|          |  |                     | (1,748 | ) |      |   |     |  |   |   
|          |  |                     |        |   |      |   |      |  |   |    
|Total     |  | $                   | 861    |   |      | $ | 408  |  | $ | 219
|          |  |                     |        |   |      |   |      |  |   |    

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



|                                                    |  |          |         |   |      |   |        |      |  |   |        |  
|--------------------------------------------------- |  | -------- | ------- | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                                    |  | June 30, |        
|                                                    |  | 2008     |         |   | 2007 |   |        | 2006 | 
|Income tax provision at federal statutory rate      |  | $        | 1,223   |   |      | $ | 2,206  |      |  | $ | 1,450  |  
|Elimination of NOL and R&D tax credit carryforwards |  |          | 26,939  |   |      |   | 1,569  |      |  |   |       |  
|Stock-based compensation                            |  |          | 1,124   |   |      |   | 423    |      |  |   |       |  
|Credits                                             |  |          | (1,032  | ) |      |   | (1,467 | )    |  |   | (284   | )
|State taxes                                         |  |          | 206     |   |      |   | 668    |      |  |   | (143   | )
|Other                                               |  |          | (49     | ) |      |   | 530    |      |  |   | 327    |  
|Change in valuation allowance                       |  |          | (27,550 | ) |      |   | (3,521 | )    |  |   | (1,131 | )
|                                                    |  |          |         |   |      |   |        |      |  |   |        |  
|Total                                               |  | $        | 861     |   |      | $ | 408    |      |  | $ | 219    |  
|                                                    |  |          |         |   |      |   |        |      |  |   |        |  

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



|                                 |  |          |        |   |      |   |         |  
|-------------------------------- |  | -------- | ------ | - | ---- | - | ------- | -
|                                 |  | June 30, |       
|                                 |  | 2008     |        |   | 2007 |  
|Net operating loss carryforwards |  | $        | 26     |   |      | $ | 26,209  |  
|Tax credit carryforwards         |  |          | 1,666  |   |      |   | 4,677   |  
|Other                            |  |          | 5,433  |   |      |   | 3,261   |  
|                                 |  |          |        |   |      |   |         |  
|Total deferred tax assets        |  |          | 7,125  |   |      |   | 34,147  |  
|Less valuation allowance         |  |          | (5,377 | ) |      |   | (34,147 | )
|                                 |  |          |        |   |      |   |         |  
|Net deferred tax assets          |  | $        | 1,748  |   |      | $ |        |  
|                                 |  |          |        |   |      |   |         |  

During the year ended June 30, 2008, management completed their 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 and California research and development tax credit carryforwards subject to the Section 382 limitations could not be utilized. Consequently, approximately $26.2 million of the
deferred tax asset associated with net operating loss carryforwards and

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SHORETEL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



$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. The remaining decrease in the valuation allowance of $0.7 million in fiscal 2008 was primarily associated with the reversal of other deferred tax assets that the Company was able to utilize in the current year.
Similarly, for the year ended June 30, 2007, approximately $1.5 million of Federal research and development tax credit carryforwards subject to Section 382 limitations were eliminated with a corresponding reduction in the valuation allowance. Such
amount has been reclassified from the credits line item in the previously reported reconciliation of the difference between the income tax provision for the year ended June 30, 2007 and the amount computed by applying the federal income tax rate, to
conform to the current year presentation. 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, 2008, management does not believe it is more
likely than not that $5.4 million of the $7.1 million 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. In addition, the occurrence of negative evidence with respect to deferred tax assets which currently have no valuation allowance could result in an increase in the valuation allowance in a future period. 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.

As of June 30, 2008, the Company had state net operating loss carryforwards of $0.4 million and federal and California tax credit carryforwards of $0.3 million and $2.1 million, respectively. The state net
operating loss carryforwards expire at various dates between 2020 and 2027. The federal tax credit carryforwards expire at various dates between 2012 and 2028. The federal Alternative Minimum Tax and the California tax credits may be carryforward
indefinitely.

Adoption of FIN 48

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

The cumulative effect of adoption of FIN 48 did not result in an
adjustment to the Companys tax liability for unrecognized income tax benefits because the Company had recorded a 100% valuation allowance against its net deferred tax assets as of June 30, 2007. The total amount of gross unrecognized tax
benefits as of the date of adoption for federal and state was $0.7 million and $0.4 million, respectively. The unrecognized tax benefits are primarily related to the Companys research and development tax credits.

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



|                                                 |  |   |      
|------------------------------------------------ |  | - | -----
|                                                 | 
|Balance at July 1, 2007                          |  | $ | 1,220
|Gross increases in tax positions for prior years |  |   | 305  
|                                                 |  |   |      
|Balance at June 30, 2008                         |  | $ | 1,525
|                                                 |  |   |      

As of June 30, 2008, the Companys total amount of unrecognized tax benefit was
approximately $1.5 million of which none, if recognized, would impact the effective tax rate as the Company has a valuation allowance on its carryforward attributes. The Company does not expect its unrecognized tax benefits to change materially over
the next 12 months.



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SHORETEL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



The Companys policy to include interest and penalties related to unrecognized tax benefits
within the provision for taxes on the consolidated condensed statements of operations did not change as a result of implementing the provisions of FIN 48. Management determined that no accrual for interest and penalties was required as of
June 30, 2008.

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 2008 remain open and subject to tax examination by the appropriate federal or state taxing authorities.

6
..    COMMON STOCK AND WARRANTS

Warrants

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

The Company had the following common stock warrants outstanding as of June 30, 2008.



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



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

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

In December 2007, 67,703 common stock warrants outstanding with respect to Series E and Series F offerings were exercised under the net issuance
provision. The provision requires that common shares with a fair value equivalent to the purchase price of the warrants are surrendered in lieu of a cash payment. As a result, 60,705 common shares were issued related to the exercise of Series E and
Series F common stock warrants.

Reverse Stock Split

On June 1, 2007, the Companys board of directors approved a 1-for-10 reverse stock split of the Companys common stock and redeemable
convertible preferred stock (collectively, Capital Stock), which became effective on June 22, 2007. On the effective date of the reverse stock split, (i) each 10 shares of outstanding Capital Stock were reduced to one
share of Capital Stock; (ii) the number of shares of Capital Stock into which each outstanding warrant or option to purchase Capital Stock is exercisable was proportionately reduced on a 10-to-1 basis; (iii) the exercise price of each
outstanding warrant or option to purchase Capital Stock was proportionately increased on a 1-to-10 basis; and (iv) each 10 shares of authorized Capital Stock were reduced to one share of Capital Stock. All of the share numbers, share
prices, and exercise prices have been adjusted, on a retroactive basis, to reflect this 1-for-10 reverse stock split.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



Common Shares Subject to Repurchase

At June 30, 2008, 126,082 shares of common stock were subject to repurchase in connection with the early exercise of incentive stock options
under the Companys stock option plan.

Common Shares Reserved for Issuance

At June 30, 2008, the Company has reserved shares of common stock for issuance as follows (in thousands):



|                                            |  |       
|------------------------------------------- |  | ------
|                                            | 
|Reserved under stock option plans           |  | 9,447 
|Reserved under employee stock purchase plan |  | 810   
|Conversion of warrants                      |  | 2     
|                                            |  |       
|Total                                       |  | 10,259
|                                            |  |       

7.    STOCK-BASED COMPENSATION

Determining Fair Value of Stock 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.

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 described in SAB 107 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 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 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  Management 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.



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



The Company estimated the grant date fair value of stock option awards under the provisions of
SFAS 123(R) with the following assumptions:



|                                                     |  |                         |   |  |                         |   |  |           |  
|---------------------------------------------------- |  | ----------------------- | - |  | ----------------------- | - |  | --------- | -
|                                                     |  | Year EndedJune 30, 2008 |   |  | Year EndedJune 30, 2007 |  
|                                                     |  | Class One               |   |  | Class Two               |  
|Expected life of option plan                         |  | 6.08 years              |   |  | 6.08 years              |   |  | 4.0 years |  
|Expected life of Employee Stock Purchase Plan (ESPP) |  | 0.50 years              |   |  |                        |   |  |          |  
|Risk-free interest rate range for option plan        |  | 2.42-4.50               | % |  | 4.6-4.8                 | % |  | 4.6-4.8   | %
|Risk-free interest rate for ESPP                     |  | 2.03-2.49               | % |  |                        |   |  |          |  
|Volatility for option plan                           |  | 62                      | % |  | 71                      | % |  | 55        | %
|Volatility for ESPP                                  |  | 47-136                  | % |  |                        |   |  |          |  
|Dividend yield                                       |  | 0                       | % |  | 0                       | % |  | 0         | %

SFAS 123(R) requires that the Company recognize compensation expense only for the portion of
stock options that are expected to vest, assuming an expected forfeiture rate in determining stock-based compensation expense, which could affect the stock-based compensation expense recorded if there is a significant difference between actual and
estimated forfeiture rates. The estimated forfeiture rate in the year ended June 30, 2008 was 10.7%. As of June 30, 2008, total unrecognized compensation cost related to stock-based awards granted to employees and non-employee directors
was $23.6 million, net of estimated forfeitures of $6.7 million. This cost will be amortized on a straight-line basis over a weighted-average vesting period of approximately three years.

8.    STOCK OPTION PLAN

In
January 1997, the Board of Directors and stockholders adopted the 1997 stock option plan (the 1997 Plan) which, as amended, provides for granting incentive stock options (ISOs) and nonqualified stock options
(NSOs) for shares of common stock to employees, directors, and consultants of the Company. In September 2006, the Companys board of directors increased the number of shares authorized and reserved for issuance under the 1997 Plan
to 10,513,325 shares of common stock. In accordance with the 1997 Plan, the stated exercise price shall not be less than 100% and 85% of the estimated fair market value of common stock on the date of grant for ISOs and NSOs, respectively, as
determined by the Board of Directors. The 1997 Plan provides that the options shall be exercisable over a period not to exceed ten years. Options generally vest ratably over four years from the date of grant. Options granted to certain executive
officers are exercisable immediately and unvested shares issued upon exercise are subject to repurchase by the Company at the exercise price. During fiscal year 2006, 87,067 unvested shares issued upon exercise of options were repurchased under this
provision. There were no repurchases of unvested shares in fiscal years 2008 or 2007. The Companys repurchase right for such options lapses as the options vest, generally over four years from the date of grant.

In February 2007, the Company adopted the 2007 Equity Incentive Plan (the 2007 Plan) which, as amended, provides for grants of incentive
common stock options (ISOs) and nonqualified common stock options (NSOs) to employees, directors and consultants of the Company. This plan serves as the successor to the 1997 Plan, which terminated in January 2007. Five
million shares of common stock are reserved for future issuance in the form of stock options, restricted stock awards or units, stock appreciation rights and stock bonuses. In February 2008, pursuant to the automatic increase provisions of the 2007
Plan, the Companys board of directors increased the number of shares authorized and reserved for issuance under the 2007 Plan by 2,136,449 shares to 7,136,449 shares. 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 2008 and 2007, the Company granted options for
3,518,000 and 1,514,000 shares of common stock, respectively, under its 2007 Plan.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



Class Two options granted to certain executive officers are exercisable immediately and shares
issued upon exercise are subject to repurchase by the Company at the exercise price, in the event the employee is terminated; such repurchase right lapses gradually over a four year period. The Company does not consider the exercise of stock options
substantive when the issued stock is subject to repurchase. Accordingly, the proceeds from the exercise of such options are accounted for as a deposit liability until the repurchase right lapses, at which time the proceeds are reclassified to
permanent equity. As of June 30, 2008 and 2007, there were 126,082 and 767,612 shares subject to repurchase, respectively, of the Companys common stock outstanding and $72,000 and $292,000, respectively, of related recorded
liability, which is included in accrued liabilities.

During fiscal years 2006 the Company had outstanding loans to certain executives and
employees pursuant to the 1997 Plan for the purchase of stock upon the exercise of incentive stock options in the aggregate amounts of $231,000. The loan agreements allow the Company to repurchase the unvested shares within 60 days of
termination at a price equal to the original exercise price. The loans bear interest at rates ranging from 6.4%  8.0% per annum and are due upon the earlier of termination of employment or four years from the option exercise date.
All loans were due by June 30, 2006. In fiscal 2002, as part of his termination settlement, the Company repurchased unvested shares and amended the terms of the remaining notes issued to the former CEO, such that they are nonrecourse. In March
2003, the Company amended the terms of the remaining loans, such that they are nonrecourse. Of the 271,790 shares purchased, 127,418 were unvested at the time of the note amendments. Due to the conversion of these full recourse notes to
non-recourse, the deemed new awards were subject to variable accounting until the loans were settled. As such, additional stock-based compensation expense was recorded to the extent the Companys share price appreciated above the value for
which the Company had already recorded compensation charges. Stock-based compensation expense recorded for these awards in fiscal 2008, 2007, and 2006 was $0, $1,377,000 and $54,000, respectively.

During the year ended June 30, 2007, one employee repaid his loan in the amount of $12,000 plus accrued interest of $7,000. In March 2007, the
Company entered into a Note Repayment Agreement with the sole remaining note holder, whereby he agreed to surrender 57,671 shares of the Companys common stock as full consideration for the principal and fully-reserved interest balances
due on his stock loans and his promissory note (see Note 4). During fiscal 2006, one employee was terminated and the Company repurchased 46,000 unvested shares issued upon exercise of options and wrote off the balance of his loan of $141,000
plus accrued interest of $40,000.



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SHORETEL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



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



|                                                                                                          |  |                                                  |   |  |                                    |   |  |                               |      
|--------------------------------------------------------------------------------------------------------- |  | ------------------------------------------------ | - |  | ---------------------------------- | - |  | ----------------------------- | -----
|                                                                                                          |  | SharesAvailablefor Grant                         |   |  | SharesSubject toOptionsOutstanding |   |  | Weighted-AverageExercisePrice
|                                                                                                          |  | (Amounts in thousands, except per share amounts)
|Outstanding  July 1, 2005                                                                                |  | 461                                              |   |  | 5,336                              |   |  | $                             | 0.40 
|Shares authorized                                                                                         |  | 1,500                                            |   |  |                                    |   |  |                               |      
|Options granted  Class 1 (weighted average fair value of $0.60 per share)                                |  | (449                                             | ) |  | 449                                |   |  |                               | 0.80 
|Options granted  Class 2 (weighted average fair value of $0.40 per share)                                |  | (851                                             | ) |  | 851                                |   |  |                               | 0.60 
|Options exercised                                                                                         |  |                                                 |   |  | (3,429                             | ) |  |                               | 0.30 
|Options repurchased                                                                                       |  | 133                                              |   |  |                                   |   |  |                               | 1.10 
|Options canceled                                                                                          |  | 129                                              |   |  | (129                               | ) |  |                               | 0.50 
|                                                                                                          |  |                                                  |   |  |                                    |   |  |                               |      
|Outstanding  June 30, 2006                                                                               |  | 923                                              |   |  | 3,078                              |   |  |                               | 0.60 
|Shares authorized                                                                                         |  | 6,030                                            |   |  |                                    |   |  |                               |      
|Options granted  Class 1 (weighted average fair value of $6.02 per share)                                |  | (2,094                                           | ) |  | 2,094                              |   |  |                               | 8.89 
|Options granted  Class 2 (weighted average fair value of $5.00 per share)                                |  | (530                                             | ) |  | 530                                |   |  |                               | 2.75 
|Options exercised                                                                                         |  |                                                 |   |  | (901                               | ) |  |                               | 0.64 
|Options canceled                                                                                          |  | 175                                              |   |  | (175                               | ) |  |                               | 1.07 
|                                                                                                          |  |                                                  |   |  |                                    |   |  |                               |      
|Outstanding  June 30, 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 canceled                                                                                          |  | 372                                              |   |  | (372                               | ) |  |                               | 7.47 
|Restricted stock awards (See note 10)                                                                     |  | (101                                             | ) |  |                                    |   |  |                               |      
|Outstanding  June 30, 2008                                                                               |  | 2,202                                            |   |  | 7,175                              |   |  |                               | 8.18 
|                                                                                                          |  |                                                  |   |  |                                    |   |  |                               |      
|                                                                                                          |  |                                                  |   |  |                                    |   |  |                               |      
|Options exercisable at June 30, 2008                                                                      |  |                                                  |   |  | 2,126                              |   |  |                               | 2.71 
|                                                                                                          |  |                                                  |   |  |                                    |   |  |                               |      

The total intrinsic value for options exercised in the years ended June 30, 2008, 2007 and
2006 was $4.1 million, $7.6 million, and $2.9 million, respectively, representing the difference between the estimated fair values of the Companys common stock underlying these options at the dates of exercise and the exercise prices paid.
There were 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.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



The following table summarizes information about outstanding and exercisable options at June 30,
2008:



|                            |  |                                               |  |                                                 |  |                              |  |                        
|--------------------------- |  | --------------------------------------------- |  | ----------------------------------------------- |  | ---------------------------- |  | -----------------------
|                            |  | As of June 30, 2008                          
|Exercise Prices             |  | Options Outstanding                           |  | WeightedAverageRemainingContractualLife (Years) |  | WeightedAverageExercisePrice |  | AggregateIntrinsicValue
|                            |  | (Amounts in thousands, except per share data)
|$0.10 - 0.40                |  | 952                                           |  | 6.20                                            |  | $0.31                        |  |                        
|$0.80 - 1.00                |  | 542                                           |  | 7.14                                            |  | $0.89                        |  |                        
|$2.00 - 3.20                |  | 737                                           |  | 8.10                                            |  | $3.08                        |  |                        
|$3.60 - 4.94                |  | 716                                           |  | 9.48                                            |  | $4.76                        |  |                        
|$5.02 - 6.00                |  | 513                                           |  | 9.48                                            |  | $5.34                        |  |                        
|$9.50 - 11.30               |  | 911                                           |  | 8.83                                            |  | $11.12                       |  |                        
|$11.40 - 12.55              |  | 626                                           |  | 8.93                                            |  | $11.53                       |  |                        
|$13.44 - 13.73              |  | 693                                           |  | 9.15                                            |  | $13.71                       |  |                        
|$ 14.61                     |  | 850                                           |  | 9.42                                            |  | $14.61                       |  |                        
|$15.38 - 15.41              |  | 364                                           |  | 9.38                                            |  | $15.40                       |  |                        
|$ 17.00                     |  | 271                                           |  | 9.27                                            |  | $17.00                       |  |                        
|                            |  |                                               |  |                                                 |  |                              |  |                        
|Total Outstanding           |  | 7,175                                         |  | 8.54                                            |  | $8.18                        |  | $6,884                 
|                            |  |                                               |  |                                                 |  |                              |  |                        
|Exercisable                 |  | 2,126                                         |  | 7.11                                            |  | $2.71                        |  | $5,726                 
|Vested and expected to vest |  | 5,817                                         |  | 8.41                                            |  | $7.88                        |  | $6,195                 

9.    EMPLOYEE STOCK PURCHASE PLAN

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

On February 6, 2008, pursuant to the
automatic increase provisions of the ESPP, the Companys Board of Directors approved an increase to the number of shares authorized and reserved for issuance under the ESPP by 427,289 shares, pursuant to the terms of that plan. The Company
issued 117,000 shares under the ESPP in fiscal 2008 at weighted average price per share of $4.17. The weighted average fair value of those shares was $4.14 per share. As of June 30, 2008, 810,000 shares had been reserved for future issuance
under the ESPP.

10.    RESTRICTED STOCK UNITS

Under the 2007 Plan, during the year ended June 30, 2008, the Company issued restricted stock units to non-employee directors electing to receive them in lieu of an annual cash retainer. Restricted stock units
can be issued to eligible employees, and vest either 25% one year from the date of grant or 50% two years from the date of grant, and 25% annually thereafter.



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



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



|                  |  |      |  
|----------------- |  | ---- | -
|                  |  | 2008 |  
|Beginning balance |  |     |  
|Awarded           |  | 101  |  
|Released          |  | (31  | )
|Forfeited         |  |     |  
|                  |  |      |  
|Ending balance    |  | 70   |  
|                  |  |      |  

Information regarding restricted stock units outstanding at June 30, 2008 is summarized below:



|                                   |  |                            |  |                                         |  |                                    |    
|---------------------------------- |  | -------------------------- |  | --------------------------------------- |  | ---------------------------------- | ---
|                                   |  | Number ofShares(thousands) |  | WeightedAverageRemainingContractualLife |  | AggregateIntrinsicValue(thousands)
|Shares outstanding                 |  | 70                         |  | 2.42 years                              |  | $                                  | 309
|Shares vested and expected to vest |  | 51                         |  | 2.35 years                              |  | $                                  | 228

11.    LITIGATION, COMMITMENTS AND CONTINGENCIES

Litigation  The Company is a party to the following lawsuits:

Mitel Patent 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
alleged that the Company infringed four of its U.S. patents: U.S. Patent No. 5,940,834, entitled Automatic Web Page Generator, U.S. Patent No. 5,703,942 entitled Portable Telephone User Profiles Using
Central Computer, U.S. Patent No. 5,541,983 entitled Automatic Telephone Feature Selector and U.S. Patent No. 5,657,446 entitled Local Area Communications Server. On August 21, 2007, Mitel filed
an amended complaint, which alleges that the Company infringed two additional U.S. patents held by Mitel: U.S. Patent No. 5,007,080, entitled Communications System Supporting Remote Operations, and U.S. Patent
No. 5,657,377, entitled Portable Telephone User Profiles. The lawsuit includes claims that relate to components or features that are material to the Companys products. In relation to its claims under each patent, Mitel seeks a
permanent injunction against infringement, attorneys fees and compensatory damages. On July 31, 2007, the Company filed counterclaims in the Eastern District of Texas. In addition to denying all of Mitels claims of patent
infringement, the counterclaims allege that Mitels IP phone systems, including the Mitel 3300 IP Communications Platform, infringes ShoreTels U.S. Patent No. 7,167,486 B2 entitled Voice Traffic Through a Firewall. A
claim construction hearing has been set for February 2010, and a trial date for this lawsuit has been set for June 2010. ShoreTel believes that it has meritorious defenses to this lawsuit and intends to defend the litigation vigorously. It is not
possible for the Company to quantify the extent of the potential liability, if any. As such, no liability for any potential loss has been accrued as of June 30, 2008.

Mitel Trade Libel Litigation.    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. The Company filed claims for approximately $11 million in damages and an injunction against Mitel. In April 2008, the Company expanded the trade libel complaint against Mitel and increased the damages claim to
$20 million.

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 was filed on January 29, 2008. The lawsuits were consolidated, and a consolidated amended class action complaint, captioned
In Re ShoreTel, Inc. Securities Litigation, was filed on June 27, 2008. The consolidated complaint purports to bring

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



suit on behalf of those who purchased the Companys common stock pursuant to the initial public offering on July 3, 2007 and purports to allege
claims for violations of the federal securities laws. The consolidated complaint seeks unspecified compensatory damages and other relief. Management believes that the Company has meritorious defenses to these claims and intends to defend the
litigation vigorously. It is not possible for the Company to quantify the extent of the potential liability, if any. As such, no liability for any potential loss has been accrued as of June 30, 2008.

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

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

Leases The Company leases its facilities under non-cancelable operating leases which expire at various times through 2013. 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, 2008, are as follows (in thousands):



|                      |  |   |      
|--------------------- |  | - | -----
|Years Ending June 30, |  |  
|2009                  |  | $ | 1,771
|2010                  |  |   | 939  
|2011                  |  |   | 368  
|2012                  |  |   | 302  
|2013                  |  |   | 108  
|                      |  |   |      
|Total                 |  | $ | 3,488
|                      |  |   |      

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, 2008.

Rent expense for the years ended
June 30, 2008, 2007 and 2006, was $1.6 million, $0.7 million and $0.6 million, respectively.

Purchase commitments  As of
June 30, 2008, the Company had purchase commitments with contract manufacturers for inventory and with technology firms for usage of software licenses totaling approximately $10.4 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.



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

12.    EMPLOYEE BENEFIT 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.

13.    SEGMENT INFORMATION

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

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



|              |  |                     |         |      |   |        |  |   |       
|------------- |  | ------------------- | ------- | ---- | - | ------ |  | - | ------
|              |  | Year Ended June 30,
|              |  | 2008                |         | 2007 |   | 2006  
|North America |  | $                   | 122,741 |      | $ | 95,448 |  | $ | 60,954
|International |  |                     | 5,988   |      |   | 2,379  |  |   | 654   
|              |  |                     |         |      |   |        |  |   |       
|Total         |  | $                   | 128,729 |      | $ | 97,827 |  | $ | 61,608
|              |  |                     |         |      |   |        |  |   |       

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SHORETEL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



14.    QUARTERLY FINANCIAL DATA (Unaudited)



|                                                                     |  |                                          |        |   |              |   |        |              |  |              |        |              |   |        |              |   |        |              |  |   |              |   |  |   |        |   |  |   |        |  
|-------------------------------------------------------------------- |  | ---------------------------------------- | ------ | - | ------------ | - | ------ | ------------ |  | ------------ | ------ | ------------ | - | ------ | ------------ | - | ------ | ------------ |  | - | ------------ | - |  | - | ------ | - |  | - | ------ | -
|                                                                     |  | Three Months Ended                       |       
|                                                                     |  | Jun. 30,2008                             |        |   | Mar. 31,2008 |   |        | Dec. 31,2007 |  | Sep. 30,2007 |        | Jun. 30,2007 |   |        | Mar. 31,2007 |   |        | Dec. 31,2006 |  |   | Sep. 30,2006 |  
|                                                                     |  | (In thousands, except per share amounts) |       
|Total revenue                                                        |  | $                                        | 34,704 |   |              | $ | 31,489 |              |  | $            | 30,561 |              | $ | 31,975 |              | $ | 28,923 |              |  | $ | 26,009       |   |  | $ | 22,480 |   |  | $ | 20,415 |  
|Gross profit                                                         |  |                                          | 21,697 |   |              |   | 19,518 |              |  |              | 19,657 |              |   | 20,412 |              |   | 18,459 |              |  |   | 16,199       |   |  |   | 14,118 |   |  |   | 12,463 |  
|Net income (loss)                                                    |  |                                          | (47    | ) |              |   | (1,714 | )            |  |              | 1,837  |              |   | 2,557  |              |   | 1,893  |              |  |   | 2,040        |   |  |   | 1,102  |   |  |   | 1,046  |  
|Accretion of preferred stock                                         |  |                                          |       |   |              |   |       |              |  |              |       |              |   |       |              |   | (13    | )            |  |   | (12          | ) |  |   | (13    | ) |  |   | (12    | )
|                                                                     |  |                                          |        |   |              |   |        |              |  |              |        |              |   |        |              |   |        |              |  |   |              |   |  |   |        |   |  |   |        |  
|Net income (loss) available to common stockholders                   |  | $                                        | (47    | ) |              | $ | (1,714 | )            |  | $            | 1,837  |              | $ | 2,557  |              | $ | 1,880  |              |  | $ | 2,028        |   |  | $ | 1,089  |   |  | $ | 1,034  |  
|                                                                     |  |                                          |        |   |              |   |        |              |  |              |        |              |   |        |              |   |        |              |  |   |              |   |  |   |        |   |  |   |        |  
|Basic net income (loss) per share available to common stockholders   |  | $                                        | 0.00   |   |              | $ | (0.04  | )            |  | $            | 0.04   |              | $ | 0.06   |              | $ | 0.20   |              |  | $ | 0.23         |   |  | $ | 0.13   |   |  | $ | 0.13   |  
|                                                                     |  |                                          |        |   |              |   |        |              |  |              |        |              |   |        |              |   |        |              |  |   |              |   |  |   |        |   |  |   |        |  
|Diluted net income (loss) per share available to common stockholders |  | $                                        | 0.00   |   |              | $ | (0.04  | )            |  | $            | 0.04   |              | $ | 0.06   |              | $ | 0.05   |              |  | $ | 0.05         |   |  | $ | 0.03   |   |  | $ | 0.03   |  
|                                                                     |  |                                          |        |   |              |   |        |              |  |              |        |              |   |        |              |   |        |              |  |   |              |   |  |   |        |   |  |   |        |  

The previously issued Condensed Consolidated Statements of Cash Flows for the fiscal quarters ended
March 31 2008, December 31, 2007 and September 30, 2007 contained an understatement of cash provided by operating activities and a corresponding overstatement of cash provided by financing activities which resulted from a
classification error for the payment of accrued initial public offering costs. The payment of such costs was classified as operating cash outflows instead of financing cash outflows. The Company will restate its interim Condensed Consolidated
Statements of Cash Flows on Form 10-Qs during fiscal year 2009 to reflect the restatements for the periods shown below. This adjustment to the Condensed Consolidated Statements of Cash Flows does not affect the Companys unaudited Condensed
Consolidated Balance Sheets, Condensed Consolidated Statements of Operations, cash and cash equivalents, or earnings per share. The following is a summary of the restatements associated with the Companys unaudited Condensed Consolidated
Statements of Cash Flows for the fiscal 2008 quarters in thousands.



|                                                    |  |                                 |        |            |                                   |        |            |                                      |   |                      |   |  |            |        |   |            |   |        |                      |  |   |            |   |  |            |        |   |  |   |        |   |  |   |        |  
|--------------------------------------------------- |  | ------------------------------- | ------ | ---------- | --------------------------------- | ------ | ---------- | ------------------------------------ | - | -------------------- | - |  | ---------- | ------ | - | ---------- | - | ------ | -------------------- |  | - | ---------- | - |  | ---------- | ------ | - |  | - | ------ | - |  | - | ------ | -
|                                                    |  | Nine months endedMarch 31, 2008 |        |            | Six months endedDecember 31, 2007 |        |            | Three months endedSeptember 30, 2007 |  
|                                                    |  | Aspreviouslyreported            |        | Adjustment |                                   |        | Asrestated |                                      |   | Aspreviouslyreported |   |  | Adjustment |        |   | Asrestated |   |        | Aspreviouslyreported |  |   | Adjustment |   |  | Asrestated |       
|Cash flows from operating activities:               |  |                                 |        |            |                                   |        |            |                                      |   |                      |   |  |            |        |   |            |   |        |                      |  |   |            |   |  |            |        |   |  |   |        |   |  |   |        |  
|Change in assets and liabilities:                   |  |                                 |        |            |                                   |        |            |                                      |   |                      |   |  |            |        |   |            |   |        |                      |  |   |            |   |  |            |        |   |  |   |        |   |  |   |        |  
|Accounts payable                                    |  | $                               | 677    |            | $                                 | 1,360  |            |                                      | $ | 2,037                |   |  | $          | (1,382 | ) |            | $ | 1,360  |                      |  | $ | (22        | ) |  | $          | (2,554 | ) |  | $ | 1,200  |   |  | $ | (1,354 | )
|                                                    |  |                                 |        |            |                                   |        |            |                                      |   |                      |   |  |            |        |   |            |   |        |                      |  |   |            |   |  |            |        |   |  |   |        |   |  |   |        |  
|Accrued liabilities and other                       |  |                                 | 1,135  |            |                                   | 300    |            |                                      |   | 1,435                |   |  |            | 1,300  |   |            |   | 300    |                      |  |   | 1,600      |   |  |            | 679    |   |  |   | 300    |   |  |   | 979    |  
|                                                    |  |                                 |        |            |                                   |        |            |                                      |   |                      |   |  |            |        |   |            |   |        |                      |  |   |            |   |  |            |        |   |  |   |        |   |  |   |        |  
|Net cash provided by operating activities           |  |                                 | 6,881  |            |                                   | 1,660  |            |                                      |   | 8,541                |   |  |            | 8,779  |   |            |   | 1,660  |                      |  |   | 10,439     |   |  |            | 2,231  |   |  |   | 1,500  |   |  |   | 3,731  |  
|                                                    |  |                                 |        |            |                                   |        |            |                                      |   |                      |   |  |            |        |   |            |   |        |                      |  |   |            |   |  |            |        |   |  |   |        |   |  |   |        |  
|Cash flows from financing activities:               |  |                                 |        |            |                                   |        |            |                                      |   |                      |   |  |            |        |   |            |   |        |                      |  |   |            |   |  |            |        |   |  |   |        |   |  |   |        |  
|Initial public offering costs*                      |  |                                 |       |            |                                   | (1,660 | )          |                                      |   | (1,660               | ) |  |            |       |   |            |   | (1,660 | )                    |  |   | (1,660     | ) |  |            |       |   |  |   | (1,500 | ) |  |   | (1,500 | )
|                                                    |  |                                 |        |            |                                   |        |            |                                      |   |                      |   |  |            |        |   |            |   |        |                      |  |   |            |   |  |            |        |   |  |   |        |   |  |   |        |  
|Net cash provided by (used in) financing activities |  |                                 | 80,591 |            |                                   | (1,660 | )          |                                      |   | 78,931               |   |  |            | 80,381 |   |            |   | (1,660 | )                    |  |   | 78,721     |   |  |            | 80,314 |   |  |   | (1,500 | ) |  |   | 78,814 |  
|                                                    |  |                                 |        |            |                                   |        |            |                                      |   |                      |   |  |            |        |   |            |   |        |                      |  |   |            |   |  |            |        |   |  |   |        |   |  |   |        |  



|* | Previously described as Deferred initial public offering costs included in other assets.
|- | ------------------------------------------------------------------------------------------



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|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

We have previously reported on-going remediation efforts relating to the material weakness
identified as of June 30, 2007 related to the deferral of revenue for the entire arrangement fees associated with transactions in which vendor specific evidence or fair value does not exist for undelivered product elements. During fiscal 2008,
we designed and placed in operation new controls to remediate the material weakness. Specifically, we have educated our sales and marketing personnel regarding revenue recognition policies and procedures, hired a revenue recognition accounting
manager, and implemented review process regarding customer communications As of June 30, 2008, we have determined that the new controls are effectively designed and have demonstrated effective operation for a sufficient period of time to enable
management to conclude the material weakness identified in 2007 has been remediated

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 2008 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Based on that
evaluation, other than as described above, there have been no such changes during the fourth quarter of fiscal 2008.

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, 2008.

The effectiveness of our internal control over financial reporting as of June 30, 2008 has been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in its report which appears below.

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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.



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REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of ShoreTel, Inc.:

We have audited the internal control over financial reporting of ShoreTel, Inc. and subsidiaries (collectively, the Company) as of
June 30, 2008, 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 the 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, 2008, 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, 2008 of the
Company and our report dated September 12, 2008, expressed an unqualified opinion on those financial statements and included an explanatory paragraph relating to the adoption of Statement of Financial Accounting Standards Board Interpretation
No. 48, Accounting for Uncertainty in Income Taxes  an interpretation of FASB Statement No. 109.



|                         
|-------------------------
|/s/ Deloitte & Touche LLP
|                         
|San Jose, California     
|September 12, 2008       

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|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 2008 Annual Meeting of Stockholders to be
filed with the SEC within 120 days after the end of our fiscal year ended June 30, 2008.



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

The
information required by this item is incorporated by reference to our definitive Proxy Statement for the 2008 Annual Meeting of Stockholders to be filed with the SEC within 120 days after the end of our fiscal year ended June 30, 2008.



|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 2008 Annual Meeting of Stockholders to be
filed with the SEC within 120 days after the end of our fiscal year ended June 30, 2008.



|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 2008 Annual Meeting of Stockholders to be
filed with the SEC within 120 days after the end of our fiscal year ended June 30, 2008.



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

The information required by this item is incorporated by reference to our definitive Proxy Statement for the 2008 Annual Meeting of Stockholders to be filed with the SEC within 120 days after the end of our fiscal year ended
June 30, 2008.

PART IV



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

(a) (1) Financial Statements  See Index to Financial Statements at Page 47 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 81 of this Report.



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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-K to be signed on its behalf by the undersigned, thereunto duly authorized, on this 12th day of September, 2008.



ShoreTel, Inc.By:

/s/    MICHAEL E.
HEALYMichael E. HealyChief Financial Officer


POWER OF ATTORNEY

KNOW ALL THESE, PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints John W. Combs, William P. Garvey and
Michael E. Healy, and each of them, his attorneys-in-fact, each with full power of substitution, for him in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K, and to file the same, with exhibits thereto
and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each said attorneys-in-fact or his substitute or substitutes, may 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 John W. Combs           |  | Chairman, President and Chief Executive Officer (Principal Executive Officer)          |  | September 10, 2008
|                                             |  |                                                                                       
|/s/    MICHAEL E. HEALY
Michael E. Healy     |  | Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer) |  | September 10, 2008
|                                             |  |                                                                                       
|/s/    EDWIN J. BASART
Edwin J. Basart       |  | Director                                                                               |  | September 10, 2008
|                                             |  |                                                                                       
|/s/    MARK F. BREGMAN
Mark F. Bregman       |  | Director                                                                               |  | September 10, 2008
|                                             |  |                                                                                       
|/s/    GARY J.
DAICHENDT Gary J. Daichendt   |  | Director                                                                               |  | September 10, 2008
|                                             |  |                                                                                       
|/s/    KENNETH D.
DENMAN Kenneth D. Denman   |  | Director                                                                               |  | September 10, 2008
|                                             |  |                                                                                       
|/s/    CHARLES D.
KISSNER Charles D. Kissner |  | Director                                                                               |  | September 10, 2008
|                                             |  |                                                                                       
|/s/    EDWARD F.
THOMPSON Edward F. Thompson |  | Director                                                                               |  | September 10, 2008

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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.



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EXHIBIT INDEX



|               |  |                                                                                                                                       
|-------------- |  | --------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  | Exhibit Title                                                                                                                         
|3.1(1)         |  | Third Restated Certificate of Incorporation of the Registrant                                                                         
|               | 
|3.2(1)         |  | Second 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 equityholders.    
|               | 
|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+          |  | ShoreTel FY 2009 Executive Bonus Plan                                                                                                 
|               | 
|10.6(1) +      |  | Offer Letter, dated as of July 14, 2004, by the Registrant and John W. Combs.                                                         
|               | 
|10.7(1) +      |  | Offer Letter, dated as of September 8, 2005, by the Registrant and Joseph A. Vitalone.                                                
|               | 
|10.8(1) +      |  | Offer Letter, dated as of April 13, 2005, by the Registrant and Walter Weisner.                                                       
|               | 
|10.9(1)+       |  | Offer Letter, dated April 22, 2007, by the Registrant and Michael E. Healy                                                            
|               | 
|10.10(1) +     |  | Change of Control Agreement, dated as of August 5, 2004, between the Registrant and John W. Combs.                                    
|               | 
|10.11(1)+      |  | Change of Control Agreement, dated as of August 1, 2001, between the Registrant and Edwin J. Basart.                                  
|               | 
|10.12(3)+      |  | Employment Agreement, dated as of January 23, 2008, between the Registrant and Donald Girskis.                                        
|               | 
|10.13(1)       |  | Sublease, dated as of October 1998, between Registrant and Applied Materials, Inc., as amended.                                       
|               | 
|10.14(1)      |  | ODM Product Development and Purchase Agreement, dated as of March 19, 2004, between Registrant and Giant Electronics Ltd., as amended.
|               | 
|10.15(1)       |  | Manufacturing Services Agreement, dated October 28, 2005, between Registrant and Jabil Circuit, Inc.                                  
|               | 
|10.16(1)       |  | Office Lease Oakmead West, dated April 20, 2007, between Registrant and Carr NP Properties, L.L.C.                                    
|               | 
|21             |  | Subsidiaries                                                                                                                          
|               | 
|23.1           |  | Consent of Deloitte & Touche LLP, independent registered public accounting firm.                                                      
|               | 
|24.1           |  | Power of Attorney (included on the signature page hereto).                                                                            
|               | 
|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) | Previously filed as an exhibit to the Registrants Registration Statement on Form S-1 (333-140630).
|--- | ---------------------------------------------------------------------------------------------------

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|(2) | Previously filed as an exhibit to the Registrants Annual Report on Form 10-K for the year ended June 30, 2007
|--- | --------------------------------------------------------------------------------------------------------------



|(3) | Previously filed as an exhibit to the Registrants Quarterly Report on Form 10-Q for the quarter ended March 31, 2008
|--- | ---------------------------------------------------------------------------------------------------------------------



|+ | 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.



82