Enterprises have historically operated separate networks for voice and data communications which resulted in significant complexity and high cost. Multi-site enterprises typically operated separate telecommunications systems at each of their sites that often were difficult to install and manage. These systems also required significant additional investments to scale and did not enable delivery of a uniform set of features and functions across all sites.

Enterprises are increasingly migrating to a single IP network for both voice and data communications to reduce costs and network complexity and increase end user productivity. This migration has created a significant market opportunity for enterprise IP telecommunications systems providers. Gartner, Inc., an independent research firm, estimates that worldwide enterprise telephony systems equipment end user revenue was $17.2 billion in 2006, including legacy TDM PBX/KTS equipment, IP-enabled PBX equipment and IP-PBX equipment.

According to Gartner, the IP-PBX market was estimated to have been $3.9 billion in 2006 and is expected to grow to $7.9 billion by 2010, which represents a 19.1% compound annual growth rate.

Multi-site enterprises typically have deployed one of three primary types of telecommunications systems: TDM systems, hybrid systems or IP systems, which include server-centric and switch-based systems. These systems are comprised of multiple phones that are independently connected to a switch within the enterprise, called the private branch exchange, or PBX.

The Company introduced its first suite of products in 1998. The Company’s solution is comprised of ShoreGear switches, ShorePhone IP phones and ShoreWare software applications. As new software versions of the Company’s solution have been released, existing enterprise customers have been able to upgrade their switches, phones and applications, allowing them to preserve their ShoreTel investment.

The Company’s 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 telecommunications can survive a variety of LAN, WAN and hardware failures.

In addition, the Company’s switches connect to the public telephone network via one of several interfaces, including T1 and E1 interfaces for high-density connectivity to the public telephone network. The Company offers five switches of varying sizes to meet the needs of enterprises of all sizes.

The Company offers a range of innovative, high performance phones to meet the needs of the different types of end users across the enterprise. The Company’s phones are designed to provide a superior combination of ergonomics, sound quality and appearance. The Company offers five phones that vary by size, display features and line capacity. ShorePhone IP phones are designed to function without any configuration, simplifying installation. The Company’s systems also support Wi-Fi phones for mobile workers.

The Company’s ShoreWare software features a number of applications that facilitate the end user experience and enterprise system management. In addition, the Company offers 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 the Company’s systems, which run entirely on ShoreGear switches.

Total gross margin increased from 54% in the three months ended September 30, 2005, to 61% in the three months ended September 30, 2006.

Research and development expenses increased $1.0 million, or 52%, from $2.1 million in the three months ended September 30, 2005, to $3.1 million in the three months ended September 30, 2006.

Sales and marketing expenses increased $2.6 million, or 85%, from $3.1 million in the three months ended September 30, 2005 to $5.7 million in the three months ended September 30, 2006.

General and administrative expenses increased $1.7 million, or 194%, from $875,000 in the three months ended September 30, 2005 to $2.6 million in the three months ended September 30, 2006.

Other income increased $127,000 from $30,000 in the three months ended September 30, 2005 to $157,000 in the three months ended September 30, 2006.