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, 2009 refers to the fiscal year ended June 30, 2009, 2008 refers to the fiscal year ended June 30, 2008, and 2007 refers to the fiscal year ended June 30, 2007.

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 700 as of June 30, 2009. Channel partners typically purchase our products

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

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

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

We are headquartered in Sunnyvale, California and the majority of our personnel work at this location. Sales and support personnel are located throughout the United States and, to a lesser extent, in the United Kingdom, Germany, Belgium, Spain, Hong Kong, Singapore and Australia. Most of our enterprise customers are located in the United States. Revenue from international sales has been less than 10% of our total revenue for 2009, 2008, and 2007, respectively. Although we intend to focus on increasing international sales, we expect that sales to enterprise customers in the United States will continue to comprise the significant majority of our sales.

We have experienced some growth despite the economic recession, with our total revenue growing to $134.8 million for 2009 from $128.7 million for 2008. This growth in revenue has largely been driven by increased revenue from support and services. Our operating expenses have increased significantly to $98.3 million for 2009 from $81.9 million for 2008. This increase in operating expenses is primarily a result of a 2009 litigation settlement, restructuring costs, increases in advertising and promotion expense, facilities expenses, and compensation expense. Compensation expense included increases in stock-based compensation and commissions and reflected higher headcount. We increased headcount from 365 at June 30, 2008 to 375 at June 30, 2009. We expect to continue to add personnel primarily in our sales and customer support areas.

Key Business Metrics

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

Initial and repeat sales orders. Our goal is to attract a significant number of new enterprise customers and to encourage existing enterprise customers to purchase additional products and support. Many enterprise customers make an initial purchase and deploy additional sites at a later date, and also buy additional products and support as their businesses expand. As our installed enterprise customer base has grown we have experienced an increase in orders attributable to existing enterprise customers, which currently represents a significant portion of our total revenue. For fiscal year 2009 order volume from existing enterprise customers represented approximately 54% of total order volume, while in fiscal year 2007 and 2008 it has been approximately 50%.

Deferred revenue. Deferred revenue relates to the timing of revenue recognition for specific transactions based on service, support, specific commitments and other factors. Deferred revenue primarily consists of billings or payments received in advance of revenue recognition from the Company's transactions described above and are recognized as the revenue recognition criteria are met. Nearly all system sales include the purchase of post-contractual support contracts with terms of up to five years, and 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 renewal rate on post contractual support contracts was approximately 80% in fiscal year 2009.

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

Gross margin for support and services is slightly lower than gross margin for products, and is impacted primarily by personnel costs and labor related expenses. The primary goal of our support and services function is to ensure a high level of 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. In recent periods, litigation costs have also adversely affected our operating costs, although with the settlement of the Mitel litigation, we expect these costs to decrease substantially. 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 81%, 86%, and 89% of our total revenue for 2009, 2008 and 2007, respectively.

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

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

Research and development expenses. Research and development expenses primarily include personnel costs, outside engineering costs, professional services, prototype costs, test equipment, software usage fees and facilities expenses. Research and development expenses are recognized when incurred. We capitalize software development costs incurred from determination of technological feasibility through general release of the product to customers. Research and development capitalized and shown under other assets was $0.5 million, $0 and $0 in fiscal 2009, 2008, and 2007, respectively.

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

Sales and marketing expenses. Sales and marketing expenses primarily include personnel costs, sales commissions, travel, marketing promotional and lead generation programs, advertising, trade shows, demo equipment, professional services fees and facilities expenses. We plan to continue to invest in development of our distribution channel by increasing the size of our field sales force and the number of our channel partners to enable us to expand into new geographies, including Europe and Asia Pacific, and further increase our sales to large enterprises. In conjunction with channel growth, we plan to increase the investment in our training and support of channel partners to enable them to more effectively sell our products. We also plan to continue investing in our

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

Other income (expense). Other income (expense) primarily consists of interest earned on cash and short-term investments 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 account for income taxes under an asset and liability approach. Deferred income taxes reflect the impact of temporary differences between assets and liabilities recognized for financial reporting purposes and such amounts recognized for income tax reporting purposes, net operating loss carry-forwards and other tax credits measured by applying currently enacted tax laws. Valuation allowances are provided when necessary to reduce deferred tax assets to an amount that is more likely than not to be realized.

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

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,
                                                       --------------------------
                                                        2009       2008     2007
                                                       -------     -----    -----
       Revenue:
       Product                                              81 %      86 %     89 %
       Support and services                                 19 %      14 %     11 %
                                                       -- ----     - ---    - ---
       Total revenue                                       100 %     100 %    100 %
       Cost of revenue:
       Product                                              28 %      29 %     30 %
       Support and services                                  8 %       8 %      7 %
                                                       -- ----     - ---    - ---
       Total cost of revenue                                36 %      37 %     37 %
                                                       -- ----     - ---    - ---
       Gross profit                                         64 %      63 %     63 %
       Operating expenses:
       Research and development                             23 %      21 %     18 %
       Sales and marketing                                  33 %      29 %     27 %
       General and administrative                           14 %      13 %     12 %
       Litigation settlement                                 3 %       -        -
                                                       -- ----     - ---    - ---
       Total operating expenses                             73 %      63 %     57 %
                                                       -- ----     - ---    - ---
       Operating income (loss)                              (9 )%      -        6 %
       Other income, net                                     1 %       3 %      -
                                                       -- ----     - ---    - ---
       Income (loss) before provision for income tax        (8 )%      3 %      6 %
       Provision for income taxes                           (1 )%     (1 )%     -
                                                       -- ----     - ---    - ---
       Net income (loss)                                    (9 )%      2 %      6 %
                                                       -- ----     - ---    - ---


     Fiscal 2009 compared to Fiscal 2008

     Revenue.


                                     Year ended
                            ----------------------------      Change
                              June 30,        June 30,     -------------
                                2009            2008          $       %
                            ------------    ------------   -------   ---
                                 (in thousands, except percentages)

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

Gross margin.

                                         Year ended
                                ----------------------------      Change
                                  June 30,        June 30,     -------------
                                    2009            2008          $       %
                                ------------    ------------   -------   ---
                                     (in thousands, except percentages)
              Cost of revenue   $     49,107    $     47,445   $ 1,662     4 %
              Gross profit      $     85,715    $     81,284   $ 4,431     5 %
              Gross margin              63.6 %          63.1 %     n/a     1 %

The increase in gross margin was attributable to an increase in support and services gross margin from 45% in 2008 to 57% in 2009. This increase was partially offset by a decline in product gross margin from 66% in 2008 to 65% in 2009 due to a decline in average selling price of our ShoreGear Switches of 10% and a decline in our IP Phones of 2%. Support and services gross margin increased due to support and services revenue increasing by 39% and service costs only increasing by 10%, compared to the same period in 2008. The service costs increase was limited to 10% as the Company deployed employee resources to a lower cost region

Operating expenses.

                                              Year ended
                                      --------------------------       Change
                                        June 30,       June 30,    ---------------
                                          2009           2008         $        %
                                      ------------    ----------   -------   -----
                                           (in thousands, except percentages)
         Operating expenses:
         Research and development     $     30,587    $   26,691   $ 3,896      15 %
         Sales and marketing          $     44,306    $   37,780   $ 6,526      17 %
         General and administrative   $     19,306    $   17,420   $ 1,886      11 %
         Litigation settlement        $      4,110    $        -   $ 4,110     n/a

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

Sales and marketing. These expenses represented 33% and 29% of total revenue in 2009 and 2008, respectively. Compensation, including stock-based compensation for sales and marketing employees represented $4.7 million of the increase. The increase in sales and marketing compensation included increases of $0.8 million in stock-based compensation, $1.5 million in commissions and $2.4 million due to increased headcount during the year. Additional increase in sales and marketing expenses included increases of $0.2 million each in restructuring expenses, consulting expenses, facilities expenses, and in travel expenses, and $1.1 million in promotional expenses.

General and administrative. These expenses represented 14% and 13% of total revenue in 2009 and 2008, respectively. Compensation for general and administrative employees, including stock-based compensation, accounted for $0.5 million of the increase. Additional increases in general and administrative expenses included $0.8 million in the provision for doubtful accounts, $0.1 million each in depreciation expense, employee relations expenses, equipment expenses and restructuring expenses, $0.3 million in sales tax expense and $0.2 million each in telecom and in legal expenses. These increases were partially offset by a decrease of $0.3 million in facilities expenses and $0.2 million in corporate bonus expense.

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

Other income

                                        Year ended
                                 -------------------------        Change
                                   June 30,      June 30,    ----------------
                                     2009          2008         $         %
                                 ------------   ----------   --------   -----
                                      (in thousands, except percentages)

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

Income tax provision.

                                       Year ended
                              ----------------------------       Change
                                June 30,        June 30,     --------------
                                  2009            2008         $        %
                              ------------    ------------   ------   -----
                                   (in thousands, except percentages)