BASIS OF PRESENTATION - Note 2

6 Months Ended

Sep. 30, 2011

Notes to Financial Statements

BASIS OF PRESENTATION - Note 2

2. BASIS OF PRESENTATION

The accompanying interim condensed consolidated financial statements are unaudited and have been prepared on substantially the same basis as our annual financial statements for the fiscal year ended March 31, 2011. In the opinion of the Company's management, these financial statements reflect all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair statement of our financial position, results of operations and cash flows for the periods presented. The preparation of financial statements in conformity with generally accepted accounting principles 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 condensed consolidated financial statements and the reported amounts of revenue and expenses during the reporting periods. Actual results could differ from these estimates.

The March 31, 2011 year-end condensed consolidated balance sheet data in this document were derived from audited consolidated financial statements and do not include all of the disclosures required by U.S. generally accepted accounting principles. These financial statements should be read in conjunction with the Company's audited consolidated financial statements as of and for the fiscal year ended March 31, 2011 and notes thereto included in the Company's fiscal 2011 Annual Report on Form 10-K.

The results of operations and cash flows for the interim periods included in these financial statements are not necessarily indicative of the results to be expected for any future period or the entire fiscal year.

Service Revenue

The Company recognizes new subscriber revenue in the month in which the new order is shipped, net of an allowance for expected cancellations. The allowance for expected cancellations is based on the Company's history of subscriber cancellations within the 30-day trial period offered with new services.

Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") 605-25 requires that revenue arrangements with multiple deliverables be divided into separate units of accounting if the deliverables in the arrangement meet specific criteria. In addition, arrangement consideration must be allocated among the separate units of accounting based on their relative fair values, with certain limitations. The provisioning of the 8x8 service with the accompanying IP phone equipment constitutes a revenue arrangement with multiple deliverables. In accordance with the guidance of ASC 605-25, the Company allocates revenue from new subscriptions, including activation fees, between the IP phone equipment and subscriber services. Revenue allocated to the IP phone equipment is recognized as product revenue during the period of the sale less the allowance for estimated returns during the 30-day trial period. All other revenue is recognized when the related services are provided.

Product revenue

The Company recognizes revenue from product sales for which there are no related services to be rendered upon shipment to partners and end users provided that persuasive evidence of an arrangement exists, the price is fixed, title has transferred, collection of resulting receivables is reasonably assured, there are no customer acceptance requirements, and there are no remaining significant obligations. Gross outbound shipping and handling charges are recorded as revenue, and the related costs are included in cost of goods sold. Reserves for returns and allowances for partner and end user sales are recorded at the time of shipment. In accordance with the ASC 985-605, the Company records shipments to distributors, retailers, and resellers, where the right of return exists, as deferred revenue. The Company defers recognition of revenue on sales to distributors, retailers, and resellers until products are resold to the end user.

Deferred Cost of Goods Sold

Deferred cost of goods sold represents the cost of products sold for which the customer has a right of return. The cost of the products sold is recognized contemporaneously with the recognition of revenue.

Goodwill and Other Intangible Assets

Goodwill and intangible assets with indefinite useful lives are not amortized. Intangible assets with finite useful lives are amortized on a straight-line basis over the periods benefited. The Company reviews the recoverability of its long-lived assets, such as plant and equipment, when events or changes in circumstances occur that indicate that the carrying value of the asset or asset group may not be recoverable. The assessment of possible impairment is based on the Company's ability to recover the carrying value of the asset or asset group from the expected future pre-tax cash flows (undiscounted and without interest charges) of the related operations. If these cash flows are less than the carrying value of such asset, an impairment loss is recognized for the difference between estimated fair value and carrying value. The measurement of impairment requires management to estimate future cash flows and the fair value of long-lived assets.

Amortization expense for the customer relationship intangible asset is included in selling, general and administrative expenses. Amortization expense for technology is included in cost of service revenue. The carrying values of intangible assets as of September 30, 2011 and 2010 were as follows (in thousands):

		September 30, 2011						September 30, 2010
		Gross						Gross
		Carrying		Accumulated		Net Carrying		Carrying		Accumulated		Net Carrying
		Amount		Amortization		Amount		Amount		Amortization		Amount
Technology	$	8,242	$	(20)	$	8,222	$	-	$	-	$	-
Customer relationships		3,305		(148)		3,157		308		(43)		265
Trade names/domains		957		-		957		-		-		-
Total acquired identifiable
intangible assets	$	12,504	$	(168)	$	12,336	$	308	$	(43)	$	265

Annual amortization of intangible assets, based upon our existing intangible assets and current useful lives, is estimated to be the following as of September 30, 2011 (in thousands):

		Amount
Remaining 2012	$	714
2013		1,428
2014		1,334
2015		1,325
2016		1,325
Thereafter		5,253
Total	$	11,379

Warrant Liability

The Company previously had two outstanding warrants that were classified as liabilities, which expired on December 19, 2010. The Company accounts for its warrants in accordance with ASC 480-10 which requires warrants to be classified as permanent equity, temporary equity or as assets or liabilities. In general, warrants that either require net-cash settlement or are presumed to require net-cash settlement are recorded as assets and liabilities at fair value and warrants that require settlement in shares are recorded as equity instruments.

Accounting for Stock-Based Compensation

The Company accounts for stock-based compensation under ASC 718 - Stock Compensation which establishes standards for the accounting for equity instruments exchanged for employee services. Under the provisions of ASC 718, share-based compensation cost is measured at the grant date, based on the estimated fair value of the award, and is recognized as an expense over the employee's requisite service period (generally the vesting period of the equity grant), net of estimated forfeitures.

Stock-based compensation expense recognized in the Company's condensed consolidated statements of income for the three and six months ended September 30, 2011 included the unvested portion of stock-based awards granted. Stock-based awards were measured based on ASC 718 criteria and the compensation expense for all share-based payment awards granted is recognized using the straight-line single-option method. Stock-based compensation expense includes the impact of estimated forfeitures. ASC 718 requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.

Stock-based Compensation Plans

The Company has several stock-based compensation plans that are described in Note 5 "Stockholders' Equity" of the Notes to Consolidated Financial Statements contained in the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 2011. The Company, under its various equity plans, grants stock-based awards for shares of common stock to employees, non-employee directors and consultants.

As of September 30, 2011, the 1992 Stock Plan, 1996 Stock Plan and 1996 Director Option Plan had expired and the 1999 Nonstatutory Stock Option Plan had been cancelled by the Board, but there were unexercised options granted under these plans. Options granted under these plans generally vested over four years, were granted at fair market value on the date of the grant and expire ten years from that date.

The Company has reserved a total of 7,000,000 shares of common stock for issuance under its 2006 Stock Plan (the "2006 Plan"). The 2006 Plan is the Company's only active plan for providing stock-based incentive compensation ("awards") to its eligible employees, non-employee directors or consultants. Awards that may be granted under the 2006 Plan include incentive stock options, nonstatutory stock options and stock purchase rights. The exercise price of incentive stock options granted and purchase price of stock purchase rights may not be less than the fair market value on the effective date of the grant. Other types of options and awards under the 2006 Plan may be granted at any price approved by the administrator, which generally will be the board of directors. Options and stock purchase rights generally vest over four years and expire ten years after grant. The 2006 Plan expires in May 2016.

In the second fiscal quarter of 2012, the Company assumed the Amended and Restated Contactual, Inc. 2003 Stock Option Plan (the "2003 Contactual Plan") and registered an aggregate of 171,974 shares of the Company's common stock that may be issued upon the exercise of stock options previously granted under the 2003 Contactual Plan. No new grants can be granted under 2003 Contactual Plan.

Option and Stock Purchase Right Activity

Stock purchase right activity since March 31, 2011 is summarized as follows:

			Weighted	Weighted
			Average	Average
			Grant-Date	Remaining
	Number of		Fair Market	Contractual
	Shares		Value	Term (in Years)
Balance at March 31, 2011	886,445	$	1.51
Granted	401,568		3.41
Released	(136,576)		1.24
Forfeited	-		-
Balance at September 30, 2011	1,151,437	$	2.20	2.91

Option activity since March 31, 2011 is summarized as follows:

				Weighted
		Shares		Average
	Shares	Subject to		Exercise
	Available	Options		Price
	for Grant	Outstanding		Per Share
Balance at March 31, 2011	1,553,979	6,969,196	$	1.56
Granted (1)(2)	(567,568)	337,974		3.77
Exercised	-	(252,772)		1.38
Canceled/forfeited	10,000	(10,000)		2.58
Termination of plans	-	-		-
Balance at September 30, 2011	996,411	7,044,398	$	1.65

(1) The reduction to shares available for grant includes awards granted of 401,568.
(2) The increase to shares subject to options outstanding includes 171,974 options assumed under the 2003 Contactual Plan.

The following table summarizes the stock options outstanding and exercisable at September 30, 2011:

	Options Outstanding						Options Exercisable
			Weighted	Weighted					Weighted
			Average	Average					Average
			Exercise	Remaining		Aggregate			Exercise		Aggregate
			Price	Contractual		Intrinsic			Price		Intrinsic
	Shares		Per Share	Life (Years)		Value	Shares		Per Share		Value
$0.01 - $1.15	1,438,641	$	0.87	6.38	$	4,584,830	1,438,641	$	0.87	$	4,584,830
$1.16 - $1.27	1,832,990	$	1.25	4.92		5,149,017	1,832,990	$	1.25		5,149,017
$1.28 - $1.72	1,409,098	$	1.50	3.99		3,605,214	1,409,098	$	1.50		3,605,214
$1.73 - $2.69	1,423,169	$	1.92	4.08		3,048,963	1,239,452	$	1.85		2,741,702
$2.70 - $4.95	940,500	$	3.43	6.62		756,375	399,500	$	3.62		251,355
	7,044,398				$	17,144,399	6,319,681			$	16,332,118

Stock-based Compensation Expense

As of September 30, 2011, there was $3.2 million of unamortized stock-based compensation expense related to unvested stock awards which is expected to be recognized over a weighted average period of 3.38 years.

To value option grants and other awards for actual and pro forma stock-based compensation, the Company has used the Black-Scholes option valuation model. When the measurement date is certain, the fair value of each option grant is estimated on the date of grant. Fair value determined using Black-Scholes varies based on assumptions used for the expected stock price volatility, expected life, risk-free interest rates and future dividend payments. During the three and six month periods ended September 30, 2011 and 2010, the Company used historical volatility of the common stock over a period equal to the expected life of the options to estimate their fair value. The expected life assumption represents the weighted-average period stock-based awards are expected to remain outstanding. These expected life assumptions are established through the review of historical exercise behavior of stock-based award grants with similar vesting periods. The risk-free interest rate is based on the closing market bid yields on actively traded U.S. treasury securities in the over-the-counter market for the expected term equal to the expected term of the option. The dividend yield assumption is based on the Company's history and expectation of future dividend payouts.

The following table summarizes the weighted average assumptions used to compute reported stock-based compensation to employees and directors for the three and six months ended September 30, 2011 and 2010:

		Three Months Ended				Six Months Ended
		September 30,				September 30,
		2011		2010		2011		2010
Expected volatility		76%		-		76%		-
Expected dividend yield		-		-		-		-
Risk-free interest rate		0.31%		-		0.33%		-
Weighted average expected option term		3.00 years		-		3.00 years		-
Weighted average fair value of options granted	$	2.27	$	-	$	2.25	$	-

In accordance with ASC 718, the Company recorded $214,000 and $37,000 in compensation expense relative to stock-based awards for the three months ended September 30, 2011 and 2010 and $400,000 and $56,000 for the six months ended September 30, 2011 and 2010, respectively.

Employee Stock Purchase Plan

Under the Company's Employee Stock Purchase Plan, eligible employees can participate and purchase common stock semi-annually through payroll deductions at a price equal to 85% of the fair market value of the common stock at the beginning of each one year offering period or the end of the applicable six month purchase period within that offering period, whichever is lower. The contribution amount may not exceed 10% of an employee's base compensation, including commissions but not including bonuses and overtime. The Company accounts for the Employee Stock Purchase Plan as a compensatory plan and recorded compensation expense of $115,000 and $19,000 for the three months ended September 30, 2011 and 2010 and $195,000 and $73,000 for the six months ended September 30, 2011 and 2010, respectively, in accordance with ASC 718.

The estimated fair value of stock purchase rights granted under the Employee Stock Purchase Plan was estimated at the date of grant using the Black-Scholes pricing model with the following weighted-average assumptions:

		Three Months Ended				Six Months Ended
		September 30,				September 30,
		2011		2010		2011		2010
Expected volatility		68%		64%		68%		64%
Expected dividend yield		-		-		-		-
Risk-free interest rate		0.10%		0.24%		0.10%		0.24%
Weighted average expected option term		0.75 years		0.75 years		0.75 years		0.75 years
Weighted average fair value of options granted	$	1.49	$	0.53	$	1.49	$	0.53

As of September 30, 2011, there was $225,000 of total unrecognized compensation cost related to employee stock purchases. These costs are expected to be recognized over a weighted average period of 0.6 years.

ASC 718 requires the benefits of tax deductions in excess of recognized compensation costs to be reported as a financing cash flow, rather than as an operating cash flow. The future realization of tax benefits related to stock compensation is dependent upon the timing of employee exercises and future taxable income, among other factors. The Company did not realize any tax benefit from the stock compensation charge incurred during the three and six months ended September 30, 2011 and 2010 as the Company believes that it is more likely than not that it will not realize the benefit from tax deductions related to such equity compensation.

The following table summarizes the distribution of stock-based compensation expense related to employee stock options and employee stock purchases under ASC 718 among the Company's operating functions for the three and six months ended September 30, 2011 and 2010 which was recorded as follows (in thousands):

		Three Months Ended				Six Months Ended
		September 30,				September 30,
		2011		2010		2011		2010
Cost of service revenues	$	26	$	7	$	46	$	16
Cost of product revenues		-		-		-		-
Research and development		56		15		104		37
Selling, general and administrative		247		34		445		76
Total stock-based compensation expense
related to employee stock options and
employee stock purchases, pre-tax		329		56		595		129
Tax benefit		-		-		-		-
Stock based compensation expense related to
employee stock options and employee stock
purchases, net of tax	$	329	$	56	$	595	$	129

Recent Accounting Pronouncements

In December 2010, FASB issued ASU 2010-29, "Business Combinations (Topic 805): Disclosure of Supplementary Pro Forma Information for Business Combinations (a consensus of the FASB Emerging Issues Task Force)." ASU 2010-29 provides amendments to subtopic 805-10 of the FASB ASC, that requires a public entity to disclose pro forma information for business combinations that occurred in the current reporting period. ASU 2010-29 is effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010, with early adoption permitted. The adoption of ASU 2010-29 did not have a material impact on the Company's consolidated results of operation and financial condition.

In May 2011, the FASB issued ASU 2011-04, "Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards ("IFRSs")." Under ASU 2011-04, the guidance amends certain accounting and disclosure requirements related to fair value measurements to ensure that fair value has the same meaning in U.S. GAAP and in IFRSs and that their respective fair value measurement and disclosure requirements are the same. ASU 2011-03 is effective for public entities during interim and annual periods beginning after December 15, 2011. Early adoption by public entities is not permitted. The Company does not believe that the adoption of ASU 2011-04 will have a material impact on the Company's consolidated results of operation and financial condition.

In June 2011, the FASB issued ASU No. 2011-05, "Comprehensive Income (ASC Topic 220): Presentation of Comprehensive Income," ("ASU 2011-05") which amends current comprehensive income guidance. This accounting update eliminates the option to present the components of other comprehensive income as part of the statement of shareholders' equity. Instead, we must report comprehensive income in either a single continuous statement of comprehensive income which contains two sections, net income and other comprehensive income, or in two separate but consecutive statements. ASU 2011-05 will be effective for public companies during the interim and annual periods beginning after Dec. 15, 2011 with early adoption permitted. The Company does not believe that the adoption of ASU 2011-05 will have a material impact on the Company's consolidated results of operation and financial condition.

In September 2011, the FASB issued ASU No. 2011-08, "Intangibles - Goodwill and Other (Topic 350): Testing Goodwill for Impairment," ("ASU 2011-08") which simplifies how entities test goodwill for impairment. This accounting update permits an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step good will impairment test described in Topic 350. The more-likely- than-not threshold is defined as having a likelyhood of more than 50 percent. ASU 2011-08 will be effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011 with early adoption permitted. We do not believe that the adoption of ASU 2011-08 will have a material impact on the Company's consolidated results of operation and financial condition.