BASIS OF PRESENTATION - Note 2

9 Months Ended

Dec. 31, 2012

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, 2012. 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, 2012 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, 2012 and notes thereto included in the Company's fiscal 2012 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.

VoIP Service and Product Revenue

The Company's VoIP service and product revenue is derived from the sale of communications services and IP business telephones, respectively.

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 8x8 IP telephone constitutes a revenue arrangement with multiple deliverables. In accordance with the guidance of ASC 605-25, the Company allocates 8x8 revenues, including activation fees, among the 8x8 IP telephones and subscriber services. Revenues allocated to these devices are recognized as product revenues during the period of the sale less the allowance for estimated returns during the 30-day trial period. All other revenues are recognized as license and service revenues when the related services are provided. The Company records revenue net of any sales-related taxes that are billed to its customers. The Company believes this approach results in financial statements that are more easily understood by users.

Under the terms of the Company's typical subscription agreement, new customers can terminate their service within 30 days of order placement and receive a full refund of fees previously paid. The Company has determined that it has sufficient history of subscriber conduct to make a reasonable estimate of cancellations within the 30-day trial period. Therefore, the Company recognizes new subscriber revenue in the month in which the new order was shipped, net of an allowance for expected cancellations.

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.

Deferred Cost of Goods Sold

Deferred cost of goods sold represents the cost of products sold for which the end customer or distributor has a right of return. The cost of the products sold is recognized contemporaneously with the recognition of revenue, when the subscriber has accepted the service.

Goodwill and Other Intangible Assets

Amortization expense for the customer relationship intangible asset is included in sales and marketing expenses. Amortization expense for technology is included in cost of service revenue. The carrying values of intangible assets were as follows (in thousands):

		December 31, 2012						March 31, 2012
		Gross						Gross
		Carrying		Accumulated		Net Carrying		Carrying		Accumulated		Net Carrying
		Amount		Amortization		Amount		Amount		Amortization		Amount
Technology	$	8,242	$	(1,050)	$	7,192	$	8,242	$	(432)	$	7,810
Customer relationships		3,305		(903)		2,402		3,305		(450)		2,855
Trade names/domains		957		-		957		957		-		957
Total acquired identifiable
intangible assets	$	12,504	$	(1,953)	$	10,551	$	12,504	$	(882)	$	11,622

At December 31, 2012, annual amortization of intangible assets, based upon our existing intangible assets and current useful lives, is estimated to be the following (in thousands):

		Amount
Remaining 2013	$	357
2014		1,334
2015		1,325
2016		1,325
2017		1,318
Thereafter		3,935
Total	$	9,594

Deferred Rent

In April 2012, the Company entered into an 87-month lease agreement for its new headquarters. Under the terms of the lease agreement:

• the Company received a three month rent holiday from rental payments;
• base rent is $130,821 for the 15 months after the rent holiday; and
• rent expense increases 3% each year thereafter.

The Company also received a $1.7 million allowance for tenant improvements. In accordance with the guidance in ASC 840-20, Leases, the Company accounts for its headquarters facility operating lease as follows:

Rent Holidays. The Company recognizes the related rent expense on a straight-line basis at the earlier of the first rent payment or the date of possession of the leased property. The difference between the amounts charged to expense and the rent paid is recorded as deferred lease incentives and amortized over the lease term.

Rent Escalations. The Company recognizes escalating rent provisions on a straight-line basis over the lease term. The difference between the amounts charged to expense and the rent paid is recorded as deferred lease incentives and amortized over the lease term.

Tenant Improvement Allowance. The tenant improvement allowance is deferred and amortized on a straight-line basis over the life of the lease as a reduction to rent expense.

In the second quarter of fiscal 2013, the Company received a $1.7 million reimbursement for the cost of tenant improvements that the Company included in cash flows from operating activities. At December 31, 2012, total deferred rent included in Other accrued liabilities and Non-current liabilities was $0.1 million and $1.9 million, respectively.

Stock Purchase Right/Restricted Stock Unit and Option Activity

Stock purchase right/restricted stock unit activity since March 31, 2012 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, 2012	966,400	$	2.50	2.61
Granted	409,936		5.65
Released	(281,938)		2.16
Forfeited	(80,244)		2.72
Balance at December 31, 2012	1,014,154	$	3.85	2.62

Option activity since March 31, 2012 is summarized as follows:

				Weighted
		Shares		Average
	Shares	Subject to		Exercise
	Available	Options		Price
	for Grant	Outstanding		Per Share
Balance at March 31, 2012	375,546	6,034,335	$	1.90
Change in options available for grant	4,100,000	-		-
Granted - options	(932,000)	932,000		5.80
Stock purchase rights/restricted stock units	(409,936)	-		-
Exercised	-	(777,487)		1.48
Canceled/forfeited	135,133	(135,133)		4.01
Termination of plans	(43,004)	-		-
Balance at December 31, 2012	3,225,739	6,053,715	$	2.51

The following table summarizes the stock options outstanding and exercisable at December 31, 2012:

	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
$0.55 - $1.26	1,781,500	$	1.04	5.0	$	11,299,025	1,781,500	$	1.04	$	11,299,025
$1.27 - $1.72	1,504,919	$	1.53	2.6		8,806,130	1,504,919	$	1.53		8,806,130
$1.73 - $3.35	1,326,608	$	2.56	5.6		6,396,028	886,007	$	2.43		4,382,974
$3.36 - $5.87	1,398,688	$	5.29	8.9		2,919,012	204,018	$	5.04		477,705
$5.88 - $5.89	42,000	$	5.89	9.8		62,580	1,750	$	5.89		2,608
	6,053,715				$	29,482,775	4,378,194			$	24,968,442

Stock-based Compensation Expense

The following table summarizes the classification of stock-based compensation expense for the three and nine months ended December 31, 2012 and 2011 (in thousands):

		Three Months Ended				Nine Months Ended
		December 31,				December 31,
		2012		2011		2012		2011
Cost of service revenues	$	63	$	41	$	149	$	87
Cost of product revenues		-		-		1		-
Research and development		125		72		295		176
Sales and marketing		355		255		979		610
General and administrative		222		50		403		140
Total stock-based compensation expense related to
employee stock options and employee stock purchases, pre-tax		765		418		1,827		1,013
Tax benefit		-		-		-		-
Stock based compensation expense related to employee
stock options and employee stock purchases, net of tax	$	765	$	418	$	1,827	$	1,013

As of December 31, 2012, there was $7.4 million of unamortized stock-based compensation expense related to unvested options and stock awards which is expected to be recognized over a weighted average period of 3.14 years.

To value option grants and stock purchase rights/restricted stock units for stock-based compensation, the Company used the Black-Scholes option valuation model. Fair value determined using the Black-Scholes option valuation model 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 nine month periods ended December 31, 2012 and 2011, the Company used the historical volatility of the Company's stock over a period equal to the expected life of the options. The expected life assumptions represent the weighted-average period the 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 assumptions used to estimate the fair value of stock options to employees and directors for the three and nine months ended December 31, 2012 and 2011:

		Three Months Ended				Nine Months Ended
		December 31,				December 31,
		2012		2011		2012		2011
Expected volatility		68%		75%		68%		76%
Expected dividend yield		-		-		-		-
Risk-free interest rate		0.68%		0.44%		0.70%		0.35%
Weighted average expected option term		4.50 years		3.25 years		5.28 years		3.04 years
Weighted average fair value of options granted	$	3.18	$	1.96	$	3.32	$	2.20

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, subject to a calendar year maximum total purchase price per employee of $25,000. The Company accounts for the Employee Stock Purchase Plan as a compensatory plan and recorded compensation expense of $115,000 and $117,000 for the three months ended December 31, 2012 and 2011 and $356,000 and $312,000 for the nine months ended December 31, 2012 and 2011, 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 Black-Scholes pricing model with the following weighted average assumptions:

		Three Months Ended				Nine Months Ended
		December 31,				December 31,
		2012		2011		2012		2011
Expected volatility		-		-		34%		68%
Expected dividend yield		-		-		-		-
Risk-free interest rate		-		-		0.16%		0.10%
Weighted average expected option term		-		-		0.75 years		0.75 years
Weighted average fair value of options granted	$	-	$	-	$	1.45	$	1.49

As of December 31, 2012, there was $84,000 of total unrecognized compensation cost related to employee stock purchases. These costs are expected to be recognized over a weighted average period of 0.5 years.

The future realization of tax benefits related to stock-based 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-based compensation charges incurred during the three and nine months ended December 31, 2012 and 2011.

Segment Reporting

No customer represented greater than 10% of the Company's total revenue for the three and nine months ended December 31, 2012 or 2011. Revenue from technology licensing and related software and customers outside the United States was not material for the three and nine months ended December 31, 2012 or 2011.