BASIS OF PRESENTATION - Note 2

3 Months Ended

Jun. 30, 2013

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 consolidated financial statements for the fiscal year ended March 31, 2013. 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, 2013 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 condensed consolidated 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, 2013 and notes thereto included in the Company's fiscal 2013 Annual Report on Form 10-K.

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

Service and Product Revenue

The Company recognizes service revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, price is fixed or determinable and collectability is reasonably assured. The Company defers recognition of service revenues in instances when cash receipts are received before services are delivered and recognizes deferred revenues ratably as services are provided.

The Company recognizes revenue from product sales for which there are no related services to be rendered upon shipment to customers 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 customer 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 customer.

The Company records revenue net of any sales-related taxes that are billed to its customers. The Company believes this approach results in consolidated 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.

Multiple Element Arrangements

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.  The provisioning of the 8x8 VoIP service with the accompanying 8x8 IP telephone constitutes a revenue arrangement with multiple deliverables.  For arrangements with multiple deliverables, the Company allocates the arrangement consideration to all deliverables based on their relative selling prices. In such circumstances, the accounting principles establish a hierarchy to determine the relative selling price to be used for allocating arrangement consideration to deliverables as follows: (i) vendor-specific objective evidence of fair value ("VSOE"), (ii) third-party evidence of selling price ("TPE"), and (iii) best estimate of the selling price ("BESP").

VSOE generally exists only when the Company sells the deliverable separately, on more than a limited basis, at prices within a relatively narrow range.  When VSOE cannot be established, the Company attempts to establish the selling price of deliverables based on relevant TPE. TPE is determined based on manufacturer's prices for similar deliverables when sold separately, when possible. When the Company is unable to establish selling price using VSOE or TPE, it uses a BESP for the allocation of arrangement consideration. The objective of BESP is to determine the price at which the Company would transact a sale if the product or service was sold on a stand-alone basis. BESP is generally used for offerings that are not typically sold on a stand-alone basis or for new or highly customized offerings. The Company determines BESP for a product or service by considering multiple factors including, but not limited to:

• the price list established by its management which is typically based on general pricing practices and targeted gross margin of products and services sold; and
• analysis of pricing history of new arrangements, including multiple element and stand-alone transactions.

In accordance with the guidance of ASC 605-25, when the Company enters into revenue arrangements with multiple deliverables the Company allocates arrangement consideration, including activation fees, among the 8x8 IP telephones and subscriber services based on the their relative selling prices. Arrangement consideration allocated to the IP telephones is recognized as product revenues during the period of the sale less the allowance for estimated returns during the 30-day trial period. Arrangement consideration allocated to subscriber services is recognized ratably as service revenues as the related services are provided, which is generally over the initial contract term.

No customer represented greater than 10% of the Company's total revenue for the three months ended June 30, 2013 or 2012. Revenue from technology licensing and related software and customers outside the United States was not material for the three months ended June 30, 2013 or 2012.

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.

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):

		June 30, 2013						March 31, 2013
		Gross						Gross
		Carrying		Accumulated		Net Carrying		Carrying		Accumulated		Net Carrying
		Amount		Amortization		Amount		Amount		Amortization		Amount
Technology	$	8,242	$	(1,462)	$	6,780	$	8,242	$	(1,256)	$	6,986
Customer relationships		3,305		(1,188)		2,117		3,305		(1,054)		2,251
Trade names/domains		957		-		957		957		-		957
Total acquired identifiable
intangible assets	$	12,504	$	(2,650)	$	9,854	$	12,504	$	(2,310)	$	10,194

At June 30, 2013, 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 2014	$	994
2015		1,325
2016		1,325
2017		1,318
2018		1,070
Thereafter		2,865
Total	$	8,897

Research, Development and Software Costs

The Company accounts for software to be sold or otherwise marketed in accordance with ASC 985-20, Costs of Software to be Sold, Leased or Marketed which requires capitalization of certain software development costs subsequent to the establishment of technological feasibility. The Company defines establishment of technological feasibility as the completion of a working model. Software development costs for software to be sold or otherwise marketed incurred prior to the establishment of technological feasibility are included in research and development and are expensed as incurred. Software development costs incurred subsequent to the establishment of technological feasibility through the period of general market availability of the product are capitalized, if material.

In the first fiscal quarter of 2014, the Company capitalized $0.3 million of software development costs in accordance with ASC 985-20. At June 30, 2013, total capitalized software development costs included in other long-term assets was approximately $0.5 million and there were no accumulated amortization costs related to capitalized software.

Stock Purchase Right/Restricted Stock Unit and Option Activity

Stock purchase right activity for the three months ended June 30, 2013 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, 2013	958,575	$	4.11	2.52
Granted	-		-
Released	(85,205)		2.29
Forfeited	(8,750)		5.30
Balance at June 30, 2013	864,620	$	4.27	2.36

Restricted stock unit activity for the three months ended June 30, 2013 is summarized as follows:

				Weighted
			Weighted	Average
			Average	Remaining
	Number of		Purchase	Contractual
	Shares		Price	Term (in Years)
Balance at March 31, 2013	25,000	$	-	2.47
Granted	73,500		-
Released	-		-
Forfeited	-		-
Balance at June 30, 2013	98,500	$	-	2.28

Option activity for the three months ended June 30, 2013 is summarized as follows:

				Weighted
		Shares		Average
	Shares	Subject to		Exercise
	Available	Options		Price
	for Grant	Outstanding		Per Share
Balance at March 31, 2013	3,175,261	5,991,544	$	2.52
Granted - options	(90,000)	90,000		7.56
Stock purchase rights/restricted stock unit (1)	(73,500)	-		-
Exercised	-	(575,570)		2.25
Canceled/forfeited	10,046	(10,046)		3.83
Termination of plans	(1,774)	-		-
Balance at June 30, 2013	3,020,033	5,495,928	$	2.63

(1) The reduction to shares available for grant includes awards granted of 73,500 shares.

The following table summarizes the stock options outstanding and exercisable at June 30, 2013:

	Options Outstanding						Options Exercisable
			Weighted	Weighted					Weighted
			Average	Average					Average
			Exercise	Remaining		Aggregate			Exercise		Aggregate
Range of			Price	Contractual		Intrinsic			Price		Intrinsic
Exercise Price	Shares		Per Share	Life (Years)		Value	Shares		Per Share		Value
$0.55 - $1.26	1,760,000	$	1.04	4.4	$	12,676,010	1,760,000	$	1.04	$	12,676,010
$1.27 - $1.77	1,112,961	$	1.49	2.7		7,515,829	1,112,961	$	1.49		7,515,829
$1.78 - $3.35	1,205,402	$	2.61	5.3		6,786,158	880,627	$	2.54		5,021,497
$3.36 - $5.87	1,285,565	$	5.35	8.9		3,711,260	330,931	$	5.16		1,019,054
$5.88 - $7.56	132,000	$	7.03	9.7		159,900	10,749	$	6.47		18,999
	5,495,928				$	30,849,157	4,095,268			$	26,251,389

Stock-based Compensation Expense

As of June 30, 2013, there was $7.1 million of unamortized stock-based compensation expense related to unvested stock awards which is expected to be recognized over a weighted average period of 2.74 years.

To value option grants and stock purchase rights 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 month periods ended June 30, 2013 and 2012, the Company used the historical volatility of the Company's stock over a period equal to the expected life of the options to their fair value. 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 compute reported stock-based compensation to employees and directors for the three months ended June 30, 2013 and 2012:

		Three Months Ended
		June 30,
		2013		2012
Expected volatility		66%		70%
Expected dividend yield		-		-
Risk-free interest rate		0.73%		0.60%
Weighted average expected option term		4.50 years		4.30 years
Weighted average fair value of options granted	$	3.96	$	2.25

In accordance with ASC 718 - Stock Compensation, the Company recorded $718,000 and $382,000 in compensation expense relative to stock-based awards for the three months ended June 30, 2013 and 2012, respectively.

Employee Stock Purchase Plan

Under the Company's Employee Stock Purchase Plan, or ESPP, 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 ESPP as a compensatory plan and recorded compensation expense of $189,000 and $174,000 for the three months ended June 30, 2013 and 2012, respectively, in accordance with ASC 718.

As of June 30, 2013, there was $186,000 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.

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-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 months ended June 30, 2013 and 2012.

The following table summarizes the classification 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 months ended June 30, 2013 and 2012 which was recorded as follows (in thousands):

		Three Months Ended
		June 30,
		2013		2012
Cost of service revenues	$	68	$	43
Cost of product revenues		-		1
Research and development		154		95
Sales and marketing		347		316
General and administrative		338		101
Total stock-based compensation expense related to
employee stock options and employee stock purchases, pre-tax		907		556
Tax benefit		-		-
Stock-based compensation expense related to employee
stock options and employee stock purchases, net of tax	$	907	$	556