8x8
Annual Report 2010

Plain-text annual report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended March 31, 2010 Commission file number 000-21783 (Exact name of Registrant as Specified in its Charter) Delaware (State or Other Jurisdiction of Incorporation or Organization) 77-0142404 (I.R.S. Employer Identification Number) 810 West Maude Avenue Sunnyvale, CA 94085 (Address of Principal Executive Offices including Zip Code) (408) 727-1885 (Registrant's Telephone Number, Including Area Code) Securities registered pursuant to Section 12(b) of the Act: Title of each class COMMON STOCK, PAR VALUE $.001 PER SHARE Name of each exchange on which registered NASDAQ Stock Market LLC Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. (cid:133) YES ⌧ NO Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. (cid:133) YES ⌧ NO Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ⌧ YES (cid:133) NO Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). (cid:133) YES (cid:133) NO Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K, or any amendment to this Form 10-K. ⌧ Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer (cid:133) Accelerated filer ⌧ Smaller reporting company (cid:133) Non-accelerated filer (cid:133) (Do not check if a smaller reporting company) Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act.) Yes (cid:133) No ⌧ Based on the closing sale price of the Registrant's common stock on the NASDAQ Capital Market System on September 30, 2009, the aggregate market value of the voting stock held by non-affiliates of the Registrant was $54,517,980. For purposes of this disclosure, shares of common stock held by persons who hold more than 5% of the outstanding shares of common stock and shares held by officers and directors of the Registrant have been excluded because such persons may be deemed to be affiliates. The determination of affiliate status for this purpose is not necessarily a conclusive determination for any other purpose. The number of shares of the Registrant's common stock outstanding as of May 24, 2010 was 63,575,488. DOCUMENTS INCORPORATED BY REFERENCE Items 10, 11, 12, 13 and 14 of Part III incorporate information by reference from the Proxy Statement to be filed within 120 days of March 31, 2010 for the 2010 Annual Meeting of Stockholders. 8X8, INC. INDEX TO ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED MARCH 31, 2010 Part I. Item 1. Business Item 1A. Risk Factors Item 1B. Unresolved Staff Comments Item 2. Properties Item 3. Legal Proceedings Item 4. (Removed and Reserved) Part II. Item 5. Market for Registrant's Common Stock and Related Security Holder Matters Item 6. Selected Financial Data Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Item 7A. Quantitative and Qualitative Disclosures About Market Risk Item 8. Financial Statements and Supplementary Data Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Item 9A. Controls and Procedures Item 9B. Other Information Part III. Item 10. Directors, Executive Officers and Corporate Governance Item 11. Executive Compensation Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Item 13. Certain Relationships and Related Transactions, and Director Independence Item 14. Principal Accountant Fees and Services Part IV. Item 15. Exhibits and Financial Statement Schedules Signatures Page 1 11 24 25 25 25 25 27 27 40 40 68 68 69 69 69 70 70 70 70 71 ITEM 1. BUSINESS Forward-Looking Statements and Risk Factors PART I Statements contained in this annual report on Form 10-K, or Annual Report, regarding our expectations, beliefs, estimates, intentions or strategies are forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. Any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. For example, words such as “may,” “will,” “should,” “estimates,” “predicts,” “potential,” “continue,” “strategy,” “believes,” “anticipates,” “plans,” “expects,” “intends,” and similar expressions are intended to identify forward-looking statements. You should not place undue reliance on these forward-looking statements. Actual results and trends may differ materially from historical results or those projected in any such forward-looking statements depending on a variety of factors. These factors include, but are not limited to, customer acceptance and demand for our voice over Internet protocol, or VoIP, telephony products and services, the reliability of our services, the prices for our services, customer renewal rates, customer acquisition costs, actions by our competitors, including price reductions for their telephone services, potential federal and state regulatory actions, compliance costs, potential warranty claims and product defects, our needs for and the availability of adequate working capital, our ability to innovate technologically, the timely supply of products by our contract manufacturers, potential future intellectual property infringement claims that could adversely affect our business and operating results, and our ability to retain our listing on the NASDAQ Capital Market. The forward-looking statements may also be impacted by the additional risks faced by us as described in this Report, including those set forth under the section entitled "Factors that May Affect Future Results." All forward-looking statements included in this Annual Report are based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements. Readers are urged to carefully review and consider the various disclosures made in this Annual Report, which attempt to advise interested parties of the risks and factors that may affect our business, financial condition, results of operations and prospects. Our fiscal year ends on March 31 of each calendar year. Each reference to a fiscal year in this Annual Report, refers to the fiscal year ending March 31 of the calendar year indicated (for example, fiscal 2010 refers to the fiscal year ended March 31, 2010). Unless the context requires otherwise, references to “we,” “us,” “our,” “8x8” and the “Company” refer to 8x8, Inc. and its consolidated subsidiaries. Overview 8x8 develops and markets telecommunications services for Internet protocol, or IP, telephony and video applications as well as web-based conferencing and unified communications services. We offer the 8x8 VoIP (Voice over Internet Protocol) voice and video digital phone service, 8x8 Virtual Office hosted PBX service, 8x8 Complete Contact Center service, 8x8 Trunking service, 8x8 Hosted Key System service, 8x8 MobileTalk service, 8x8 Virtual Meeting web conferencing service and the 8x8 Virtual Office Pro unified communications solution. We launched 8x8 digital phone service in November 2002, the 8x8 Virtual Office hosted PBX business service in March 2004, the 8x8 videophone service in June 2004, the 8x8 Complete Contact Center in July 2007, the 8x8 MobileTalk service in November 2007, the 8x8 Trunking service in June 2008, the 8x8 Hosted Key System service in July 2008, the 8x8 Virtual Meeting web conferencing service in September 2009 and the 8x8 Virtual Office Pro unified communications solution in January 2010. In May 2010, we acquired Central Host, Inc., a provider of managed hosting and cloud-based computing solutions and began offering 8x8 Managed Hosting and Cloud-Based Computing solutions to business customers. Between November 2002 and April 2009, we marketed our services under the Packet8 brand. In May 2009, we began marketing our services under the 8x8 brand. As of March 31, 2010, we had more than 20,000 business customers who use our services as their primary business telephone system. Each business customer subscribes to a number of various lines and services (e.g. physical phone extensions, virtual extensions, fax lines, toll free numbers, receptionist software, unified communications services, etc.) 1 The 8x8 voice and video broadband phone service enables broadband Internet users to add digital voice and video communications services to their high-speed Internet connections. Customers can choose a regular direct-dial phone number from any of the rate centers offered by the service and then use an existing telephone to make and receive calls over a standard broadband Internet connection. All 8x8 telephone accounts come with bundled voice mail, caller ID, call waiting, call waiting caller ID, call forwarding, hold, line-alternate, 3-way conferencing, web and voice-prompt access to account controls, and online billing. In addition, we offer videophones and video telephony software in conjunction with our service plans that connect to a customer’s high-speed Internet network to deliver all of the voice features above, as well as unlimited video calls, to any other 8x8 videophone customer worldwide. The 8x8 Virtual Office suite of business phone services offers small and medium-sized businesses feature-rich, HD (high definition) audio-enhanced communications services that eliminate the need for traditional telecommunications services and business phone systems. The 8x8 Virtual Office solution essentially replaces an on-premise PBX (private branch exchange), telephone system with a hosted, Internet-based business phone service that is delivered over a managed or unmanaged Internet connection. We sell pre-programmed IP telephones with speakerphones and a display screen, in conjunction with our Virtual Office service plans, which enable our business customers to access additional Virtual Office features through on-screen phone menus. The 8x8 Virtual Office Pro unified communications solution, introduced in January 2010, bundles the 8x8 Virtual Office hosted PBX phone service with other essential businesses software communications services such as web conferencing, call recording and archiving, Internet fax, chat, voicemail and presence management and a mobile iPhone/iPad extension in a competitively priced offering. 8x8 Virtual Office Pro takes the functionality of an already powerful hosted PBX phone service to a new level with high fidelity HD voice, remote accessibility via any web browser or smart phone and integration with vital collaboration tools. Available Information We maintain a corporate Internet website at the address http://www.8x8.com. The contents of this website are not incorporated in or otherwise to be regarded as part of this Annual Report. We file reports with the Securities and Exchange Commission, or SEC, which are available on our website free of charge. These reports include annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to such reports, each of which is provided on our website as soon as reasonably practical after we electronically file such materials with or furnish them to the SEC. You can also read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. You can obtain additional information about the operation of the Public Reference Room by calling the SEC at 1.800.SEC.0330. In addition, the SEC maintains a website (www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC, including 8x8. Industry Background The technology we employ to deliver our service, known as Voice over Internet Protocol (VoIP), enables communications over the Internet through the compression of voice, video and/or other media into data packets that can be efficiently transmitted over data networks and then converted back into the original media at the other end. Data networks, such as the Internet or local area networks, or LANs, have always utilized packet-switched technology to transmit information between two communicating terminals (for example, a PC downloading a page from a web server, or one computer sending an e-mail message to another computer). IP is the most commonly used protocol for communicating on these packet switched networks. VoIP allows for the transmission of voice and data over these same packet-switched networks, providing an alternative to traditional telephone networks which use a fixed electrical path to carry voice signals through a series of switches to a destination. As a result of the potential cost savings and added features of VoIP, consumers, enterprises, traditional telecommunication service providers and cable television providers view VoIP as the future of telecommunications. VoIP has experienced significant growth in recent years due to: • Demand for lower cost telephone service; • Improved quality and reliability of VoIP calls due to technological advances, increased network development and greater bandwidth capacity; and • New product innovations that allow VoIP providers to offer services not currently offered by traditional telephone companies. 2 The traditional telephone networks maintained by many local and long distance telephone companies, known as the public- switched telephone networks, or PSTN, were designed solely to carry low-fidelity audio signals with a high level of reliability. Although these traditional telephone networks are very reliable for voice communications, we believe these networks are not well-suited to service the explosive growth of digital communication applications for the following reasons: • They are expensive to build because each subscriber's telephone must be individually connected to the central office switch, which is usually several miles away from a typical subscriber's location; • They transmit data at very low rates and resolutions, making them poorly suited for delivering high-fidelity audio, entertainment-quality video or other rich multimedia content; • They use dedicated circuits for each telephone call which allot fixed bandwidth throughout the duration of each call, whether or not voice is actually being transmitted which is an inefficient use of the investment in the network; and • They may experience difficulty in providing new or differentiated services or functions, such as video communications, that the network was not originally designed to accommodate. Until recently, traditional telephone companies have avoided the use of packet-switched networks for transmitting voice calls due to the potential for poor sound quality attributable to latency issues (delays) and lost packets which can prevent real-time transmission. Recent improvements in packet-switching technology, compression and broadband access technologies, as well as improved hardware and provisioning techniques, have significantly improved the quality and usability of packet-switched voice calls. Historically, packet-switched networks were built mainly for carrying non real-time data, although they are now fully capable of transmitting real time data. The advantages of such networks are their efficiency, flexibility and scalability. Bandwidth is only consumed when needed. Networks can be built in a variety of configurations to suit the number of users, client/server application requirements and desired availability of bandwidth, and many terminals can share the same connection to the network. As a result, significantly more traffic can be transmitted over a packet-switched network, such as a home network or the Internet, than a circuit-switched telephony network. Packet-switching technology allows service providers to converge their traditionally separate voice and data networks and more efficiently utilize their networks by carrying voice, video, facsimile and data traffic over the same network. The improved efficiency of packet switching technology creates network cost savings that can be passed on to the consumer in the form of lower telephony rates. The growth of the Internet in recent years has proven the scalability of these underlying packet-switched networks. As broadband connectivity, including cable modem and digital subscriber line (or DSL), has become more available and less expensive, it is now possible for service providers like 8x8 to offer voice and video services that run over these IP networks to businesses and residential consumers. Providing such services has the potential to both substantially lower the cost of telephone service and equipment to these customers and increase the breadth of features available to our subscribers. Services like full- motion, two-way video are now supported by the bandwidth spectrum commonly available to broadband customers, whether business or residential. Our Strategy Our objective is to provide reliable, scalable, and profitable worldwide Internet-based communications services with unmatched quality by leveraging our patented software technologies to deliver innovative, competitively priced offerings. We foster an environment that empowers our employees to provide the best service to our customers and partners at every point of interaction. We intend to bring the best possible voice, video and unified communications services, at an affordable price, to businesses and residential consumers and enhance the ways in which these customers communicate with each other and the world. Specific strategies to accomplish this objective include: • Focus on our 8x8 Virtual Office hosted PBX and 8x8 Virtual Office Pro unified communications services. Toward the end of fiscal 2006, we began to shift the focus of our sales and marketing efforts to growing the 8x8 Virtual Office services and applications. 8x8 Virtual Office currently generates higher margins for us than our residential consumer service offerings. The businesses that subscribe to this service pay for the premise 3 equipment and generate higher monthly service revenues. In addition, they are more likely to subscribe to our add-on services and are less likely to leave the service. • Capitalize on our technological expertise to introduce new products and features. Over the past 10 years, we have developed or acquired several core technologies that form the backbone of our video and VoIP service which we intend to use to develop product enhancements and future products. We developed the core software associated with the Virtual Office product line including the call control engine, protocol stacks and network address translation (NAT) traversal firmware for the customer premise equipment. As a result, we are able to update the software functionality of our services without third party assistance and limit the distribution of our unique customer premise equipment features such as NAT traversal to customer premise equipment that is sold in conjunction with our services. We were the first VoIP service provider to ship two-way video-enabled hardware, and our 8x8 Virtual Office services are among the most feature-rich hosted VoIP business services in the industry. • Offer the best possible service and support to our customers with a world class customer support organization. We have an established call center and customer support group at our headquarters in Sunnyvale, California and outsourced call center operation located in Santa Maria, California. We also have invested in significant upgrades to our existing back office infrastructure to enhance the support we can provide to new and existing subscribers, as well as our distribution partners. Our strengths include customer service from technically sophisticated customer service agents providing support from onshore facilities located in California. Our 8x8 Services Our services work over virtually any high-speed Internet connection worldwide to allow calls to or from any phone in the world, whether that phone is an IP phone or a PSTN phone. 8x8’s service utilizes IP customer premise equipment to enable plug and play installation and a familiar dial tone user interface. The 8x8 service also uses web-based technologies to enable unified communications services such as web conferencing and Internet fax as well as account setup, account management, billing and customer support. We have developed proprietary implementation of standards-based technologies underlying our 8x8 service, which works with third party carriers to terminate VoIP calls on the PSTN network. As part of the 8x8 service, we currently resell IP telephones and videophones which utilize derivatives of our licensed semiconductor technology and unique software modifications to the protocol and application code that enable them to connect to the 8x8 IP services platform. We continue to enhance and develop new functionality in the software code that is embedded in these devices. 8x8 VoIP and Video Telephone Service We introduced our 8x8 residential VoIP telephone service in November 2002. To obtain the service, the customer must enter into a service agreement with us and select a calling plan based on the anticipated use of the service. Service plans provide alternatives for minutes of usage, up to an unlimited amount, at varying rates for calls in the United States and Canada that are made to non-8x8 customers. Subscribers are charged at a per-minute rate for international calls to non-8x8 customers and, depending on the level of plan selected, may be charged for calls to the PSTN if they exceed the minutes allowed under the chosen plan. All of our plans allow for unlimited calling between 8x8 customers, regardless of their location. Each subscriber is assigned a telephone number in any of the area codes and underlying rate centers currently offered by the service. We currently offer area codes in 48 contiguous U.S. states along with free number porting from the customer’s previous service provider to 8x8. All 8x8 customers receive access to a variety of telephone features, including voice mail, caller ID, call forwarding, call waiting, 3-way calling, online account management and billing, international call blocking and caller ID blocking. We currently offer enhanced 9-1-1, or E-911, service on all 8x8 calling plans with a United States service address. An 8x8 E-911 call is routed as 9-1-1 emergency traffic and is accompanied by caller information. Subscribers may also have toll-free numbers (e.g., 800 numbers) or virtual numbers. A virtual number is an additional phone number which will ring through to an existing subscriber line. We offer virtual numbers in all of our U.S. rate centers, as well as in certain international countries. We also offer video over IP service using the 8x8 Tango videophone product, which includes all of the voice service plans and features described above plus unlimited video calls to any other 8x8 videophone subscriber anywhere in the world. 8x8 Virtual Office Business Telephone Service Our 8x8 Virtual Office business telephone service was launched in March 2004 and is targeted at the small and medium-sized business market. 8x8 Virtual Office is an affordable, easy-to-use alternative to traditional PBX systems or Centrex class services from legacy telecommunications providers that offers features and services neither provide. 8x8 Virtual Office allows 4 users with a high-speed Internet connection anywhere in the world to be part of a virtual PBX that includes automated attendants to assist callers, conference bridges, extension-to-extension dialing and ring groups, in addition to a rich variety of other business class PBX features normally found on dedicated PBX equipment. 8x8 Virtual Office extensions do not require a dedicated communications infrastructure. The service is received through an office’s existing Internet connection, thus eliminating the need for additional phone lines or digital subscriber lines for extensions, in contrast to traditional Centrex or PBX products. The service is provided by 8x8 software that runs on computing platforms located in our data centers. 8x8 Virtual Office subscribers have the ability to choose any phone number available to 8x8 subscribers regardless of a user's geographic location. Subscribers also can port numbers, including toll-free numbers, from other service providers at no additional cost. Each extension in the virtual PBX can be located anywhere in the world with high-speed Internet access. 8x8 Virtual Office extension-to-extension calls and transfers are accomplished over the Internet, anywhere in the world, free of extra charges to third party telecommunications carriers. 8x8 Virtual Office offers the following essential services for small and medium-sized businesses: • Auto-attendant providing dial by extension, name or group; • Unlimited calling to the US, Canada, 17 additional countries and other 8x8 subscribers, as well as low international rates; • Unlimited 8x8 extension-to-extension dialing anywhere in the world; • Direct Inward Dial (DID) phone number with any desired area code for each extension; • Conference bridge, 3-way calling, music on hold, call park/pick-up, call transfer, hunt groups, and do not disturb; • Business-class voice mail including email alerts and direct transfer to mailbox; • Call waiting / Caller-ID; • Distinctive tone ringing, and • Optional receptionist console application offering: o Multiple call viewing and handling; o Direct transfer to extension's voicemail; o Supervised transfers, and o View of extension status As of March 31, 2010, each 8x8 Virtual Office customer subscribed to an average of between seven and eight of our business services. 8x8 Complete Contact Center The 8x8 Complete Contact Center, introduced in July 2007, is a fully integrated hosted call center solution that works with any broadband Internet service and provides enterprise class contact center functionality combined with Virtual Office hosted PBX calling features. The 8x8 Complete Contact Center lets companies quickly deploy and operate multi-channel contact centers within 8x8’s hosted PBX infrastructure without the time and expense of purchasing, installing and maintaining costly, specialized equipment. Delivered entirely as a hosted service, the 8x8 Complete Contact Center requires no specialized hardware or software, no telecom equipment and no up-front capital expenditures, making it an ideal solution for blending in- house and offsite or multi-site agents. Agents require nothing more than a web browser and a directly addressable voice terminal. 5 The 8x8 Complete Contact Center service offers features such as skill-based routing, multi-media management, real time monitoring and reporting, voice recording and logging, historical reporting, Interactive Voice Response, CRM integration with Salesforce.com and NetSuite and contact and case management tools. 8x8 Trunking Services In June 2008, we launched the 8x8 Trunking service. The 8x8 Trunking service provides companies that have already made a substantial or recent investment in premise-based PBX phone system hardware with an opportunity to reduce recurring monthly service and toll charges by delivering digital quality dial tone service to their phone system hardware over their broadband connection rather than a separate voice circuit from an incumbent or local exchange carrier. The customer's existing phone system equipment continues to provide the user feature set while the 8x8 Trunking services provide dial tone together with local, long distance and international call routing services to that equipment from the 8x8 network. 8x8 Hosted Key System Services In July 2008, we launched the 8x8 Hosted Key System service. The 8x8 Hosted Key System service is designed to replace traditional premise-based telephone "key systems" typically used by companies whose size or structure dictates the sharing of multiple, common phone lines among employees, regardless of where the employees are located. The 8x8 Hosted Key System expands our addressable market to include businesses that require shared line appearance services rather than the PBX functionality offered with our 8x8 Virtual Office hosted PBX solution. 8x8 IP Telephones In the second quarter of fiscal 2009, we launched the 8x8 675xi series of IP phones that incorporate 8x8's advanced NAT traversal technologies to facilitate the network-independent operational advantages of the 8x8 service. These advantages include the ability to simply plug the phone into any public or private Internet connection and immediately make or receive calls without performing any network configuration or firewall manipulation. The 8x8 675xi IP phones also deliver enhanced equipment and service features including high definition HD audio, corporate directory display and lookup, intercom paging, shared line appearance and Power over Ethernet capability. We use third-party manufacturers to make the videophones, IP business telephones and cordless handsets that we sell to our customers. We do not have long-term purchase agreements with any of our contract manufacturers. While we believe that we could replace our suppliers if necessary, our ability to provide service to our subscribers would be impacted during this timeframe, and this could have an adverse effect on our business, financial condition and results of operations. 8x8 Virtual Meeting The 8x8 Virtual Meeting video web conferencing service, introduced in September 2009, is an online collaboration tool accessible instantly (no software download required) from any web browser and any computing platform. Available as an add- on service for existing 8x8 customers, a standalone offering for new subscribers or as part of the Virtual Office Pro unified communications bundle, 8x8 Virtual Meeting lets users conduct centralized online meetings, complete with integrated voice conferencing (to and from any telephone or web browser platform), presentation slide sharing, desktop and application sharing, instant messaging, chair control, conference control and call recording. 8x8 Virtual Meeting offers unlimited conferencing, giving users the flexibility to conduct regular meetings with employees, associates, customers and prospects in remote locations worldwide. 8x8 Virtual Office Pro Unified Communications Introduced in January 2010, 8x8 Virtual Office Pro is a powerful unified communications service that allows subscribers to manage essential, advanced business communications functions online through a centralized portal. Integrated with the 8x8 Virtual Office VoIP (Voice over Internet Protocol) hosted PBX phone service, Virtual Office Pro enhances business productivity by providing users with a complete, instantly accessible suite of communication tools used in everyday business interactions. 8x8 Virtual Office Pro delivers these tools through an easy-to-use online dashboard which provides: (cid:131) A visual overview and online control of 8x8 Virtual Office business calling activity including point-and-click access to inbound and outbound calls and call management features such as call transfer, do not disturb (DND) and call forwarding 6 (cid:131) Microsoft Outlook Contacts and Corporate Directory integration (cid:131) Virtual Meeting - allows you to create, join and invite participants to web, audio and video meetings. (cid:131) iPhone Virtual Office Mobile extension – place and receive (VoIP) calls and access common Virtual Office services and functions from an iPhone/iPod Touch/iPad mobile handset (cid:131) Fax - enables users to send and receive unlimited faxes using either a separate phone number for fax or the same number as your 8x8 extension (cid:131) Call recording - enables any inbound or outbound call to be recorded and later reviewed, downloaded or deleted (cid:131) Presence management - tells other co-workers whether you are logged in, logged off, on the phone, off the phone or currently unavailable (cid:131) My Inbox overview - gives a comprehensive view of all voicemails, recordings, FAX messages, calls, and chat history 8x8 Managed Hosting and Cloud-Based Computing Solutions In May 2010, we introduced 8x8 managed hosting and cloud-based computing solutions enable business customers to reduce costs and gain performance and reliability advantages by eliminating in-house ownership of server equipment and costly information technology systems management staff. Sales, Marketing and Promotional Activities We currently sell and market our 8x8 services to end users through our direct sales force, website, retail channels, and third party resellers. Our inside sales force primarily takes inbound telephone calls and website leads which are generated from third party lead generation sources and direct web advertising such as Google and Yahoo. Our sales force decreased slightly from 63 sales representatives at the end of fiscal 2009 to 61 sales representatives at the end of fiscal 2010. These sales representatives are paid a base salary and monthly commission for selling our products and services. The commission is based on new sales made by the sales representative. We launched the retail channel in fiscal 2005 and refocused this channel on our 8x8 Virtual Office service in 2006 with Office Depot and subsequently Office Max. Retail channels, online channels and third party resellers generated less than 5% of our subscriber additions in fiscal 2010. Competition We face strong competition from incumbent telephone companies, cable companies and alternative voice and video communication providers. Because most of our target customers are already purchasing communications services from one or more of these providers, our success is dependent upon our ability to attract these customers away from their existing providers. This will potentially become more difficult as the early adopter market for VoIP services becomes saturated and mainstream customers make up more of our target market. We believe that the principal competitive factors affecting our ability to attract and retain customers are price, call quality, reliability, customer service, and enhanced services and features. For more information regarding the risks associated with such strong competition, please refer to Item 1A, Risk Factors “Intense competition in the markets in which we compete could prevent us from increasing or sustaining our revenue and increasing or maintaining profitability.” Incumbent telephone companies The incumbent telephone companies are our primary competitors and have historically dominated their regional markets. These competitors include AT&T, Qwest Communications and Verizon Communications as well as rural incumbents, such as CenturyTel and Windstream. These competitors are substantially larger and better capitalized than we are and have the advantage of a large existing customer base, and larger marketing budgets than we have. Moreover, they also provide the broadband services that are required to use our service, which is a significant competitive advantage. 7 Vendors of private branch exchange (“PBX”) systems and alternative voice communications providers Competitors for the 8x8 business service include traditional PBX and key system manufacturers and their resellers, including Cisco, Avaya, Nortel, Mitel and Toshiba, Centrex services offered by incumbent telephone companies, and VoIP services offered by XO Communications, Cbeyond, M5 and other companies. Operations We have a centrally managed platform consisting of data management, monitoring, control and billing systems that support all of our products and services. We have invested substantial resources to develop and implement our real-time call management information system. Key elements of this system include a prospective customer quotation portal, customer provisioning, customer access, fraud control, network security, call routing, call monitoring, media processing and normalization, call reliability, and detailed call records. Our platform monitors our process of digitizing and compressing voice and video into packets and transmitting these packets over data networks around the world. We maintain a call switching platform in software that manages call admission, call control, call rating and routes calls to an appropriate destination or customer premise equipment. Unless the recipient is using an Internet telephony device, the packets (representing a voice and/or video call initiated by an 8x8 subscriber) are sent to a gateway belonging to one of our partner telecommunications carriers, where they are reassembled and the call is transferred to the PSTN and directed to a regular telephone anywhere in the world. Our billing and back office systems manage and enroll customers and bill calls as they originate and terminate on the service. Network Operations Center We maintain a network operations center at our headquarters in Sunnyvale, California and employ a staff of 23 individuals with experience in voice and data operations to provide 24-hour operations support, 7 days per week. We use various tools to monitor and manage all elements of our network and our partners’ networks in real-time. We also monitor the network elements of some of our larger business customers. Additionally, our network operations center provides technical support to troubleshoot equipment and network problems. We also rely upon the network operations centers and resources of our telecommunications carrier partners to augment our monitoring and response efforts. Customer and Technical Support We maintain a call center at our headquarters in Sunnyvale, California and have a staff of 79 employees and contractors that provide customer service and technical support to customers. In addition, we have outsourced certain customer support activities to third parties. Customers who access our services directly through our web site receive customer service and technical support through multilingual telephone communication, web-based and “chat” sessions and e-mail support. Interconnection Agreements We are a party to telecommunications interconnect and service agreements with VoIP providers and PSTN telecommunications carriers, such as Global Crossing, Level(3) Communications, Qwest Communications and Neutral Tandem. Pursuant to these agreements, VoIP calls originating on our network can be terminated on other VoIP networks or the PSTN. Correspondingly, calls originating on other VoIP networks and the PSTN can be terminated on our network. While we believe that relations with these providers and carriers are good, we have no assurance that these partners will be able or willing to supply services to us in the future. Research and Development The VoIP market is characterized by rapid technological changes and advancements. Accordingly, we make substantial investments in the design and development of new products and services, as well as the development of enhancements and features to our existing 8x8 products and services. Future development also will focus on the use and interoperability of our products and services with emerging audio and video telephony standards and protocols, quality and performance enhancements to multimedia compression algorithms, support of new customer premise equipment, new unified communication service offerings, and wireless and mobile applications. We believe that the development of new products and services and the enhancement of existing products and services are essential to our success. 8 We currently employ 29 individuals in research, development and engineering activities in our facilities in Sunnyvale, California. Research and development expenses in each of the fiscal years ended March 31, 2010, 2009 and 2008 were $5.0 million, $5.2 million and $4.3 million, respectively. Regulatory Although several regulatory proceedings are underway or are being contemplated by federal and state authorities, including the FCC and state regulatory agencies, VoIP communication services, like ours, are unregulated at the state level and are subject to less regulation at the federal level than traditional telecommunications services. Providers of traditional telecommunications services are subject to the highest degree of regulation, while providers of information services are largely exempt from most federal and state regulations governing traditional common carriers. The FCC has subjected VoIP service providers to a smaller subset of regulations that apply to traditional telecommunications service providers and have not yet classified VoIP services as either telecommunications or information. The FCC is currently examining the status of VoIP service providers and the services they provide. The FCC initiated a notice of proposed rule-making (NPRM) in early 2004 to gather public comment on the appropriate regulatory environment for IP telephony. In November 2004, the FCC ruled that the VoIP service of a competitor and "similar" services are jurisdictionally interstate and not subject to state certification, tariffing and most other state telecommunications regulations. The FCC ruling was appealed by several states and on March 21, 2007, the United States Court of Appeals for the Eighth Circuit affirmed the FCC ruling. Recently, the FCC has stated that it is considering reclassifying the transmission component of broadband Internet access services as a telecommunications service but would only subject the service to specific regulations applicable to traditional telecommunications services. The effect of any future laws, regulations and the orders on our operations, including, but not limited to, the 8x8 service, cannot be determined. But as a general matter, increased regulation and the imposition of additional funding obligations increases service costs that may or may not be recoverable from our customers, which could result in 1) making our services less competitive with traditional telecommunications services if we increase our retail prices or 2) decrease our profit margins if we attempt to absorb such costs. Regulation of the Internet In addition to regulations addressing Internet telephony and broadband services, other regulatory issues relating to the Internet, in general could affect our ability to provide our services. Congress has adopted legislation that regulates certain aspects of the Internet, including online content, user privacy, taxation, liability for third-party activities and jurisdiction. In addition, a number of initiatives pending in Congress and state legislatures would prohibit or restrict advertising or sale of certain products and services on the Internet, which may have the effect of raising the cost of doing business on the Internet generally. Federal, state, local and foreign governmental organizations are considering other legislative and regulatory proposals that would regulate and/or tax applications running over the Internet. We cannot predict whether new taxes will be imposed on our services, and depending on the type of taxes imposed, whether and how our services would be affected thereafter. Increased regulation of the Internet may decrease its growth and hinder technological development, which may negatively impact the cost of doing business via the Internet or otherwise materially adversely affect our business, financial condition and results of operations. Intellectual Property and Proprietary Rights Our ability to compete depends, in part, on our ability to obtain and enforce intellectual property protection for our technology in the United States and internationally. We currently rely primarily on a combination of trade secrets, patents, copyrights, trademarks and licenses to protect our intellectually property. As of March 31, 2010, we had been issued 76 United States patents and additional United States and foreign patent applications pending. Our patents expire on dates ranging from 2012 to 2027. We cannot predict whether our pending patent applications will result in issued patents. To protect our trade secrets and other proprietary information, we require our employees to sign agreements providing for the maintenance of confidentiality and also the assignment of rights to inventions made by them while in our employ. There can be no assurance that our means of protecting our proprietary rights in the United States or abroad will be adequate or that competition will not independently develop technologies that are similar or superior to our technology, duplicate our technology or design around any of our patents. In addition, the laws of foreign countries in which our products are or may be sold do not protect our intellectual property rights to the same extent as do the laws of the United States. Our failure to protect our proprietary information could cause our business and operating results to suffer. 9 We are also subject to the risks of adverse claims and litigation alleging infringement of the intellectual property rights of others. Such claims and litigation could require us to expend substantial resources and distract key employees from their normal duties, which could have a material adverse effect on our operating results, cash flows and financial condition. The communications and software industries are subject to frequent litigation regarding patent and other intellectual property rights. Moreover, the VoIP service provider community has historically been a target of patent holders. There is a risk that we will be a target of assertions of patent rights and that we may be required to expend significant resources to investigate and defend against such assertions of patent rights. For example, on April 22, 2009, we were named as a defendant, along with Comcast, Microsoft, Avaya, Embarq, and Qwest, in a complaint filed by Web Telephony, LLC in the Eastern District of Texas. On April 29, 2009, we entered into a settlement agreement with Web Telephony, which filed a motion to dismiss the lawsuit on May 8, 2009. Also, on May 2, 2008, we received a letter from AT&T Intellectual Property, L.L.C. (“AT&T IP”) expressing the belief that we must license a specified patent for use in our 8x8 broadband telephone service, as well as suggesting that we obtain a license to its portfolio of MPEG-4 patents for use with our video telephone products and services. At the same time, we began an evaluation of whether AT&T IP’s affiliated entities may need to license any of our patents or other intellectual property. We have continued to engage in discussions with AT&T IP to explore a mutually agreeable resolution of the parties’ respective assertions regarding these intellectual property issues. We are unable at this time to state whether we will enter into any license or cross-license agreements with AT&T IP or whether we ultimately anticipate any material effects on our operating results or financial condition as a consequence of these matters. We rely upon certain technology, including hardware and software, licensed from third parties. There can be no assurance that the technology licensed by us will continue to provide competitive features and functionality or that licenses for technology currently utilized by us or other technology which we may seek to license in the future will be available to us on commercially reasonable terms or at all. The loss of, or inability to maintain, existing licenses could result in shipment delays or reductions until equivalent technology or suitable alternative products could be developed, identified, licensed and integrated, and could harm our business. These licenses are on standard commercial terms made generally available by the companies providing the licenses. To date, the cost and terms of these licenses individually has not been material to our business. Information about Segments and Geographic Areas We have only one reportable segment. Financial information relating to our product lines and information on revenues generated in different geographic areas are set forth in Note 6 to our consolidated financial statements contained in Part II, Item 8 of this Report. Employees As of March 31, 2010, our workforce consisted of 242 employees. None of our employees are represented by a labor union or are subject to a collective bargaining arrangement. Executive Officers of the Registrant Our executive officers as of the date of this report are listed below. Bryan R. Martin, Chairman and Chief Executive Officer. Bryan R. Martin, age 42, has served as our Chairman since December 2003. Mr. Martin has served as Chief Executive Officer and as a director of the Company since February 2002. From March 2007 to November 2008, he served as President of the Company. From February 2001 to February 2002, he served as President and Chief Operating Officer and a director of the Company. He served as Senior Vice President, Engineering Operations from July 2000 to February 2001 and as the Company’s Chief Technical Officer from August 1995 to August 2000. He also served as a director of the Company from January 1998 through July 1999. In addition, Mr. Martin served in various technical roles for the Company from April 1990 to August 1995. He received a B.S. and an M.S. in Electrical Engineering from Stanford University. Dan Weirich, President and Chief Financial Officer. Dan Weirich, age 36, has served as our President since November 2008 and as our Chief Financial Officer since July 2006. From June 2006 to July 2006, Mr. Weirich served as our Acting Chief Financial Officer. Mr. Weirich served as Vice President of Operations of the Company from April 2006 to June 2006 and Director of Strategic Sales from March 2004 to April 2006. From September 2001 to March 2004, Mr. Weirich served as independent consultant in Asia and the United States. From August 1996 to September 2001, Mr. Weirich served in various roles for iAsiaworks, Qwest Communications and Phoenix Network. He received a B.S. in International Business from the University of Colorado at Boulder. 10 Huw Rees, Vice President of Business Development. Huw Rees, age 49, has served as Vice President, Business Development since November 2008. From January 2001 to November 2008, Mr. Rees served as our Vice President, Sales and Marketing. He served as the Chairman and Chief Executive Officer of the Company’s wholly owned subsidiary, Centile, Inc., from July 2001 until September 2003. Additionally, he served as Vice President, Sales and Business Development of Centile from March 2001 to July 2001. He served as Vice President, Sales of the Solutions Group of the Company from August 2000 until February 2001 and as Director, North American Sales of the Company from April 1999 to August 2000. He previously worked at Mitel Corporation as Sales Manager of the Western Region and also in sales management roles at GEC Plessey Inc. and Marconi PLC. He received a B.Sc. (Hons) from the University of Manchester, Institute of Science and Technology in Electrical and Electronic Engineering and a M.B.A. from the University of LaVerne. Debbie Jo Severin, Chief Marketing Officer and Vice President of Marketing. Debbie Jo Severin, age 50, has served as Chief Marketing Officer and Vice President of Marketing since March 2009. From 2003 to March 2009, Ms. Severin served as Vice President of Marketing for Covad Communications. From 1998 to 2003, Ms. Severin was Vice President of Marketing for PrimeOne Tele-TV, Northpoint Communications and Valiant Networks. Between 1986 and 1998, Ms. Severin served in various marketing roles for BellSouth Telecommunications and Pacific Bell. She received a Masters Degree in Mathematics and a Bachelor of Science from the University of Alabama, Birmingham. Ramprakash Narayanaswamy, Chief Technology Officer and Vice President of Engineering. Ramprakash Narayanaswamy, age 45, was appointed Chief Technology Officer in April 2010 and is responsible for our research, development and engineering operations. From February 2005 to April 2010, Mr. Narayanaswamy held multiple numerous engineering roles including Vice President of Engineering. Between 1992 and 2005, Mr. Narayanaswamy served in various engineering roles for Nextance Inc., Bluelight.com and Sun Microsystems, Inc. He received his Masters degree in Computer Applications from National Institute of Technology, Tiruchirapalli, India. ITEM 1A. RISK FACTORS If any of the following risks actually occur, our business, results of operations and financial condition could suffer significantly. The impact of the current economic climate and tight financing markets may impact customer demand for our products and services. Many of our existing and target customers are in the small and medium business sector. Although we believe our products and services are less costly than traditional telephone services, these businesses may be more likely to be significantly affected by economic downturns than larger, more established businesses. Additionally, these customers often have limited discretionary funds, which they may choose to spend on items other than our products and services. If small and medium businesses experience economic hardship, it could negatively affect the overall demand for our products and services, could cause delay and lengthen sales cycles and could cause our revenue to decline. Although the majority of our billing arrangements with customers are prepaid, we regularly monitor the percentage of customers who cease to pay for our services due to closing or downsizing their business. Even though our customer churn rates improved in fiscal 2010, a larger percentage of our total customer churn was due to these economic issues and we cannot guarantee that we will continue to experience the same improvement in churn rates given current economic conditions. Additionally, the combination of our sales cycle coupled with challenging economic conditions could have a negative impact on the results of our operations. The success of our Company is dependent on the growth and public acceptance of 8x8 Services. Our future success as a Company depends on our ability to significantly increase revenues generated from our 8x8 services. In turn, the success of our 8x8 voice and video communications services depends, among other things, upon future demand for VoIP telephony systems and services. Because the use of our service requires that the user be a subscriber to an existing broadband Internet service, usually provided through a cable or digital subscriber line, or DSL, connection, slow or limited adoption of broadband Internet service could adversely affect the growth in our subscriber base and revenues. Although the number of broadband subscribers worldwide has grown significantly over the last five years, VoIP service has not yet been adopted by a majority of consumers. To increase the deployment of broadband Internet services from broadband Internet service providers, telephone companies and cable companies must continue to invest in the deployment of high speed broadband networks to residential and business customers, over which we have no control. In addition, VoIP networks must 11 improve quality of service for real-time communications, managing effects such as packet jitter, packet loss, and unreliable bandwidth, so that toll-quality service can be consistently provided. VoIP telephony equipment and services must achieve a similar level of reliability that users of the PSTN have come to expect from their telephone service, and the cost and feature benefits of VoIP must be sufficient to cause customers to switch away from traditional telephony service providers. We must devote substantial resources to educate customers and end users about the benefits of VoIP telephony solutions, in general, and our services in particular. Substantial, ongoing interaction with our customers in order to train and assist them with the deployment and use of our services over these networks is sometimes required. If any or all of these factors fail to occur, our business may be affected adversely. We have a history of losses and are uncertain of our future profitability. We recorded operating income of approximately $4 million for the fiscal year ended March 31, 2010 and ended the period with an accumulated deficit of $199 million. In addition, we recorded an operating loss of approximately $3 million and $4 million for the fiscal years ended March 31, 2009 and 2008, respectively. Although we achieved operating income of $4 million during the current fiscal year, we may incur operating losses for the foreseeable future, and such losses may be substantial. We will need to increase revenues in order to generate sustainable operating profit. Given our history of fluctuating revenues and operating losses, we cannot be certain that we will be able to achieve operating profitability on an annual basis or maintain operating profitability on a quarterly basis in the future. Our business depends on continued and unimpeded access to the Internet by us and our users. Internet access providers and Internet backbone providers may be able to block, degrade or charge for access to certain of our products and services, which could lead to additional expenses and the loss of users. Our products and services depend on the ability of our users to access the Internet, and certain of our products require significant bandwidth to work effectively. Currently, this access is provided by companies that have significant and increasing market power in the broadband and Internet access marketplace, including incumbent telephone companies, cable companies and mobile communications companies. Some of these providers have stated that they may take measures that could degrade, disrupt or increase the cost of user access to certain of our products by restricting or prohibiting the use of their infrastructure to support or facilitate our offerings, or by charging increased fees to us or our users to provide our offerings, while others, including some of the largest providers of broadband Internet access services, have committed to not engaging in such behavior. The ability of the FCC to regulate broadband Internet access services has been called into question by a recent ruling of the United States Court of Appeals for the D.C. Circuit. While interference with access to our products and services seems unlikely, broadband Internet access provider interference has occurred, in very limited circumstances in the U.S., and could result in a loss of existing users and increased costs, and could impair our ability to attract new users, thereby harming our revenue and growth. The VoIP telephony market is subject to rapid technological change, and we depend on new product and service introductions in order to maintain and grow our business. VoIP telephony is an emerging market that is characterized by rapid changes in customer requirements, frequent introductions of new and enhanced products, and continuing and rapid technological advancement. To compete successfully in this emerging market, we must continue to design, develop, manufacture, and sell new and enhanced VoIP telephony software products and services that provide increasingly higher levels of performance and reliability at lower cost. Decreasing telecommunications rates and increasing regulatory charges may diminish or eliminate our competitive pricing advantage. Decreasing telecommunications rates may diminish or eliminate the competitive pricing advantage of our services, while increased regulation and the imposition of additional regulatory funding obligations at the federal, state and local level could require us to either increase the retail price for our services, thus making us less competitive, or absorb such costs, thus decreasing our profit margins. International and domestic telecommunications rates have decreased significantly over the last few years in most of the markets in which we operate, and we anticipate these rates will continue to decline in all of the markets in which we do business or expect to do business. Users who select our services to take advantage of the current pricing differential between traditional telecommunications rates and our rates may switch to traditional telecommunications carriers if such pricing differentials diminish or disappear, however, and we will be unable to use such pricing differentials to attract new customers in the future. Continued rate decreases would require us to lower our rates to remain competitive and would reduce or possibly eliminate any gross profit from our services. In addition, we may lose subscribers for our services. 12 On the other hand, the FCC is seeking to reform the federal universal service fund that is applicable to us. The way we calculate our contribution may change if the FCC engages in such reform. While we cannot predict how or if the FCC will reform the contribution mechanism for the universal service fund, nor can we determine the impact on our business at this time, should the FCC adopt a new federal universal service fund contribution mechanism that increases our contribution obligation, we will either need to raise the amount we currently collect from our customers to cover this obligation or reduce our profit margins. Furthermore, certain states continue to attempt to apply state universal service fund obligations on our service though we do not believe that the current state of the law requires us to make such contributions. Recently, two states, Kansas and Nebraska, filed a petition with the FCC seeking the authority to impose state universal service fund contribution obligations on our service and also sought retroactive application of such authority. We cannot predict the outcome of this proceeding, nor can we determine the impact on our business at this time. Should the FCC allow states to impose state universal service fund obligations on our nomadic interconnected VoIP service, we would pass any increased cost of state universal service fund contributions through to our customers. Our services may become less competitive with other providers should we raise the price customers ultimately pay for the services we offer to cover these additional regulatory costs. We may become subject to state regulation for certain service offerings. Certain states take the position that offerings by VoIP companies, like us, are intrastate and therefore subject to state regulation. These states argue that if the beginning and end points of communications are known, and if some of these communications occur entirely within the boundaries of a state, the state can regulate that offering. We believe that the FCC has pre-empted states from regulating VoIP offerings. We cannot predict how this issue will be resolved or its impact on our business at this time. We rely on third party network service providers to originate and terminate substantially all of our public switched telephone network calls. We leverage the infrastructure of third party network service providers to provide telephone numbers, PSTN call termination and origination services, and local number portability for our customers rather than deploying our own network throughout the United States. This decision has resulted in lower capital and operating costs for our business in the short term but has reduced our operating flexibility and ability to make timely service changes. If any of these network service providers cease operations or otherwise terminate the services that we depend on, the delay in switching our technology to another network service provider, if available, and qualifying this new service could have a material adverse effect on our business, financial condition or operating results. While we believe that relations with our current service providers are good and we have contracts in place, there can be no assurance that these service providers will be able or willing to supply cost-effective services to us in the future or that we will be successful in signing up alternative or additional providers. While we believe that we could replace our current providers, if necessary, our ability to provide service to our subscribers could be impacted during this timeframe, and this could have an adverse effect on our business, financial condition or results of operations. The loss of access to, or requirement to change, the telephone numbers we provide to our customers also could have a material adverse effect on our business, financial condition or operating results. Due to our reliance on these service providers, when problems occur in a network, it may be difficult to identify the source of the problem. The occurrence of hardware and software errors, whether caused by our 8x8 service or another vendor’s products, may result in the delay or loss of market acceptance of our products and any necessary revisions may force us to incur significant expenses. The occurrence of some of these types of problems may seriously harm our business, financial condition or operating results. Intense competition in the markets in which we compete could prevent us from increasing or sustaining our revenue and increasing or maintaining profitability. The telecommunications industry is highly competitive. We face intense competition from traditional telephone companies, wireless companies, cable companies, competitive local exchange carriers, alternative voice communication providers and independent VoIP providers. Most of our current and potential competitors have longer operating histories, significantly greater resources and name recognition, and a larger base of customers than we have. As a result, these competitors may have greater credibility with our existing and potential customers. They also may be able to adopt more aggressive pricing policies and devote greater resources to the development, promotion and sale of their products than we can to ours. Our competitors may also offer bundled service 13 arrangements offering a more complete product despite the technical merits or advantages of our products. Competition could decrease our prices, reduce our sales, lower our gross profits or decrease our market share. We also compete against established alternative voice communication providers and face competition from other large, well- capitalized Internet companies that have recently launched or plan to launch VoIP-enabled services. In addition, we compete with independent VoIP service providers. Some of these service providers may choose to sacrifice revenue in order to gain market share by offering their services at lower prices or free. In order to compete with such service providers, we may have to significantly reduce our prices, which would affect our profitability. We also are subject to the risk that new technologies may be developed that are able to deliver competing voice services at lower prices, better or more conveniently. Future competition from new technologies could have a material adverse effect on our growth and operating results. Given the significant price competition in the markets for our products, we are at a significant disadvantage compared to many of our competitors, especially those with substantially greater resources, and therefore may be better able to withstand an extended period of downward pricing pressure. The adverse impact of a shortfall in our revenues may be magnified by our inability to adjust spending to compensate for such shortfall. Announcements of new products and technologies by our competitors or us could cause customers to defer purchases of our existing products, which also could have a material adverse effect on our business, financial condition or operating results. We depend on contract manufacturers to manufacture substantially all of our products, and any delay or interruption in manufacturing by these contract manufacturers would result in delayed or reduced shipments to our customers and may harm our business. We do not have long-term purchase agreements with our contract manufacturers and we depend on a concentrated group of contract manufacturers for a substantial portion of manufacturing our products. There can be no assurance that our contract manufacturers will be able or willing to reliably manufacture our products, in volumes, on a cost-effective basis or in a timely manner. If we cannot compete effectively for the business of these contract manufacturers, or if any of the contract manufacturers experience financial or other difficulties in their businesses, our revenue and our business could be adversely affected. In particular, if one of our contract manufacturers becomes subject to bankruptcy proceedings, we may not be able to obtain any of our products held by the contract manufacturer. We also rely on third party component suppliers to provide semiconductor circuit packages for our products. In some instances, these components are provided by a single supplier. Our reliance on these suppliers involves a number of risks, including reduced control over delivery schedules, quality assurance and costs. We currently do not have long-term supply contracts with any of these component vendors. As a result, most of these third party vendors are not obligated to provide products or perform services to us for any specific period, in any specific quantities or at any specific price, except as may be provided in a particular purchase order. The inability of these third party vendors to deliver components of acceptable quality and in a timely manner, particularly the sole source vendors, could adversely affect our operating results or cause them to fluctuate more than anticipated. Additionally, some of our products may require specialized or high-performance component parts that may not be available in quantities or in time frames that meet our requirements. Our infringement of a third party’s proprietary technology would disrupt our business. There has been substantial litigation in the communications, VoIP services, semiconductor, electronics, and related industries regarding intellectual property rights and, from time to time, third parties may claim infringement by us of their intellectual property rights. Our broad range of current and former technology, including IP telephony systems, digital and analog circuits, software, and semiconductors, increases the likelihood that third parties may claim infringement by us of their intellectual property rights. For example, on May 2, 2008, we received a letter from AT&T Intellectual Property, L.L.C. (“AT&T IP”) expressing the belief that we must license a specified patent for use in our 8x8 broadband telephone service, as well as suggesting that we obtain a license to its portfolio of MPEG-4 patents for use with our video telephone products and services. At the same time, we began an evaluation of whether AT&T IP’s affiliated entities may need to license any of our patents or other intellectual property. We have continued to engage in discussions with AT&T IP to explore a mutually agreeable resolution of the parties’ respective assertions regarding these intellectual property issues. We are unable at this time to state whether we will enter into any license or cross-license agreements with AT&T IP or whether we ultimately anticipate any material effects on our operating results or financial condition as a consequence of these matters. If we were found to be infringing on the intellectual property rights of any third party, we could be subject to liabilities for such infringement, which could be material. We could also be required to refrain from using, manufacturing or selling certain products or using certain 14 processes, either of which could have a material adverse effect on our business and operating results. From time to time, we have received, and may continue to receive in the future, notices of claims of infringement, misappropriation or misuse of other parties' proprietary rights. There can be no assurance that we will prevail in these discussions and actions or that other actions alleging infringement by us of third party patents will not be asserted or prosecuted against us. Certain technology necessary for us to provide our services may, in fact, be patented by other parties either now or in the future. If such technology were held under patent by another person, we would have to negotiate a license for the use of that certain technology. We may not be able to negotiate such a license at a price that is acceptable. The existence of such a patent, or our inability to negotiate a license for any such technology on acceptable terms, could force us to cease using such technology and offering products and services incorporating such technology. For example, on April 22, 2009, we were named as a defendant, along with Comcast, Microsoft, Avaya, Embarq, and Qwest, in a complaint filed by Web Telephony, LLC in the Eastern District of Texas. On April 29, 2009, we entered into a settlement agreement with Web Telephony, which filed a motion to dismiss the lawsuit on May 8, 2009, under which we have made significant payments as described in Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations -- Acquired Product Rights.” We license technology from third parties that we do not control and cannot be assured of retaining. We rely upon certain technology, including hardware and software, licensed from third parties. There can be no assurance that the technology licensed by us will continue to provide competitive features and functionality or that licenses for technology currently utilized by us or other technology which we may seek to license in the future, will be available to us on commercially reasonable terms or at all. The loss of, or inability to maintain, existing licenses could result in shipment delays or reductions until equivalent technology or suitable alternative products could be developed, identified, licensed and integrated, and could harm our business. These licenses are on standard commercial terms made generally available by the companies providing the licenses. The cost and terms of these licenses individually are not material to our business. Inability to protect our proprietary technology would disrupt our business. We rely, in part, on trademark, copyright, and trade secret law to protect our intellectual property in the United States and abroad. We seek to protect our software, documentation, and other written materials under trade secret and copyright law, which afford only limited protection. We also rely, in part, on patent law to protect our intellectual property in the United States and internationally. As of March 31, 2010, we had been awarded 76 United States patents and have additional United States and foreign patent applications pending. We cannot predict whether such pending patent applications will result in issued patents that effectively protect our intellectual property. We may not be able to protect our proprietary rights in the United States or internationally (where effective intellectual property protection may be unavailable or limited), and competitors may independently develop technologies that are similar or superior to our technology, duplicate our technology or design around any patent of ours. We have, in the past, licensed and, in the future, expect to continue licensing our technology to others, many of whom are located or may be located abroad. There are no assurances that such licensees will protect our technology from misappropriation. Moreover, litigation may be necessary in the future to enforce our intellectual property rights, to determine the validity and scope of the proprietary rights of others, or to defend against claims of infringement or invalidity. Such litigation could result in substantial costs and diversion of management time and resources and could have a material adverse effect on our business, financial condition, and operating results. Any settlement or adverse determination in such litigation would also subject us to significant liability. Our products must comply with industry standards, FCC regulations, state, local, country-specific and international regulations, and changes may require us to modify existing products and/or services. In addition to reliability and quality standards, the market acceptance of telephony over broadband IP networks is dependent upon the adoption of industry standards so that products from multiple manufacturers are able to communicate with each other. Our VoIP telephony products rely heavily on communication standards such as SIP, MGCP and network standards such as TCP/IP and UDP to interoperate with other vendors' equipment. There is currently a lack of agreement among industry leaders about which standard should be used for a particular application, and about the definition of the standards themselves. These standards, as well as audio and video compression standards, continue to evolve. We also must comply with certain rules and regulations of the FCC regarding electromagnetic radiation and safety standards established by Underwriters Laboratories, as well as similar regulations and standards applicable in other countries. Standards are continuously being modified and replaced. As standards evolve, we may be required to modify our existing products or develop and support new versions of our products. We must comply with certain federal, state and local requirements regarding how we interact with our customers, including marketing practices, consumer protection, privacy, and billing issues, the provision of 9-1-1 emergency service and the quality of service we provide to our customers. The failure of our products and services to comply, or delays in compliance, with 15 various existing and evolving standards could delay or interrupt volume production of our VoIP telephony products, subject us to fines or other imposed penalties, or harm the perception and adoption rates of our service, any of which would have a material adverse effect on our business, financial condition or operating results. Our ability to offer services outside the U.S. is subject to different local regulatory environments, which may be unknown, complicated and uncertain. Regulatory treatment of VoIP telephony outside the United States varies from country to country and often the laws are unclear. We currently distribute our products and services directly to consumers and through resellers that may be subject to telecommunications regulations in their home countries. The failure by us or our customers and resellers to comply with these laws and regulations could reduce our revenue and profitability. Because of our relationship with the resellers, some countries may assert that we are required to register as a telecommunications provider in that country. In such case, our failure to do so could subject us to fines or penalties. In addition, some countries are considering subjecting VoIP services to the regulations applied to traditional telephone companies. Regulatory developments such as these could have a material adverse effect on the use of our services in international locations. Future legislation or regulation of the Internet and/or voice and video over IP services could restrict our business, prevent us from offering service or increase our cost of doing business. There are an increasing number of regulations and rulings that specifically address access to commerce and communications services on the Internet, including IP telephony. We are unable to predict the impact, if any, that future legislation, legal decisions or regulations concerning the Internet may have on our business, financial condition, and results of operations. Regulation may be targeted towards, among other things, assessing access or settlement charges, imposing taxes related to Internet communications and imposing tariffs or regulations based on encryption concerns or the characteristics and quality of products and services, any of which could restrict our business or increase our cost of doing business. The increasing growth of the broadband IP telephony market and popularity of broadband IP telephony products and services heighten the risk that governments or other legislative bodies will seek to regulate broadband IP telephony and the Internet. In addition, large, established telecommunication companies may devote substantial lobbying efforts to influence the regulation of the broadband IP telephony market, which may be contrary to our interests. Many regulatory actions are underway or are being contemplated by federal and state authorities, including the FCC and other state and local regulatory agencies. On February 12, 2004, the FCC initiated a notice of public rule-making to update FCC policy and consider the appropriate regulatory classification for VoIP and other IP enabled services. On November 9, 2004, the FCC ruled that Vonage DigitalVoice and similar services are jurisdictionally interstate and not subject to state certification, tariffing and other common carrier regulations. This ruling was subsequently appealed by several states. On March 21, 2007, the United States Court of Appeals for the Eighth Circuit affirmed the FCC’s declaratory ruling. There is risk that a regulatory agency will require us to conform to rules that are unsuitable for IP communications technologies or rules that cannot be complied with due to the nature and efficiencies of IP routing, or are unnecessary or unreasonable in light of the manner in which 8x8 offers service to its customers. It is not possible to separate the Internet, or any service offered over it, into intrastate and interstate components as we currently have no means to automatically identify the physical location of one of our subscribers on the Internet. While suitable alternatives may be developed in the future, the current IP network does not enable us to identify the geographic nature of the traffic traversing the Internet, or dynamically pinpoint or update the location of our customers’ telephony devices. In the United States, the FCC as well as our competitors have made statements in the past suggesting that we should be required to automatically determine the physical location of our customers’ equipment as a precondition for offering telecommunications services to them. Internet service providers might restrict our ability to provide VoIP telephony services in the future. It is not clear whether suppliers of broadband Internet access have a legal obligation to allow their customers to access and use our service without interference. As a result of recent decisions by the U.S. Supreme Court and the FCC, providers of broadband services are subject to relatively light regulation by the FCC. Consequently, federal and state regulators might not prohibit broadband providers from limiting their customers’ access to VoIP applications and services, or otherwise discriminating against VoIP providers. Conceivably, some providers of broadband access may take measures that affect their customers’ ability to use our service, such as degrading the quality of the data packets we transmit over their lines, giving those packets lower priority, giving other packets higher priority than ours, interfering with or blocking our packets entirely or attempting to charge their customers more for also using our services. Interference with our service or higher charges for also using our service could cause us to lose existing customers, impair our ability to attract new customers and harm our revenue 16 and growth. These problems have occurred to us in the past in the United States and in certain international markets. Increased taxes on our service will increase our customers' cost of using our service and/or reduce our profit margins (to the extent the costs are not passed through to our customers) and we may be subject to liabilities for past sales and additional taxes, surcharges and fees. Until 2007, we did not collect or remit state or municipal taxes, such as sales, excise, and ad valorem taxes, fees or surcharges on the charges to our customers for our services, except that we have historically complied with the collection of California sales tax and financial contributions to the 9-1-1 system and the federal Universal Service Fund. We have received inquiries or demands from a number of state and municipal taxing agencies seeking payment of taxes, fees or surcharges that are applied to or collected from customers of providers of traditional public switched telephone network services. Although we have consistently maintained that these taxes, fees or surcharges do not apply to our service for a variety of reasons depending on the statute or rule that establishes such obligations, a number of states have changed their statutes as part of streamlined sales tax initiatives and we are now collecting and remitting sales taxes in those states. The collection of these taxes, fees or surcharges will have the effect of decreasing any price advantage we may have over other providers who have historically paid these taxes and fees. Our compliance with these tax initiatives will also make us less competitive with those competitors who choose not to comply with these tax initiatives. Three states currently are conducting sales tax audits of our records. In October 2009, we received notices of proposed assessment as a result of one of the sales tax audits amounting to approximately $1.6 million, which we consider to be unsubstantiated and have accrued a tax liability of $0.1 million as of March 31, 2010 to account for our estimated liability for past sales tax obligations related to these audits. If our ultimate liability exceeds that amount, it could result in significant charges to our earnings. Our emergency and E-911 calling services are different from those offered by traditional wireline telephone companies and may expose us to significant liability. There may be risks associated with limitations associated with E-911 emergency dialing with the 8x8 service. Both our emergency calling service and our E-911 calling service are different, in significant respects, from the emergency calling services offered by traditional wireline telephone companies. In each case, the differences may cause significant delays, or even failures, in callers' receipt of the emergency assistance they need. Traditional wireline telephone companies route emergency calls over a dedicated infrastructure directly to an emergency services dispatcher at the Public Safety Answering Point, or PSAP, in the caller's area. Generally, the dispatcher automatically receives the caller's phone number and actual location information. While the E-911 service we have deployed in the United States is designed to route calls in a fashion similar to traditional wireline services, our E-911 capabilities are not yet available from all locations. In addition, the only location information that our E-911 service can transmit to a dispatcher at a PSAP is the information that our customers have registered with us prior to the 9-1-1 call. A customer's registered location may be different from the customer's actual location at the time of the call because customers can use the 8x8 service from any broadband connection anywhere in the world. We are currently deploying E-911 service that is similar to the emergency calling services provided to customers of traditional wireline telephone companies in the same area. For those customers located in an E-911 area, emergency calls are routed, subject to the limitations discussed below, directly to an emergency services dispatcher at the PSAP in the area of the customer's registered location. The dispatcher will have automatic access to the customer's telephone number and registered location information. If a customer moves their 8x8 service to a new location, the customer's registered location information must be updated and verified by the customer. Until that takes place, the customer will have to verbally advise the emergency dispatcher of his or her actual location at the time of an emergency 9-1-1 call. This can lead to delays in the delivery of emergency services. The emergency calls of customers located in areas where we are currently unable to provide E-911 service as described above are supported by a national call center that is run by a third-party provider and operates 24 hours per day, seven days per week. These operators still receive the customer's registered service location and phone number automatically, and coordinate connecting the caller to the appropriate PSAP or emergency services provider and providing the customer's registered service location and phone number to those local authorities, which can also delay the delivery of emergency services. In the event that a customer experiences a broadband or power outage, or if a network failure were to occur, the customer will not be able to reach an emergency services provider using our services. 17 Delays our customers may encounter when making emergency services calls and any inability of the answering point to automatically recognize the caller's location or telephone number can result in life threatening consequences. Customers may, in the future, attempt to hold us responsible for any loss, damage, personal injury or death suffered as a result of any failure of our E-911 services. In late July 2008, the President signed into law the "New and Emerging Technologies 911 Improvement Act of 2008." The law provides public safety, interconnected VoIP providers and others involved in handling 911 calls the same liability protections when handling 911 calls from interconnected VoIP users as from mobile or wired telephone service users. The applicability of the liability protections to our national call center solution is unclear at the present time. Also, we may be exposed to liability for 911 calls made prior to the adoption of this new law although we are unaware of any such liability. In May 2005, the FCC unanimously adopted an order and Notice of Proposed Rulemaking, or NPRM, which required VoIP providers that interconnect with the PSTN, or interconnected VoIP providers, to provide enhanced 9-1-1, or E-911, service. On November 7, 2005, the Enforcement Bureau of the FCC issued a notice to interconnected VoIP providers detailing the information required to be submitted to the FCC in E-911 compliance letters due by November 28, 2005. In this notice, the Enforcement Bureau stated that, although it would not require providers that had not achieved full E-911 compliance by November 28, 2005, to discontinue the provision of interconnected VoIP services to any existing customers, it did expect that such providers would discontinue marketing VoIP services, and accepting new customers for their services, in all areas where they are not transmitting 9-1-1 calls to the appropriate PSAP in full compliance with the FCC rules. On November 28, 2005, we began offering nomadic E-911 service to all of our customers with United States service addresses, and began charging those customers an additional $1.99 per month plus any applicable local 9-1-1 taxes and surcharges effective January 1, 2006. On November 28, 2005, we also modified the 8x8 account signup procedures to require service addresses to be entered and validated, at the time an order for service is placed, to ascertain whether 8x8's nomadic E-911 service is available at that address. On November 28, 2005, we also filed our E-911 compliance report which is available on the FCC's website, at http://www.fcc.gov, under Wireline Competition Docket Number 05-196. On March 19, 2007, we received a letter from the Enforcement Bureau of the FCC requesting that we file an updated E-911 Status Report no later than April 11, 2007. On April 11, 2007, we responded to the FCC stating that 91% of our customers are either in compliance with the VoIP 9-1-1 order or were signed up prior to November 28, 2005. We provide a nomadic emergency calling service to 100% of our customers who have a service location, as registered by the customer, within the United States. The FCC may determine that our nomadic emergency calling solution does not satisfy the requirements of its VoIP E-911 order because, in some instances, our nomadic emergency calling solution requires that we route an emergency call to a national emergency call center instead of connecting our customers directly to a local PSAP through a dedicated connection and through the appropriate selective router. The FCC may issue further guidance on compliance requirements in the future that might require us to disconnect those customers not receiving access to emergency services in a manner consistent with the VoIP E-911 order. The effect of such disconnections, monetary penalties, cease and desist orders or other enforcement actions initiated by the FCC or other agency or task force against us could have a material adverse effect on our business, financial condition or operating results. On June 1, 2007, the FCC released a Notice of Proposed Rulemaking in which it tentatively concluded that all interconnected VoIP service providers that allow customers to use their service in more than one location (nomadic VoIP service providers such as us) must utilize an automatic location technology that meets the same accuracy standards which apply to providers of commercial mobile radio services (mobile phone service providers). The outcome of this proceeding cannot be determined at this time and we may or may not be able to comply with any such obligations that may be adopted. At present, we currently have no means to automatically identify the physical location of one of our customers on the Internet. The FCC's VoIP E-911 order has increased our cost of doing business and may adversely affect our ability to deliver the 8x8 service to new and existing customers in all geographic regions or to nomadic customers who move to a location where emergency calling services compliant with the FCC's mandates are unavailable. Our compliance with and increased costs due to the FCC's VoIP E-911 order put us at a competitive disadvantage to those VoIP service providers who have chosen not to comply with the FCC's mandates. We cannot guarantee that emergency calling service consistent with the VoIP E-911 order will be available to all of our customers, especially those accessing our services from outside of the United States. The FCC's current VoIP E-911 order or follow-on orders or clarifications or their impact on our customers due to service price increases or other factors could have a material adverse effect on our business, financial condition or operating results. 18 There may be risks associated with our ability to comply with the requirements of federal law enforcement agencies. On August 5, 2005, the FCC unanimously adopted an order responsive to a joint petition filed by the Department of Justice, the Federal Bureau of Investigation, and the Drug Enforcement Administration asking the FCC to declare that broadband Internet access services and VoIP services be covered by the Communications Assistance for Law Enforcement Act, or CALEA. The FCC, in a subsequent order released on May 12, 2006, required all interconnected VoIP providers to become fully CALEA compliant by May 14, 2007. The FCC allowed VoIP providers to comply with CALEA through the use of a solution provided by a trusted third party with the ability to extract call content and call-identifying information from a VoIP provider’s network. While the FCC permits carriers to use the services provided these third parties to become CALEA compliant by the deadline, the carrier remains ultimately responsible for ensuring the timely delivery of call content and call-identifying information to law enforcement, and for protecting subscriber privacy, as required by CALEA. We selected a partner to work with us to develop a solution for CALEA compliant lawful interception of communications and, as of May 14, 2007, we had installed this solution in our network operations and data centers, but had not yet completed certification testing of all required intercept capabilities of this equipment. We completed formal CALEA compliance testing with this partner in March 2009 and currently, our tested CALEA solution is fully deployed in our network. However, we could be subject to an enforcement action by the FCC or law enforcement agencies for any delays related to meeting, or if we fail to comply with, any current or future CALEA obligations. There may be risks associated with our ability to comply with requirements of the Telecommunications Relay Service. On June 15, 2007, the FCC extended the disability access requirements of Sections 225 and 255 of the Communications Act, which applied to traditional phone services, to providers of interconnected VoIP services and to manufacturers of specially designed equipment used to provide those services. In addition, the FCC determined that interconnected VoIP providers were subject to the requirements of Section 225, including contributing to the Telecommunications Relay Services, or TRS, fund and that they must offer 7-1-1 abbreviated dialing for access to relay services. While the rules became effective October 5, 2007, the FCC granted a limited waiver to interconnected VoIP providers concerning the 7-1-1 call routing requirement until March 31, 2009. Interconnected VoIP providers do not have to route such calls to the "appropriate relay center," meaning the relay center(s) serving the state in which the caller is geographically located or the relay center(s) associated with the caller's last registered address until the waiver period expires. As of April 5, 2008, we have implemented a 7-1-1 system which routes such calls to the appropriate relay center based upon the customer’s assigned telephone number. We may be subject to enforcement actions including, but not limited to, fines, cease and desist orders, or other penalties if the FCC believes we are not compliant with these new disability requirements. There may be risks associated with our ability to comply with the requirements of federal and other regulations related to Customer Proprietary Network Information (CPNI). On April 2, 2007, the FCC released an order extending the application of the customer proprietary network information, or CPNI, rules to interconnected VoIP providers. VoIP providers have six months from the effective date of the order to implement all the CPNI rules. CPNI includes information such as the phone numbers called by a consumer, the frequency, duration, and timing of such calls, and any services/features purchased by the consumer, such as call waiting, call forwarding, and caller ID, in addition to other information that may appear on a consumer’s bill. Under the FCC’s existing rules, carriers may not use CPNI without customer approval except in narrow circumstances related to the provision of existing services, and must comply with detailed customer approval processes when using CPNI outside of these narrow circumstances. The new CPNI requirements are also aimed at establishing more stringent security measures for access to a customer’s CPNI data in the form of required passwords for on-line access and call-in access to account information as well as customer notification of account or password changes. At the present time, we do not utilize our customer’s CPNI in a manner which would require us to obtain consent from our customers but, in the event that we do in the future, we will be required to adhere to specific CPNI rules aimed at marketing such services. Before December 8, 2007, we implemented internal processes in order to be in compliance with all of the FCC’s CPNI rules. Our failure to achieve compliance with any future CPNI orders, rules, filings or standards, or any enforcement action initiated by the FCC or other agency, state or task force against us could have a material adverse effect on our business, financial condition or operating results. 19 There may be risks associated with our ability to comply with funding requirements of the Universal Service Fund, or USF, Telecommunications Relay Service, or TRS, fund, federal regulatory recovery fees and similar state or federal funds, or that our customers will cancel service due to the impact of these price increases to their services. On June 21, 2006, the FCC expanded the base of Universal Service Fund, or USF, contributions to interconnected VoIP providers. The FCC established a safe harbor percentage of interstate revenue of 64.9% of total VoIP service revenue. We were allowed to calculate our contribution based on the safe harbor or by preparing a traffic study. We began contributing to the federal USF on October 1, 2006. For a period of at least two quarters beginning October 1, 2006, we were required to contribute to the USF for all subscribers' retail revenues as well as through its underlying carriers' wholesale charges. The FCC order applying USF contributions to interconnected VoIP providers was appealed and on June 1, 2007, the U.S. Court of Appeals for the District of Columbia ruled that the FCC was within its authority when it required interconnected VoIP service providers to contribute to the Universal Service Fund, though it struck down the provision of the order which required pre- approval of traffic studies by the FCC and the provision that required double contributions to the fund for two quarters from our underlying carriers’ wholesale charges. There is also a risk that state Universal Service Funds may attempt to impose state USF contribution obligations and other state and local charges. At this time, at least three states, including Kansas and Nebraska, contend that providers of interconnected VoIP services, like us, should contribute to its USF fund. On March 3, 2008, the U.S. District Court for Nebraska issued a preliminary injunction and found that Nebraska’s state Public Service Commission does not have jurisdiction to require Universal Service contributions from VoIP providers. On May 1, 2009, a panel of the U.S. Circuit Court of Appeals for the Eighth Circuit affirmed the U.S. District court ruling. Subsequently, the Kansas and Nebraska state commissions filed a joint petition with the FCC seeking the ability to assess state USF contribution obligations on VoIP providers, like us, retroactively. We cannot predict the outcome of this proceeding at this time nor its impact on our business. As of March 31, 2009, we were collecting or remitting state USF in one state. Effective June 1, 2009, we ceased collecting and remitting state USF. We charge our subscribers a USF fee equal to the USF contribution amounts we must contribute based upon our subscribers' retail revenues. The impact of this price increase on our customers or our inability to recoup our costs or liabilities in remitting USF contributions or other factors could have a material adverse effect on our financial position, results of operations and cash flows. The FCC and various state commissions are considering the imposition of additional fees on interconnected VoIP providers, like us. Several states are either considering extending or have imposed state USF, state TRS fees, and other taxes and fees on interconnected VoIP providers like us. If we pass through the taxes, fees and surcharges that may be applied to our service, the impact of this price increase on our customers or our inability to recoup our costs or liabilities in remitting such taxes, fees and surcharges could have a material adverse effect on our financial position, results of operations and cash flows. We may also be at a competitive disadvantage to other providers who choose not to comply with these payment obligations. If we are unable to improve our process for local number portability provisioning, our growth may be negatively affected. We support local number portability, or LNP, which allows our customers to retain their existing telephone numbers when subscribing to our services. Transferring numbers is a manual process that, in the past, has taken us 20 business days or longer, although we have taken steps to automate this process to reduce the delay. A new customer of our services must maintain both the new 8x8 service and the customer’s existing telephone service during the number transfer process. By comparison, transferring wireless telephone numbers among wireless service providers generally takes several hours, and transferring wireline telephone numbers among traditional wireline service providers generally takes a few days. The additional delay that we experience is due to our reliance on third party carriers to transfer the numbers, as well as the delay the existing telephone service provider may contribute to the process. Local number portability is considered an important feature by many potential customers, especially our business customers, and if we fail to reduce related delays, we may experience increased difficulty in acquiring new customers or retaining existing customers. Moreover, the FCC now requires interconnected VoIP providers, like us, to comply with industry standard timeframes and a new order shortens the timeframe for certain types of ports considerably, although compliance with the new timeframes will not be required until August 2, 2010. If we are unable to process ports within the requisite timeframes, we could be subject to fines and/or penalties. Additionally, both customers and carriers may seek relief from the relevant state public utility commission, the FCC, and/or in state or federal court. During fiscal 2008, the FCC required interconnected VoIP providers to remit regulatory and local number portability fees. 20 The rates we pay to underlying telecommunications carriers may increase which may reduce our profitability and increase the retail price of our service. The FCC has several open proceedings considering new rules that may impact charges that regulated telecommunications carriers assess each other for originating and terminating traffic. It is possible that the FCC will adopt new rules that subjects interconnected VoIP traffic to increased charges. Should this occur, the rates that we pay to our underlying carriers may increase which may reduce our profitability and may also increase the retail price of our service making our service less competitive with other providers of similar calling services. We cannot predict either the timing or the outcome of these proceedings. We may be subject to new rules or legislation that could either increase the retail price of our service or reduce our net profit margins due to the FCC's National Broadband Plan. In March 2010, the FCC presented its national broadband plan to the U.S. Congress. Details on the plan are available at http://www.broadband.gov/. It is unclear what specific proposals the FCC will make but there is a chance the FCC will attempt to revise rules or request new legislation pertaining to the regulatory classification and treatment of broadband access and Internet services, intercarrier compensation, universal service funding obligations and open Internet access obligations. We could be negatively impacted by any changes that cause our underlying service providers to incur greater cost either through a new rate structure, a new contribution metric, or paired down protections related to open Internet access. Of course, any litigation that may result from the new rules could also increase our costs. We cannot predict how the FCC's national broadband plan will impact us at this time. Our success also depends on our ability to handle a large number of simultaneous calls, which our network may not be able to accommodate. We expect the volume of simultaneous calls to increase significantly as the 8x8 subscriber base grows. Our network hardware and software may not be able to accommodate this additional volume. If we fail to maintain an appropriate level of operating performance, or if our service is disrupted, our reputation could be hurt and we could lose customers, all of which could have a material adverse effect on our business, financial condition or operating results. We could be liable for breaches of security on our web site, fraudulent activities of our users, or the failure of third- party vendors to deliver credit card transaction processing services. A fundamental requirement for operating an Internet-based, worldwide voice and video communications service and electronically billing our 8x8 customers is the secure transmission of confidential information and media over public networks. Although we have developed systems and processes that are designed to protect consumer information and prevent fraudulent credit card transactions and other security breaches, failure to mitigate such fraud or breaches may adversely affect our operating results. The law relating to the liability of providers of online payment services is currently unsettled and states may enact their own rules with which we may not comply. We rely on third party providers to process and guarantee payments made by 8x8 subscribers up to certain limits, and we may be unable to prevent our customers from fraudulently receiving goods and services. Our liability risk will increase if a larger fraction of our 8x8 transactions involve fraudulent or disputed credit card transactions. Any costs we incur as a result of fraudulent or disputed transactions could harm our business. In addition, the functionality of our current billing system relies on certain third-party vendors delivering services. If these vendors are unable or unwilling to provide services, we will not be able to charge for our 8x8 services in a timely or scalable fashion, which could significantly decrease our revenue and have a material adverse effect on our business, financial condition and operating results. We have experienced losses due to subscriber fraud and theft of service. Subscribers have, in the past, obtained access to the 8x8 service without paying for monthly service and international toll calls by unlawfully using our authorization codes or by submitting fraudulent credit card information. To date, such losses from unauthorized credit card transactions and theft of service have not been significant. We have implemented anti-fraud procedures in order to control losses relating to these practices, but these procedures may not be adequate to effectively limit all of our exposure in the future from fraud. If our procedures are not effective, consumer fraud and theft of service could significantly decrease our revenue and have a material adverse effect on our business, financial condition and operating results. 21 A higher rate of customer terminations would negatively affect our business by reducing our revenue or requiring us to spend more money to grow our customer base. Our rate of customer terminations, or average monthly customer churn, was 3.5% for the fiscal year ended March 31, 2010. Our churn rate could increase in the future if customers are not satisfied with our service. Other factors, including increased competition from other VoIP providers, alternative technologies, and adverse business conditions also influence our churn rate. Because of churn, we have to acquire new customers on an ongoing basis just to maintain our existing level of customers and revenues. As a result, marketing expenditures are an ongoing requirement of our business. If our churn rate increases, we will have to acquire even more new customers in order to maintain our existing revenues. We incur significant costs to acquire new customers, and those costs are an important factor in determining our net profitability. Therefore, if we are unsuccessful in retaining customers or are required to spend significant amounts to acquire new customers beyond those budgeted, our revenue could decrease and our net income could decrease. Our future operating results may vary substantially from period to period and may be difficult to predict. Our historical operating results have fluctuated significantly and will likely continue to fluctuate in the future, and a decline in our operating results could cause our stock price to fall. On an annual and a quarterly basis, there are a number of factors that may affect our operating results, many of which are outside our control. These include, but are not limited to: • • • • • • changes in market demand; the timing of customer orders; customer cancellations; competitive market conditions; lengthy sales cycles and/or regulatory approval cycles; new product introductions by us or our competitors; • market acceptance of new or existing products; • • • • • • the cost and availability of components; the mix of our customer base and sales channels; the mix of products sold; the management of inventory; continued compliance with industry standards and regulatory requirements; and general economic conditions. Due to these and other factors, we believe that period-to-period comparisons of our results of operations are not meaningful and should not be relied upon as indicators of our future performance. It is possible that in some future periods our results of operations may be below the expectations of public market analysts and investors. If this were to occur, the price of our common stock would likely decline significantly. We need to retain key personnel to support our products and ongoing operations. The development and marketing of our VoIP services will continue to place a significant strain on our limited personnel, management, and other resources. Our future success depends upon the continued services of our executive officers and other key employees who have critical industry experience and relationships that we rely on to implement our business plan. None of our officers or key employees are bound by employment agreements for any specific term. The loss of the services of any of our officers or key employees could delay the development and introduction of, and negatively impact our ability to sell our services which could adversely affect our financial results and impair our growth. We currently do not maintain key person life insurance policies on any of our employees. 22 We may not be able to manage our inventory levels effectively, which may lead to inventory obsolescence that would force us to incur inventory write-downs. Our products have lead times of up to several months and are built to forecasts that are necessarily imprecise. Because of our practice of building our products to necessarily imprecise forecasts, it is likely that from time to time we will have either excess or insufficient product inventory. In addition, because we rely on third party vendors for the supply of components and contract manufacturers to assemble our products, our inventory levels are subject to the conditions regarding the timing of purchase orders and delivery dates that are not within our control. Excess inventory levels would subject us to the risk of inventory obsolescence, while insufficient levels of inventory may negatively affect relations with customers. For instance, our customers rely upon our ability to meet committed delivery dates, and any disruption in the supply of our products could result in legal action from our customers, loss of customers or harm to our ability to attract new customers. Any of these factors could have a material adverse effect on our business, financial condition or operating results. The fair value of certain warrant liabilities may increase or decrease, and as a result, we may be required, pursuant to ASC 480-10, to reflect a corresponding increase or decrease in our net income or net loss, as the case may be, and the amount of our recorded liability for the warrants for the applicable quarter also may fluctuate materially. Pursuant to ASC 480-10 (formerly Emerging Issues Task Force Issue No. 00-19, “Accounting for Derivative Financial Instruments Indexed to and Potentially Settled in a Company’s Own Stock”), warrants issued to two investors in an equity financing we consummated in fiscal 2006 are classified as liabilities because of the possibility, however likely or unlikely, that the Company would be unable to deliver registered shares upon a future exercise of these warrants means that the warrants are deemed to include a "net cash settlement" provision within the meaning of ASC 480-10. The required accounting for a warrant with a "net cash settlement" provision under ASC 480-10 is to estimate the fair value on the date of issuance and to record a liability equal to that value to reflect the required assumption that the Company will breach its obligation to deliver registered shares in the future (which we refer to as a "presumed breach"). The warrants will continue to be recorded as liabilities until such time as the warrants are exercised, expire or we and the warrant holders amend the applicable warrant agreement in a manner that renders this accounting treatment unnecessary. In the event that at the end of any fiscal quarter the fair value of these warrants increases or decreases, we will be required to re-value the warrants and reflect such change for the applicable fiscal quarter in our financial statements in accordance with ASC 480-10. If the fair value at the end of any fiscal quarter increases, we will recognize a corresponding increase in expense for such fiscal quarter, as well as reflect a corresponding increase in our liabilities for such fiscal quarter, in accordance with ASC 480-10, resulting in a reduction of our stockholders’ equity on our balance sheet for such fiscal quarter and a decrease in net income on our income statement for such fiscal quarter. If the fair value at the end of any fiscal quarter decreases, we will recognize a corresponding decrease in expense for such fiscal quarter, as well as reflect a corresponding decrease in our liabilities for such fiscal quarter, in accordance with ASC 480-10, resulting in an increase of our stockholders’ equity on our balance sheet for such fiscal quarter and increase in net income on our income statement for such fiscal quarter. The amount we record as a liability under ASC 480-10 is not, nor do we intend for it to be, an admission or stipulation of the amount that we would owe or be obligated to pay the warrant holder in the event of an actual breach by us of the warrant terms. In fact, we have made no determination of the amount of liability, if any, that we would owe to the warrant holder in the event of such a breach. We may need to raise additional capital to support our future operations. As of March 31, 2010, we had cash and cash equivalents and investments of approximately $18.1 million. While we believe these funds are sufficient to meet our current and anticipated liquidity requirements, we may need to raise additional capital. We may not be able to obtain such additional financing as needed on acceptable terms, or at all, which may require us to reduce our operating costs and other expenditures, including reductions of personnel and capital expenditures. If we issue additional equity or convertible debt securities to raise funds, the ownership percentage of our existing stockholders would be reduced and they may experience significant dilution. New investors may demand rights, preferences or privileges senior to those of existing holders of our common stock. If we are not successful in these actions, we may be forced to cease operations. Our stock price has been highly volatile. The market price of the shares of our common stock has been and is likely to continue to be highly volatile. It may be significantly affected by factors such as: • • actual or anticipated fluctuations in our operating results; announcements of technical innovations; 23 • • • • • • future legislation or regulation of the Internet and/or VoIP; loss of key personnel; new entrants into the VOIP service marketplace, including cable and incumbent telephone companies and other well- capitalized competitors; new products or new contracts by us, our competitors or their customers; the perceived or real impact of events that negatively affect our direct competitors; and developments with respect to patents or proprietary rights, general market conditions, changes in financial estimates by securities analysts, and other factors which could be unrelated to, or outside of, our control. The stock market has from time to time experienced significant price and volume fluctuations that have particularly affected the market prices for the common stocks of technology companies and that have often been unrelated to the operating performance of particular companies. These broad market fluctuations may adversely affect the market price of our common stock. In the past, following periods of volatility in the market price of a company's securities, securities class action litigation has often been initiated against the issuing company. If our stock price is volatile, we may also be subject to such litigation. Such litigation could result in substantial costs and a diversion of management's attention and resources, which would disrupt business and could cause a decline in our operating results. Any settlement or adverse determination in such litigation would also subject us to significant liability. We may not be able to maintain our listing on the NASDAQ Capital Market. Our common stock trades on the NASDAQ Capital Market, which has certain compliance requirements for continued listing of common stock. We have, in the past, been subject to delisting procedures due to a drop in the price of our common stock. If our minimum closing bid price per share falls below $1.00 for a period of 30 consecutive trading days in the future, we may again be subject to delisting procedures. As of the close of business on May 24, 2010, our common stock had a closing bid price of approximately $1.17 per share. We must also meet additional continued listing requirements contained in NASDAQ Marketplace Rule 5550(b), which requires that we have either (1) a minimum of $2,500,000 in stockholders' equity, (2) $35,000,000 market value of listed securities held by non-affiliates or (3) $500,000 of net income from continuing operations for the most recently completed fiscal year (or two of the three most recently completed fiscal years). As of May 24, 2010, based on our closing price as of that day, the market value of our securities held by non-affiliates approximated $73,106,000 and we were in compliance with NASDAQ Marketplace Rule 5550(b). There can be no assurance that we will continue to meet the continued listing requirements. Delisting could reduce the ability of our shareholders to purchase or sell shares as quickly and as inexpensively as they have done historically. For instance, failure to obtain listing on another market or exchange may make it more difficult for traders to sell our securities. Broker-dealers may be less willing or able to sell or make a market in our common stock. Not maintaining our NASDAQ Capital Market listing may (among other effects): result in a decrease in the trading price of our common stock; lessen interest by institutions and individuals in investing in our common stock; • • • make it more difficult to obtain analyst coverage; and • make it more difficult for us to raise capital in the future. ITEM 1B. UNRESOLVED STAFF COMMENTS None. 24 ITEM 2. PROPERTIES Our principal operations are located in Sunnyvale, CA in a facility that is approximately 52,000 square feet and is leased through August 2012. We believe our Sunnyvale facility will adequately meet our current and foreseeable future needs. For additional information regarding our obligations under leases see Note 3 to the consolidated financial statements contained in Part II, Item 8 of this Report. ITEM 3. LEGAL PROCEEDINGS From time to time, we become involved in various legal claims and litigation that arise in the normal course of our operations. While the results of such claims and litigation cannot be predicted with certainty, we are not currently aware of any such matters that we believe would have a material adverse effect on our financial position, results of operations or cash flows. On January 27, 2010, we were named a defendant in a lawsuit, Nikki Meierdiercks et al. v. 8x8, Inc., filed by three former employees in Santa Clara County Superior Court as a putative class action seeking damages and various penalties under the California Labor Code for alleged unpaid overtime, meal breaks, rest breaks and alleged late wage payments and unreimbursed business expenses. The Plaintiffs’ filed a First Amended Complaint on April 29, 2010 and we filed our Answer to the First Amended Complaint on May 26, 2010. We have factual and legal defenses to these claims and are presenting a vigorous defense. Plaintiffs have not made a specific monetary demand and we cannot estimate potential liability in this case at this early stage of litigation. ITEM 4. (REMOVED AND RESERVED) PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES We completed our initial public offering on July 2, 1997 under the name 8x8, Inc. From that date through April 3, 2000, our common stock was traded on what was then known as the NASDAQ National Market (the NASDAQ) under the symbol "EGHT." From April 4, 2000 through July 18, 2001, our common stock was traded on the NASDAQ under the symbol "NTRG." Since July 19, 2001 our common stock has traded under the symbol "EGHT." In July 2002, our listing was transferred to the NASDAQ Capital Market of the NASDAQ Stock Market LLC. We have never paid cash dividends on our common stock and have no plans to do so in the foreseeable future. We did not repurchase any of our equity securities during the fourth quarter of fiscal 2010. As of May 24, 2010, there were 272 holders of record of our common stock. The following table sets forth the range of high and low close prices for each period indicated: Period Fiscal 2010: First quarter Second quarter Third quarter Fourth quarter Fiscal 2009: First quarter Second quarter Third quarter Fourth quarter High Low $ 0.85 $ 1.05 $ 1.50 $ 1.63 $ 1.27 $ 1.14 $ 0.90 $ 0.65 $ 0.58 $ 0.60 $ 0.89 $ 1.20 $ 0.97 $ 0.87 $ 0.42 $ 0.45 25 See Item 12 of Part III of this Report regarding information about securities authorized for issuance under our equity compensation plans. The graph below shows the cumulative total stockholder return over a five year period assuming the investment of $100 on March 31, 2005 in each of 8x8’s common stock, the NASDAQ Composite Index and the NASDAQ Telecommunications Index. The graph is furnished, not filed, and the historical return cannot be indicative of future performance. Sales of Unregistered Securities. On May 1, 2010, we entered into an agreement with Central Host, Inc. and Andrew Schwabecher pursuant to which we acquired this provider of managed hosting services from its sole shareholder, Schwabecher. Under the terms of the Agreement, we closed the acquisition on May 1, 2010, and paid $1,000,000 in cash and issued 432,276 shares of common stock, at an average price of $1.388 per share and calculated based on the trailing 5-day average closing price of 8x8 common stock on the NASDAQ Exchange as of the Effective Date of the transaction, to Schwabecher in exchange for 100% of the outstanding shares of capital stock of Central Host, Inc. The shares of our common stock were not registered for sale and were issued pursuant to an exemption from the registration requirements under section 5 of the Securities Act of 1933, as amended, provided by section 4(2) thereof. 26 ITEM 6. SELECTED FINANCIAL DATA Total revenues Net income (loss) Net income (loss) per share: Basic Diluted Total assets Fair value of warrant liability Accumulated deficit Total stockholders' equity $ $ $ $ $ $ $ $ 2010 63,396 3,879 $ $ 2009 Years Ended March 31, 2008 (in thousands, except per share amounts) 53,130 61,646 (9,930) 30 64,674 (2,500) 2007 $ $ $ $ 2006 $ $ 31,892 (23,253) 0.06 0.06 23,712 167 (198,840) (0.04) $ (0.04) $ 21,856 $ $ 21 $ (202,719) 0.00 $ 0.00 $ 21,551 $ $ 335 $ (200,219) (0.16) $ (0.16) $ 19,958 $ $ 3,387 $ (200,249) (0.42) $ (0.42) $ 31,120 $ $ 7,123 $ (190,319) 13,300 $ 9,030 $ 7,849 $ 5,377 $ 12,970 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW We were founded in 1987 and completed an initial public offering of common stock in 1997. We develop and market telecommunications services for Internet protocol, or IP, telephony and video applications as well as web-based conferencing and unified communications services. We offer the 8x8 VoIP (Voice over Internet Protocol) voice and video digital phone service, 8x8 Virtual Office hosted PBX service, 8x8 Complete Contact Center service, 8x8 Trunking service, 8x8 Hosted Key System service, 8x8 MobileTalk service, 8x8 Virtual Meeting web conferencing service, the 8x8 Virtual Office Pro unified communications solution and 8x8 Managed Hosting and Cloud-Based Computing solutions. As of March 31, 2010, we had more than 20,000 business customers. Each business customer subscribes to a number of various lines and services (e.g. physical phone extensions, virtual extensions, fax lines, toll free numbers, receptionist software, unified communications services, etc.) Since fiscal 2004, substantially all of our revenues have been generated from the sale, license and provision of VoIP products, services and technology. Prior to fiscal 2003, our focus was on our VoIP semiconductor business. CRITICAL ACCOUNTING POLICIES & ESTIMATES Our consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America. Note 1 to the consolidated financial statements in Part II, Item 8 of this Report describes the significant accounting policies and methods used in the preparation of our consolidated financial statements. We have identified the policies below as some of the more critical to our business and the understanding of our results of operations. These policies may involve a higher degree of judgment and complexity in their application and represent the critical accounting policies used in the preparation of our financial statements. Although we believe our judgments and estimates are appropriate, actual future results may differ from our estimates. If different assumptions or conditions were to prevail, the results could be materially different from our reported results. The impact and any associated risks related to these policies on our business operations is discussed throughout Management's Discussion and Analysis of Financial Condition and Results of Operations where such policies affect our reported and expected financial results. Use of Estimates The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and equity and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, we evaluate our estimates, including, but not limited to, those related to bad debts, valuation of inventories, and litigation and other contingencies. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent 27 from other sources. Actual results could differ from those estimates under different assumptions or conditions. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets, liabilities and equity that are not readily apparent from other sources. Actual results could differ from those estimates under different assumptions or conditions. Additional information regarding risk factors that may impact our estimates is included above under Item 1A, "Risk Factors." Revenue Recognition Our revenue recognition policies are described in Note 1 to the consolidated financial statements in Part II, Item 8 of this Report. As described below, significant management judgments and estimates must be made and used in connection with the revenue recognized in any accounting period. Material differences may result in the amount and timing of our revenue for any period if our management made different judgments or utilized different estimates. Under the terms of our typical subscription agreement, new customers can terminate their service within 30 days of order placement and receive a full refund of fees previously paid. We have determined that we have sufficient history of subscriber conduct to make a reasonable estimate of cancellations within the 30-day trial period. Therefore, we recognize new subscriber revenue in the month in which the new order was shipped, net of an allowance for expected cancellations. Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 605-25 (formerly Emerging Issues Task Force consensus No. 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables”) 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, we allocate 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 when the related services are provided. We record revenue net of any sales-related taxes that are billed to our customers. We believe this approach results in financial statements that are more easily understood by investors. The cost of the products sold is recognized contemporaneously with the recognition of revenue. At the time of each revenue transaction, we assess whether the revenue amount is fixed and determinable and whether collection is reasonably assured. We assess whether the fee is fixed and determinable based on the payment terms associated with the transaction. If a significant portion of a fee is due after our normal payment terms, which are 30-90 days from invoice date, we account for the fee as not being fixed and determinable. In these cases, we recognize revenue as the fees become due. We assess collection based on a number of factors, including past transaction history with the customer and the creditworthiness of the customer. We generally do not request collateral from our customers. If we determine that collection of a fee is not reasonably assured, we defer the fee and recognize revenue at the time collection becomes reasonably assured, which is generally upon receipt of payment. We defer recognition of revenue on product sales to retailers where the right of return exists until products are resold to the end user and the trial period has expired. During fiscal 2010, 2009 and 2008, revenue from software licensing and related arrangements were limited. For arrangements with multiple obligations (for example, undelivered maintenance and support), we have allocated revenue to each component of the arrangement using the residual value method based on the fair value of the undelivered elements, which is specific to us. This means that we defer revenue from the arranged fee that is equivalent to the fair value of the undelivered elements. Fair values for the ongoing maintenance and support obligations for our technology licenses are based upon separate sales of renewals to other customers or upon renewal rates quoted in the contracts. We base the fair value of services, such as training or consulting, on separate sales of these services to other customers. We recognize revenue for maintenance services ratably over the contract term. Our training and consulting services are billed based on hourly rates, and we generally recognize revenue as these services are performed. Under our revenue recognition accounting principles, if a software license arrangement includes acceptance criteria, we do not recognize revenue until we can demonstrate objectively that the software or service can meet the acceptance criteria or that the customer has signed formal acceptance documentation. If a software license arrangement obligates us to deliver unspecified future products, we recognize revenue on a subscription basis, ratably over the term of the contract. 28 For all sales, except those completed via the Internet, we use either a binding purchase order or other signed agreement as evidence of an arrangement. For sales over the Internet, we use a credit card authorization as evidence of an arrangement, and recognize revenue upon settlement of the transaction, if there are no customer acceptance conditions. We do not settle credit card transactions until equipment related to the transaction, if any, is shipped to a customer. We launched the retail channel in fiscal 2005 and began using it for our 8x8 Virtual Office service in 2006 with product offerings through Office Depot and subsequently Office Max. Our retail channels and online retailers have unlimited return rights for this equipment. The Company records shipments to distributors, retailers, and resellers, where the right of return exists, as deferred revenue. Consequently, we defer recognition of revenue on sales to distributors, retailers, and resellers where the right of return exists until products are resold to the end user. Our ability to enter into revenue generating transactions and recognize revenue in the future is subject to a number of business and economic risks discussed above under Item 1A,"Risk Factors." Collectability of Accounts Receivable We must make estimates of the collectability of our accounts receivable. Management specifically analyzes accounts receivable, including historical bad debts, customer concentrations, customer creditworthiness, current economic trends and changes in our customer payment terms when evaluating the adequacy of the allowance for doubtful accounts. As of March 31, 2010, the accounts receivable balance was $670,000, net of an allowance for doubtful accounts of $36,000, including a reserve for disputed credits, and an estimated returns reserve of $80,000. If the financial condition of our customers deteriorates, our actual losses may exceed our estimates, and additional allowances would be required. Valuation of Inventories We write down our inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand, market conditions and replacement costs. If actual future demand or market conditions are less favorable than those projected by us, additional inventory write- downs may be required. Acquired Product Rights On April 29, 2009, we resolved a patent litigation matter with Web Telephony by entering into a license and settlement agreement that resolved all legal claims by Web Telephony. As part of the settlement, we agreed to pay eight quarterly payments totaling $800,000 over the next two years between April 2009 and December 2010. Under the transaction, we expensed $339,000 of the patent settlement costs during the year ended March 31, 2009 that were related to benefits received by us in and during the periods prior to fiscal year 2009. We recorded the remaining license fee of $432,000 as other long term assets as of March 31, 2009 and we are amortizing this amount to cost of service revenues in the Consolidated Statements of Operations over the remaining life of the primary patent, which expires in September 2017. Warrant Liability We account for our warrants in accordance with ASC 480-10 (formerly Emerging Issues Task Force Issue No. 00-19, “Accounting for Derivative Financial Instruments Indexed to and Potentially Settled in a Company’s Own Stock”) 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. Certain of our warrants require settlement in shares and are accounted for as permanent equity. We also have two investor warrants that are classified as liabilities because they include a provision that specifies that we must deliver freely tradable shares upon exercise by the warrant holder. Because there are circumstances, irrespective of likelihood, which may not be within our control that could prevent delivery of registered shares, ASC 480-10 requires the warrants be recorded as a liability at fair value, with subsequent changes in fair value recorded as income (loss) in change in fair value of warrant liability. The fair value of the warrant is determined using a Black-Scholes option pricing model, and is affected by changes in inputs to that model including our stock price, expected stock price volatility and contractual term. The amount we record as a liability under ASC 480-10 is not, nor do we intend for it to be an admission or stipulation of the amount that we would owe or be obligated to pay the warrant holder in the event of an actual breach by us of the warrant terms. In fact, we have made no determination of the amount of liability, if any, that we would owe to the warrant holder in the event of such a breach. 29 Income and Other Taxes As part of the process of preparing our consolidated financial statements we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process requires us to estimate our actual current tax expense and to assess temporary differences resulting from book-tax accounting differences for items such as deferred revenue. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheet. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income and to the extent we believe that recovery is not likely, we must establish a valuation allowance. In the event that we determine that we would be able to realize deferred tax assets in the future in excess of the net recorded amount, an adjustment to the deferred tax asset would increase income in the period such determination was made. Significant management judgment is required to determine the valuation allowance recorded against our net deferred tax assets, which consist of net operating loss and tax credit carry forwards. We have recorded a valuation allowance of approximately $68.7 million as of March 31, 2010, due to uncertainties related to our ability to utilize most of our deferred tax assets before they expire. The valuation allowance is based on our estimates of taxable income by jurisdiction in which we operate and the period over which our deferred tax assets will be recoverable. We have received inquiries, demands or audit requests from several states and municipal taxing and 9-1-1 agencies seeking payment of taxes that are applied to or collected from the customers of providers of traditional public switched telephone network services. We have recorded an expense of $0, $72,000 and $375,000 for the years ended March 31, 2010, 2009 and 2008, respectively, as our estimate of the increase in probable tax exposure for such assessments. Our cumulative estimate for probable assessments is $0.1 million as of March 31, 2010, which is recorded in the accrued taxes line item in the consolidated balance sheets. Stock-Based Compensation We account for our employee stock options and stock purchase rights granted under the 1996 Stock Plan, 1996 Director Option Plan, 1999 Nonstatutory Stock Option Plan and the 2006 Stock Plan and stock purchase rights under the 1996 Employee Stock Purchase Plan (“Purchase Plan”) under the provisions of ASC 718 – Stock Compensation (formerly Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment”). 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. We have adopted the modified prospective transition method as provided by ASC 718 and, accordingly, financial statement amounts for the prior periods have not been restated to reflect the fair value method of expensing share-based compensation. Stock-based compensation expense recognized in the Consolidated Statements of Operations for fiscal 2010 and 2009 included both the unvested portion of stock-based awards granted prior to April 1, 2006 and stock-based awards granted subsequent to April 1, 2006. Stock options granted in periods prior to fiscal 2007 were measured based on ASC 718 (formerly SFAS No. 123) criteria, whereas stock options granted subsequent to April 1, 2006 were measured based on ASC 718 (formerly SFAS No. 123(R)) criteria. In conjunction with the adoption of SFAS No. 123(R), we changed our method of attributing the value of stock-based compensation to expense from the accelerated multiple-option approach to the straight-line single option method. Compensation expense for all share-based payment awards granted subsequent to April 1, 2006 has been recognized using the straight-line single-option method. Stock-based compensation expense included in fiscal 2010 included 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. To value option grants and stock purchase rights under the Purchase Plan for actual and pro forma stock-based compensation we 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 prices volatility, expected life, risk free interest rates and future dividend payments. For fiscal years 2010, 2009 and 2008, we used the historical volatility of our 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 stock- based awards are expecting to remain outstanding. These expected life assumptions were established through the review of historical exercise behavior of stock-based award grants with similar vesting periods. The risk free interest was 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 was based on our history and expectation of future dividend payout. 30 ASC 718 requires us to calculate the additional paid in capital pool (“APIC Pool”) available to absorb tax deficiencies recognized subsequent to adopting ASC 718, as if we had adopted ASC 718 at its effective date of January 1, 1995. There are two allowable methods to calculate our APIC Pool: (1) the long form method as set forth in ASC 718 or (2) the short form method as set forth in ASC 718 (formerly FASB Staff Position No. 123(R)-3). We have elected to use the long form method under which we track each award grant on an employee-by-employee basis and grant-by-grant basis to determine if there is a tax benefit or tax deficiency for such award. We then compared the fair value expense to the tax deduction received for each grant and aggregated the benefits and deficiencies to establish the APIC Pool. Due to the adoption of ASC 718, some exercises result in tax deductions in excess of previously recorded benefits based on the option value at the time of grant, or windfalls. We recognize windfall tax benefits associated with the exercise of stock options directly to stockholders’ equity only when realized. Accordingly, we are not recognizing deferred tax assets for net operating loss carryforwards resulting from windfall tax benefits occurring from April 1, 2006 onward. A windfall tax benefit occurs when the actual tax benefit realized by the company upon an employee’s disposition of a share-based award exceeds the deferred tax asset, if any, associated with the award that the company had recorded. We use the “with and without” approach as described in ASC 740 (formerly Emerging Issues Task Force (“EITF”) Topic No. D-32), in determining the order in which our tax attributes are utilized. The “with and without” approach results in the recognition of the windfall stock option tax benefits only after all other tax attributes of ours have been considered in the annual tax accrual computation. Also, we have elected to ignore the indirect tax effects of share-based compensation deductions in computing our research and development tax and as such, we recognize the full effect of these deductions in the income statement in the period in which the taxable event occurs. On January 27, 2009, when our stock price closed at $0.55 per share our board of directors approved the acceleration of unvested stock options to purchase 3,902,186 shares of common stock. 1,737,509 of these shares are subject to options held by our executive officers and directors. These options of our executive officers and directors, taken as a whole, have a weighted average exercise price of $1.06 per share and range from $0.63 to $1.79 per share, and a weighted average remaining vesting term of 2.85 years. Approximately $1.1 million of the $2.4 million stock-based compensation charge in the fourth quarter of 2009 applies to the options held by our executive officers and directors. SELECTED OPERATING STATISTICS We periodically review certain key business metrics, within the context of our articulated performance goals, in order to evaluate the effectiveness of our operational strategies, allocate resources and maximize the financial performance of our business. The selected operating statistics include the following: 31 Gross business customer additions (1) Gross business customer cancellations (less cancellations within 30 days of sign-up) Business customer churn (less cancellations within 30 days of sign-up) (2) Total business customers (3) Business customer average monthly service revenue per customer (4) Selected Operating Statistics March 31, 2010 2,875 Dec. 31, 2009 2,785 Sept. 30, 2009 2,609 June 30, 2009 2,907 1,616 1,331 1,416 1,371 March 31, 2009 2,792 1,245 Dec. 31, 2008 2,437 Sept. 30, 2008 3,324 June 30, 2008 2,398 1,224 1,187 1,098 2.7% 20,428 2.4% 19,407 2.7% 18,199 2.7% 17,266 2.7% 16,013 2.9% 14,706 3.1% 13,744 3.2% 11,898 $ 204 $ 204 $ 201 $ 196 $ 202 $ 208 $ 220 $ 237 Service revenue from business customers (in '000s) Product revenue from business customers (in '000s) Total revenue from business customers (in '000s) $ $ $ 12,182 1,266 13,448 Revenue from business customers (in '000s) Revenue from residential customers (in '000s) Revenue from technology licensing (in '000s) Total Revenue $ $ $ $ 13,448 2,396 23 15,867 $ $ $ 11,494 1,156 12,650 $ $ $ $ 12,650 3,278 16 15,944 $ $ $ 10,714 1,128 11,842 $ $ $ $ 11,842 4,168 17 16,027 $ $ $ 9,787 935 10,722 $ $ $ $ 10,722 4,811 25 15,558 $ $ $ 9,293 1,435 10,728 $ $ $ 8,883 1,731 10,614 $ $ $ 8,466 1,360 9,826 $ $ $ $ 10,728 5,236 (199) 15,765 $ $ $ $ 10,614 5,572 17 16,203 $ $ $ $ 9,826 6,356 243 16,425 Percentage of revenue from business customers Percentage of revenue from residential customers Percentage of revenue from technology licensing Total Revenue Overall service margin Overall product margin Overall gross margin 84.8% 15.1% 0.1% 100.0% 77% -43% 68% 79.3% 20.6% 0.1% 100.0% 78% -59% 68% 73.9% 26.0% 0.1% 100.0% 76% -42% 67% 68.9% 30.9% 0.2% 100.0% 76% -75% 66% 68.1% 33.2% -1.3% 100.0% 71% -50% 59% 65.5% 34.4% 0.1% 100.0% 74% 9% 67% 59.8% 38.7% 1.5% 100.0% 73% -10% 65% $ $ $ 8,073 1,004 9,077 $ $ $ $ 9,077 7,192 12 16,281 55.8% 44.1% 0.1% 100.0% 75% -13% 68% Total (business, residential and video) subscriber acquisition cost per service (5) Business subscriber acquisition cost per service (6) Average number of services subscribed to per business customer Business customer subscriber acquisition cost (7) $ $ 97 97 $ $ 102 102 $ $ 88 90 $ $ 108 93 $ $ 119 118 $ $ 135 141 $ $ 163 171 $ $ 162 171 7.5 723 $ 7.3 749 $ 7.1 638 $ 6.9 638 $ 6.6 785 6.6 933 $ 6.9 1,174 $ 7.1 1,217 $ $ (1) Includes 1,154 "Find me, Follow me" and 40 8x8 Virtual Office customers acquired in the second quarter of fiscal 2009 from Avtex Solutions, LLC ("Avtex"). (2) Business customer churn is calculated by dividing the number of business customers that terminated (after the expiration of the 30-day trial) during that period by the simple average number of business customers during the period and dividing the result by the number of months in the period. The simple average number of business customers during the period is the number of business customers on the first day of the period plus the number of business customers on the last day of the period divided by two. (3) Business customers are defined as customers paying for service. Customers that have prepaid for their first month of service and are currently in the 30-day trial period are considered to be customers that are paying for service. (4) Business customer average monthly service revenue per customer is service revenue from business customers in the period divided by the number of months in the period divided by the simple average number of business customers during the period. (5) Total (business, residential and video) subscriber acquisition cost per service is defined as the combined costs of advertising, marketing, promotions, commissions and equipment subsidies during the period divided by the number of gross services added during the period. (6) Business subscriber acquisition cost per service is defined as the combined costs of advertising, marketing, promotions, commissions and equipment subsidies for business services sold during the period divided by the number of gross business services added during the period. The addition of 1,154 Avtex customers that migrated to 8x8 in the second fiscal quarter of 2009 but subscribed to “Find me, Follow me” services rather than 8x8 Virtual Office service, and the $79,230 in expense related to the acquisition of these 1,154 customers, is excluded from this calculation. 32 (7) Business customer subscriber acquisition cost is business subscriber acquisition cost per service times the average number of services subscribed to per business customer. We believe it is useful to monitor these metrics together and not individually, as we do not make business decisions based upon any single metric. RESULTS OF OPERATIONS The following discussion should be read in conjunction with our Consolidated Financial Statements and related notes included elsewhere in this Report. REVENUES Service revenues Percentage of total revenues Years Ended March 31, Year-over-Year Change 2010 2009 2008 2009 to 2010 2008 to 2009 (dollar amounts in thousands) 58,486 90.4% $ $ 56,177 91.1% $ 58,683 92.6% $ 197 0.3% $ 2,309 4.1% Service revenues consist primarily of revenues attributable to the provision of our 8x8 services and royalties earned under our VoIP technology licenses. We expect that 8x8 service revenues will continue to comprise nearly all of our service revenues for the foreseeable future. The increase in fiscal year 2010, compared with fiscal year 2009, was primarily attributable to a $9.5 million increase in 8x8 service revenues resulting from the growth of our business service subscriber base. Our business service subscriber base grew from approximately 16,000 customers at the end of fiscal 2009 to approximately 20,000 customers on March 31, 2010. The increase was offset by a decrease of $9.3 million attributable to residential services. The decrease in service revenues from residential customers resulted from a reduction in the number of residential lines in service. These changes are consistent with the redirection of most of our marketing efforts toward our business customer service and we expect the trends to continue in future periods. The increase in fiscal year 2009, compared with fiscal year 2008, was primarily attributable to a $9.3 million increase in 8x8 service revenues resulting from the growth of our business service subscriber base. Our business service subscriber base grew from approximately 11,000 customers at the end of fiscal 2008 to approximately 16,000 customers on March 31, 2009. The increase was offset by a decrease of $5.7 million attributable to residential and videophone services and a $0.7 million decrease in revenue attributable to royalties earned. The decrease in service revenues from residential and video customers resulted from a reduction in the number of residential and video lines in service from approximately 107,000 in fiscal 2008 to approximately 82,000 in fiscal 2009. Also, compared with fiscal 2008, there was a $0.6 million reduction in the one time recognition of revenue due to a ruling by the U.S. Court of Appeals for the District of Columbia in June 2007 that interconnected VoIP providers are not required to obtain pre-approval of traffic studies. As a result of the ruling, in the first quarter of fiscal 2008 we retroactively applied our traffic study contribution rate to our historical subscriber retail revenues which resulted in the recognition of revenue of $0.6 million from the reduction of the related accrued liability in the first fiscal quarter of 2008. Years Ended March 31, Year-over-Year Change 2010 2009 2008 2009 to 2010 2008 to 2009 Product revenues Percentage of total revenues $ (dollar amounts in thousands) 6,188 9.6% 4,713 7.4% $ $ 5,469 8.9% $ (1,475) -23.8% $ 719 13.1% Product revenues consist primarily of revenues from sales of IP telephones, primarily attributable to our 8x8 service. The decrease in product revenues in fiscal year 2010 from fiscal year 2009 resulted from a selling price reduction as we elected to increase the subsidy on IP telephone sales to business service customers and a decline in product revenue attributable to residential and videophone service customers. 33 The increase in fiscal year 2009 from fiscal year 2008 resulted from a $2.2 million increase in product revenue attributable to growth in our business customer subscriber base. However, product revenue attributable to residential and video service customers declined by $1.5 million. No single customer represented more than 10% of our total revenues during fiscal 2010, 2009 or 2008. The following table illustrates our net revenues by geographic area. Revenues are attributed to countries based on the destination of shipment (in thousands): United States Other locations COST OF REVENUES Cost of service revenues Percentage of service revenues Years Ended March 31, 2010 2009 2008 $ $ 63,272 124 63,396 $ $ 64,633 41 64,674 $ $ 61,052 594 61,646 Years Ended March 31, Year-over-Year Change 2010 2009 2008 2009 to 2010 2008 to 2009 (dollar amounts in thousands) 15,714 26.9% $ $ 16,671 29.7% $ 13,599 23.2% $ (2,115) -13.5% $ (957) -5.7% Cost of service revenues primarily consists of costs associated with network operations and related personnel, telephony origination and termination services provided by third party carriers and technology license and royalty expenses. Cost of service revenues for fiscal 2010 compared with fiscal 2009 decreased $2.1 primarily due to a reduction in the prices we pay to third party network service vendors, as well as our use of multiple third party network provider vendors, which allows us to route call traffic to the third party network provider vendor with the most favorable pricing. The reduction in pricing by third party network service vendors was partially offset by an increase in personnel and licenses fee costs compared with the prior fiscal year. Cost of service revenues for fiscal 2009 compared with fiscal 2008 decreased $1.0 primarily due to a reduction in the prices we pay to third party network service vendors, as well as our use of multiple third party network service vendors, which allows us to route call traffic to the third party network service vendor with the most favorable pricing. The reduction in the prices we pay to third party network service vendors was partially offset by an increase in personnel and licenses fee costs compared with the prior fiscal year. Years Ended March 31, Year-over-Year Change 2010 2009 2008 2009 to 2010 2008 to 2009 Cost of product revenues Percentage of product revenues $ (dollar amounts in thousands) 7,135 115.3% 7,257 154.0% $ $ 6,762 123.6% $ 122 1.7% $ 373 5.5% The cost of product revenues consist of costs associated with systems, components, system manufacturing, assembly and testing performed by third party vendors, estimated warranty obligations and direct and indirect costs associated with product purchasing, scheduling, quality assurance, shipping and handling. We allocate a portion of service revenues to product revenues but these revenues are less than the cost of the product. The increase in the cost of product revenues for fiscal 2010 from fiscal 2009 was primarily due to a $0.6 million increase in the shipment of equipment to our business customers. The increase in cost of product revenues was partially offset by a $0.3 million decrease in shipments of equipment to residential customers, a $0.1 million reduction in payroll and related expenses, and a $0.1 million reduction in freight costs. The cost of product revenues as a percentage of product revenues increased due to an increase in discounting of product sales by our sales force in fiscal 2010. 34 The increase in the cost of product revenues for fiscal 2009 from fiscal 2008 was primarily due to a $2.0 million increase in the shipment of equipment to our business customers. The increase in cost of product revenues was partially offset by a $1.7 million decrease in shipments of equipment to residential subscribers and a $0.4 million reduction in freight costs. The cost of product revenues as a percentage of product revenues decreased in part due to a reduction in discounting of product sales by our sales force in fiscal 2009. RESEARCH AND DEVELOPMENT EXPENSES Years Ended March 31, Year-over-Year Change 2010 2009 2008 2009 to 2010 2008 to 2009 Research and development Percentage of total revenues $ (dollar amounts in thousands) 5,212 8.1% 5,049 8.0% $ $ 4,335 7.0% $ (163) -3.1% $ 877 20.2% Historically, our research and development expenses have consisted primarily of personnel, system prototype design, and equipment costs necessary for us to conduct our development and engineering efforts. We expense research and development costs, including software development costs, as they are incurred. The decrease in research and development expenses for fiscal 2010 from fiscal 2009 was primarily attributable to a decrease in overall expenses offset by an increase in personnel and contractor headcount expenses. The increase in research and development expenses for fiscal 2009 from fiscal 2008 was primarily attributable to an increase in personnel and contractor headcount expenses, including a $0.3 million increase in SFAS 123(R) stock-based compensation expense. In April 2010, we sold our French research and development subsidiary and expect our research and development expense to decline in fiscal 2011 compared with fiscal 2010. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES Years Ended March 31, Year-over-Year Change 2010 2009 2008 2009 to 2010 2008 to 2009 Selling, general and administrative $ 33,516 52.9% Percentage of total revenues (dollar amounts in thousands) 39,680 61.4% $ $ 37,596 61.0% $ (6,164) -15.5% $ 2,084 5.5% Selling, general and administrative expenses consist primarily of personnel and related overhead costs for sales, marketing, customer support, finance, human resources and general management. Such costs also include outsourced customer service call center operations, sales commissions, as well as trade show, advertising and other marketing and promotional expenses. The decrease in selling, general and administrative expenses for fiscal 2010 from fiscal 2009 was due to a $2.3 million decrease in employee and temporary personnel costs, primarily due to a decrease in ASC 718 stock-based compensation expense as a result of accelerating the vesting period of stock options in fiscal 2009, $1.9 million decrease in advertising, public relations and other marketing and promotional expenses, a $1.7 million decrease in sales agent and retailer commissions, a $0.2 million decrease in credit card processing fees, $0.1 million decrease in travel and meal expenses, a $0.1 million decrease in telephone expenses. This decrease was partially offset by a $0.1 million increase in facility expenses. The increase in selling, general and administrative expenses for fiscal 2009 from fiscal 2008 was primarily due to a $4.1 million increase in employee and temporary personnel costs, including a $1.5 million increase in SFAS 123(R) stock-based compensation expense, $0.5 million increase in advertising, public relations and other marketing and promotional expenses, a $0.2 million increase in travel and meal expenses, a $0.1 million increase in printing expenses, and a $0.1 million increase in expensed equipment and software. This increase was partially offset by a $1.5 million decrease in sales agent and retailer commissions, a $0.9 million decrease in sales and use tax expenses as we began to collect and remit taxes in states outside of California, a $0.3 million decrease in accounting and tax fees, and a $0.2 million decrease in credit card processing fees. 35 INTEREST INCOME AND OTHER, NET Years Ended March 31, Year-over-Year Change 2010 2009 2008 2009 to 2010 2008 to 2009 Interest income and other, net Percentage of total revenues $ (dollar amounts in thousands) 53 0.1% 298 0.5% $ $ 1,606 2.6% $ (245) -82.2% $ (1,308) -81.4% Our interest income and other, net, primarily consists of interest and investment income earned on our cash, cash equivalents and investment balances. This item primarily consisted of interest income in fiscal 2010 and 2009. Other income in fiscal 2008 included $1.2 million from the sale of two patents. The decrease in other income for fiscal 2010 from fiscal 2009 consists primarily of a reduction in interest and investment income earned on our cash, cash equivalents and investment balances due to lower interest rates. INCOME ON CHANGE IN FAIR VALUE OF WARRANT LIABILITY Years Ended March 31, Year-over-Year Change 2010 2009 2008 2009 to 2010 2008 to 2009 (dollar amounts in thousands) Income (loss) on change in fair value of warrant liability Percentage of total revenues $ $ (146) -0.2% $ 314 0.5% 2,142 3.5% $ (460) -146.5% $ (1,828) -85.3% In connection with the sale of shares of our common stock in fiscal 2005 and 2006, we issued warrants in three different equity financings. The warrants included a provision that we must deliver freely tradable shares upon exercise of the warrant. Because there are circumstances that may not be within our control that could prevent delivery of registered shares, ASC 480- 10 requires the warrants be recorded as a liability at fair value with subsequent changes in fair value recorded as a gain or loss. The fair value of the warrant is determined using a Black-Scholes option pricing model, and is affected by changes in inputs to that model including our stock price, expected stock price volatility and contractual term. To the extent that the fair value of the warrant liability increases or decreases, we record a loss or income in our statement of operations. The amount we record as a liability under ASC 480-10 is not, nor do we intend for it to be, an admission or stipulation of the amount that we would owe or be obligated to pay the warrant holder in the event of an actual breach by us of the warrant terms. In fact, we have made no determination of the amount of liability, if any, that we would owe to the warrant holder in the event of such a breach. The decrease in the income from change in fair value of warrants in fiscal 2010 from fiscal 2009 occurred because the fair value of warrants and warrant liability increased due to an increase in our stock price and the expected stock price volatility, offset by a reduction in the risk free interest rate and contractual life of the warrants, which are the primary assumptions applied to the Black-Scholes model which we have used to calculate the fair value of the warrants. The decrease in the income from change in fair value of warrants in fiscal 2009 from fiscal 2008 occurred because the fair value of warrants and warrant liability declined due to a reduction in our stock price, expected stock price volatility, risk free interest rate and contractual life of the warrants which are the primary assumptions applied to the Black-Scholes model which we have used to calculate the fair value of the warrants. Investor warrants for 1,785,714 shares of common stock issued on December 19, 2005 will be accounted for as liabilities until they are exercised or they expire in December 2010. Therefore, there will not be any additional income or loss for these warrants after the third quarter of fiscal 2011. 36 PROVISION FOR INCOME TAXES Provision for income taxes Percentage of total revenues $ Years Ended March 31, Year-over-Year Change 2010 2009 2008 2009 to 2010 2008 to 2009 (dollar amounts in thousands) 3 0.0% 45 0.1% $ $ $ (42) -93.3% $ 45 100.0% - 0.0% We had a $3,000 provision for income taxes for the fiscal year ended March 31, 2010 for state tax in several states and foreign tax, offset by federal refund in lieu of bonus depreciation (in accordance with the Economic Stimulus Act of 2010). We had a $45,000 provision for income taxes in the fiscal years ended March 31, 2009. We had no provision for income taxes in the fiscal year ended March 31, 2008. At March 31, 2010, we had net operating loss carryforwards for federal and state income tax purposes of approximately $154.0 million and $90.3 million, respectively, that expire at various dates beginning in 2011 and continuing through 2030. In addition, at March 31, 2010, we had research and development credit carryforwards for federal and state tax reporting purposes of approximately $1.7 million and $2.9 million, respectively. The federal credit carryforwards will begin expiring in 2011 continuing through 2030, while the California credit will carry forward indefinitely. Under the ownership change limitations of the Internal Revenue Code of 1986, as amended, the amount and benefit from the net operating losses and credit carryforwards may be impaired or limited in certain circumstances. At March 31, 2010 and 2009, we had gross deferred tax assets of approximately $68.7 million and $71.4 million, respectively. Because of uncertainties regarding the realization of deferred tax assets, we have applied a full valuation allowance as of March 31, 2010 and 2009. LIQUIDITY AND CAPITAL RESOURCES As of March 31, 2010, we had $18.1 million of cash and cash equivalents. By comparison, at March 31, 2009, we had $16.4 million in cash and cash equivalents. We currently have no borrowing arrangements. 2009 to 2010 Net cash provided by operating activities for fiscal 2010 was $2.5 million, compared with $2.3 million provided by operating activities for fiscal 2009. The increase in cash flow was primarily due to a decline in third party network service expenses and a decline in stock-based compensation expense, offset partially by discounting of equipment sold to business service customers during fiscal 2010. Cash used in or provided by operating activities has historically been affected by: the amount of net income, sales of subscriptions, changes in working capital accounts, particularly in deferred revenue due to timing of annual plan renewals, add-backs of non-cash expense items such as depreciation and amortization, and the expense associated with stock-based awards. Net cash used in investing activities was $0.9 million in fiscal 2010, compared with $2.6 million provided by investing activities in fiscal 2009. The decrease in cash flow from investing activities during fiscal 2010 is primarily related to the investment of operating cash balances. Our financing activities for fiscal 2010 provided cash of $0.4 million from the issuance of common stock under our stock option and employee stock purchase plans which was offset by $0.2 million used to repurchase shares of common stock under our share repurchase plan. Our financing activities for fiscal 2009 provided cash of $0.4 million from the issuance of common stock under the employee stock purchase plan. 2008 to 2009 Net cash provided by operating activities for fiscal 2009 was $2.3 million, compared with $3.0 million provided by operating activities for fiscal 2008. The decrease in cash flow was primarily due to an increase in stock-based compensation, which includes $2.4 million due to the acceleration of unvested employee stock options in January 2009, a $0.6 million provision for inventory primarily due to $0.5 million of excess inventory related to our business services analog phone, a $0.4 million provision for doubtful accounts primarily related to royalty revenue, and a $0.2 million write off of our legacy billing system, 37 offset partially by a $1.3 million increase in other current and noncurrent liabilities primarily due to a license and settlement agreement. Net cash provided by investing activities was $2.6 million in fiscal 2009, compared with $1.2 million provided by investing activities in fiscal 2008. The increase in cash flow from investing activities during fiscal 2009 is primarily related to maturity of short-term investment. Our financing activities for fiscal 2009 provided cash of $0.4 million from the issuance of common stock under our employee stock purchase plans. Our financing activities for fiscal 2008 provided cash of $0.2 million from the issuance of common stock under the employee stock purchase plan. Although we have achieved positive cash flows from operations in the fiscal year ended March 31, 2010 and 2009, historical net losses and negative cash flows have been funded primarily through the issuance of equity securities and borrowings. Based on our current expectations, we believe that our current cash and cash equivalents and short-term investments, together with cash expected to be generated from future operations, will be sufficient to satisfy our expected working capital and capital expenditure requirements for the next 12 months. Nevertheless, our future capital requirements will depend on many factors, including the amount of revenue we generate, the timing and extent of spending to support product development efforts, the expansion of sales and marketing activities, the timing of introductions of new services or products, the costs to ensure access to our telecommunications services, the continuing market acceptance of our service and products and the extent to which we use our cash to acquire other businesses. However, if we do not meet our plan, we could be required, or might elect, to seek additional funding through public or private equity or debt financing and additional funds may not be available on terms acceptable to us at all. We also might decide to raise additional capital at such times and upon such terms as management considers favorable and in our interests, but we cannot be assured that our capital-raising efforts will be successful. Contractual Obligations Future operating lease payments, capital lease payments and purchase obligations at March 31, 2010 for the next five years were as follows (in thousands): Capital leases Office leases License fee Purchase obligations Third party customer support provider Open purchase orders 2011 41 594 250 2,158 1,955 4,998 $ $ $ $ Year Ending March 31, 2013 7 284 - 2012 40 657 - $ $ 2014 - - 697 $ - - 291 $ 2015 Total 88 1,535 250 2,158 1,955 5,986 - - - - - - $ $ - - - - - - $ $ In March 2007 and August 2009, we entered into a series of noncancelable capital lease agreements for office equipment bearing interest at various rates. Assets under capital lease at March 31, 2010 totaled $156,000 with accumulated amortization of $77,000. On May 1, 2009, we entered into a three-year lease for a new primary facility in Sunnyvale, California that expires in fiscal 2013. The facility leases include rent escalation clauses and require us to pay utilities and normal maintenance costs. Rent expense is reflected in our consolidated financial statements on a straight-line basis over the term of the leases. In the third quarter of 2010, we amended our contract with one of our third party customer support vendors containing a minimum monthly commitment of approximately $430,000. The agreement requires a 150-day notice to terminate. At March 31, 2010, the total remaining obligation under the contract was $2.2 million. At March 31, 2010 we had open purchase orders of $2.0 million, primarily related to inventory purchases from our contract manufacturers. These purchase commitments are reflected in our consolidated financial statements once goods or services have been received or at such time when we are obligated to make payments related to these goods or services. At March 31, 2010, we had a $167,000 liability related to warrants issued to two investors in an equity financing transaction in fiscal 2006. The warrants expire in December 2010. We account for these warrants as liabilities because of the possibility, however likely or unlikely, that we would be unable to deliver registered shares upon a future exercise of these warrants. The 38 required accounting for a warrant with an assumed "net cash settlement" provision under ASC 480 is to estimate the fair value on the date of issuance and to record a liability equal to that value with subsequent changes in the fair value recorded as income or expense at the end of each reporting period. The amount we record as a liability under ASC 480-10 is not, nor do we intend for it to be, an admission or stipulation of the amount that we would owe or be obligated to pay the warrant holder in the event that we are unable to deliver registered shares to the warrant holder. In fact, we have made no determination of the amount of liability, if any, that we would owe to the warrant holder in the event of such a breach. RECENT ACCOUNTING PRONOUNCEMENTS In May 2009, the FASB issued an amendment to ASC 855 - Subsequent Events (formerly SFAS No. 165, "Subsequent Events"). The statement is to establish general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued. ASC 855 was effective for interim and annual periods ending after June 15, 2009. The adoption of ASC 855 did not have a material impact on our consolidated results of operation and financial condition. In July 2009, the FASB issued Accounting Standards Update ("ASU") No. 2009-1, "Topic 105 - Generally Accepted Accounting Principles," ("ASU 2009-1") which amended ASC 105, "Generally Accepted Accounting Principles," to establish the Codification as the source of authoritative GAAP recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the SEC under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. On the effective date, the Codification superseded all then-existing non-SEC accounting and reporting standards. All previous references to the superseded standards in our consolidated financial statements have been replaced by references to the applicable sections of the Codification. The adoption of ASU 2009-1 did not have a material impact on our consolidated results of operation and financial condition. In October 2009, the FASB issued ASU No. 2009-13, "Multiple-Deliverable Revenue Arrangements-a consensus of the FASB Emerging Issues Task Force" (“ASU 2009-13”). ASU 2009-13 updates the existing multiple-element revenue arrangements guidance currently included under ASC 605-25, which originated primarily from the guidance in EITF Issue No. 00-21, "Revenue Arrangements with Multiple Deliverables" (“EITF 00-21”). The revised guidance primarily provides two significant changes: 1) eliminates the need for objective and reliable evidence of the fair value for the undelivered element in order for a delivered item to be treated as a separate unit of accounting, and 2) eliminates the residual method to allocate the arrangement consideration. In addition, the guidance also expands the disclosure requirements for revenue recognition. ASU 2009-13 will be effective for the first annual reporting period beginning on or after June 15, 2010, with early adoption permitted provided that the revised guidance is retroactively applied to the beginning of the year of adoption. We are currently assessing the future impact of this new accounting update to our consolidated financial statements. In October 2009, the FASB issued ASU No. 2009-14, "Certain Revenue Arrangements that Include Software Elements-a consensus of the FASB Emerging Issues Task Force" ("ASU 2009-14"). ASU 2009-14 amends the scope of pre-existing software revenue guidance by removing from the guidance non-software components of tangible products and certain software components of tangible products. ASU 2009-14 will be effective for the first annual reporting period beginning on or after June 15, 2010, with early adoption permitted provided that the revised guidance is retroactively applied to the beginning of the year of adoption. We are currently assessing the future impact of this new accounting update to our consolidated financial statements. In January 2010, Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update 2010-2 (“ASU 2010- 2”), “Accounting and Reporting for Decreases in Ownership of a Subsidiary – a Scope Clarification. ASU 2010-2 addresses implementation issues related to the changes in ownership provisions in the Consolidation—Overall Subtopic (Subtopic 810- 10) of the FASB ASC, originally issued as SFAS 160, “Noncontrolling Interests in Consolidated Financial Statements”. Subtopic 810-10 establishes the accounting and reporting guidance for noncontrolling interests and changes in ownership interests of a subsidiary. An entity is required to deconsolidate a subsidiary when the entity ceases to have a controlling financial interest in the subsidiary. Upon deconsolidation of a subsidiary, an entity recognizes a gain or loss on the transaction and measures any retained investment in the subsidiary at fair value. The gain or loss includes any gain or loss associated with the difference between the fair value of the retained investment in the subsidiary and its carrying amount at the date the subsidiary is deconsolidated. In contrast, an entity is required to account for a decrease in ownership interest of a subsidiary that does not result in a change of control of the subsidiary as an equity transaction. The adoption of ASU 2010-2 did not have a material effect on our consolidated results of operation and financial condition. In January 2010, FASB issued ASU 2010-6, “Improving Disclosures about Fair Measurements". ASU 2010-6 provides amendments to subtopic 820-10 of the FASB Accounting Standards Codification, originally issued as FASB Statement No. 39 157, “Fair Value Measurements” that require separate disclosure of significant transfers in and out of Level 1 and Level 2 fair value measurements and the presentation of separate information regarding purchases, sales, issuances and settlements for Level 3 fair value measurements. Additionally, ASU 2010-6 provides amendments to subtopic 820-10 that clarify existing disclosures about the level of disaggregation and inputs and valuation techniques. ASU 2010-6 is effective for financial statements issued for interim and annual periods ending after December 15, 2010. We will adopt this pronouncement in the third quarter of fiscal 2011 and do not expect the adoption of ASU 2010-06 will have a material impact on our consolidated results of operation and financial condition. In February 2010, FASB issued ASU 2010-9 Subsequent Events (Topic 855) Amendments to Certain Recognition and Disclosure Requirements.” ASU 2010-9 amends disclosure requirements within Subtopic 855-10. An entity that is an SEC filer is not required to disclose the date through which subsequent events have been evaluated. This change alleviates potential conflicts between Subtopic 855-10 and the SEC's requirements. The adoption of ASU 2010-09 did not have a material impact on our consolidated results of operation and financial condition. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The primary objective of our investment activities is to preserve principal while maximizing income without significantly increasing risk. Some of the securities in which we invest may be subject to market risk. This means that a change in prevailing interest rates may cause the principal amount of the investment to fluctuate. To minimize this risk, we may maintain our portfolio of cash equivalents and investments in a variety of securities, including commercial paper, money market funds, debt securities and certificates of deposit. The risk associated with fluctuating interest rates is limited to our investment portfolio and we do not believe that a 10% change in interest rates would have a significant impact on our interest income. During the years ended March 31, 2010 and 2009, we did not have any outstanding debt instruments other than equipment under capital leases and, therefore, we were not exposed to market risk relating to interest rates. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE FINANCIAL STATEMENTS: Report of Independent Registered Public Accounting Firm Report of Independent Registered Public Accounting Firm Consolidated Balance Sheets at March 31, 2010 and 2009 Consolidated Statements of Operations for each of the three years in the period ended March 31, 2010 Consolidated Statements of Stockholders' Equity for each of the three years in the period ended March 31, 2010 Consolidated Statements of Cash Flows for each of the three years in the period ended March 31, 2010 Notes to Consolidated Financial Statements FINANCIAL STATEMENT SCHEDULE: Schedule II -- Valuation and Qualifying Accounts Schedules other than the one listed above have been omitted because they are inapplicable, because the required information has been included in the financial statements or notes thereto, or the amounts are immaterial. Consolidated Quarterly Financial Data 40 Page 41 42 43 44 45 46 47 67 68 Report of Independent Registered Public Accounting Firm Board of Directors and Stockholders of 8x8, Inc. We have audited the accompanying consolidated balance sheets of 8x8, Inc. (the Company) as of March 31, 2010 and 2009 and the related consolidated statements of operations, stockholders’ equity and cash flows for the years then ended. Our audit also included the financial statement Schedule II- Valuation and Qualifying Accounts. We also have audited the Company’s internal control over financial reporting as of March 31, 2010, based on criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework. The Company's management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in management’s report on internal control over financial reporting appearing under Item 9A. Our responsibility is to express an opinion on these financial statements and an opinion on the Company's internal control over financial reporting based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also include performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinion. A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of 8x8, Inc. and consolidated subsidiaries, as of March, 31, 2010 and 2009, and the consolidated results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement Schedule II, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. Also in our opinion, 8x8, Inc., maintained, in all material respects, effective internal control over financial reporting as of March 31, 2010, based on criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework. San Francisco, California May 26, 2010 /s/ Moss Adams LLP 41 Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders of 8x8, Inc: In our opinion, the consolidated statements of operations, stockholders’ equity and cash flows for the year ended March 31, 2008 present fairly, in all material respects, the results of operations and cash flows of 8x8, Inc. and its subsidiaries for the year ended March 31, 2008, in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule for the year ended March 31, 2008 presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audit. We conducted our audit of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. /s/ PricewaterhouseCoopers LLP PricewaterhouseCoopers LLP San Jose, California May 23, 2008 42 8X8, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS) ASSETS Current assets: Cash and cash equivalents Accounts receivable, net of allowance of $36 and $302 Inventory Deferred cost of goods sold Other current assets Total current assets Property and equipment, net Other assets Total assets LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable Accrued compensation Accrued warranty Accrued taxes Deferred revenue Other accrued liabilities Total current liabilities Non-current liabilities Fair value of warrant liability Total liabilities $ $ $ March 31, 2010 2009 $ $ $ 18,056 554 2,174 107 558 21,449 1,871 392 23,712 3,780 1,444 331 1,804 1,310 1,465 10,134 111 167 16,376 414 2,297 193 648 19,928 1,485 443 21,856 4,810 1,264 328 1,777 2,254 2,081 12,514 291 21 10,412 12,826 Commitments and contingencies (Note 3) Stockholders' equity: Preferred stock, $0.001 par value: Authorized: 5,000,000 shares; Issued and outstanding: no shares at March 31, 2010 and at March 31, 2009 Common stock, $0.001 par value: Authorized: 100,000,000 shares at March 31, 2010 and March 31, 2009; Issued and outstanding: 63,172,536 shares at March 31, 2010 and 62,686,039 shares at March 31, 2009 Additional paid-in capital Accumulated deficit Total stockholders' equity Total liabilities and stockholders' equity $ - - 63 212,077 (198,840) 13,300 23,712 $ 63 211,686 (202,719) 9,030 21,856 The accompanying notes are an integral part of these consolidated financial statements. 43 8X8, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Service revenues Product revenues Total revenues Operating expenses: Cost of service revenues Cost of product revenues Research and development Selling, general and administrative Total operating expenses Incone (loss) from operations Other income, net (Loss) income on change in fair value of warrant liability Income (loss) before provision for income taxes Provision for income taxes Net income (loss) Net income (loss) per share: Basic Diluted Weighted average number of shares: Basic Diluted Years Ended March 31, 2010 2009 2008 $ $ 58,683 4,713 63,396 $ 58,486 6,188 64,674 13,599 7,257 5,049 33,516 59,421 3,975 53 (146) 3,882 3 15,714 7,135 5,212 39,680 67,741 (3,067) 298 314 (2,455) 45 $ 3,879 $ (2,500) $ $ $ 0.06 0.06 $ $ (0.04) (0.04) $ $ 62,861 63,262 62,317 62,317 56,177 5,469 61,646 16,671 6,762 4,335 37,596 65,364 (3,718) 1,606 2,142 30 - 30 0.00 0.00 61,897 62,112 The accompanying notes are an integral part of these consolidated financial statements. 44 8X8, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (IN THOUSANDS, EXCEPT SHARES) Common Stock Amount Additional Paid-in Capital Accumulated other Comprehensive Income (Loss) $ 62 $ 205,567 $ (3) $ Accumulated Deficit (200,249) Total $ 5,377 Balance at March 31, 2007 Issuance of common stock under stock plans Stock compensation charge Conversion of warrant liability to equity Unrealized investment loss Net Income Total comprehensive loss Balance at March 31, 2008 Issuance of common stock under stock plans Issuance of common stock on exercise of warrant Stock compensation charge Unrealized investment loss Net loss Total comprehensive loss Balance at March 31, 2009 Issuance of common stock under stock plans Repurchase of common stock Stock compensation charge Net income Total comprehensive income Balance at March 31, 2010 Shares 61,771,832 295,437 - - - - - 62,067,269 513,770 105,000 - - - - 62,686,039 768,873 (282,376) - - - 63,172,536 $ - - - - - - 62 1 - - - - - 63 - - - - - 63 $ 252 1,272 910 - - - 208,001 317 73 3,295 - - - 211,686 399 (212) 204 - - 212,077 $ - - - 8 - - 5 - - - (5) - - - - - - - - - $ - - - - 30 - (200,219) - - - - (2,500) - (202,719) - - - 3,879 - (198,840) 252 1,272 910 38 7,849 318 73 3,295 (2,505) 9,030 399 (212) 204 3,879 13,300 $ The accompanying notes are an integral part of these consolidated financial statements. 45 8X8, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) Cash flows from operating activities: Net income (loss) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization Stock compensation expense Loss (Income) on change in fair value of warrant liability Amortization of discount and premium on marketable securities Change in inventory reserve Change in doubtful accounts receivable Loss on disposal of fixed assets Realized loss on disposal of investment Changes in assets and liabilities: Accounts receivable, net Inventory Other current and noncurrent assets Deferred cost of goods sold Accounts payable Accrued compensation Accrued warranty Accrued taxes Deferred revenue Other current and noncurrent liabilities Net cash provided by operating activities Cash flows from investing activities: Acquisitions of property and equipment Proceeds from the sale of property and equipment Restricted cash decrease Purchase of investments Sale of short-term investments Maturities of short-term investments Net cash provided by (used in) investing activities Cash flows from financing activities: Proceeds from issuance of common stock under employee stock plans Repurchase of common stock Capital lease payments Net cash provided by financing activities Net increase in cash and cash equivalents Cash and cash equivalents, beginning of year Cash and cash equivalents, end of year Supplemental and non-cash disclosures: Conversion of warrant liability to equity Assets acquired under capital lease Interest paid Years Ended March 31, 2009 2010 2008 $ 3,879 $ (2,500) $ 30 998 204 146 - (422) 113 3 - (253) 545 41 86 (1,323) 180 3 27 (944) (792) 2,491 (1,052) 4 100 - - - (948) 399 (212) (50) 137 1,680 16,376 18,056 - 46 29 $ $ $ $ 1,269 3,295 (314) (8) 598 361 159 - 1,032 (1,356) (406) 750 (177) 216 14 (1,119) (885) 1,325 2,254 (801) - - - - 3,385 2,584 391 - (38) 353 5,191 11,185 16,376 - - 9 $ $ $ $ 1,529 1,272 (2,142) (55) 96 131 (17) 180 (1,202) 994 (97) 121 (54) 223 (9) 818 1,651 (438) 3,031 (699) 37 - (5,323) 3,520 3,650 1,185 272 - (38) 234 4,450 6,735 11,185 910 - 8 $ $ $ $ The accompanying notes are an integral part of these consolidated financial statements. 46 8X8, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. THE COMPANY AND SIGNIFICANT ACCOUNTING POLICIES THE COMPANY 8x8, Inc. (“8x8” or the “Company”) develops and markets telecommunications services for Internet protocol, or IP, telephony and video applications as well as web-based conferencing and unified communications services .The Company was incorporated in California in February 1987 and was reincorporated in Delaware in December 1996. The Company offers the 8x8 VoIP (Voice over Internet Protocol) voice and video digital phone service, 8x8 Virtual Office hosted PBX service, 8x8 Complete Contact Center service, 8x8 Trunking service, 8x8 Hosted Key System service, 8x8 MobileTalk service, 8x8 Virtual Meeting web conferencing service, 8x8 Virtual Office Pro unified communications solution and 8x8 Managed Hosting and Cloud-Based Computing solutions. Between November 2002 and April 2009, the Company marketed its services under the Packet8 brand. In May 2009, the Company began marketing our services under the 8x8 brand. As of March 31, 2010, the Company had more than 20,000 business customers. Each business customer subscribes to a number of various lines and services (e.g. physical phone extensions, virtual extensions, fax lines, toll free numbers, receptionist software, unified communications services, etc.). The 8x8 voice and video broadband phone service enables broadband Internet users to add digital voice and video communications services to their high-speed Internet connections. Customers can choose a regular direct-dial phone number from any of the rate centers offered by the service and then use an existing telephone to make and receive calls over a standard broadband Internet connection. The 8x8 Virtual Office suite of business phone services offers small and medium sized businesses feature-rich, HD (high definition) audio-enhanced communications services that eliminate the need for traditional telecommunications services and business phone systems. The 8x8 Virtual Office solution essentially replaces an on-premise PBX (private branch exchange), telephone system with a hosted, Internet-based business phone service that is delivered over a managed or unmanaged Internet connection. We sell pre-programmed IP telephones with speakerphones and a display screen, in conjunction with our Virtual Office service plans, which enable our business customers to access additional Virtual Office features through on-screen phone menus. The 8x8 Virtual Office Pro unified communications solution, introduced in January 2010, bundles the 8x8 Virtual Office hosted PBX phone service with essential businesses communications services such as web conferencing, call recording and archiving, Internet fax, chat, voicemail and presence management and a mobile iPhone extension in a competitively priced offering. 8x8 Virtual Office Pro takes the functionality of an already powerful hosted PBX phone service to a new level with high fidelity HD voice, remote accessibility via any web browser or smart phone and integration with vital collaboration tools. The 8x8 Managed Hosting and Cloud-Based Computing solutions enable business customers to reduce costs and gain performance and reliability advantages by eliminating in-house ownership of server equipment and costly information technology (IT) systems management staff. The Company’s fiscal year ends on March 31 of each calendar year. Each reference to a fiscal year in these notes to the consolidated financial statements refers to the fiscal year ending March 31 of the calendar year indicated (for example, fiscal 2010 refers to the fiscal year ending March 31, 2010). PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of 8x8 and its subsidiaries. All material intercompany accounts and transactions have been eliminated. USE OF ESTIMATES The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and equity and disclosure of contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, the Company evaluates its estimates, including, but not limited to, those related to bad debts, returns reserve for expected cancellations, valuation of inventories, income and sales tax, and 47 litigation and other contingencies. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results could differ from those estimates under different assumptions or conditions. REVENUE RECOGNITION VoIP service and product revenue The Company’s VoIP service and product revenue is derived from the sale of IP business telephones and VoIP service. Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 605-25 (formerly Emerging Issues Task Force (EITF) consensus No. 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables”) 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 investors. 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. 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. 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. License and other revenue During fiscal 2010, 2009 and 2008, revenues from software and technology licensing and related arrangements were limited. The Company recognizes revenue from license contracts when a non-cancelable, non-contingent license agreement has been signed, the software product has been delivered, no uncertainties surrounding product acceptance exist, fees from the agreement are fixed or determinable, and collection is probable. The Company uses the residual method to recognize revenue when a license agreement includes one or more elements to be delivered at a future date if evidence of the fair value of all undelivered elements exists. If evidence of the fair value of the undelivered elements does not exist, revenue is deferred and recognized when delivery occurs. When the Company enters into a license agreement requiring that the Company provide significant customization of the software products, the license and consulting revenue is recognized using contract accounting. Revenue from maintenance agreements is recognized ratably over the term of the maintenance agreement, which in most instances is one year. The Company recognizes royalties upon notification of sale by its licensees. Revenue from consulting, training, and development services is recognized as the services are performed. 48 CASH, CASH EQUIVALENTS AND INVESTMENTS The Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents. Management determines the appropriate categorization of its investments at the time of purchase and reevaluates the classification at each reporting date. The cost of the Company's investments is determined based upon specific identification. The Company’s investments are comprised of money market funds. At March 31, 2010 and 2009, all investments were classified as available-for-sale and reported at fair value, based upon quoted market prices, with unrealized gains and losses, net of related tax, if any, included in other comprehensive loss and disclosed as a separate component of stockholders’ equity. Realized gains and losses on sales of all such investments are reported within the caption of other income, net in the statements of operations and computed using the specific identification method. The Company’s investments in marketable securities are monitored on a periodic basis for impairment. In the event that the carrying value of an investment exceeds its fair value and the decline in value is determined to be other-than-temporary, an impairment charge is recorded and a new cost basis for the investment is established. Available-for-sale investments were (in thousands): As of March 31, 2010 Money market funds Total available-for-sale investments Reported as (in thousands): Cash and cash equivalents Total As of March 31, 2009 Money market funds Total available-for-sale investments Reported as (in thousands): Cash and cash equivalents Total Gross Amortized Unrealized Costs Loss $ $ 16,733 16,733 $ $ - - Gross Amortized Unrealized Costs Loss $ $ 15,466 15,466 $ $ - - Estimated Fair Value 16,733 16,733 16,733 16,733 Estimated Fair Value 15,466 15,466 15,466 15,466 $ $ $ $ $ $ $ $ ACCOUNTS RECEIVABLE ALLOWANCE The Company estimates the amount of uncollectible accounts receivable at the end of each reporting period based on the aging of the receivable balance, current and historical customer trends, and communications with its customers. Amounts are written off only after considerable collection efforts have been made and the amounts are determined to be uncollectible. 49 INVENTORY Inventory is stated at the lower of standard cost, which approximates actual cost using the first-in, first-out method, or market. Inventory reserves are established when conditions indicate that the current replacement cost or market is below the carrying value due to obsolescence, changes in price levels, or other causes. Reserves are established for excess inventory generally based on inventory levels in excess of demand, as determined by management, for each specific product. Inventory at March 31, 2010 and 2009 was comprised of the following: Work-in-process Finished goods PROPERTY AND EQUIPMENT March 31, 2010 2009 (in thousands) $ 1,701 473 2,174 $ 1,695 602 2,297 $ $ Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are computed using the straight-line method. Estimated useful lives of three years are used for equipment and software and five years for furniture and fixtures. Amortization of leasehold improvements is computed using the shorter of the remaining facility lease term or the estimated useful life of the improvements. Property and equipment at March 31, 2010 and 2009 was comprised of the following: Machinery and computer equipment Furniture and fixtures Licensed software Leasehold improvements Less: accumulated depreciation and amortization March 31, 2010 2009 $ (in thousands) $ 4,619 261 1,935 253 7,068 (5,197) $ 1,871 $ 4,413 167 1,628 300 6,508 (5,023) 1,485 Maintenance, repairs and ordinary replacements are charged to expense. Expenditures for improvements that extend the physical or economic life of the property are capitalized. Gains or losses on the disposition of property and equipment are recorded in the loss from operations. IMPAIRMENT OF LONG-LIVED ASSETS 8x8 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. ACQUIRED PRODUCT RIGHTS On April 29, 2009, the Company resolved a patent litigation matter with Web Telephony by entering into a license and settlement agreement that resolved all legal claims between the companies. As part of the settlement, the Company agreed to pay eight quarterly payments totaling $800,000 over the next two years between April 2009 and December 2010. Under the transaction, the Company expensed $339,000 of the patent settlement costs during the year ended March 31, 2009 that were related to benefits received by the Company in and during the periods prior to fiscal year 2009. The remaining license amount was recorded as other long term assets as of March 31, 2009 and is being amortized to cost of service revenues in the Consolidated Statements of Operations over the remaining life of the primary patent, which expires in September 2017. See also Note 3, Commitments and Contingencies, Legal Proceedings. 50 WARRANTY EXPENSE The Company accrues for estimated product warranty cost upon revenue recognition. Accruals for product warranties are calculated based on the Company’s historical warranty experience adjusted for any specific requirements. WARRANT LIABILITY The Company accounts for its warrants in accordance with ASC 480-10 (formerly Emerging Issues Task Force Issue No. 00- 19, “Accounting for Derivative Financial Instruments Indexed to and Potentially Settled in a Company’s Own Stock”), 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. Certain of the Company’s warrants require settlement in shares and are accounted for as permanent equity. The Company has two investor warrants that are classified as liabilities because they include a provision that specifies that the Company must deliver freely tradable shares upon exercise by the warrant holder. Because there are circumstances, irrespective of likelihood, which may not be within the control of the Company that could prevent delivery of registered shares, ASC 480-10 requires the warrants be recorded as a liability at fair value, with subsequent changes in fair value recorded as income (loss) in change in fair value of warrant liability. The fair value of the warrant is determined using a Black-Scholes option pricing model, and is affected by changes in inputs to that model including the Company’s stock price, expected stock price volatility and contractual term. The amount the Company records as a liability under ASC 480-10 is not, nor does the Company intend for it to be an admission or stipulation of the amount that the Company would owe or be obligated to pay the warrant holder in the event of an actual breach by the Company of the warrant terms. In fact, the Company has made no determination of the amount of liability, if any, that the Company would owe to the warrant holder in the event of such a breach. RESEARCH, DEVELOPMENT AND SOFTWARE COSTS Research and development costs are charged to operations as incurred. 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. The Company defines establishment of technological feasibility as the completion of a working model. 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. To date, all software development costs for software to be sold or otherwise marketed have been expensed as incurred. In accordance with ASC 350-40 (formerly American Institute of Certified Public Accountants Statement of Position (SOP) No. 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use”), the Company capitalizes purchase and implementation costs of internal use software. In accordance with ASC 350-40, during fiscal 2010, 2009 and 2008, the Company capitalized $0, $0, and $0, respectively. SALE OF PATENTS In the third quarter of fiscal 2008, the Company completed the sale of two of its patents for $1.2 million. The proceeds from the sale of the two patents are included in other income, net. The Company has retained a worldwide, royalty-free nonexclusive, non-sublicensable, non-transferable right and license to use the technology covered by these patents for all of its current and future products. The Company has no ongoing obligations associated with this transaction. ADVERTISING COSTS Advertising costs are expensed as incurred and were $5,022,000, $7,297,000 and $6,989,000 for the years ended March 31, 2010, 2009 and 2008, respectively. SUBSCRIBER ACQUISITION COSTS Subscriber acquisition costs are expensed as incurred and include the advertising, marketing, promotions, commissions, rebates and equipment subsidy costs associated with the Company’s efforts to acquire new subscribers. 51 FOREIGN CURRENCY TRANSLATION Assets and liabilities of the Company's foreign subsidiaries are translated from their respective functional currencies at exchange rates in effect at the balance sheet date, and revenues and expenses are translated at average exchange rates prevailing during the year. If the functional currency is the local currency, resulting translation adjustments are reflected as a separate component of stockholders' equity. If the functional currency is the U.S. dollar, resulting conversion adjustments are included in the results of operations. Foreign currency transaction gains and losses, which have been immaterial, are also included in results of operations. Total assets of the Company's foreign subsidiaries were $69,000, $150,000 and $44,000 as of March 31, 2010, 2009 and 2008, respectively. At March 31, 2010, the U.S. dollar was the functional currency for all foreign subsidiaries. The Company does not undertake any foreign currency hedging activities. INCOME TAXES Income taxes are accounted for using the asset and liability approach. Under the asset and liability approach, a current tax liability or asset is recognized for the estimated taxes payable or refundable on tax returns for the current year. A deferred tax liability or asset is recognized for the estimated future tax effects attributed to temporary differences and carryforwards. If necessary, the deferred tax assets are reduced by the amount of benefits that, based on available evidence, it is more likely than not expected to be realized. CONCENTRATIONS Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash and cash equivalents, investments and trade accounts receivable. The Company has cash equivalents and investment policies that limit the amount of credit exposure to any one financial institution and restricts placement of these funds to financial institutions evaluated as highly credit-worthy. The Company has not experienced any material losses relating to its investment instruments. However, in February 2008, two auction rate securities held by the Company failed to auction due to sell orders exceeding buy orders. In March 2008, the Company sold its remaining two auction rate securities for less than par value, which resulted in a loss of $180,000. The Company sells its products to consumers and distributors and OEMs. The Company performs ongoing credit evaluations of its customers' financial condition and generally does not require collateral from its customers. For the year ended March 31, 2010, the Company wrote-off one customer for approximately $0.3 million of which $0.3 million was fully reserved as of March 31, 2009. For year ended March 31, 2009 and 2008, the Company experienced minimal write-offs for bad debts and doubtful accounts. At March 31, 2010, one customer accounted for 12% of accounts receivable. At March 31, 2009, one customer accounted for 32% of accounts receivable. The Company outsources the manufacturing of its hardware products to independent contract manufacturers. The inability of any contract manufacturer to fulfill supply requirements of the Company could materially impact future operating results, financial position or cash flows. If any of these contract manufacturers fail to perform on their obligations to the Company, such failure to fulfill supply requirements of the Company could materially impact future operating results, financial position and cash flows. The Company also relies primarily on two third party network service providers to provide telephone numbers and public switched telephone network (PSTN) call termination and origination services for its customers. If these service providers failed to perform their obligations to the Company, such failure could materially impact future operating results, financial position and cash flows. FAIR VALUE OF FINANCIAL INSTRUMENTS The estimated fair value of financial instruments is determined by the Company using available market information and valuation methodologies considered to be appropriate. The carrying amounts of the Company's cash and cash equivalents, accounts receivable and accounts payable approximate their fair values due to their short maturities. The Company’s investments are carried at fair values. 52 ACCOUNTING FOR STOCK-BASED COMPENSATION The Company accounts for its employee stock options and stock purchase rights granted under the 1996 Stock Plan, 1996 Director Option Plan, 1999 Nonstatutory Stock Option Plan and the 2006 Stock Plan and stock purchase rights under the 1996 Employee Stock Purchase Plan (“Purchase Plan”) under the provisions of ASC 718 – Stock Compensation (formerly Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment”). 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. The Company has elected to adopt the modified prospective transition method as provided by ASC 718 and, accordingly, financial statement amounts for the prior periods have not been restated to reflect the fair value method of expensing share-based compensation. To value option grants and stock purchase rights under the Purchase Plan for actual and pro forma 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 prices volatility, expected life, risk free interest rates and future dividend payments. For fiscal years 2010, 2009 and 2008, 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 stock-based awards are expecting 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 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 payout. Stock-based compensation expense recognized in the Consolidated Statements of Operations for fiscal 2010, 2009 and 2008 included both the unvested portion of stock-based awards granted prior to April 1, 2006 and stock-based awards granted subsequent to April 1, 2006. Stock options granted in periods prior to fiscal 2007 were measured based on ASC 718 (formerly SFAS No. 123) criteria, whereas stock options granted subsequent to April 1, 2006 were measured based on ASC 718 (formerly SFAS No. 123(R)) criteria. In conjunction with the adoption of ASC 718 (formerly SFAS No. 123(R)), the Company changed its method of attributing the value of stock-based compensation to expense from the accelerated multiple-option approach to the straight-line single option method. Compensation expense for all share-based payment awards granted subsequent to April 1, 2006 is recognized using the straight-line single-option method. Stock-based compensation expense included in fiscal 2010, 2009 and 2008 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. On January 27, 2009, when the share price of the Company’s stock closed at $0.55 per share, the Company’s board of directors approved the acceleration of unvested stock options to purchase 3,902,186 shares of common stock. 1,737,509 of these shares are subject to options held by the Company’s executive officers and directors. These options of the Company’s executive officers and directors, taken as a whole, have a weighted average exercise price of $1.06 per share and range from $0.63 to $1.79 per share, and a weighted average remaining vesting term of 2.85 years. Approximately $1.1 million of the $2.4 million stock-based compensation charge in the fourth quarter of 2009 applies to the options held by the Company’s executive officers and directors. 53 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 years ended March 31, 2010, 2009 and 2008 that was recorded as follows (in thousands): Cost of service revenues Cost of product revenues Research and development Selling, general and administrative Total stock-based compensation expense related to employee stock options and employee stock purchases, pre-tax Tax benefit Stock based compensation expense related to employee stock options and employee stock purchases, net of tax $ 2010 Years Ended March 31, 2009 2008 $ 20 - 63 121 204 - $ 216 47 542 2,490 3,295 - 33 18 255 966 1,272 - $ 204 $ 3,295 $ 1,272 ASC 718 requires the Company to calculate the additional paid in capital pool (“APIC Pool”) available to absorb tax deficiencies recognized subsequent to adopting ASC 718, as if the Company had adopted ASC 718 at its effective date of January 1, 1995. There are two allowable methods to calculate the Company’s APIC Pool: (1) the long form method as set forth in ASC 718 (formerly SFAS No. 123(R)) and (2) the short form method as set forth in ASC 718 (formerly FASB Staff Position No. 123(R)-3). The Company has elected to use the long form method under which the Company tracks each award grant on an employee-by-employee basis and grant-by-grant basis to determine if there is a tax benefit or tax deficiency for such award. The Company then compares the fair value expense to the tax deduction received for each grant and aggregated the benefits and deficiencies to establish the APIC Pool. Due to the adoption of ASC 718, some exercises result in tax deductions in excess of previously recorded benefits based on the option value at the time of grant, or windfalls. The Company recognizes windfall tax benefits associated with the exercise of stock options directly to stockholders’ equity only when realized. Accordingly, deferred tax assets are not recognized for net operating loss carryforwards resulting from windfall tax benefits occurring from April 1, 2006 onward. A windfall tax benefit occurs when the actual tax benefit realized by the company upon an employee’s disposition of a share-based award exceeds the deferred tax asset, if any, associated with the award that the company had recorded. The Company uses the “with and without” approach as described in ASC 718 (formerly Emerging Issue Task Force (“EITF”) Topic No. D-32), in determining the order in which its tax attributes are utilized. The “with and without” approach results in the recognition of the windfall stock option tax benefits only after all other tax attributes of the Company have been considered in the annual tax accrual computation. Also, the Company has elected to ignore the indirect tax effects of share-based compensation deductions in computing the Company’s research and development tax and as such, the Company recognizes the full effect of these deductions in the income statement in the period in which the taxable event occurs. RECENT ACCOUNTING PRONOUNCEMENTS In May 2009, the FASB issued an amendment to ASC 855 - Subsequent Events (formerly SFAS No. 165, "Subsequent Events"). The statement is to establish general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued. ASC 855 was effective for interim and annual periods ending after June 15, 2009. The adoption of ASC 855 did not have a material impact on the Company’s consolidated results of operation and financial condition. In July 2009, the FASB issued Accounting Standards Update ("ASU") No. 2009-1, "Topic 105 - Generally Accepted Accounting Principles," ("ASU 2009-1") which amended ASC 105, "Generally Accepted Accounting Principles," to establish the Codification as the source of authoritative GAAP recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the SEC under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. On the effective date, the Codification superseded all then-existing non-SEC accounting and reporting standards. All previous references to the superseded standards in our consolidated financial statements have been replaced by references to the applicable sections of the Codification. The adoption of ASU 2009-1 did not have a material impact on the Company’s consolidated results of operation and financial condition. 54 In October 2009, the FASB issued ASU No. 2009-13, "Multiple-Deliverable Revenue Arrangements-a consensus of the FASB Emerging Issues Task Force" (“ASU 2009-13”). ASU 2009-13 updates the existing multiple-element revenue arrangements guidance currently included under ASC 605-25, which originated primarily from the guidance in EITF Issue No. 00-21, "Revenue Arrangements with Multiple Deliverables" (“EITF 00-21”). The revised guidance primarily provides two significant changes: 1) eliminates the need for objective and reliable evidence of the fair value for the undelivered element in order for a delivered item to be treated as a separate unit of accounting, and 2) eliminates the residual method to allocate the arrangement consideration. In addition, the guidance also expands the disclosure requirements for revenue recognition. ASU 2009-13 will be effective for the first annual reporting period beginning on or after June 15, 2010, with early adoption permitted provided that the revised guidance is retroactively applied to the beginning of the year of adoption. We are currently assessing the future impact of this new accounting update to our consolidated financial statements. In October 2009, the FASB issued ASU No. 2009-14, "Certain Revenue Arrangements that Include Software Elements-a consensus of the FASB Emerging Issues Task Force" ("ASU 2009-14"). ASU 2009-14 amends the scope of pre-existing software revenue guidance by removing from the guidance non-software components of tangible products and certain software components of tangible products. ASU 2009-14 will be effective for the first annual reporting period beginning on or after June 15, 2010, with early adoption permitted provided that the revised guidance is retroactively applied to the beginning of the year of adoption. We are currently assessing the future impact of this new accounting update to our consolidated financial statements. In January 2010, Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update 2010-2 (“ASU 2010- 2”), “Accounting and Reporting for Decreases in Ownership of a Subsidiary – a Scope Clarification. ASU 2010-2 addresses implementation issues related to the changes in ownership provisions in the Consolidation—Overall Subtopic (Subtopic 810- 10) of the FASB ASC, originally issued as SFAS 160, “Noncontrolling Interests in Consolidated Financial Statements”. Subtopic 810-10 establishes the accounting and reporting guidance for noncontrolling interests and changes in ownership interests of a subsidiary. An entity is required to deconsolidate a subsidiary when the entity ceases to have a controlling financial interest in the subsidiary. Upon deconsolidation of a subsidiary, an entity recognizes a gain or loss on the transaction and measures any retained investment in the subsidiary at fair value. The gain or loss includes any gain or loss associated with the difference between the fair value of the retained investment in the subsidiary and its carrying amount at the date the subsidiary is deconsolidated. In contrast, an entity is required to account for a decrease in ownership interest of a subsidiary that does not result in a change of control of the subsidiary as an equity transaction. The adoption of ASU 2010-2 did not have a material effect on the Company’s consolidated results of operation and financial condition. In January 2010, FASB issued ASU 2010-6, “Improving Disclosures about Fair Measurements". ASU 2010-6 provides amendments to subtopic 820-10 of the FASB Accounting Standards Codification, originally issued as FASB Statement No. 157, “Fair Value Measurements” that require separate disclosure of significant transfers in and out of Level 1 and Level 2 fair value measurements and the presentation of separate information regarding purchases, sales, issuances and settlements for Level 3 fair value measurements. Additionally, ASU 2010-6 provides amendments to subtopic 820-10 that clarify existing disclosures about the level of disaggregation and inputs and valuation techniques. ASU 2010-6 is effective for financial statements issued for interim and annual periods ending after December 15, 2010. The Company will adopt this pronouncement in the third quarter of fiscal 2011 and do not expect the adoption of ASU 2010-06 will have a material impact on the Company’s consolidated results of operation and financial condition. In February 2010, FASB issued ASU 2010-9 Subsequent Events (Topic 855) Amendments to Certain Recognition and Disclosure Requirements.” ASU 2010-9 amends disclosure requirements within Subtopic 855-10. An entity that is an SEC filer is not required to disclose the date through which subsequent events have been evaluated. This change alleviates potential conflicts between Subtopic 855-10 and the SEC's requirements. The adoption of ASU 2010-09 did not have a material impact on the Company’s consolidated results of operation and financial condition. COMPREHENSIVE INCOME (LOSS) Comprehensive income (loss), as defined, includes all changes in equity (net assets) during a period from non-owner sources. The difference between net income (loss) and comprehensive income (loss) is due to unrealized gains or losses on investments classified as available-for-sale. Comprehensive income (loss) is reflected in the consolidated statements of stockholders' equity. 55 NET INCOME (LOSS) PER SHARE Basic net income (loss) per share is computed by dividing net income (loss) available to common stockholders (numerator) by the weighted average number of vested, unrestricted common shares outstanding during the period (denominator). Diluted net income per share is computed on the basis of the weighted average number of shares of common stock plus the effect of dilutive potential common shares outstanding during the period using the treasury stock method. Dilutive potential common shares include outstanding stock options, shares to be issued under the employee stock purchase plan and warrants. 2010 Years Ended March 31, 2009 (in thousands, except per share amounts) 2008 Numerator: Net income (loss) available to common stockholders $ 3,879 $ (2,500) $ 30 Denominator: Common shares Denominator for basic calculation Employee stock options Employee stock purchase plan Employee restricted purchase rights Warrants 62,861 62,861 318 - 83 - 62,317 62,317 - - - - 61,897 61,897 133 36 - 46 Denominator for diluted calculation 63,262 62,317 62,112 Net income (loss) per share Basic Diluted $ $ 0.06 0.06 $ $ (0.04) (0.04) $ $ 0.00 0.00 The following shares attributable to outstanding stock options and warrants were excluded from the calculation of diluted earnings per share because their inclusion would have been anti dilutive (in thousands): Common stock options Stock purchase rights Warrants 2. INCOME TAXES 2010 Years Ended March 31, 2009 2008 8,403 1 1,786 10,190 10,736 100 5,445 16,281 9,038 - 7,838 16,876 For the year ended March 31, 2010 and 2009, the Company recorded a provision for income taxes of $3,000 and $45,000, respectively, which was attributable to state tax in several states and foreign tax, offset by federal refund in lieu of bonus depreciation (in accordance with the Economic Stimulus Act of 2010). There was no income tax provision for the year ended March 31, 2008.The components of the consolidated provision for income taxes for fiscal 2010 and 2009 consisted of the following (in thousands): Current: Federal State Foreign 2010 March 31, 2009 2008 (77) 70 10 3 $ $ $ (72) 64 53 45 $ - - - - $ $ 56 The Company's income (loss) before income taxes included $38,000, $38,000 and $29,000 of foreign subsidiary income for the fiscal years ended March 31, 2010, 2009 and 2008, respectively. Deferred tax assets were comprised of the following (in thousands): Research and development credit carryforwards Net operating loss carryforwards Inventory valuation Reserves and allowances Fixed assets and intangibles Valuation allowance Total March 31, 2010 2009 $ $ 2,517 57,714 95 1,817 6,548 68,691 (68,691) $ - $ 3,510 57,568 298 2,194 7,783 71,353 (71,353) - Because of uncertainties regarding the realization of deferred tax assets, management has applied a full valuation allowance as of March 31, 2010 and 2009. At March 31, 2010, the Company had net operating loss carryforwards for federal and state income tax purposes of approximately $154.0 million and $90.3 million, respectively, which expire at various dates beginning in 2011 and continuing through 2030. The net operating loss carryforwards include approximately $10.0 million resulting from employee exercises of non-qualified stock options or disqualifying dispositions, the tax benefits of which, when realized, will be accounted for as an addition to additional paid-in capital rather than as a reduction of the provision for income taxes. In addition, at March 31, 2010, the Company had research and development credit carryforwards for federal and state tax reporting purposes of approximately $1.7 million and $2.9 million, respectively. The federal credit carryforwards will expire at various dates beginning in 2011 and continuing through 2030, while the California credits will carry forward indefinitely. Under applicable tax laws, the amount of and benefits from net operating losses and credits that can be carried forward may be impaired or limited in certain circumstances. Events which may cause limitations in the amount of net operating loss carryforwards that the Company may utilize in any one year include, but are not limited to, a cumulative ownership change of more than 50% over a three year period. A reconciliation of the tax provision (benefit) to the amounts computed using the statutory U.S. federal income tax rate of 34% is as follows (in thousands): Tax provision (benefit) at statutory rate State income taxes (benefit) before valuation allowance, net of federal effect Research and development credits Change in valuation allowance Income from change in fair value of warrant liability Compensation/option differences Non-deductible compensation Other 2010 Years Ended March 31, 2009 2008 $ 1,320 $ (835) $ 298 (112) (1,536) 50 (20) 51 (48) 20 (100) 395 (107) (5) 674 3 $ 3 $ 45 $ 12 (67) (52) 519 (728) (9) 307 18 - 57 Effective April 1, 2007, the Company adopted the provisions of ASC 740 (formerly Financial Accounting Standards Board Interpretation No. 48, “Accounting for Uncertainty in Income Taxes: an Interpretation of FASB Statement No. 109”), which clarifies the accounting and disclosure for uncertainty in income taxes recognized in an enterprise’s financial statements. As a result of the implementation of ASC 740, the Company recognized no material adjustment to the April 1, 2007 balance of retained earnings. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in thousands): Balance at beginning of year Gross increases - tax position in prior period Gross decreases - tax position in prior period Gross increases - tax positions related to the current year Settlements Lapse of statue of limitations Balance at end of year Unrecognized Tax Benefits 2010 2009 $ 2,206 $ 2,122 2008 2,044 - (586) 123 - - 1,743 $ - (27) 111 - - 2,206 $ - - 78 - - 2,122 The total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate is $1.7 million, but any affect would have been fully offset by the application of the valuation allowance. To the extent that the unrecognized tax benefits are ultimately recognized, they may have an impact on the effective tax rate in future periods; however, such impact on the effective tax rate would only occur if the recognition of such unrecognized tax benefits occurs in a future period when the Company has already determined that its deferred tax assets are more likely than not realizable. The Company does not expect the unrecognized tax benefits to change significantly over the next 12 months. The Company files U.S. federal, state and foreign income tax returns in jurisdictions with varying statutes of limitations. The Company has not been under examination by income tax authorities in federal, state or other foreign jurisdictions. The 1995 through fiscal 2010 tax years generally remain subject to examination by federal and most state tax authorities. In significant foreign jurisdictions, the fiscal year 2007 through 2010 tax years remain subject to examination by their respective tax authorities. The Company's policy for recording interest and penalties associated with audits is to record such items as a component of operating expense income before taxes. During the fiscal year ended March 31, 2010 and 2009, the Company did not recognize any interest or penalties related to unrecognized tax benefits. Undistributed earnings of the Company’s foreign subsidiaries are indefinitely reinvested in foreign operations. No provision has been made for taxes that might be payable upon remittance of such earnings, nor is it practicable to determine the amount of this liability. 3. COMMITMENTS AND CONTINGENCIES Guarantees Indemnifications In the normal course of business, the Company may agree to indemnify other parties, including customers, lessors and parties to other transactions with the Company, with respect to certain matters such as breaches of representations or covenants or intellectual property infringement or other claims made by third parties. These agreements may limit the time within which an indemnification claim can be made and the amount of the claim. In addition, the Company has entered into indemnification agreements with its officers and directors. It is not possible to determine the maximum potential amount of the Company’s exposure under these indemnification agreements due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each particular agreement. Historically, payments made by the Company under these agreements have not had a material impact on the Company’s operating results, financial position or cash flows. Under some of these agreements, however, the Company’s potential indemnification liability might not have a contractual limit. 58 Product Warranties The Company accrues for the estimated costs that may be incurred under its product warranties upon revenue recognition. Changes in the Company’s product warranty liability, which is included in cost of product revenues in the consolidated statements of operations, during the years ended March 31, 2010, 2009 and 2008 were as follows (in thousands): Balance at beginning of year Accruals for warranties Payments Changes in estimates Balance at end of year Standby letter of credit 2010 Years Ended March 31, 2009 2008 $ $ 328 446 (404) (39) $ 314 366 (352) - $ 331 $ 328 $ 323 297 (306) - 314 At March 31, 2009, the Company had certain restricted deposits totaling $100,000 which were recorded in the other assets line item on the consolidated balance sheets. This deposit was made in order to obtain a standby letter of credit in accordance with certain contractual obligations, and is collateralized by a cash deposit at the Company’s bank. Leases The Company leases its primary facility in Sunnyvale, California under an operating lease agreement that expires in August 2012. The facility leases include rent escalation clauses, and require the Company to pay utilities and normal maintenance costs. At March 31, 2010, future minimum annual lease payments under non-cancelable operating leases, net of sublease income, were as follows (in thousands): Year Ending March 31, 2011 2012 2013 Total minimum payments $ $ 594 657 284 1,535 Rent expense for the years ended March 31, 2010, 2009 and 2008 was $632,000, $494,000 and $486,000, respectively. Capital Leases In March 2007 and August 2009, the Company entered into a series of non-cancelable capital lease agreements for office equipment bearing interest at various rates. At March 31, 2010, future minimum annual lease payments under noncancelable capital leases were as follows (in thousands): Year ending March 31: 2011 2012 2013 Total minimum payments Less: Amount representing interest Less: Short-term portion of capital lease obligations Long-term portion of capital lease obligations $ $ 41 40 7 88 (6) 82 (38) 44 Capital leases included in office equipment were $156,000 at March 31, 2010. Total accumulated amortization was $77,000 at March 31, 2010. Amortization expense for assets recorded under capital leases is included in depreciation expense. 59 Minimum Third Party Customer Support Commitments In the third quarter of 2010, the Company amended its contract with one of its third party customer support vendors containing a minimum monthly commitment of approximately $430,000 effective April 1, 2010. The agreement requires a 150-day notice to terminate. At March 31, 2010, the total remaining obligation under the contract was $2.2 million. Legal Proceedings The Company, from time to time, is involved in various legal claims or litigation, including patent infringement claims that can arise in the normal course of the Company’s operations. Pending or future litigation could be costly, could cause the diversion of management’s attention and could upon resolution, have a material adverse effect on the Company’s business, results of operations, financial condition and cash flows. On January 27, 2010, the Company was named a defendant in a lawsuit, Nikki Meierdiercks et al. v. 8x8, Inc., filed by three former employees in Santa Clara County Superior Court as a putative class action seeking damages and various penalties under the California Labor Code for alleged unpaid overtime, meal breaks, rest breaks and alleged late wage payments and unreimbursed business expenses. The Plaintiffs’ filed a First Amended Complaint on April 29, 2010 and the Company filed its Answer to the First Amended Complaint on May 26, 2010. The Company has factual and legal defenses to these claims and is presenting a vigorous defense. Plaintiffs have not made a specific monetary demand and the Company cannot estimate potential liability in this case at this early stage of litigation. In April 2009, the Company entered into a license and settlement agreement with a patent holder. The agreement requires the Company to pay eight quarterly payments over the next two years. At March 31, 2010, future minimum annual payments under the license and settlement agreement were as follows (in thousands): Year ending March 31: 2011 Total minimum payments Less: Amount representing interest Less: Short-term portion of license fee Long-term portion of license fee obligation State and Municipal Taxes $ $ 250 250 (5) 245 (245) - For a period of time, the Company did not collect or remit state or municipal taxes (such as sales, excise, and ad valorem taxes), fees or surcharges ("Taxes") on the charges to the Company's customers for its services, although the Company historically complied with the California sales tax and financial contributions to the 9-1-1 system and Universal Service Fund. The Company has received inquiries or demands from a number of state and municipal taxing agencies seeking payment of Taxes that are applied to or collected from customers of providers of traditional public switched telephone network services. Although the Company has consistently maintained that these Taxes do not apply to its service for a variety of reasons depending on the statute or rule that establishes such obligations, a number of states have changed their statutes as part of streamlined sales tax initiatives and, in response to these statutory changes, the Company has begun collecting and remitting Taxes in those states. Some of these Taxes could apply to the Company retroactively, and three states currently are conducting Tax audits of the Company's records. The Company has accrued a tax liability of $0.1 million at March 31, 2010 as its current estimate of the potential tax exposure for any retroactive Tax assessment by numerous states and municipalities. Regulatory VoIP communication services, like ours are subject to less regulation at the federal level than traditional telecommunication services and states are preempted from regulating such services. Many regulatory actions are underway or are being contemplated by federal and state authorities, including the FCC, and state regulatory agencies. The FCC initiated a notice of public rule-making in early 2004 to gather public comment on the appropriate regulatory environment for IP telephony which would include the services we offer. In November 2004, the FCC ruled that the VoIP service of a competitor and "similar" services are jurisdictionally interstate and not subject to state certification, tariffing and other legacy telecommunication carrier regulations. 60 The effect of any future laws, regulations and the orders on the Company’s operations, including, but not limited to, the 8x8 service, cannot be determined. But as a general matter, increased regulation and the imposition of additional funding obligations increases the Company’s costs of providing service that may or may not be recoverable from the Company’s customers which could result in making the Company’s services less competitive with traditional telecommunications services if the Company increases its retail prices or decreases the Company’s profit margins if it attempts to absorb such costs. 4. STOCKHOLDERS' EQUITY 1996 Stock Plan In June 1996, the Board adopted the 1996 Stock Plan (the 1996 Plan) and reserved 1,000,000 shares of the Company's common stock for issuance under this plan. The Company's stockholders subsequently authorized increases in the number of shares of the Company's common stock reserved for issuance under the 1996 Plan of 500,000 shares in June 1997 and 2,000,000 shares in August 2000. The 1996 Plan also provides for an annual increase in the number of shares reserved for issuance under the 1996 Plan on the first day of the Company's fiscal year in an amount equal to 5% of the Company's common stock issued and outstanding at the end of the immediately preceding fiscal year, subject to a maximum annual increase of 1,000,000 shares. The annual increase was 1,000,000 shares in each of fiscal 2007, 2006 and 2005. To date, this provision has resulted in increases in shares reserved for issuance under the 1996 Plan totaling 8,535,967. The 1996 Plan provides for granting incentive stock options to employees and nonstatutory stock options to employees, directors or consultants. The stock option price of incentive stock options granted may not be less than the determined fair market value at the date of grant. Options generally vest over four years and expire ten years after grant. The 1996 Plan expired in June 2006. 1996 Director Option Plan The Company's 1996 Director Option Plan (the Director Plan) was adopted in June 1996 and became effective in July 1997. A total of 150,000 shares of common stock were initially reserved for issuance under the Director Plan. The Company's stockholders subsequently authorized an increase in the number of shares of common stock reserved for issuance under the Director Plan to 500,000 shares in August 2000, and 1,000,000 in July 2002. The Director Plan provides for both discretionary and periodic grants of nonstatutory stock options to non-employee directors of the Company (the Outside Directors). The exercise price per share of all options granted under the Director Plan will be equal to the fair market value of a share of the Company's common stock on the date of grant. Options generally vest over a period of four years. Options granted to Outside Directors under the Director Plan have a ten year term, or shorter upon termination of an Outside Director's status as a director. The Director Plan expired in June 2006. 1999 Nonstatutory Stock Option Plan In fiscal 2000, the Board approved the 1999 Nonstatutory Stock Option Plan (the 1999 Plan) with 600,000 shares initially reserved for issuance thereunder. In fiscal 2001, the number of shares reserved for issuance was increased to 3,600,000 shares by the Board. Under the terms of the 1999 Plan, options may not be issued to either officers or directors of the Company provided, however, that options may be granted to an officer in connection with the officer's initial employment by the Company. Options generally vest over four years and expire ten years after grant. The 1999 Plan has not been approved by the stockholders of the Company. In May 2006, the Board cancelled the 1999 Plan, and no new grants may be made from the 1999 Plan. 2006 Stock Plan In May 2006, the Board approved the 2006 Stock Plan (the “2006 Plan”). The Company’s stockholders subsequently adopted the 2006 Plan at the 2006 Annual Meeting of Stockholders held September 18, 2006, and the 2006 Plan became effective in October 2006. The Company reserved 7,000,000 shares of the Company’s common stock for issuance under this plan. The 2006 Plan provides for granting incentive stock options to employees and nonstatutory stock options to employees, directors or consultants. The stock option price of incentive stock options granted 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 compensation committee of the board of directors. Options generally vest over four years and expire ten years after grant. In 2009, the 2006 Plan was amended to provide for the granting of stock purchase rights. The 2006 Plan expires in May 2016. 61 Option and Stock Purchase Right Activity Stock Purchase Right Activity since March 31, 2009 is summarized as follows: Balance at March 31, 2008 Granted Vested Forfeited Balance at March 31, 2009 Granted Vested Forfeited Balance at March 31, 2010 Weighted Average Weighted Average Grant-Date Remaining Number of Fair Market Contractual Shares Value Term (in Years) - $ 100,000 - - 100,000 331,464 (77,744) - 353,720 $ - 0.57 - - 0.57 0.74 0.68 - 0.71 3.26 Option activity under the Company's stock option plans since March 31, 2007, is summarized as follows: Balance at March 31, 2007 Granted - Options Exercised Canceled/Forfeited Termination of plans Balance at March 31, 2008 Granted - Options Stock purchase rights Exercised Canceled/Forfeited Termination of plans Balance at March 31, 2009 Stock purchase rights Exercised Canceled/Forfeited Termination of plans Balance at March 31, 2010 Shares Available for Grant 5,926,459 (2,299,000) - 905,706 (598,040) 3,935,125 (1,855,500) (100,000) - 1,330,985 (894,735) 2,415,875 (331,464) - 1,273,376 (488,376) 2,869,411 62 Shares Subject to Options Outstanding 8,929,978 2,299,000 (22,208) (905,706) - 10,301,064 1,855,500 - (89,300) (1,330,985) - 10,736,279 - (195,500) (1,273,376) - 9,267,403 $ Weighted Average Exercise Price Per Share 2.17 1.26 0.90 1.80 $ 2.00 0.84 0.57 0.37 1.72 1.85 0.74 0.73 1.68 1.90 Significant option groups outstanding at March 31, 2010 and related weighted average exercise price and contractual life information for 8x8, Inc.'s stock option plans are as follows: Options Outstanding Weighted Average Exercise Price Per Share Weighted Average Remaining Contractual Life (Years) 0.91 1.27 1.58 1.89 5.03 6.8 6.9 5.1 2.7 2.0 Options Exercisable Weighted Average Exercise Price Per Share Aggregate Intrinsic Value 0.91 $ 1,094 1.27 1.58 1.89 5.03 383 12 - - $ $ $ $ $ Aggregate Intrinsic Value Shares $ 1,094 2,041,762 383 12 - - 2,116,500 1,866,710 1,987,431 1,255,000 $ 1,489 9,267,403 $ 1,489 Shares 2,041,762 2,116,500 1,866,710 1,987,431 1,255,000 9,267,403 $ $ $ $ $ $ 0.55 to $ 1.18 $ 1.19 to $ 1.32 $ 1.33 to $ 1.72 $ 1.73 to $2.31 $2.32 to $14.94 The Company recognized stock compensation expense in fiscal 2010, 2009 and 2008 of $204,000, $3,295,000 and $1,272,000, respectively. The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (the aggregate difference between the closing stock price of the Company’s common stock on March 31, 2010 and the exercise price for in-the-money options) that would have been received by the option holders if all in-the-money options had been exercised on March 31, 2010. The total intrinsic value of options exercised in the years ended March 31, 2010, 2009 and 2008 were $70,000, $49,000 and $9,000, respectively. As of March 31, 2010, there was $249,000 of unamortized stock-based compensation expense related to unvested stock awards which is expected to be recognized over a weighted average period of 3.26 years. Cash received from option exercises and purchases of shares under the Purchase Plan for the years ended March 31, 2010, 2009 and 2008 were $0.4 million, $0.3 million and $0.3 million, respectively. The total tax benefit attributable to stock options exercised in the year ended March 31, 2010 was $0. The Company did not recognize and does not expect to recognize in the near future any tax benefit related to employee stock- based compensation cost as a result of the full valuation allowance on its net deferred tax assets and because of its net operating loss carryforwards. 1996 Employee Stock Purchase Plan The Company's 1996 Stock Purchase Plan (the Purchase Plan) was adopted in June 1996 and became effective upon the closing of the Company's initial public offering in July 1997. The Company suspended the Purchase Plan in 2003 and reactivated the Plan in fiscal 2005. Under the Purchase Plan, 500,000 shares of common stock were initially reserved for issuance. At the start of each fiscal year, the number of shares of common stock subject to the Purchase Plan increases so that 500,000 shares remain available for issuance. During fiscal 2010, 2009 and 2008, 499,969, 424,470 and 273,229 shares, respectively, were issued under the Purchase Plan. In May 2006, the Board approved a ten-year extension of the Purchase Plan so that it would be effective until 2017. Stockholders approved a ten-year extension of the Purchase Plan at the 2006 Annual Meeting of Stockholders held September 18, 2006. The Purchase Plan is effective until 2017. The Purchase Plan permits eligible employees to purchase common stock through payroll deductions at a price equal to 85% of the fair market value of the common stock at the beginning of each two year offering period or the end of a six month purchase period, whichever is lower. When the Purchase Plan was reinstated in fiscal 2005, the offering period was reduced from two years to one year. The contribution amount may not exceed ten percent of an employee's base compensation, including commissions, but not including bonuses and overtime. In the event of a merger of the Company with or into another corporation or the sale of all or substantially all of the assets of the Company, the Purchase Plan provides that a new exercise date will be set for each option under the plan which exercise date will occur before the date of the merger or asset sale. 63 Assumptions Used to Calculate Stock-Based Compensation Expense The fair value of each of the Company's option grants has been estimated on the date of grant using the Black-Scholes pricing model with the following assumptions: Expected volatility Expected dividend yield Risk-free interest rate Weighted average expected option term Weighted average fair value of options granted $ Years Ended March 31, 2010 2009 2008 - - - - - 79% - 79% - 1.4% to 3.2% 2.2% to 4.8% 4.6 years 3.4 years $ 0.52 $ 0.71 The estimated fair value of stock purchase rights granted under the Purchase Plan were estimated using the Black-Scholes pricing model with the following weighted-average assumptions: Expected volatility Expected dividend yield Risk-free interest rate Years Ended March 31, 2010 2009 2008 84% - 0.30% 68% - 0.87% 54% - 3.83% Weighted average expected rights term 0.79 years 0.81 years 0.75 years Weighted average fair value of rights granted $ 0.40 $ 0.28 $ 0.44 STOCK REPURCHASES In July 2009, the Company’s board of directors authorized the Company to purchase up to $2.0 million of its common stock from time to time until July 28, 2010 (the “Repurchase Plan”). Share repurchases, if any, will be funded with available cash. Repurchases under the Repurchase Plan may be made through open market purchases at prevailing market prices or in privately negotiated transactions. The timing, volume and nature of share repurchases are subject to market prices and conditions, applicable securities laws and other factors, and are at the discretion of the Company’s management. Share repurchases under the Repurchase Plan may be commenced, suspended or discontinued at any time. The remaining authorized repurchase amount at March 31, 2010 is $1.8 million. The activity under the Repurchase Plan for the fiscal year ended March 31, 2010 is summarized as follows: Repurchase of common stock Balance at March 31, 2010 Weighted Average Price Shares Amount Repurchased Per Share Repurchased 282,376 282,376 $ $ 0.75 0.75 $ $ 211,741 211,741 The total purchase prices of the common stock repurchased and retired were reflected as a reduction to stockholders’ equity during the period of repurchase. 64 5. EMPLOYEE BENEFIT PLAN 401(k) Savings Plan In April 1991, the Company adopted a 401(k) savings plan (the Savings Plan) covering substantially all of its U.S. employees. Eligible employees may contribute to the Savings Plan from their compensation up to the maximum allowed by the Internal Revenue Service. No matching contribution was made in fiscal 2006. On January 1, 2007, the Company reactivated the employer matching contribution. The employee matching contribution is 100% of each employee’s contributions in each year, not to exceed $1,500 per annum. The employee matching expense in 2010, 2009 and 2008 was $0.2 million, $0.2 million and $0.1 million, respectively. The Savings Plan does not allow employee contributions to be invested in the Company’s common stock. 6. SEGMENT REPORTING ASC 280 “Segment Reporting (formerly SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information”) establishes annual and interim reporting standards for an enterprise’s business segments and related disclosures about its products, services, geographic areas and major customers. Under ASC 280, the method for determining what information to report is based upon the way management organizes the operating segments within the Company for making operating decisions and assessing financial performance. The Company has only one reportable segment. The following table presents net revenues by groupings of similar products (in thousands). 8x8 service, equipment and other Technology licensing and related software Total revenues Years Ended March 31, 2010 2009 2008 $ $ 63,315 81 63,396 $ $ 64,601 73 64,674 $ $ 60,891 755 61,646 Revenue from customers outside the United States was not material for the fiscal years ended March 31, 2010, 2009 and 2008. The majority of the Company's property and equipment was located in the United States. The following table illustrates property and equipment by country (in thousands): United States France March 31, 2010 2009 1,861 10 1,871 $ $ 1,482 3 1,485 $ $ No customer represented more than 10% of the Company’s total revenues in fiscal 2010, 2009 or 2008. 7. SUBSEQUENT EVENTS In April 2010, the Company sold its wholly-owned French research and development subsidiary, 8x8 Europe, SARL, to Stonyfish, a privately-held company in Los Altos, California. 8x8 also invested $250,000 cash in the new venture and granted a non-exclusive license to certain 8x8 technology. 8x8 will own 17% of Stonyfish following its initial round of external fundraising. On May 1, 2010, the Company, entered into an agreement with Central Host, Inc. and Andrew Schwabecher pursuant to which the Company acquired this provider of managed hosting services from its sole shareholder, Schwabecher. Under the terms of the Agreement, the Company closed the acquisition on May 1, 2010 and paid $1,000,000 in cash and issued 432,276 shares of 65 its common stock, at an average price of $1.388 per share and calculated based on the trailing 5-day average closing price of 8x8 common stock on the NASDAQ Exchange as of the Effective Date of the transaction, to Schwabecher in exchange for 100% of the outstanding shares of capital stock of Central Host, Inc. The shares of the Company's common stock were not registered for sale and were issued pursuant to an exemption from the registration requirements under section 5 of the Securities Act of 1933, as amended, provided by section 4(2) thereof. The shares are subject to a lock-up restriction that prohibits any sale or transfer before May 1, 2011, after which Schwabecher may sell up to 50% of the shares. If Schwabecher remains continuously employed by the Company until May 1, 2012, he may sell the remaining 50% of the shares thereafter, or, if his employment with the Company ceases before then, he may sell the remaining shares after May 1, 2013. 66 8X8, INC. SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS (IN THOUSANDS) Description Year ended March 31, 2008: Allowance for doubtful accounts Valuation allowance for deferred tax assets Year ended March 31, 2009: Allowance for doubtful accounts Valuation allowance for deferred tax assets Year ended March 31, 2010: Allowance for doubtful accounts Valuation allowance for deferred tax assets Balance at Beginning of Year Additions Charged to Costs, Expenses and Other $ 54 73,173 $ 61 72,086 302 71,353 142 - 338 - - - Deductions $ $ 135 1,087 97 733 266 2,662 Balance at End of Year 61 72,086 302 71,353 36 68,691 67 8X8, INC. CONSOLIDATED QUARTERLY FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) March 31, Dec. 31, Sept. 30, June 30, March 31, Dec. 31, Sept. 30, June 30, 2010 2009 2009 2009 2009 2008 2008 2008 $ 14,588 $ 14,737 $ 14,838 $ 14,520 $ 14,198 $ 14,366 $ 14,903 $ 15,019 QUARTER ENDED Service revenues Product revenues Total revenues Operating expenses: Cost of service revenues Cost of product revenues Research and development Selling, general, and administrative Total operating expenses Income (loss) from operations Other income (loss), net Income (loss) on change in fair value of warrant liability Income (loss) before provision for income taxes Provision (benefit) for income taxes Net income (loss) Net income (loss) per share: Basic Diluted 1,279 15,867 3,309 1,825 1,308 8,536 14,978 889 3 216 1,207 15,944 3,254 1,925 1,239 8,251 14,669 1,275 7 1,189 16,027 3,535 1,686 1,265 8,156 14,642 1,385 31 1,038 15,558 3,501 1,821 1,237 8,573 15,132 426 12 1,567 15,765 4,179 2,349 1,538 11,700 19,766 (4,001) 32 (265) (90) (7) (11) 1,108 1,017 1,326 1,837 16,203 3,699 1,681 1,183 9,562 16,125 78 74 66 218 38 180 1,522 16,425 4,022 1,673 1,299 9,667 16,661 (236) 107 190 61 17 44 0.00 0.00 1,262 16,281 3,814 1,432 1,192 8,751 15,189 1,092 85 69 1,246 58 1,188 0.02 0.02 $ $ $ $ $ $ (7) $ 1,115 $ $ 0.02 0.02 3 1,014 0.02 0.02 $ $ $ $ $ $ $ $ $ (10) 1,336 0.02 0.02 62,774 62,873 Shares used in per share calculations: Basic Diluted 63,064 63,992 62,852 63,393 431 17 414 (3,980) (68) $ (3,912) $ 0.01 0.01 $ $ (0.06) (0.06) $ $ 0.00 0.00 62,688 62,766 62,568 62,568 62,332 62,394 62,278 62,361 62,096 62,192 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. ITEM 9A. CONTROLS AND PROCEDURES Changes in Internal Control Over Financial Reporting There have not been any changes in the Company's internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended (the "Exchange Act") during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. 68 Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures Evaluation of Disclosure Controls and Procedures The Company's management, with the participation of the Company's Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company's disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, as of March 31, 2010. Based on such evaluation, the Company's Chief Executive Officer and Chief Financial Officer have concluded that, as of March 31, 2010, the Company's disclosure controls and procedures were effective. Management’s Report on Internal Control Over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rules 13a-15(f) or 15d-15(f) under the Exchange Act. Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, the Company conducted an assessment of the effectiveness of its internal control over financial reporting based on criteria established in the framework in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, our management concluded that its internal control over financial reporting was effective as of March 31, 2010. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risks that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Moss Adams LLP, the independent registered public accounting firm that audited the financial statements included in this Annual Report on Form 10-K has issued an attestation report on our internal control over financial reporting which appears in Item 8 of this Annual Report on Form 10-K. ITEM 9B. OTHER INFORMATION None. PART III Certain information required by Part III is omitted from this Report on Form 10-K in that the Registrant will file its definitive Proxy Statement for its Annual Meeting of Stockholders (the 2010 Proxy Statement) pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended, not later than 120 days after the end of the fiscal year covered by this Report, and certain information included in the 2010 Proxy Statement is incorporated herein by reference. ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE Information regarding our directors and corporate governance will be presented in our definitive proxy statement for our 2010 Annual Meeting of Stockholders to be held on or about August 31, 2010, which information is incorporated into this report by reference. However, certain information regarding current executive officers found under the heading “Executive Officers” in Item 1 of Part I hereof is also incorporated by reference in response to this Item 10. We have adopted a Code of Conduct and Ethics that applies to our principal executive officer, principal financial officer and all other employees at 8x8, Inc. This Code of Conduct and Ethics is posted in the corporate governance section of our website at http://investors.8x8.com. We intend to satisfy the disclosure requirement under Item 10 of Form 8-K regarding an amendment to, or waiver from, a provision of this Code of Conduct and Ethics by posting such information in the corporate governance section on its website at http://investors.8x8.com. ITEM 11. EXECUTIVE COMPENSATION Information relating to executive compensation will be presented in our definitive proxy statement for our 2010 Annual Meeting of Stockholders to be held on or about August 31, 2010, which information is incorporated into this report by reference. 69 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS Information relating to securities authorized for issuance under equity compensation plans and other information required to be provided in response to this item will be presented in our definitive proxy statement for our 2010 Annual Meeting of Stockholders to be held on or about August 31, 2010, which information is incorporated into this report by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE Information required to be provided in response to this item will be presented in our definitive proxy statement for our 2010 Annual Meeting of Stockholders to be held on or about August 31, 2010, which information is incorporated into this report by reference. ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES Information required to be provided in response to this item will be presented in our definitive proxy statement for our 2010 Annual Meeting of Stockholders to be held on or about August 31, 2010, which information is incorporated into this report by reference. PART IV ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (a)(1) Financial Statements. The information required by this item is included in Item 8. (a)(2) Financial Statement Schedules. The information required by this item is included in Item 8. (a)(3) Exhibits. The documents listed on the Exhibit Index appearing in this Report are filed herewith or hereby incorporated by reference. Copies of the exhibits listed in the Exhibit Index will be furnished, upon request, to holders or beneficial owners of the Company's common stock. 70 Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant, 8x8, Inc., a Delaware corporation, has duly caused this Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Sunnyvale, State of California, on May 26, 2010. SIGNATURES 8X8, INC. By: /s/ BRYAN R. MARTIN Bryan R. Martin, Chairman and Chief Executive Officer POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENT, that each person whose signature appears below constitutes and appoints Bryan R. Martin and Daniel Weirich, jointly and severally, his attorneys-in-fact, each with the power of substitution, for him in any and all capacities, to sign any amendments to this Report on Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorney-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities and Exchange Act of 1934, this Report on Form 10-K has been signed by the following persons in the capacities and on the date indicated: Signature Title /s/ BRYAN R. MARTIN Bryan R. Martin Chairman and Chief Executive Officer (Principal Executive Officer) Date May 26, 2010 /s/ DANIEL WEIRICH Daniel Weirich /s/ GUY L. HECKER Guy L. Hecker, Jr. /s/ JOE PARKINSON Joe Parkinson /s/ DONN WILSON Donn Wilson Chief Financial Officer, President and Secretary (Principal Financial and Accounting Officer) May 26, 2010 Director Director Director May 26, 2010 May 26, 2010 May 26, 2010 71 Exhibit Number 8X8, INC. EXHIBIT INDEX Exhibit Title 3.1 (a) Form of Restated Certificate of Incorporation of Registrant. 3.1.1(b) Certificate of Amendment of Restated Certificate of Incorporation of Registrant, dated August 15, 2000. 3.1.1(c) Certificate of Amendment of Amended and Restated Certificate of Incorporation of the Registrant, dated July 16, 2001 3.2 (d) Bylaws of Registrant. 4.1 (e) 4.2 (e) 4.3 (f) 4.4 (f) Form of Common Stock Warrant issued in connection with the sale of the Registrant's common stock and warrants under its shelf registration statement (File No. 333-114133), as amended, and as supplemented by a prospectus supplement dated June 21, 2004. Form of Common Stock Warrant issued to the placement agents in connection with the sale of the Registrant's common stock and warrants under its shelf registration statement (File No. 333- 114133), as amended, and as supplemented by a prospectus supplement dated June 21, 2004. Form of Common Stock Warrant issued in connection with the sale of the Registrant's common stock and warrants under its shelf registration statement (File No. 333-114133), as amended, and as supplemented by a prospectus supplement dated September 29, 2004. Side Letter dated September 30, 2004, to amend the warrant dated June 23, 2004 in connection with the sale of the Registrant's common stock and warrants under its shelf registration statement (File No. 333-114133), as amended, and as supplemented by a prospectus supplement dated September 29, 2004. 4.5 (f) Form of Common Stock Warrant issued to the placement agents in connection with the sale of the Registrant's common stock and warrants under its shelf registration statement (File No. 333- 114133), as amended, and as supplemented by a prospectus supplement dated September 29, 2004. 4.12 (g) Form of Common Stock Warrant issued in connection with a private placement of equity securities by the Registrant completed on July 29, 2003. 4.13 (h) 4.14 (i) Common Stock Purchase Warrant issued to AGE Investments, Inc., dated March 7, 2005, in connection with the sale of the Registrant's common stock and warrants under its shelf registration statement (File No. 333-114133), as amended, and as supplemented by a prospectus supplement dated March 3, 2005. Common Stock Purchase Warrant issued to Griffin Securities, Inc., dated March 7, 2005, in connection with the sale of the Registrant's common stock and warrants under its shelf registration statement (File No. 333-114133), as amended, and as supplemented by a prospectus supplement dated March 3, 2005. 4.15 (j) Form of Common Stock Warrant issued in connection with the sale of the Registrant's common stock and warrants under its shelf registration statement (File No. 333-126350), as amended, and as supplemented by a prospectus supplement dated December 15, 2005. 72 4.16 (k) Form of Common Stock Warrant issued to the placement agents in connection with the sale of the Registrant's common stock and warrants under its shelf registration statement (File No. 333- 126350), as amended, and as supplemented by a prospectus supplement dated December 15, 2005. 4.17 (l) Amendment to June 21, 2004, Common Stock Purchase Warrant dated August 29, 2007. 4.18 (m) Amendment to September 30, 2004, Common Stock Purchase Warrant dated August 29, 2007. 10.1 (a) Form of Indemnification Agreement between the Registrant and each of its directors and officers. 10.2 (a)* 1992 Stock Option Plan, as amended, and form of Stock Option Agreement. 10.3 (n)* 1996 Stock Plan, as amended, and form of Stock Option Agreement. 10.4 (o)* Amended and Restated 1996 Employee Stock Purchase Plan, as amended, and form of Subscription Agreement. 10.5 (p)* 1996 Director Option Plan, as amended. and Form of Director Option Agreement. 10.5.1 (q)* Form of Director Option Agreement for 1996 Director Option Plan. 10.6 (r)* 1999 Nonstatutory Stock Option Plan, as amended, and form of Stock Option Agreement. 10.7 (s)* 2006 Stock Plan, as amended. 10.8 (t) Sublease dated September 29, 2004, between the Registrant and SafeNet, Inc. 10.9 (u)* Form of 2006 Stock Option Agreement under the 2006 Stock Plan. 10.10 (v)* Form of Notice of Award of Stock Purchase Right and Stock Purchase Agreement under the 2006 Stock Plan. 10.11 (w) Lease dated May 1, 2009, between the Registrant and SILICON VALLEY CA-I, LLC. 10.12 Acquisition Agreement between 8x8, Inc., Central Host, Inc. and Andrew Schwabecher 21.1 Subsidiaries of Registrant. 23.1 Consent of Independent Registered Public Accounting Firm. 23.2 Consent of Independent Registered Public Accounting Firm. 24.1 Power of Attorney (included on page 71). 31.1 31.2 32.1 32.2 Certification of Chief Executive Officer of the Registrant pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. Certification of Chief Financial Officer of the Registrant pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. Certification of Chief Executive Officer of the Registrant pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. Certification of Chief Financial Officer of the Registrant pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. __________ 73 * Indicates management contract or compensatory plan or arrangement. (a) Incorporated by reference to the same numbered exhibits to the Registrant's Registration Statement on Form S-1 (Commission File No. 333-15627), as amended, declared effective July 1, 1997. (b) Incorporated by reference to exhibit 3.3 to the Registrant’s Form 10-K filed May 24, 2001 (File No. 000-21783). (c) Incorporated by reference to exhibit 3.1 to the Registrant’s Form 10-Q filed October 25, 2001 (File No. 000-21783). (d) Incorporated by reference to exhibit 3.2 to the Registrant’s Report on Form 8-K filed December 19, 2007 (File No. 000- 21783). (e) Incorporated by reference to the same numbered exhibits to the Registrant's Report on Form 8-K filed June 22, 2004 (File No. 000-21783). (f) Incorporated by reference to the same numbered exhibits to the Registrant's Report on Form 8-K filed October 1, 2004 (File No. 000-21783). (g) Incorporated by reference to the same numbered exhibit to the Registrant's Report on Form 8-K filed July 31, 2003 (File No. 000-21783). (h) Incorporated by reference to exhibit 4.3 to the Registrant's Report on Form 8-K/A filed March 8, 2005 (File No. 000- 21783). (i) Incorporated by reference to exhibit 4.4 to the Registrant's Report on Form 8-K/A filed March 8, 2005 (File No. 000- 21783). (j) Incorporated by reference to exhibit 4.3 to the Registrant's Report on Form 8-K/A filed December 20, 2005 (File No. 000- 21783). (k) Incorporated by reference to exhibit 4.5 to the Registrant's Report on Form 8-K/A filed December 20, 2005 (File No. 000- 21783). (l) Incorporated by reference to exhibit 4.1.1 to the Registrant's Report on Form 8-K filed August 31, 2007 (File No. 000- 21783). (m) Incorporated by reference to exhibit 4.3.1 to the Registrant's Report on Form 8-K filed on August 31, 2007 (File No. 000- 21783). (n) Incorporated by reference to exhibit 4.1 to the Registrant's Form S-8 filed November 7, 2000 (File No. 333-49410). (o) Incorporated by reference to exhibit 10.5 to the Registrant's Form S-8 filed September 26, 2006 (File No. 333-137-599). (p) Incorporated by reference to exhibit 10.3 to the Registrant's Form S-8 filed August 28, 2003 (File No. 333-108290). (q) Incorporated by reference to exhibit 4.2 to the Registrant's Form S-8 filed November 7, 2000 (File No. 333-49410). (r) Incorporated by reference to exhibit 4.1 to the Registrant's Form S-8 filed July 17, 2000 (File No. 333-41594). (s) Incorporated by reference to exhibit 10.7 to the Registrant’s Form 10-K filed May 26, 2009 (File No. 000-21783). (t) Incorporated by reference to exhibit 10.1 to the Registrant's Report on Form 8-K filed October 5, 2004 (File No. 000- 21783). (u) Incorporated by reference to exhibit 10.1 to the Registrant's Form 10-Q filed February 7, 2007 (File No. 000-21783). (v) Incorporated by reference to exhibit 10.10 to the Registrant’s Form 10-K filed May 26, 2009 (File No. 000-21783). (w) Incorporated by reference to exhibit 10.11 to the Registrant’s Form 10-K filed May 26, 2009 (File No. 000-21783). 74 AGREEMENT BETWEEN 8X8, INC. CENTRAL HOST, INC. AND ANDREW SCHWABECHER ACQUISITION AGREEMENT This Acquisition Agreement (the “Agreement”) is made and entered into as of May 1, 2010, by and among 8X8, INC., a Delaware corporation (“8x8” or the “Company”), CENTRAL HOST, INC., a California corporation (“Central Host”) and ANDREW SCHWABECHER, Central Host’s sole stockholder (“Stockholder”) (each a “Party” and collectively, the “Parties”) to be effective as of the date that first appears in the Agreement. A. Central Host is a company that provides managed hosting services. RECITALS B. Stockholder is the owner of 4,000 shares of common stock of Central Host (the “Shares”), which Shares represent 100% of the issued and outstanding shares of capital stock of Central Host. C. 8x8 is a company that provides various types of Voice over Internet Protocol (“VoIP”) and communications services. D. 8x8 desires to purchase all of the issued and outstanding shares of common stock in the capital of Central Host (the “Shares”) on the terms and conditions hereinafter set forth. AGREEMENT NOW, THEREFORE, in consideration of the foregoing premises, and mutual covenants and agreements hereinafter set forth, the Parties to this Agreement hereby agree as follows: 1. Definitions. As used in this Agreement, terms defined in the preamble and recitals hereto shall have the respective meanings specified therein and the following terms shall have the meanings set forth below: a. “Acquisition Shares” shall have the meaning provided in Section 3 of the Agreement. b. “Balance Sheet Date” shall have the meaning provided in Section 5.4 of the Agreement. c. “Closing” shall have the meaning provided in Section 4.1 of the Agreement. d. “Closing Date” shall mean the date of the Closing. e. “Effective Date” shall mean the date that first appears in the Agreement. f. “Employment Agreement” shall have the meaning provided in Section 4.2(b) of the Agreement. g. “Hazardous Material” shall have the meaning provided in Section 5.14 of the Agreement. h. “Intellectual Property” shall have the meaning provided in Section 5.13 of the Agreement. i. “Material Adverse Effect” means, with respect to Party, an effect which is materially adverse to the business, properties, assets, revenues, operations, financial condition, results of operations or prospects of such Party. Page 1 j. “Person” means an individual, corporation, partnership, limited liability company, joint venture, association, trust, unincorporated organization or other entity, including a government or political subdivision or an agency or instrumentality thereof. k. “Securities Act” means the Securities Act of 1933, as amended. l. “Subsidiary” of a corporation means any corporation of which equity securities possessing a majority of the ordinary voting power in electing the board of directors are, at the time as of which such determination is being made, owned by such corporation either directly or indirectly or through one or more Subsidiaries. 2. Acquisition of Shares. 8x8 agrees to acquire, and Stockholder agrees to sell, all the Shares in exchange for cash and shares of 8x8 common stock as described in Section 3 of the Agreement. Stockholder represents and warrants to 8x8 that Stockholder owns the Shares free and clear of any liens, claims or adverse rights. 3. Consideration; Restrictions on Acquisition Shares. 3.1 At the Closing, 8x8 will purchase the Shares for $1,600,000. Payment for the Shares by 8x8 will be in the form of $1,000,000 cash and $600,000 of unregistered 8x8 common stock (the “Acquisition Shares”), the share count of which is based on the trailing 5-day average closing price of 8x8 common stock on the NASDAQ Exchange as of the Effective Date. 3.2 Stockholder agrees that the Acquisition Shares are being acquired for investment and not with an intent to resell, will contain a Securities Act restrictive legend, and will only be resold pursuant to an exemption from registration. In addition, Stockholder agrees that subject to all applicable federal and state securities laws, Stockholder will not, during the period commencing on the Effective Date and ending on the date which is three years after the Effective Date, directly or indirectly, sell, offer to sell, pledge, encumber, or otherwise transfer or dispose of (collectively, “Transfer”) any of the Acquisition Shares, provided that: (i) Stockholder may Transfer up to 50% of the Acquisition Shares after the date which is one year after the Effective Date and (ii) either (A) Stockholder may Transfer the remaining 50% of the Acquisition Shares after the date which is two years after the Effective Date, if Stockholder has been continuously employed by 8x8 for said two-year period or (B) Stockholder may Transfer the remaining 50% of the Acquisition Shares after the date which is three years after the Effective Date, if Stockholder has not been continuously employed by 8x8 for said two-year period. 4. Closing. 4.1 Time and Place. The transactions which are the subject of this Agreement shall be closed concurrently with the execution hereof or as soon thereafter as the Parties mutually agree (the “Closing”). The Closing shall take place at the offices of 8x8, Inc., 810 W. Maude Avenue, Sunnyvale, California 94085. 4.2 Stockholder Deliverables. At the Closing, Stockholder shall deliver, or cause to be delivered to 8x8 the following: a. the Agreement, duly executed by Central Host and Stockholder; b. the Employment Offer and Non-Competition Agreement (“Employment Agreement”), duly executed by Stockholder; c. copies of resolutions of the Board of Directors of Central Host authorizing the execution and delivery by Central Host of this Agreement, duly certified by the Secretary of Central Host; d. the share certificate(s) representing the Shares, together with the Assignment Separate from Stock Certificate in the form attached hereto as Exhibit A duly executed by Stockholder; e. the Resignation in the form attached hereto as Exhibit B duly executed by Stockholder; and Page 2 f. all corporate books and records, including, without limitation, the corporate minute book, accounting records and tax records. 4.3. 8x8 Deliverables. At the Closing, 8x8 shall deliver, or cause to be delivered, to Stockholder, the following: a. $1,000,000 by wire transfer to such bank account as designed by Stockholder in writing prior the Closing. b. The Acquisition Shares, delivered in the name of Stockholder. 5. Representations and Warranties of Central Host and the Stockholder. Except as disclosed in the disclosure schedules delivered to 8x8 by Central Host and Stockholder prior to the execution and delivery of this Agreement, Central Host and the Stockholder jointly and severally represent, warrant, covenant, and agree as follows: 5.1. Organization and Standing; Articles and By-Laws. Central Host is a corporation duly organized, validly existing and in good standing under the laws of the State of California. Central Host is qualified, licensed or domesticated as a foreign corporation and is in good standing in all jurisdictions where the character of its properties owned or held under lease or the nature of its activities make such qualification necessary. Central Host has all requisite power and authority and all requisite licenses permits and franchises necessary to own, lease and operate its properties, and to carry on its business in the manner and in the locations as presently conducted. Copies of the Articles of Incorporation (as certified by the California Secretary of State) and By-Laws of Central Host have been delivered to 8x8 and are accurate and complete as of the Effective Date. 5.2. Authorization. Central Host has the requisite corporate power and authority, and Stockholder has all requisite power and authority, to enter into and carry out the terms and conditions of this Agreement and all the transactions contemplated hereunder. The execution and delivery of this Agreement and the consummation of the transactions contemplated hereby have been duly authorized by Central Host's Board of Directors and, all corporate proceedings have been done and no other corporate proceedings on the part of Central Host are necessary to authorize the execution, delivery and performance by Central Host of this Agreement. This Agreement has been duly executed and delivered by Central Host and constitutes the valid and binding obligations of Central Host, enforceable in accordance with its terms. 5.3. Capitalization; Subsidiaries. (a) The Shares represent all of the issued and outstanding shares of capital stock of Central Host and are held of record and beneficially owned by Stockholder free and clear of any and all liens. Stockholder is not a party to any voting trust, proxy or other agreement or understanding with respect to the Shares. All of the Shares have been duly authorized, are validly issued, fully paid, and nonassessable and were issued in conformity with all applicable legal requirements. (b) There are no (i) outstanding options, rights (preemptive or otherwise), warrants, calls, convertible equity interests, stock appreciation, phantom interests, profit participation or similar rights or commitments, or (ii) other arrangements to which Central Host or Stockholder is a party requiring or restricting the issuance, sale or transfer of the shares of stock of such legal entities. (c) Central Host has no Subsidiaries. 5.4. Absence of Certain Changes or Events. Except as heretofore disclosed in writing to 8x8 or as otherwise contemplated by this Agreement, since Balance Sheet Date (defined in Section 5.6(b)) Central Host has conducted its business only in the ordinary and usual course consistent with past practice, and there has not been: (a) any material adverse change in the business, properties, assets, revenues, operations, financial condition, results of operations or prospects of Central Host; Page 3 (b) any change in accounting methods, principles and practices by Central Host materially affecting its assets, liabilities or business; (c) any damage, destruction or loss, whether covered by insurance or not, having a Material Adverse Effect upon Central Host; (d) any entry by Central Host into any commitment or transaction material to Central Host which is not in the ordinary course of business consistent with past practice; (e) any declaration, payment or setting aside for payment of any dividends; or (f) any grant to any officer or director of any increase in compensation, or any loan to any officer or director, or any adoption, amendment in any material respect or termination of any bonus, profit sharing, stock option, employee stock ownership, pension, retirement, deferred compensation, employment or consulting or other plan, agreement or arrangement for the benefit of employees of Central Host. 5.5. Litigation and Product Liability Matters; Warranty Obligations. (a) Except as set forth in Schedule 5.5, there are no claims, actions, suits or proceedings of any nature pending or, to the knowledge of Stockholder, threatened against or by Central Host or any of its properties, assets or business subject to any order, judgment, ruling, or decree of any competent authority. Central Host has not received notice of violation of any applicable statute, regulation, code, ordinance, rule, order, judgment, decree or requirement relating to its operation or its owned or leased properties and to Central Host's knowledge, no such violation exists, in each case. (b) Central Host has no known or anticipated warranty liability or obligations and/or refunds to current or former Central Host customers for products or services previously provided or shipped to customers prior to the Effective Date. 5.6 Financial Statements; Liabilities. (a) Copies of the balance sheets for each month from January 2010 through March 2010, and statements of profit and loss for each month from January 2007 through March 2010, of Central Host have been provided to 8x8 (collectively, the “Financial Statements”). Except as set forth on Schedule 5.6(a), each of the Financial Statements (including the footnotes thereto, if any) is in accordance with the books and records of Central Host, has been prepared on a consistent basis with the other Financial Statements, presents fairly and accurately the financial position, assets and liabilities and results of operations and cash flows of Central Host and its business at the dates and for the periods indicated, subject (only with respect to the Interim Financial Statements) to normal and immaterial year-end adjustments and footnote disclosures. The Financial Statements contain appropriate allowances and reserves for accounts receivable and other accruals. (b) As of March 31, 2010 (the “Balance Sheet Date”), Central Host had not any indebtedness or other liability (whether known or unknown, whether absolute or contingent, whether liquidated or unliquidated and whether due or to become due) which was not disclosed in the Financial Statements (including the footnotes thereto). Except as set forth on Schedule 5.6(b), Central Host has incurred from and after the Balance Sheet Date any indebtedness or other liability (whether known or unknown, whether absolute or contingent, whether liquidated or unliquidated and whether due or to become due), other than current liabilities for trade or business obligations incurred after the Balance Sheet Date in connection with the purchase of goods or performance of services in the ordinary course of business and consistent with past practice. Page 4 5.7. Tax Returns. Central Host has accurately prepared and duly and timely filed all federal and state and all other material income, property, sales and use other applicable tax reports and returns required to be filed (subject to any extensions applicable to any such filing), and has paid all taxes and other charges required to be paid with respect to the periods covered by such returns. Central Host has not been and is not delinquent in the payment of any tax, assessment or governmental charge or executed any waiver of any statute of limitations on the assessment or collection of any tax. Central Host knows of no basis for the assertion of any deficiencies for any period covered by such tax reports and returns-or otherwise payable to any taxing authority. 5.8. Title to Assets, Encumbrances. Central Host has good title to all of the properties and assets (real, personal and mixed, tangible and intangible) that are reflected on Schedule 5.8-A and the Balance Sheet free and clear of all liens, except for the equipment lease agreements listed on Schedule 5.8-B. The term "lien" as used in this Section shall include any mortgage, pledge, security, interest, encumbrance, lien, claim or charge of any kind. 5.9. No Brokers. All negotiations relative to this Agreement and the transactions contemplated hereby have been carried on without the intervention of any Person as the result of any act of Central Host in such manner as to give rise to any claim against any of the parties hereto for a brokerage commission, finder's fee, financial advisor fee or investment banking fee or other like payment except New Commerce Communications, Inc., whose fees shall be the sole responsibility of Stockholder. 5.10. Employee Plans, Leases and Contracts. Except as otherwise set forth on Schedule 5.10, Central Host is not a party to (i) any employee plan or contract that provides for bonuses, pensions, options, stock purchases, deferred compensation, retirement payments or profit sharing, (ii) any collective bargaining or other contract or agreement with any labor union, (iii) any real property lease, (iv) any employment, management, severance or consulting contract or other contracts, agreements or arrangement with any current or former officer, director, employee of consultant or with any entity in which any of the foregoing is an owner, officer, director, employee or consultant, (v) any sales representation, agency distribution agreement, or supply contract or arrangement, other than any such contract which may be terminated upon 30 days notice or less, (vi) any agreement, contract or other arrangement whereby Central Host has extended warranty protection on any of its products or services for a duration of more than 12 months, (vii) any noncompetition agreement or contract which restricts Central Host from doing business anywhere in the world, or (viii) any contract or agreement pursuant to which any Person has the right to receive any participation or other payment which is based or measured in whole or in part upon the gross or net receipts of Central Host, (ix) an agreement authorizing others to distribute, license, or sell products of Central Host, (x) any written or oral agreement, granting to others rights in Central Host's intellectual or technological property, or (xi) any other contract or agreement that includes a purchase or other commitment that is substantially in excess of the normal requirements of its business or was made at a price or on terms and conditions substantially more onerous than is usual and customary in its business and which, either individually or in the aggregate, constitute a material liability. 5.11. Minute Books. The minute books of Central Host, copies of which have been delivered to 8x8, accurately record all actions taken by its stockholders and directors. 5.12. Compliance with Applicable Law. The business of Central Host is not being conducted in violation of any applicable law, ordinance, regulation, decree or order of any governmental entity, except for violations which either singly or in the aggregate do not and are not expected to have a Material Adverse Effect on Central Host. Central Host is not a party to or subject to any judgment, decree, or order entered in any suit or proceeding brought by any governmental agency or by any other Person, enjoining Central Host with respect to any business practice, the acquisition of any property, or the conduct of business in any area. Page 5 5.13. Patents, Trade Names and Other Intellectual Property Rights. (a) Central Host owns or is validly licensed or otherwise has the right to use, free and clear of all liens, claims and restrictions of any kind or nature, any and all patents, trademarks, trade names, service marks, copyrights, trade secrets, technology, know-how and processes (collectively, “Intellectual Property”), including the trademarks "Central Host" and the domain "centralhost.com", used in or necessary for the conduct of its business as now conducted or as proposed to be conducted. (b) The operations and products of Central Host do not infringe any Intellectual Property rights of any other Person. Central Host has not received any communication alleging or stating that Central Host or any employee has violated or infringed, or by conducting business as proposed, would violate or infringe any Intellectual Property right of any other Person. (c) Each contract, license, permit or other agreement or instrument which grants to Central Host the right, or permits Central Host, to manufacture or distribute Central Host's products or services or the products or services of others, or which is otherwise material (for the purposes of Regulation S-K of the SEC) to the business or operations of Central Host as currently conducted or as proposed to be conducted (a copy of each such contract, agreement or instrument has previously been delivered to 8x8 by Central Host and is identified on Schedule 5.13) is in full force and effect and valid and binding in accordance with its terms, and Central Host is not in default under any of the material terms thereof, nor has Central Host relinquished, forfeited or waived any of its rights or privileges thereunder which are material to its ongoing business operations or received a notice of any such default, and, except as set forth on Schedule 5.13, there exists no event which with notice or the passing of time or both would constitute such a default or grant to any other party thereto the right to cancel or terminate the same or withhold or suspend its performance thereunder. 5.14. Environmental Compliance Matters. Central Host has not received any notice of any claim, proceeding or investigation under federal, state or local law or any law of any foreign jurisdiction relating to air, soil, subsurface and water pollution, soil monitoring and the storage, treatment, disposal, removal, remediation, release, discharge or emission of any Hazardous Material (as defined below) with respect to the business activity of Central Host. To the best knowledge of Central Host, neither Central Host, any Subsidiary nor any predecessor entity operating or controlling the business activity of Central Host has ever owned, leased or operated or otherwise controlled any real property at which a claim or proceeding is presently pending or threatened, nor is aware of the existence of any condition on any such property which would give rise to any such claim or proceeding under federal, state or local law or any law of any foreign jurisdiction relating to air, soil, subsurface, water pollution, soil monitoring and the storage, treatment, disposal, removal, remediation, release, discharge or emission of any Hazardous Material shall mean any flammables, asbestos, explosives, radioactive materials, hazardous wastes, toxic substances or related materials, including without limitation, any substances defined as or included in the definition of "hazardous substances", "hazardous wastes", "hazardous materials", "toxic substances" under any applicable federal, state, local or foreign laws, rules, regulations or orders or which federal, state, local or foreign laws, rules, regulations or orders designate as potentially dangerous to public health and/or safety when present in the environment. 5.15. Severance and Employment Agreements. Central Host is not a party to any agreements, and has no policy of, providing for severance or termination payments to any officer, director consultant or employee of Central Host. 5.16. No Change of Control Provision. Central Host is not a party or subject to any agreement, contract or other obligation which would require the making of any payment, other than payments as contemplated by this Agreement, to any employee, officer, director, or shareholder of Central Host or to any other Person as a result of the consummation of the transactions contemplated herein. Page 6 5.17. Insurance. Schedule 5.17 contains a complete and correct list of all policies of insurance of any kind or nature covering the business or assets of Central Host, including, without limitation, policies of life, fire, theft, professional services, employee fidelity, directors’ and officers’ and other casualty and liability insurance, and such policies are in full force and effect. 5.18 . Board Approval. The Board of Directors of Central Host has duly approved this Agreement. 5.19. Information. All written information provided to 8x8, or its agents, by or on behalf of Central Host and/or the Stockholder or any of its representatives (including, without limitation, each representation and warranty of Central Host set forth in this Agreement) is, and Central Host and Stockholder covenants that any such information provided hereafter shall be, true and correct in all material respects and does not, or shall not, omit any material statements therein, in light of the circumstances under which they were made, not misleading; provided, however, that no representation or warranty is made by Central Host as to any financial forecasts or projections previously furnished to 8x8 by Central Host, except that such financial forecast or projection has been prepared in good faith based on assumptions that are believed by Central Host to have been reasonable at the time or times made. 6. Representations and Warranties of 8x8. 8x8 represents, warrants, covenants, and agrees with Central Host as follows: 6.1. Organization and Standing; Articles and By-Laws. 8x8 is a corporation duly organized, validly existing and in good standing under the laws of the State of Delaware. 8x8 has all requisite power and authority and all requisite licenses, permits and franchises necessary to own, lease and operate its properties and assets and to carry on its business in the manner and in the locations as presently conducted. 6.2. Authorization. 8x8 has the requisite corporate power and authority to enter into and carry out the terms and conditions of this Agreement and all the transactions contemplated hereunder. 6.3. Enforceability. This Agreement has been fully executed and delivered by 8x8 and constitutes the legal, valid and binding obligation of 8x8, enforceable against it in accordance with its respective terms. 6.4. Authorization of 8x8 Common Stock. The issuance of the Acquisition Shares at the Closing will have been duly authorized by all necessary corporate action prior to the Closing Date and, when issued as contemplated by this Agreement, all such shares of will be validly issued and fully paid, subject to the terms of Section 3 of the Agreement. 6.5. SEC Reports. 8x8 heretofore has made available to Central Host and Stockholder its proxy statements with respect to its 2007, 2008 and 2009 annual meetings of stockholders, Annual Reports on Form 10- K for the years 2007, 2008 and 2009, all Current Reports, if any, on Form 8-K and its Quarterly Reports on Form 10-Q for its fiscal quarters up to, and including the quarter ending December 31, 2009. 6.6. No Brokers. All negotiations relative to this Agreement and the transactions contemplated hereby have been carried on without the intervention of any Person as the result of any act of 8x8 or any of its Subsidiaries in such manner as to give rise to any claim against any of the parties hereto for a brokerage commission finder's fee, financial advisor's fee or investment banking fee or other like payment. 6.7. Board Approval. The Board of Directors of 8x8 has duly approved this Agreement. 7. Conditions to Closing. The respective obligations of each party to effect the transactions shall be subject to the fulfillment at or prior to the Effective Date of the following conditions: 7.1. No Legal Action. No preliminary or permanent injunction or other order, decree or ruling issued by any court of competent jurisdiction, or by any governmental, administrative or regulatory agency or commission, in the United States preventing the consummation of the sale of assets shall be in effect. Page 7 7.2. Employment Agreement. 8x8 shall have received a duly executed Employment Agreement from Stockholder, in a form reasonably acceptable to 8x8. 8. Survival of Representations; Indemnification. 8.1. Survival of Representations. The respective representations and warranties of the Stockholder, Central Host, and 8x8 contained in this Agreement or in any Exhibit attached hereto shall survive the Closing. 8.2. Indemnification. (a) The Stockholder agrees to indemnify and hold 8x8 and its officers, directors, employees, agents, customers, partners and vendors harmless from damages, losses or expenses (including, without limitation, reasonable attorneys' fees and expenses) suffered or paid, directly or indirectly, through application of Central Host's or 8x8's assets or otherwise, as a result of or arising out of (i) the failure to be true and correct in all respects of any representation or warranty, or the breach of any covenant, made by the Stockholder or Central Host in this Agreement or in any schedule attached hereto as of the date of this Agreement and as of the Closing Date. (ii) any payment obligation owing to XO Communications arising from the matter described on Schedule 5.6(b). (b) The obligations to indemnify and hold harmless pursuant to this Section 8.2 shall survive the consummation of the transactions contemplated by this Agreement. 9. Non-Competition. 9.1. Stockholder agrees that from the Closing Date until the third anniversary following the Closing Date, Stockholder will not, directly or indirectly, assist in, engage in, have any financial interest in, or participate in any way in, as an owner, partner, employee, agent, board member or shareholder, any business that involves, in whole or in part, activities similar to, related to or competitive with the business heretofore or now carried on by Central Host. 9.2. Stockholder acknowledges that: (i) an essential part of the purchase by 8x8 is the goodwill of Central Host contained in the Shares and that to protect and preserve such goodwill, the covenants set forth in this Section 9 are not only reasonable and necessary but required as a condition to 8x8’s consummation of the acquisition; (ii) the provisions of this Section 9 are the product of arm’s-length negotiation and are reasonable and necessary to protect and preserve 8x8’s interests in and right to the ownership, use and operation of the business of Central Host from and after the Closing Date; and (iii) 8x8 would be damaged if Stockholder breached the covenants set forth in this Section 9. 9.3. The Parties recognize that damages in the event of a breach by Stockholder of any provision of this Section 9 would be difficult, if not impossible, to ascertain, and it is therefore agreed that 8x8, in addition to and without limiting any other remedy or right it may have, shall have the right to an injunction or other equitable relief in any court of competent jurisdiction, enjoining any such breach. The existence of this right shall not preclude any other rights or remedies at law or in equity which 8x8 may have relating to a breach of this Section 9. 9.4 Whenever possible, each provision and term of this Section 9 shall be interpreted in a manner to be effective and valid, but if any provision or term of this Section 9 is held to be prohibited or invalid, then such provision or term shall be ineffective only to the extent of such prohibition or invalidity, without invalidating or affecting in any manner whatsoever the remainder of such provision or term or the remaining provisions or terms of this Section 9. If any of the covenants set forth in this Section 9 are held to be unreasonable, arbitrary or against public policy, such covenants shall be considered divisible with respect to duration, geographic area and scope, and in such lesser duration, geographic area and scope, shall be effective, binding and enforceable against Stockholder to the greatest extent permissible. Page 8 10. Miscellaneous Provisions. 10.1. Press Releases. Neither Stockholder nor his advisors, attorneys or agents, nor Central Host prior to the Closing, shall make any press release or public announcement in connection with the transactions contemplated by this Agreement without the prior written consent of 8x8. 10.2. Notices. All notices or other communications which are required or permitted hereunder shall be in writing and sufficient if delivered personally or sent by nationally-recognized overnight courier, specifying next-day delivery, or by registered or certified mail, postage prepaid, return receipt requested, addressed as follows: a. if to 8x8 to: 8x8, Inc. ATTN: Chief Executive Officer 810 West Maude Avenue Sunnyvale, CA 94085 408-727-1885 (phone) 408-980-0432 (FAX) bmartin@8x8.com b. if to Stockholder (or Central Host prior to the Closing) to: Andrew Schwabecher 16035 Redwood Lodge Road Los Gatos, CA 95033 or to such other address as the party to whom notice is to be given may have furnished to the other party in writing in accordance herewith. All such notices or communications shall be deemed to be received (i) in the case of personal delivery, on the date of such delivery, (ii) in the case of nationally- recognized overnight courier, on the next business day after the date when sent, and (iii) in the case of mailing, on the third business day following the date on which the piece of mail containing such communication was posted. 10.3. Severability. Should any Section or any part of a Section within this Agreement be rendered void, invalid or unenforceable by any court of law for any reason, such invalidity or unenforceability shall not void or render invalid or unenforceable any other Section or part of a Section in this Agreement. 10.4. Exhibits and Schedules. Each Exhibit and Schedule delivered pursuant to the terms of this Agreement, each document, instrument and certificate delivered by the parties in connection with the transactions contemplated hereby constitutes an integral part of this Agreement and are hereby incorporated by reference. 10.5. Governing Law. THIS AGREEMENT SHALL BE GOVERNED BY AND CONSTRUED BOTH AS TO VALIDITY AND PERFORMANCE AND ENFORCED IN ACCORDANCE WITH THE LAWS OF THE STATE OF CALIFORNIA AND THE PARTIES AGREE THAT THIS AGREEMENT IS ENTERED INTO AND SHALL BE PERFORMED IN SANTA CLARA COUNTY, CALIFORNIA, AND ANY LITIGATION RESULTING HENCEFORTH WILL TAKE PLACE IN SANTA CLARA COUNTY, CALIFORNIA, TO THE EXTENT POSSIBLE. 10.6. No Adverse Construction. The rule that a contract is to be construed against the party drafting the contract is hereby waived, and shall have no applicability in construing this Agreement or any provisions hereto. 10.7. Counterparts. This Agreement may be executed in one or more counterparts, each of which shall be deemed an original but all of which together shall constitute one and the same instrument. Page 9 10.8. Costs and Attorneys' Fees. In the event that any action, suit, or other proceeding is instituted concerning or arising out of this Agreement, the prevailing party shall recover all of such party's costs, and reasonable attorneys' fees incurred in each and every such action, suit, or other proceeding, including any and all appeals or petitions therefrom. 10.9. Successors and Assigns. All rights, covenants and agreements of the parties contained in this Agreement shall, except as otherwise provided herein, be binding upon and inure to the benefit of their respective successors and assigns. 10.10. Amendment. This Agreement may not be amended except by an instrument in writing signed by an officer on behalf of each of the parties hereto, or an individual in the case of the Stockholder. 10.11. Entire Agreement. This Agreement, the attached schedules referred to in this Agreement, and the Employment Agreement contain the entire understanding of the parties and there are no further or other agreements or understandings, written or oral, in effect between the parties relating to the subject matter hereof unless expressly referred to herein. 10.12. Further Assurances. From time to time after the Closing, each of the parties shall, for no additional consideration and upon the reasonable request of another party, execute and deliver such other instruments of conveyance, assignments, agreements and other documents as may be necessary or appropriate to consummate the transaction contemplated by this Agreement. [Signature page follow.] Page 10 IN WITNESS WHEREOF, the parties hereto have executed and delivered this Agreement as of the date first above written. 8X8: 8X8, INC. a Delaware corporation By: Bryan Martin, Chief Executive Officer CENTRAL HOST: CENTRAL HOST, INC. a California corporation By: Andrew Schwabecher, President STOCKHOLDER: Andrew Schwabecher Page 11 EXHIBIT 21.1 SUBSIDIARIES OF REGISTRANT Name Jurisdiction of Incorporation 8x8 Europe SARL Netergy Microelectronics, Inc. Visit, Inc. France California, USA California, USA CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We consent to the incorporation by reference in Registration Statements on Form S-3 (Nos. 333-32930, 333-49414, 333-80379, 333-75402, 333-108289, 333-111120, 333-114133, 333-118643, 333-120457, 333-126330, 333-126350 and 333-131823) and Form S-8 (Nos. 333-30943, 333-15627, 333-50519, 333- 49410, 333-66296, 333-90172, 333-108290, 333-118642, 333-126337 and 333-137599) of our reports dated May 26, 2010, relating to the financial statements, financial statement schedule II, and the effectiveness of internal controls over financial reporting, appearing in this Annual Report on Form 10-K of 8x8, Inc. for the year ended March 31, 2010. /s/ Moss Adams LLP San Francisco, California May 26, 2010 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We hereby consent to the incorporation by reference in the Registration Statements on Form S-3 (Nos. 333-32930, 333-49414, 333-80379, 333-75402, 333-108289, 333-111120, 333-114133, 333-118643, 333-120457, 333-126330, 333-126350 and 333-131823) and Form S-8 (Nos. 333-30943, 333-15627, 333-50519, 333-49410, 333-66296, 333-90172, 333-108290, 333-118642, 333-126337 and 333-137599) of 8x8, Inc. of our report dated May 23, 2008 relating to the financial statements and financial statement schedule, which appears in this Form 10-K. /s/PricewaterhouseCoopers LLP San Jose, California May 26, 2010 CERTIFICATION PURSUANT TO RULES 13a-14(a) AND 15d-14(a) UNDER THE SECURITIES EXCHANGE ACT OF 1934 AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Bryan R. Martin, certify that: 1. I have reviewed this annual report on Form 10-K of 8x8, Inc.; Exhibit 31.1 Based on my knowledge, this report does not contain any untrue statement of a material fact or 2. omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; Based on my knowledge, the financial statements, and other financial information included in this 3. report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; The registrant's other certifying officer and I are responsible for establishing and maintaining 4. disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c. Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and d. Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and The registrant's other certifying officer and I have disclosed, based on our most recent evaluation 5. of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. May 26, 2010 /s/ BRYAN R. MARTIN Bryan R. Martin Chairman and Chief Executive Officer CERTIFICATION PURSUANT TO RULES 13a-14(a) AND 15d-14(a) UNDER THE SECURITIES EXCHANGE ACT OF 1934 AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Daniel Weirich, certify that: 1. I have reviewed this annual report on Form 10-K of 8x8, Inc.; Exhibit 31.2 Based on my knowledge, this report does not contain any untrue statement of a material fact or 2. omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; Based on my knowledge, the financial statements, and other financial information included in this 3. report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; The registrant's other certifying officer and I are responsible for establishing and maintaining 4. disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c. Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and d. Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and The registrant's other certifying officer and I have disclosed, based on our most recent evaluation 5. of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. May 26, 2010 /s/ DANIEL WEIRICH Daniel Weirich Chief Financial Officer, President and Secretary Exhibit 32.1 CERTIFICATION PURSUANT TO 18 U.S. C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report on Form 10-K of 8x8, Inc. (the "Company") for the year ended March 31, 2010, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Bryan R. Martin, Chairman and Chief Executive Officer of the Company, hereby certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: 1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ BRYAN R. MARTIN Bryan R. Martin Chairman and Chief Executive Officer May 26, 2010 This certification accompanies this Report pursuant to §906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by the Sarbanes-Oxley Act of 2002, or otherwise required, be deemed filed by the Company for purposes of §18 of the Securities Exchange Act of 1934, as amended. Exhibit 32.2 CERTIFICATION PURSUANT TO 18 U.S. C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report on Form 10-K of 8x8, Inc. (the "Company") for the year ended March 31, 2010, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Daniel Weirich, Chief Financial Officer, President and Secretary of the Company, hereby certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: 1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ DANIEL WEIRICH Daniel Weirich Chief Financial Officer, President and Secretary May 26, 2010 This certification accompanies this Report pursuant to §906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by the Sarbanes-Oxley Act of 2002, or otherwise required, be deemed filed by the Company for purposes of §18 of the Securities Exchange Act of 1934, as amended. 

Continue reading text version or see original annual report in PDF format above