UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2008
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________to _________
Commission file number 000-21783
8X8, INC.
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3151 Jay Street
Santa Clara, CA 95054
(408) 727-1885
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 reports), and (2) has been subject to such filing requirements for the past 90 days. x YES ¨ NO
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer ¨ Accelerated filer x Non-accelerated filer ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ¨ YES x NO
The number of shares of the Registrant's Common Stock outstanding as of July 24, 2008 was 62,175,269.
8X8, INC.
FORM 10-Q PDF
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION | Page No. |
Item 1. Financial Statements: |
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Condensed Consolidated Balance Sheets at June 30, 2008 and March 31, 2007 |
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Condensed Consolidated Statements of Operations for the three months ended June 30, 2008 and 2007 |
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Condensed Consolidated Statements of Cash Flows for the three months ended June 30, 2008 and 2007 |
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Notes to Unaudited Condensed Consolidated Financial Statements |
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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations |
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Item 3. Quantitative and Qualitative Disclosures About Market Risk |
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Item 4. Controls and Procedures |
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PART II. OTHER INFORMATION |
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Item 1. Legal Proceedings |
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Item 1A. Risk Factors |
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Item 6. Exhibits |
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Signature |
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Part I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
8X8, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, unaudited)
June 30, | March 31, | |||||
2008
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2008
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ASSETS | ||||||
Current assets: | ||||||
Cash and cash equivalents | $ | 13,034 | $ | 11,185 | ||
Short-term investments | 1,799 | 3,382 | ||||
Accounts receivable, net | 1,558 | 1,807 | ||||
Inventory | 1,717 | 1,539 | ||||
Deferred cost of goods sold | 1,038 | 943 | ||||
Other current assets |
473
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549
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Total current assets | 19,619 | 19,405 | ||||
Property and equipment, net | 1,856 | 2,010 | ||||
Other assets |
127
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136
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Total assets | $ |
21,602
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$ |
21,551
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LIABILITIES AND STOCKHOLDERS' EQUITY | ||||||
Current liabilities: | ||||||
Accounts payable | $ | 5,652 | $ | 4,885 | ||
Accrued compensation | 1,379 | 1,048 | ||||
Accrued warranty | 316 | 314 | ||||
Accrued taxes | 1,484 | 2,896 | ||||
Deferred revenue | 2,481 | 3,139 | ||||
Other accrued liabilities |
503
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976
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Total current liabilities | 11,815 | 13,258 | ||||
Other liabilities | 86 | 109 | ||||
Fair value of warrant liability |
266
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335
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Total liabilities |
12,167
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13,702
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Commitments and contingencies (Note 8) | ||||||
Stockholders' equity: | ||||||
Common stock | 62 | 62 | ||||
Additional paid-in capital | 208,404 | 208,001 | ||||
Accumulated other comprehensive income | - | 5 | ||||
Accumulated deficit |
(199,031)
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(200,219)
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Total stockholders' equity |
9,435
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7,849
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Total liabilities and stockholders' equity | $ |
21,602
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$ |
21,551
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The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
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Three Months Ended | ||||||
June 30,
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2008
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2007
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Service revenues | $ | 15,019 | $ | 13,411 | ||
Product revenues |
1,262
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1,331
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Total revenues |
16,281
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14,742
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Operating expenses: | ||||||
Cost of service revenues | 3,814 | 3,986 | ||||
Cost of product revenues | 1,432 | 1,383 | ||||
Research and development | 1,192 | 1,057 | ||||
Selling, general and administrative |
8,751
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8,919
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Total operating expenses |
15,189
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15,345
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Income (loss) from operations | 1,092 | (603) | ||||
Other income, net | 85 | 132 | ||||
Income on change in fair value of warrant liability |
69
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979
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Income before provision for income taxes | 1,246 | 508 | ||||
Provision for income taxes |
58
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Net income | $ |
1,188
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$ |
508
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Net income per share: | ||||||
Basic | $ | 0.02 | $ | 0.01 | ||
Diluted | $ | 0.02 | $ | 0.01 | ||
Weighted average number of shares: | ||||||
Basic | 62,096 | 61,772 | ||||
Diluted | 62,192 | 62,080 |
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
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8X8, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands, unaudited)
Three Months Ended | ||||||
June 30,
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2008
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2007
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Cash flows from operating activities: | ||||||
Net income | $ | 1,188 | $ | 508 | ||
Adjustments to reconcile net income to net cash | ||||||
provided by operating activities: | ||||||
Depreciation and amortization | 339 | 391 | ||||
Stock compensation | 328 | 205 | ||||
Change in fair value of warrant liability | (69) | (979) | ||||
Other | 23 | 24 | ||||
Changes in assets and liabilities | ||||||
Accounts receivable, net | 232 | (74) | ||||
Inventory | (192) | 7 | ||||
Other current and noncurrent assets | 85 | (87) | ||||
Deferred cost of goods sold | (95) | 113 | ||||
Accounts payable | 751 | 178 | ||||
Accrued compensation | 331 | 161 | ||||
Accrued warranty | 2 | 19 | ||||
Accrued taxes & fees | (1,412) | (108) | ||||
Deferred revenue | (658) | (23) | ||||
Other current and noncurrent liabilities |
(487)
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(122)
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Net cash provided by operating activities |
366
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213
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Cash flows from investing activities: | ||||||
Purchases of property and equipment | (168) | (91) | ||||
Purchase of investments | - | (1,351) | ||||
Maturities of short-term investments |
1,585
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Net cash provided by (used in) investing activities |
1,417
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(1,442)
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Cash flows from financing activities: | ||||||
Capital lease payments | (9) | (7) | ||||
Proceeds from issuance of common stock under employee stock plans |
75
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19
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Net cash provided by financing activities |
66
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12
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Net increase (decrease) in cash and cash equivalents | 1,849 | (1,217) | ||||
Cash and cash equivalents at the beginning of the period |
11,185
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6,735
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Cash and cash equivalents at the end of the period | $ |
13,034
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$ |
5,518
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The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
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8X8, INC. 1. DESCRIPTION OF THE BUSINESS THE COMPANY 8x8, Inc. ("8x8" or the "Company") develops and markets communication technology and services for Internet protocol, or IP, telephony
and video applications. The Company was incorporated in California in February 1987, and in December 1996 was reincorporated in Delaware. The Company offers the Packet8 broadband Voice over Internet Protocol, or VoIP, and video communications service, Packet8 Virtual Office
service, Packet8 Virtual Trunking service, Packet8 Hosted Key System service, videophone equipment and services, and Packet8 MobileTalk service.
The Packet8 voice and video communications service ("Packet8") enables broadband Internet users to add digital voice and video communications
services to their high-speed Internet connection. Customers can choose a direct-dial phone number from any of the rate centers offered by the
service, and then use an 8x8-supplied terminal adapter to connect any telephone to a broadband Internet connection to make or receive calls from a
regular telephone number. All Packet8 telephone accounts come with voice mail, caller ID, call waiting, call waiting caller ID, call forwarding, hold,
line-alternate, 3-way conferencing, web access to account controls, and online billing. In addition, 8x8 offers videophones for use with the Packet8
service. 8x8 has developed a suite of business services called Packet8 Virtual Office that offer feature-rich communications services to small and
medium-sized business, eliminating the need for traditional telecommunications services and business phone systems. 8x8's primary product focus is
on replacing private branch exchange, or PBX, telephone systems in the small business marketplace with a hosted business VoIP solution. Packet8
Virtual Office can completely replace a company's PBX infrastructure and deliver all telecom services over a managed or unmanaged Internet
connection. In June 2008, the Company launched Packet8 Virtual Trunking, which allows the customers to utilize their existing PBX and purchase
inbound and outbound service from the Company. In July 2008, the Company introduced the Packet8 Hosted Key System service which replaces
traditional premise-based telephone "key systems" typically used by companies whose size or structure dictates the sharing of multiple,
common phone lines among employees. The Company also sells pre-programmed IP and analog telephones with speakerphones and a display
screen, in conjunction with its Virtual Office service plans, which enable its business customers to access additional features of Virtual Office through
on-screen phone menus. The Company's Packet8 MobileTalk service enables mobile phone users to make international phone calls from their mobile
phones over the Packet8 international network. 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 2009 refers to the fiscal year ending March 31,
2009). LIQUIDITY Although the Company achieved positive cash flows from operations in the fiscal year ended March 31, 2008, and the quarter ended
June 30, 2008, historical net losses and negative cash flows have been funded primarily through the issuance of equity securities and borrowings.
Management believes that current cash, cash equivalents and investments will be sufficient to finance the Company's operations for at least the next
twelve months. However, the Company continually evaluates its cash needs and may pursue additional equity or debt financing in order to achieve
the Company's overall business objectives. There can be no assurance that such financing will be available, or, if available, at a price that is
acceptable to the Company. Failure to generate sufficient revenues, raise additional capital or reduce certain discretionary spending could have an
adverse impact on the Company's ability to achieve its longer term business objectives. 2. BASIS OF PRESENTATION The accompanying interim condensed consolidated financial statements are unaudited and have been prepared on substantially the same
basis as our annual financial statements for the fiscal year ended March 31, 2008. In the opinion of management, these financial statements reflect all
adjustments (consisting only of normal recurring adjustments) considered necessary for a fair statement of our financial position, results of operations
and cash flows for the periods presented. The preparation of financial statements in conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the condensed consolidated financial statements and the reported
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amounts of revenues and expenses during the reporting
periods. Actual results could differ from these estimates. The March 31, 2008 year-end condensed consolidated balance sheet data was derived from audited consolidated financial statements and does
not include all of the disclosures required by U.S. generally accepted accounting principles. These financial statements should be read in conjunction
with the Company's audited consolidated financial statements for the year ended March 31, 2008 and notes thereto included in the Company's fiscal
2008 Annual Report on Form 10-K. The results of operations and cash flows for the interim periods included in these financial statements are not necessarily indicative of the results
to be expected for any future period or the entire fiscal year. Investments The Company's investments are comprised of corporate debt, federal agency securities and money market funds. All short-term investments
are classified as available-for-sale. Packet8 Service Revenue The Company recognizes new subscriber revenue in the month the new order is shipped, net of an allowance for expected cancellations. The
allowance for expected cancellations is based on the Company's history of subscriber conduct or cancellations within the 30-day trial period. 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 Packet8 service with the accompanying desktop terminal or videophone adapter
constitutes a revenue arrangement with multiple deliverables. In accordance with the guidance of EITF No. 00-21, the Company allocates Packet8
revenues, including activation fees, among the desktop terminal adapter or videophone and subscriber services. Revenues allocated to the desktop
terminal adapter or videophone 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.
Deferred Cost of Goods Sold Deferred cost of goods sold represents the cost of products sold for which the customer has a right of return. The cost of the
products sold is recognized contemporaneously with the recognition of revenue. Warrant Liability The Company accounts for its warrants in accordance with Emerging Issues Task Force Issue No. 00-19, "Accounting for Derivative
Financial Instruments Indexed to and Potentially Settled in a Company's Own Stock" ("EITF 00-19") 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, that may not be within the
control of the Company that could prevent delivery of registered shares, EITF 00-19 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. Accounting for Stock-Based Compensation Effective April 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123(R), "Share-Based
Payment" ("SFAS 123(R)"), which establishes standards for the accounting for equity instruments exchanged for
employee services. SFAS 123(R) revised SFAS 123 "Accounting for Stock-Based Compensation" ("SFAS 123") and superseded
Accounting Principles Board Opinion No. 25 ("APB 25"), "Accounting for Stock Issued to Employees," and related interpretations. Under the
provisions of SFAS 123(R), share-based compensation cost is measured at the grant
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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 elected to adopt the modified prospective transition method as provided by SFAS 123(R). Stock-based compensation expense recognized in the Company's Condensed Consolidated Statements of Operations for the
first quarter of fiscal 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 SFAS 123 criteria, whereas
stock options granted subsequent to April 1, 2006 were measured based on SFAS 123(R) criteria. In conjunction with the adoption of SFAS 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 includes the impact of estimated forfeitures. SFAS
123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those
estimates. Stock Option Plans
The Company has several stock-based compensation plans (the "Plans") that are described in Note 5 "Stockholders'
Equity" of the Notes to Consolidated Financial Statements contained in the Company's Annual Report on Form 10-K for the fiscal year ended
March 31, 2008. The Company, under its various equity plans, grants stock options for shares of common stock to employees, non-employees,
directors and consultants.
As of June 30, 2008, the 1992 Stock Plan, 1996 Stock Plan and 1996 Director Option Plan had expired and the 1999 Nonstatutory Stock Option Plan
was cancelled by the Board, but there are still options outstanding under these plans. Options generally vest over four years, are granted at fair
market value on the date of the grant and expire ten years from that date. The Company's 2006 Stock Plan (the "2006 Plan") has 7,000,000 shares of common stock reserved for
issuance. 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. The 2006 Plan
expires in May 2016. - 8 -
Option Activity Option activity since March 31, 2008 is summarized as follows: The following table summarizes the stock options outstanding and exercisable at June 30, 2008: Stock-based Compensation Expense
As of June 30, 2008, there were $2.1 million of total unrecognized compensation costs related to stock options. These costs are expected to be
recognized over a weighted average period of 2.54 years.
To value option grants and other awards for actual and pro forma stock-based compensation, the Company has used the Black-Scholes option
valuation model. When the measurement date is certain, the fair value of each option grant is estimated on the date of grant. Fair value determined
using Black-Scholes varies based on assumptions used for the expected stock price volatility, expected life, risk-free interest rates and future dividend
payments. During the three month periods ended June 30, 2008 and 2007, the Company used historical volatility of the common stock over a period
equal to the expected life of the options to estimate their fair value. The expected life assumption represents the weighted-average period stock-based
awards are expected to remain outstanding. These expected life assumptions are established through the review of historical exercise behavior of
stock-based award grants with similar vesting periods. The risk-free interest rate is based on the closing market bid yields on actively traded U.S.
treasury securities in the over-the-counter market for the expected term equal to the expected term of the option. The dividend yield assumption is
based on the Company's history and expectation of future dividend payouts. - 9 -
The following table summarizes the assumptions used to compute reported and pro forma stock-based compensation to
employees and directors for the three months ended June 30, 2008 and 2007: In accordance with SFAS 123(R), the Company recorded $295,000 and $186,000 in compensation expense relative to stock options
for the three months ended June 30, 2008 and 2007, respectively.
Employee Stock Purchase Plan Under the Company's Employee Stock Purchase Plan, eligible employees can participate and purchase common stock
semi-annually through payroll deductions at a price equal to 85% of the fair market value of the common stock at the beginning of each one year
offering period or the end of a six month purchase period, whichever is lower. The contribution amount may not exceed ten percent of an employee's
base compensation, including commissions but not including bonuses and overtime. The Company accounts for the Employee Stock Purchase Plan
as a compensatory plan and recorded compensation expense of $33,000 and $19,000 for the three months ended June 30, 2008 and 2007,
respectively in accordance with SFAS 123(R). The adoption of SFAS 123(R) did not impact the Company's methodology to estimate the fair value of share-based
payment awards under the Company's Employee Stock Purchase Plan. The estimated fair value of stock purchase rights granted under the
Employee Stock Purchase Plan were estimated at the date of grant using the Black-Scholes pricing model with the following weighted-average
assumptions: As of June 30, 2008, there was $25,000 of total unrecognized compensation cost related to employee stock purchases. These costs
are expected to be recognized over a weighted average period of 0.2 years.
SFAS 123(R) requires the benefits of tax deductions in excess of recognized compensation costs to be reported as a financing cash flow, rather than
as an operating cash flow. The future realizability of tax benefits related to stock compensation is dependent upon the timing of employee exercises
and future taxable income, among other factors. The Company did not realize any tax benefit from the stock compensation charge incurred during the
three months ended June 30, 2008 and 2007 as the Company believes that it is more likely than not that it will not realize the benefit from tax
deductions related to equity compensation.
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As prescribed in SFAS 123(R), the following table summarizes the distribution of stock-based compensation expense related to employee stock
options and employee stock purchases under SFAS 123(R) among the Company's operating functions for the three months ended June 30, 2008 and
2007 which was recorded as follows (in thousands):
Recent Accounting Pronouncements In September 2006, the Financial Accounting Standards Board ("FASB") issued Statement of Financial
Accounting Standards (SFAS) No. 157, "Fair Value Measurements" ("SFAS No. 157"). SFAS No. 157 defines fair
value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP) and expands disclosures about fair value
measurements. SFAS No. 157 applies to other accounting pronouncements that require or permit fair value measurements, but does not
require any new fair value measurements. The adoption of SFAS No. 157 did not have a material effect on the Company's condensed consolidated
results of operations and financial condition. In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities" ("SFAS
No. 159") which permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently
required to be measured at fair value. The adoption of SFAS No. 159 did not have a material effect on the Company's condensed consolidated
results of operations and financial condition. In December 2007, the FASB issued SFAS No. 141(Revised 2007), "Business Combinations" ("SFAS No. 141(R)"). SFAS
No. 141(R) significantly changes the accounting for business combinations in a number of areas including the treatment of contingent consideration,
acquired contingencies, transaction costs, in-process research and development and restructuring costs. In addition, under SFAS No. 141(R),
changes in an acquired entity's deferred tax assets and uncertain tax positions after the measurement period will impact income tax expense. SFAS
No. 141(R) applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting
period beginning on or after December 15, 2008. Earlier adoption is prohibited. The Company will adopt this pronouncement in the first quarter of
fiscal 2010 and does not expect the adoption of SFAS No. 141(R) will have a material impact on its consolidated results of operations and financial
condition. In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interest in Consolidated Financial Statements an Amendment of ARB
no. 51" ("SFAS No. 160"), which establishes new accounting and reporting standards for the noncontrolling interest in a subsidiary,
changes in a parent's ownership interest in a subsidiary and the deconsolidation of a subsidiary. SFAS No. 160 is effective for fiscal years beginning
on or after December 15, 2008. Earlier adoption is prohibited. The Company will adopt this pronouncement in the first quarter of fiscal 2010 and does
not expect the adoption of SFAS No. 160 to have a material impact on its consolidated results of operations and financial condition. In May 2008, the FASB issued SFAS No. 162, "The Hierarchy of Generally Accepted Accounting Principles"
("SFAS No. 162"). SFAS No. 162 identifies the sources of accounting principles and the framework for selecting the principles
used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting
principles (the GAAP hierarchy). SFAS No. 162 will become effective 60 days following the SEC's approval of the Public Company
Accounting Oversight Board amendments to AU Section 411, "The Meaning of Present Fairly in Conformity With Generally
Accepted Accounting Principles." The Company does not expect the adoption of SFAS No. 162 to have a material impact on its
consolidated results of operations and financial condition. - 11 -
3. BALANCE SHEET DETAIL 4. NET INCOME PER SHARE Basic net income per share is computed by dividing net income 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.
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): - 12 -
5. COMPREHENSIVE INCOME Comprehensive income, as defined, includes all changes in equity (net assets) during a period from non-owner sources.
The difference between the Company's net income and comprehensive income is due primarily to unrealized losses on investments classified as
available-for-sale. Comprehensive income for the three months ended June 30, 2008 and 2007 was as follows (in thousands): 6. SEGMENT REPORTING 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 SFAS No. 131, 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 determined that it has only one reportable segment. The following net revenues for this segment are presented by
groupings of similar products and services (in thousands):
No customer represented greater than 10% of the Company's total revenues for the three months ended June 30, 2008 or 2007.
Revenues from customers outside the United States were not material for the three months ended June 30, 2008 or 2007. 7. 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. Other than a $58,000 foreign withholding tax on royalty
revenue from a customer in Spain, the Company made no provision for income taxes in any periods presented in the accompanying condensed
consolidated financial statements because of net losses incurred, or it expects to utilize net operating loss carryforwards for which there is a valuation
allowance. On April 1, 2007, the Company adopted the provisions of Financial Accounting Standards Board Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes: an Interpretation of FASB Statement No. 109" (FIN 48), which clarifies the accounting and disclosure for
uncertainty in income taxes recognized in an enterprise's financial statements. This Interpretation requires that the Company recognize in its financial
statements the impact of a tax position if that position is more likely than not of being sustained on audit, based on the technical merits of the position.
The Company believes that any income tax filing positions and deductions not sustained on audit will not result in a material change to its financial
position or results of operations. - 13 -
The Company had unrecognized tax benefits of approximately $2.1 million as of March 31, 2008. The Company does not believe that there has
been any change in the unrecognized tax benefits in the period ended June 30, 2008 and does not believe it is reasonably possible that the
unrecognized tax benefit will materially change in the next 12 months. The application of FIN 48 would have resulted in a decrease in the
accumulated deficit of $2.1 million, except that the decrease was fully offset by the application of a 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 it is more likely than not that its deferred tax assets are realizable. The Company is subject to taxation in the U.S., California and various states and foreign jurisdictions in which we have or had a subsidiary or
branch operations or we are collecting sales tax. All tax returns from fiscal 1995 to fiscal 2008 may be subject to examination by the Internal Revenue
Service, California and various states. The Company extended the filing date of the 2008 federal tax return and all state income tax returns. As of
June 30, 2008, these returns had not yet been filed. In addition, as of June 30, 2008, there were no active federal, state or local income
tax audits. The foreign tax jurisdictions may be subject to examination for the fiscal years 2005 to 2008. 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 three months ended June 30, 2008 and 2007, the Company did not recognize any interest or penalties related to
unrecognized tax benefits. 8. COMMITMENTS AND CONTINGENCIES Guarantees Indemnifications In the normal course of business, the Company enters into contracts under which the Company has agreed to hold harmless other parties,
including customers, lessors and parties to other transactions with the Company, with respect to certain matters such as losses arising from a breach
of representations or covenants or intellectual property infringement or other claims made against certain 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. 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 condensed consolidated statements of
operations, during the three months ended June 30, 2008 were as follows (in thousands):
- 14 -
Standby letters of credit The Company has a standby letter of credit totaling $100,000, which was issued to guarantee certain contractual obligations and is
collateralized by cash deposits at the Company's primary bank. The collateral related to this letter of credit is recorded in the other assets line items in
the condensed consolidated balance sheets. Leases At June 30, 2008, future minimum annual lease payments under noncancelable operating leases were as follows (in
thousands): In April 2005, June 2006 and March 2007, the Company entered into a series of noncancelable capital lease agreements,
respectively, for office equipment bearing interest at various rates. At June 30, 2008, future minimum annual lease payments were as follows (in
thousands): Capital leases included in office equipment were $182,000 at June 30, 2008. Total accumulated depreciation was $74,000 at June 30, 2008.
Amortization expense for assets recorded under capital leases is included in
depreciation expense. Minimum Third Party Customer Support Commitments In January 2008, the Company entered into a contract with one of its third party customer support vendors containing a minimum monthly
commitment of approximately $436,000 effective January 1, 2008 through March 31, 2009. At June 30, 2008, the total remaining obligation under the
contract was $3.9 million. Legal Proceedings From time to time, the Company may be involved in various legal claims and litigation that arise in the normal course of its operations. While
the results of such claims and litigation cannot be predicted with certainty, the Company currently believes that it is not a party to any litigation the final
outcome of which is likely to have a material adverse effect on the Company's financial position, results of operations or cash flows. However, should
the Company not prevail in any such litigation; it could have a material adverse impact on the Company's operating results, cash flows or financial
position. - 15 -
State and Municipal Taxes 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, except that the Company has historically complied with the
California sales tax and financial contributions to the 9-1-1 system and universal service fund. We have 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 the streamlined
sales tax initiatives and the Company has begun collecting and remitting Taxes in those states. Additionally, some of these Taxes could apply to the
Company retroactively. As such, we have an accrued tax liability of $0.8 million at June 30, 2008 as our best estimate of the potential tax exposure
for any retroactive assessment. Regulatory Matters Like many interconnected VoIP providers, the Company relies on a third party to route emergency calls originated by our customers. For
certain customers, the third party solution provider may route 911 calls to a national emergency call center in the event of a system outage or other
circumstances. The emergency dispatchers in this national call center may utilize the location information provided by the customer to route the call
to the correct Public Safety Answering Point ("PSAP"), which is a local call center staffed by trained emergency operators, or first
responder. The FCC could determine that calls routed in this manner do not satisfy its requirements should we be unable to connect our customers
directly to a PSAP. The Company may be subject to enforcement actions including, but not limited to, fines, cease and desist orders, or other
penalties for those customers, whose 911 calls are routed to a national emergency call center and not directly to a PSAP. As of June 30, 2008, the
Company provided emergency calling services to 100% of its customers located in the United States. On November 8, 2007, the FCC released a Report and Order concerning Local Number Portability ("LNP Order"). The
obligations require interconnected VoIP providers to contribute to shared numbering administration costs on a competitively neutral basis.
The assessment of local number portability fees to the Company's service will increase the
Company's costs and reduce its profitability or cause the Company to increase the price of its retail service offerings. The LNP Order also requires
that the Company process certain ports within a specified timeframe. The Company could be subject to fines, forfeitures and other penalties by state
public utilities commissions or the FCC if it is not able to process certain ports in the relevant timeframe or we could face legal liability in state or
federal court from customers or carriers.
The effect of any future laws, regulations and the orders on the Company's operations, including, but not limited to, the Packet8 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. This 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. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS FORWARD-LOOKING STATEMENTS This Discussion and Analysis of Financial Condition and Results of Operations contains 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 VoIP 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
- 16 -
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 Report are based on information available
to us on the date hereof, and we assume no obligation to update any such forward-looking statements. In addition to those factors discussed
elsewhere in this Form 10-Q, see the Risk Factors discussion in Item 1A of our 2008 Form 10-K and Part II, Item 1A of this Form 10-Q. The
forward-looking statements included in this Form 10-Q are made only as of the date of this report, and we undertake no obligation to update the
forward-looking statements to reflect subsequent events or circumstances. BUSINESS OVERVIEW We develop and market telecommunication technology for Internet protocol, or IP, telephony and video applications. We
offer the Packet8 broadband voice over Internet protocol, or VoIP, and video communications service, Packet8 Virtual Office service, Packet8
Trunking service, Packet8 Hosted Key System service, Packet8 MobileTalk and videophone equipment and services (collectively, Packet8). We
shipped our first VoIP product in 1998, launched our Packet8 service in November 2002, launched the Packet8 Virtual Office business service offering
in March 2004, and launched the Packet8 Virtual Trunking service offering in June 2008. Substantially all of our revenues are generated from the
sale, license and provisioning of VoIP products, services and technologies. Our fiscal year ends on March 31 of each calendar year. Each reference to a fiscal year in this report refers to the fiscal year
ending March 31 of the calendar year indicated (for example, fiscal 2009 refers to the fiscal year ending March 31, 2009). CRITICAL ACCOUNTING POLICIES & ESTIMATES The discussion and analysis of our financial condition and results of operations are based upon our consolidated
financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of
these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and
expenses, and related disclosure of assets and liabilities. On an on-going basis, we evaluate our critical accounting policies and estimates. We base
our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of
which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual
results may differ from these estimates under different assumptions or conditions. Our critical accounting policies and estimates are discussed in our
Annual Report on Form 10-K for the fiscal year ended March 31, 2008. RECENT ACCOUNTING PRONOUNCEMENTS In September 2006, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards
(SFAS) No. 157, "Fair Value Measurements" ("SFAS No. 157"). SFAS No. 157 defines fair value, establishes a
framework for measuring fair value in generally accepted accounting principles (GAAP) and expands disclosures about fair value measurements.
SFAS No. 157 applies to other accounting pronouncements that require or permit fair value measurements, but does not require any new fair
value measurements. The adoption of SFAS No. 157 did not have a material effect on our condensed consolidated results of operations and financial
condition In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities" ("SFAS
No. 159") which permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently
required to be measured at fair value. The adoption of SFAS No. 159 did not have a material effect on our condensed consolidated results of
operations and financial condition In December 2007, the FASB issued SFAS No. 141(Revised 2007), "Business Combinations" ("SFAS No. 141(R)"). SFAS
No. 141(R) significantly changes the accounting for business combinations in a number of areas including the treatment of contingent consideration,
acquired contingencies, transaction costs, in-process research and development and restructuring costs. In addition, under SFAS No. 141(R),
changes in an acquired entity's deferred tax assets and uncertain tax positions after the measurement period will impact income tax expense. SFAS
No. 141(R) applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting
period beginning on or after December 15, 2008. Earlier adoption is prohibited. We will adopt this pronouncement in the first quarter of fiscal 2010
and do not expect the adoption of SFAS No. 141(R) will have a
- 17 -
material impact on our consolidated results of operations and financial condition. In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interest in Consolidated Financial Statements an Amendment of ARB
no. 51" ("SFAS No. 160"), which establishes new accounting and reporting standards for the noncontrolling interest in a subsidiary,
changes in a parent's ownership interest in a subsidiary and the deconsolidation of a subsidiary. SFAS No. 160 is effective for fiscal years beginning
on or after December 15, 2008. Earlier adoption is prohibited. We will adopt this pronouncement in the first quarter of fiscal 2010 and do not expect
the adoption of SFAS No. 160 will have a material impact on our consolidated results of operations and financial condition. In May 2008, the FASB issued SFAS No. 162, "The Hierarchy of Generally Accepted Accounting Principles"
("SFAS No. 162"). SFAS No. 162 identifies the sources of accounting principles and the framework for selecting the principles
used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting
principles (the GAAP hierarchy). SFAS No. 162 will become effective 60 days following the SEC's approval of the Public Company
Accounting Oversight Board amendments to AU Section 411, "The Meaning of Present Fairly in Conformity With Generally
Accepted Accounting Principles." We do not expect the adoption of SFAS No. 162 to have a material impact on our consolidated results
of operations and financial condition. KEY BUSINESS METRICS 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 key business metrics
include the following: Churn: Average monthly subscriber line churn for a particular period is calculated by dividing the number of lines that terminated during
that period by the simple average number of lines during the period and dividing the result by the number of months in the period. The simple average
number of lines during the period is the number of lines on the first day of the period, plus the number of lines on the last day of the period, divided by
two. Terminations, as used in the calculation of churn statistics, do not include customers terminated during the period if termination occurred within
the first 30 days after purchasing our service. Management reviews this metric to evaluate whether we are retaining our existing customers in
accordance with our business plans. Churn approximated 3.5% for the first fiscal quarter of 2009 and 4.6% for the same period of fiscal 2008. Churn
decreased due to a greater percentage of business customers than residential customers in the first fiscal quarter of 2009 compared with the same
period in fiscal 2008. Business customers typically have a lower churn rate than residential customers. If we are unable to compete effectively
against our existing competitors as well as against potential new entrants into the VoIP telephone service business, in both retaining our existing
customers and attracting new customers, or if an increasing percentage of our customers decide to drop our VoIP services for other reasons such as
cost, lack of use, or our inability to meet their requirements for phone service, our churn will likely increase and our business will be adversely
affected. Subscriber acquisition cost: Subscriber acquisition cost is defined as the combined costs of advertising, marketing, promotions,
commissions and equipment subsidies. Management reviews this metric to evaluate how effective our marketing programs are in acquiring new
customers on an economical basis in the context of estimated subscriber lifetime value. Subscriber acquisition costs increased to $162 per service for
the first fiscal quarter of 2009 from $138 per service for the comparable period in fiscal 2008 due to our marketing focus on small businesses rather
than residential customers. Historically, the subscriber cost of acquisition for a business customer is greater than the cost to acquire a residential
subscriber. RESULTS OF OPERATIONS The following discussion should be read in conjunction with our condensed consolidated financial statements and the notes thereto. - 18 -
Service revenues consist primarily of revenues attributable to the provisioning of our Packet8 service and royalties earned under our
technology licensing program. We expect that Packet8 service revenues will continue to comprise nearly all of our service revenues for the
foreseeable future. The increase for the first quarter of fiscal 2008 was primarily due to a $2.5 million increase in revenues attributable to the growth
in the business customer base. In fiscal 2007, we redirected most of our marketing efforts from targeting residential customers to marketing our
business services to small businesses. The business customer base grew from serving approximately 8,000 businesses on June 30, 2007, to
approximately 12,000 on June 30, 2008. The increase in service revenues during the first quarter of fiscal 2009 was partially offset by a net reduction
of $0.3 million attributable to residential and videophone services and 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 the
traffic studies. As a result of that ruling, in the first quarter of fiscal 2008 we retroactively applied our traffic study contribution rate to the 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. Product revenues consist of revenues from sales of VoIP terminal adapters, telephones and videophones, primarily attributable to our
Packet8 service. Product revenue for the first quarter of fiscal 2009 was lower primarily because of a decrease in new residential customers and in the
first quarter of fiscal 2009. No customer represented greater than 10% of our total revenues for the three months ended June 30, 2008 and 2007. Revenues from customers
outside the United States were not material for the three months ended June 30, 2008 or 2007. The 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 the three months ended June 30, 2008 decreased $0.2 million over the comparable period in the
prior fiscal year primarily due to a reduction in pricing by third party network service vendors and our system for using multiple third party network provider
vendors. This system allows us to route call traffic to the third party network provider vendor with the most favorable pricing which resulted in a $0.3
million reduction in expenses during the first quarter of fiscal 2009. The $0.3 million decrease in cost of service revenues during the first quarter of
fiscal 2009 was partially offset by an increase of $0.1 million in personnel expenses related to the establishment of a network operation center. Cost of service revenues as a percentage of service revenues decreased from 29.7% of service revenues for the three
months ended June 30, 2007 to 25.4% of service revenues for the three months ended June 30, 2008. The cost of service revenues decreased from
the three months ended June 30, 2007 to the three months ended June 30, 2008 due to a reduction in pricing by third party network service vendors
and an increase in the percentage of total revenue from business customers. The cost of service revenues for business customers is less than the
cost of service revenues for residential customers. - 19 -
The cost of product revenues consists of costs associated with systems, components, system and semiconductor 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. The cost of product revenues remained consistent as product revenue did not increase. We generally do not separately charge Packet8 customers for the terminal adapters used to provide our service when they subscribe on our
website. We have offered incentives to customers who purchase terminal adapters in our retail channels to offset the cost of the equipment
purchased from a retailer, and generally these incentives are recorded as reductions of revenue. In accordance with FASB Emerging Issues Task
Force Issue No. 00-21, a portion of Packet8 services revenues is allocated to product revenues, but these revenues are less than the cost of the
terminal adapters at the time of purchase. Cost of product revenues as a percentage of product revenues increased from 103.9% of product revenues for the three months ended June 30,
2007 to 113.5% of product revenues for the three months ended June 30, 2008. The cost of product revenues as a percentage of product revenues
increased due to increased discounting of product sales by our sales force in the three months ended June 30, 2008. Research and development expenses consist primarily of personnel, system prototype, software and equipment costs necessary for us to conduct
our engineering and development efforts. The increase in research and development expenses for the first quarter of fiscal 2009, compared with the
same period in the prior fiscal year, was primarily attributable to an increase in personnel expenses. 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 sales commissions, trade show, advertising and other marketing and
promotional expenses. Selling, general and administrative expenses for the first quarter of fiscal 2009 decreased over the same quarter in the prior
fiscal year primarily because of a $0.9 reduction in sales and use tax expense as we began collecting such taxes directly from customers in fiscal
2008, a $0.3 million decrease in sales agent and retailer commission and a $0.2 million decrease in accounting and tax related expenses. The
decrease in expenses was offset by a $0.7 million net increase in personnel and temporary personnel costs and a $0.5 million increase in advertising,
public relations and other marketing and promotional expenses. - 20 -
In the first fiscal quarter of 2009, other income, net primarily consisted of interest and investment income earned on our cash, cash equivalents
and investment balances. The decrease in other income for the first quarter of fiscal 2009 over the same period in fiscal 2008 was primarily due to
lower average interest rates. 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, EITF 00-19 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 decrease in the income from
change in fair value of warrants in the first fiscal quarter of 2009 compared to the same period in fiscal 2008 was due to the reclassification of
amended warrants for 3,659,624 shares of common stock from a liability to equity in the second quarter of fiscal 2008 and a reduction in the fair value
of the remaining warrants due to a reduction in the expected stock price, volatility, interest rates 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 income tax provision for the first quarter of fiscal 2009 was due to a 10% foreign
withholding tax on royalty revenue related to one of our technology licensee customers. No income tax provision was recorded during the three month
period ended June 30, 2007, due to year to date net losses incurred.
We believe that, based on the history of our operating losses and other factors, the weight of available evidence indicates that it is more likely
than not that we will not be able to realize the entire benefit of our net operating losses. Accordingly, a valuation reserve has been recorded against
our net deferred tax assets. - 21 -
Liquidity and Capital Resources As of June 30, 2008, we had approximately $14.8 million in cash and cash equivalents and short-term investments. Net cash provided by operating activities for the three months ended June 30, 2008 was $0.4 million, compared with $0.2 million provided by
operating activities for the three months ended June 30, 2007. The net cash provided by operating activities for the three months ended June 30,
2008 resulted primarily from net income of $1.2 million, an $0.8 million increase in accounts payable, a $0.7 million adjustment for depreciation and
stock compensation and a $0.2 million reduction in accounts receivable related to the payment by a nationwide retailer reduced by an $0.8 million
reduction of accrued taxes, a $0.7 million reduction of deferred revenue, a reduction of $0.7 million due to payment of accrued sales tax, and a $0.2
million increase in inventory due to the procurement of the new business IP phones launched in July 2008. The net cash provided by operating
activities for the three months ended June 30, 2007 was primarily due to net income of $0.5 million reduced by the change in fair value of warrant
liability of $1.0 million off set by an increase in accounts payable of $0.2 million and a $0.6 million adjustment for depreciation and stock
compensation. Contractual Obligations In April 2005, June 2006 and March 2007, we entered into a series of noncancelable capital lease agreements for office equipment bearing
interest at various rates. Assets under capital lease at June 30, 2008 totaled $182,000 with accumulated amortization of $74,000. We lease our primary facility in Santa
Clara, California under a noncancelable operating lease that expires in fiscal 2010. We also have a leased facility in France. The facility leases
include rent escalation clauses that require us to pay taxes, insurance 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 January 2008, we entered into a contract with one of our third party customer support vendors containing a minimum
monthly commitment of approximately $436,000 effective January 1, 2008 through March 31, 2009. At June 30, 2008, the total remaining obligation
under the contract was $3.9 million. At June 30, 2008, we had open purchase orders of approximately $2.4 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. As of June 30, 2008, we did not have any material changes to our contractual
obligations that were disclosed in the Liquidity section of our Form 10-K for the fiscal year ended March 31, 2008 due to the adoption of Fin 48. Based upon 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 at least the next 12 months. Although we believe that our current cash and cash equivalents will satisfy our expected working capital and capital expenditure requirements
through at least the next 12 months, 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, and the continuing market acceptance of our services and
products. 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 or 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. - 22 -
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Foreign Currency Our financial market risk consists primarily of risks associated with international operations and related foreign currencies. We derive a portion
of our revenues from customers in Europe and Asia. In order to reduce the risk from fluctuation in foreign exchange rates, the vast majority of our
sales are denominated in U.S. dollars. In addition, almost all of our arrangements with our contract manufacturers are denominated in U.S. dollars.
We have a foreign subsidiary in France and are exposed to market risk from changes in exchange rates. We have not entered into any currency
hedging activities. To date, our exposure to exchange rate volatility has not been significant; however, there can be no assurance that there will not be
a material impact in the future. Investments We maintain an investment portfolio of various holdings, types and maturities. These marketable securities are generally classified as
available for sale and, consequently, are recorded on the balance sheet at fair value with unrealized gains or losses reported as a separate
component of accumulated other comprehensive loss. Part of this portfolio includes investments in federal agency securities and corporate bonds.
Evaluation of Effectiveness of Disclosure Controls and Procedures
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
Weighted
Shares
Average
Shares
Subject to
Exercise
Available
Options
Price
for Grant
Outstanding
Per Share
Balance at March 31, 2008
3,935,125
10,301,064
$
2.00
Granted
(281,000)
281,000
1.16
Exercised
-
(3,000)
0.69
Canceled/forfeited
169,595
(169,595)
1.68
Termination of plans
(98,845)
-
-
Balance at June 30, 2008
3,724,875
10,409,469
$
1.98
Options Outstanding
Options Exercisable
Weighted
Weighted
Weighted
Average
Average
Average
Exercise
Remaining
Aggregate
Exercise
Aggregate
Price
Contractual
Intrinsic
Price
Intrinsic
Shares
Per Share
Life (Years)
Value
Shares
Per Share
Value
$0.01 - $1.26
3,192,348
$
1.17
7.97
$
135,688
1,161,587
$
1.09
$
116,597
$1.27 - $1.54
2,194,000
$
1.40
7.63
-
1,261,708
$
1.41
-
$1.55 - $1.87
2,993,891
$
1.78
5.21
-
2,555,908
$
1.79
-
$1.88 - $14.50
2,024,230
$
4.18
3.95
-
1,897,079
$
4.30
-
$14.51 - $14.94
5,000
$
14.94
1.84
-
5,000
$
14.94
-
10,409,469
$
135,688
6,881,282
$
116,597
Three Months Ended
June 30,
2008
2007
Expected volatility
75%
83%
Expected dividend yield
-
-
Risk-free interest rate
2.91%
4.76%
Weighted average expected option term
4.00 years
3.95 years
Weighted average fair value of options granted
$
0.66
$
0.85
Three Months Ended
June 30,
2008
2007
Expected volatility
54%
84%
Expected dividend yield
-
-
Risk-free interest rate
3.83%
5.13%
Weighted average expected option term
0.75 years
0.75 years
Weighted average fair value of options granted
$
0.44
$
0.36
Three Months Ended
June 30,
2008
2007
Cost of service revenues
$
4
$
-
Cost of product revenues
4
1
Research and development
69
41
Selling, general and administrative
251
163
Total stock-based compensation expense related to
employee stock options and employee stock purchases, pre-tax
328
205
Tax benefit
-
-
Stock based compensation expense related to employeee
stock options and employee stock purchases, net of tax
$
328
$
205
June 30,
March 31,
2008
2008
Inventory (in thousands):
Work-in-process
$
1,014
$
1,095
Finished goods
703
444
$
1,717
$
1,539
Three Months Ended
June 30,
2008
2007
Numerator:
Net income available to common stockholders
$
1,188
$
508
Denominator:
Common shares
62,096
61,772
Denominator for basic calculation
62,096
61,772
Employee stock options
96
207
Employee stock purchase plan
-
48
Warrants
-
53
Denominator for diluted calculation
62,192
62,080
Net income per share
Basic
$
0.02
$
0.01
Diluted
$
0.02
$
0.01
Three Months Ended
June 30,
2008
2007
Common stock options
10,126
8,150
Warrants
7,838
8,222
17,964
16,372
Three Months Ended
June 30,
2008
2007
Net income, as reported
$
1,188
$
508
Unrealized loss on investments in securities
(5)
(1)
Comprehensive income
$
1,183
$
507
Three Months Ended
June 30,
2008
2007
Packet8 and videophones/equipment
$
16,269
$
14,625
Technology licensing and related software
12
117
Total revenues
$
16,281
$
14,742
Three Months Ended
June 30,
2008
2007
Balance at beginning of period
$
314
$
323
Accruals for warranties
65
104
Settlements
(63)
(85)
Balance at end of period
$
316
$
342
Year ending March 31:
Remaining 2009
$
370
2010
206
Total minimum payments
$
576
Year ending March 31:
Remaining 2009
$
32
2010
42
2011
26
2012
22
Total minimum payments
122
Less: Amount representing interest
(9)
113
Less: Short-term portion of capital lease obligations
(37)
Long-term portion of capital lease obligations
$
76
June 30,
Dollar
Percent
Service revenues
2008
2007
Change
Change
(dollar amounts in thousands)
Three months ended
$
15,019
$
13,411
$
1,608
12.0%
Percentage of total revenues
92.2%
91.0%
June 30,
Dollar
Percent
Product revenues
2008
2007
Change
Change
(dollar amounts in thousands)
Three months ended
$
1,262
$
1,331
$
(69)
-5.2%
Percentage of total revenues
7.8%
9.0%
June 30,
Dollar
Percent
Cost of service revenues
2008
2007
Change
Change
(dollar amounts in thousands)
Three months ended
$
3,814
$
3,986
$
(172)
-4.3%
Percentage of service revenues
25.4%
29.7%
June 30,
Dollar
Percent
Cost of product revenues
2008
2007
Change
Change
(dollar amounts in thousands)
Three months ended
$
1,432
$
1,383
$
49
3.5%
Percentage of product revenues
113.5%
103.9%
June 30,
Dollar
Percent
Research and development
2008
2007
Change
Change
(dollar amounts in thousands)
Three months ended
$
1,192
$
1,057
$
135
12.8%
Percentage of total revenues
7.3%
7.2%
June 30,
Dollar
Percent
Selling, general and administrative
2008
2007
Change
Change
(dollar amounts in thousands)
Three months ended
$
8,751
$
8,919
$
(168)
-1.9%
Percentage of total revenues
53.7%
60.5%
June 30,
Dollar
Percent
Other income, net
2008
2007
Change
Change
(dollar amounts in thousands)
Three months ended
$
85
$
132
$
(47)
-35.6%
Percentage of total revenues
0.5%
0.9%
Income (loss) on change in fair
June 30,
Dollar
Percent
value of warrant liability
2008
2007
Change
Change
(dollar amounts in thousands)
Three months ended
$
69
$
979
$
(910)
-93.0%
Percentage of total revenues
0.4%
6.6%
June 30,
Dollar
Percent
Provision for income tax
2008
2007
Change
Change
(dollar amounts in thousands)
Three months ended
$
58
$
-
$
58
100.0%
Percentage of total revenues
0.4%
0.0%
ITEM 4. CONTROLS AND PROCEDURES
We maintain disclosure controls and procedures ("Disclosure Controls") that are designed to ensure that information we are required to disclose in reports filed or submitted under the Securities and Exchange Act of 1934 is accumulated and communicated to management, including our principal executive and principal financial officers, as appropriate, to allow timely decisions regarding required disclosure, and that such information is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.
As of the end of the period covered by this Quarterly Report on Form 10-Q, under the supervision of our Chief Executive Officer and our Chief Financial Officer, we evaluated the effectiveness of our Disclosure Controls. Based on this evaluation our Chief Executive Officer and our Chief Financial Officer have concluded that our Disclosure Controls were effective as of June 30, 2008.
Limitations on the Effectiveness of Controls
Our management, including the Chief Executive Officer and Chief Financial Officer, do not expect that our Disclosure Controls or internal control over financial reporting will prevent all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system's objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected.
Changes in Internal Control over Financial Reporting.
During the first quarter of fiscal 2009, there were no material changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II -- OTHER INFORMATION
Descriptions of our legal proceedings are contained in Part I, Item 1, Financial Statements - Notes to Condensed Consolidated Financial Statements - "Note 8".
We face many significant risks in our business, some of which are unknown to us and not presently foreseen. These risks could have a material adverse impact on our business, financial condition and results of operations in the future. We have disclosed a number of material risks under Item 1A of our annual report on Form 10-K for the year ended March 31, 2008, which we filed with the Securities and Exchange Commission on May 27, 2008. The following discussion is of material changes to risk factors disclosed in that report.
We have a history of losses and are uncertain as to our future profitability.
We recorded operating income of $1.1 million for the three months ended June 30, 2008 and ended the period with an accumulated deficit of $199 million. We recorded an operating loss of $3.7 million for the year ended March 31, 2008 and ended the period with an accumulated deficit of $200 million. In addition, we recorded operating losses of $14 million and $25 million for the fiscal years ended March 31, 2007 and 2006, respectively. We may incur operating losses in the foreseeable future, and such losses may be substantial. We may need to increase revenues in order to generate sustainable and increasing operating profit. Given our history of fluctuating revenues and operating losses, we cannot be certain that we will be able to achieve profitability consistently or to increase our profitability on either a quarterly or annual basis in the future.
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 July 24, 2008, our common stock had a closing bid price of approximately $1.04 per share. We must also meet additional continued listing requirements contained in NASDAQ Marketplace Rule 4310(c)(2)(b), which requires that we have a minimum of $2,500,000 in stockholders' equity or $35,000,000 market value of listed securities held by non-affiliates or $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 July 24, 2008, based on our closing price as of that day, the market value of our securities held by non-affiliates approximated $63,945,000 and we were in compliance with NASDAQ Marketplace Rule 4310(c)(2)(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:
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Taxes will increase our customers' cost of using our service 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 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. We have established an accrued tax liability of $0.8 million as of June 30, 2008, to account for the claims by some states that we should have collected and remitted sales taxes in the past. 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 Packet8 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 Packet8 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 Packet8 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.
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
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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 Packet8 account signup procedures to require service addresses to be entered and validated, at the time an order for service is placed, to ascertain whether Packet8'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 Packet8 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.
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31.1 Certification of Chief Executive Officer pursuant to Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (PDF as a courtesy)
31.2 Certification of Chief Financial Officer pursuant to Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (PDF as a courtesy)
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (PDF as a courtesy)
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (PDF as a courtesy)
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Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: August 1, 2008
8X8, INC. |
(Registrant) |
By: /s/ DANIEL WEIRICH |
Daniel Weirich |
Chief Financial Officer |
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