We recorded an operating loss of approximately $19.9 million for the year ended March 31, 2005, and we ended the period with an accumulated deficit of $171 million. In addition, we recorded operating losses of $4 million and $12 million for the fiscal years ended March 31, 2004 and 2003, respectively. We expect that we will continue to incur operating losses for the foreseeable future, and such losses may be substantial. We will need to generate significant revenue growth to achieve an operating profit. Given our history of fluctuating revenues and operating losses, we cannot be certain that we will be able to achieve profitability on either a quarterly or annual basis in the future.

The market price of the shares of our common stock has been and is likely to be highly volatile. It may be significantly affected by factors such as:

The stock market has from time to time experienced significant price and volume fluctuations that have particularly affected the market prices for the common stocks of technology companies and that have often been unrelated to the operating performance of particular companies. These broad market fluctuations may adversely affect the market price of our common stock. In the past, following periods of volatility in the market price of a company's securities, securities class action litigation has often been initiated against the issuing company. If our stock price is volatile, we may also be subject to such litigation. Such litigation could result in substantial costs and a diversion of management's attention and resources, which would disrupt business and could cause a decline in our operating results. Any settlement or adverse determination in such litigation would also subject us to significant liability.

We devote substantially all of our resources to the promotion, distribution and development of our Packet8 service. As such, our future growth and profitability is dependent on revenue from our Packet8 service, as opposed to revenue from our semiconductor business, which has historically accounted for a substantial portion of the Company's consolidated revenues.

Semiconductor and related software revenues represented approximately 83% and 88%, respectively, of the Company's consolidated revenues for fiscal 2004 and 2003. However, these revenues were not sufficient to profitably operate our semiconductor business. Therefore, we have significantly reduced the scope of these operations. During the quarter ended June 30, 2003, we completed the end-of-life of our legacy videoconferencing semiconductor products. In November 2003, we sold the VIP1 video semiconductor development effort to Leadtek Research, Inc. (Leadtek). Under the terms of the transaction, Leadtek acquired the VIP1 development activities, key engineers, software tools and equipment. Revenues attributable to this development effort, prior to the aforementioned transaction, were $0 and $1.1 million during the fiscal years ended March 31, 2004 and 2003, respectively, representing approximately 0% and 12% of revenues of our semiconductor business and 0% and 10.5% of 8x8's consolidated revenues for such periods. As a result of the transfer of this development effort to Leadtek, this development revenue ceased. In January 2004, we initiated an end- of-life program for our VoIP telephony semiconductor products, including the Audacity T2 and T2U products. The semiconductor business may continue to generate revenue in the future, although we expect the amounts to decrease, both on an absolute basis and as a percentage of our consolidated revenues.

Revenues from the hosted iPBX solutions business represented approximately 3% and 8% of the Company's consolidated revenues for fiscal 2004 and 2003, respectively. In July 2003, we sold our European subsidiary, Centile Europe S.A., and licensed, on a non-exclusive basis, our iPBX technology to the purchaser. In March 2004, we announced the Packet8 Virtual Office service, which includes technologies previously offered as part of the hosted iPBX solutions business.

We have only been selling our Packet8 service since November 2002. Given our limited history with offering this service, there are many difficulties that we may encounter, including regulatory hurdles, discussed below, and other problems that we may not anticipate. To date, we have not generated significant revenue from the sale of our voice over IP, or VoIP, telephony products and services, including our Packet8 service, and there is no guarantee that we will be successful in generating significant revenues or achieving profitability. If we are not able to generate significant revenues selling into the VoIP telephony market, our business and operating results would be seriously harmed. If we are not able to retain a significant percentage of our current and future Packet8 customers on an ongoing basis, our business and operating results would be seriously harmed.

The success of our Packet8 voice and video communications service is dependent upon future demand for VoIP telephony systems and services. In order for the IP telephony market to continue to grow, several things need to occur. Telephone and cable service providers must continue to invest in the deployment of high speed broadband networks to residential and business customers. VoIP networks must improve quality of service for real-time communications, managing effects such as packet jitter, packet loss, and unreliable bandwidth, so that toll-quality service can be provided. VoIP telephony equipment and services must achieve a similar level of reliability that users of the public switched telephone network have come to expect from their telephone service. VoIP telephony service providers must offer cost and feature benefits to their customers that are sufficient to cause the customers to switch away from traditional telephony service providers. Furthermore, end users in markets serviced by recently deregulated telecommunications providers are not familiar with obtaining services from competitors of these providers and may be reluctant to use new providers, such as us. We will need to devote substantial resources to educate customers and end users about the benefits of VoIP telephony solutions in general and our services in particular. If any or all of these factors fail to occur, our business may decline.

Our historical operating results have fluctuated significantly and will likely continue to fluctuate in the future, and a decline in our operating results could cause our stock price to fall. On an annual and a quarterly basis, there are a number of factors that may affect our operating results, many of which are outside our control. These include, but are not limited to:

In the likely event that we encounter significant price competition in the markets for our products, we could be at a significant disadvantage compared to our competitors, many of whom have substantially greater resources, and therefore may be better able to withstand an extended period of downward pricing pressure. The adverse impact of a shortfall in our revenues may be magnified by our inability to adjust spending to compensate for such shortfall. Announcements by our competitors or us of new products and technologies could cause customers to defer purchases of our existing products, which would also have a material adverse effect on our business and operating results.

Due to these and other factors, we believe that period-to-period comparisons of our results of operations are not meaningful and should not be relied upon as indicators of our future performance. It is possible that in some future periods our results of operations may be below the expectations of public market analysts and investors. If this were to occur, the price of our common stock would likely decline significantly.

VoIP telephony is an emerging market that is characterized by rapid changes in customer requirements, frequent introductions of new and enhanced products, and continuing and rapid technological advancement. To compete successfully in this emerging market, we must continue to design, develop, manufacture, and sell new and enhanced VoIP telephony software products and services that provide increasingly higher levels of performance and reliability at lower cost. These new and enhanced products must take advantage of technological advancements and changes, and respond to new customer requirements. Our success in designing, developing, manufacturing, and selling such products and services will depend on a variety of factors, including:

Additionally, we may also be required to collaborate with third parties to develop our products and may not be able to do so on a timely and cost-effective basis, if at all. We have in the past experienced delays in the development of new products and the enhancement of existing products, and such delays will likely occur in the future. If we are unable, due to resource constraints or technological or other reasons, to develop and introduce new or enhanced products in a timely manner, if such new or enhanced products do not achieve sufficient market acceptance, or if such new product introductions decrease demand for existing products, our operating results would decline and our business would not grow.

Decreasing telecommunications rates may diminish or eliminate the competitive pricing advantage of our services. International and domestic telecommunications rates have decreased significantly over the last few years in most of the markets in which we operate, and we anticipate that rates will continue to be reduced in all of the markets in which we do business or expect to do business. Users who select our services to take advantage of the current pricing differential between traditional telecommunications rates and our rates may switch to traditional telecommunications carriers as such pricing differentials diminish or disappear, and we will be unable to use such pricing differentials to attract new customers in the future. In addition, our ability to market our services to other service providers depends upon the existence of spreads between the rates offered by us and the rates offered by traditional telecommunications carriers, as well as a spread between the retail and wholesale rates charged by the carriers from which we obtain wholesale services. Continued rate decreases will require us to lower our rates to remain competitive and will reduce or possibly eliminate any gross profit from our services. If telecommunications rates continue to decline, we may lose subscribers for our services.

Most of our current and potential competitors have longer operating histories, significantly greater resources and name recognition and a larger base of customers than we have. As a result, these competitors may have greater credibility with our existing and potential customers. They also may be able to adopt more aggressive pricing policies and devote greater resources to the development, promotion and sale of their products than we can to ours. Our competitors may also offer bundled service arrangements offering a more complete product despite the technical merits or advantages of our products. These competitors include traditional telephone service providers, such as AT&T, SBC and Verizon, cable television companies, such as Cablevision, Cox and Time Warner, and other VoIP service providers such as Skype and Vonage. Competition could decrease our prices, reduce our sales, lower our gross profits or decrease our market share.

We currently sell our products direct to consumers and through resellers, and are focusing efforts on increasing our distribution channels. Our future revenue growth will depend in large part on sales of our products through reseller and other distribution relationships. We may not be successful in developing additional distribution relationships. Agreements with distribution partners generally provide for one-time and recurring commissions based on our list prices, and do not require minimum purchases or restrict development or distribution of competitive products. Therefore, entities that distribute our products may compete with us. In addition, distributors and resellers may not dedicate sufficient resources or give sufficient priority to selling our products. Our failure to develop new distribution channels, the loss of a distribution relationship or a decline in the efforts of a material reseller or distributor could have a material adverse effect on our business, financial condition or results of operations.

The development and marketing of our VoIP products will continue to place a significant strain on our limited personnel, management, and other resources. Our future success depends upon the continued services of our executive officers and other key employees who have critical industry experience and relationships that we rely on to implement our business plan. None of our officers or key employees are bound by employment agreements for any specific term. The loss of the services of any of our officers or key employees could delay the development and introduction of, and negatively impact our ability to sell our products which could adversely affect our financial results and impair our growth. We currently do not maintain key person life insurance policies on any of our employees.

We do not have long-term purchase agreements with our contract manufacturers. There can be no assurance that our contract manufacturers will be able or willing to reliably manufacture our products, in volumes, on a cost-effective basis or in a timely manner. For our videophones, cordless handsets and terminal adaptors that are used with our Packet8 service, we rely on the availability of certain semiconductor products. These devices are also sourced solely from certain overseas contract manufacturers and partners, and are currently not available from any other manufacturer. Any of these factors could have a material adverse effect on our business, financial condition or results of operations.

Our Packet8 service depends on the availability of third party network service providers that provide telephone numbers and public switched telephone network (PSTN) call termination and origination services for our customers. Many of these network service providers have been affected by the downturn in the telecommunications industry and may be forced to terminate the services that we depend on. The time to interface our technology to another network service provider, if available, and qualify this new service could have a material adverse effect on our business, operating results or financial condition.

While we believe that relations with our current service providers are good and we have contracts in place, there can be no assurance that these service providers will be able or willing to supply cost-effective services to us in the future or that we will be successful in signing up alternative or additional providers. While we believe that we could replace our current providers, if necessary, our ability to provide service to our subscribers would be impacted during this timeframe, and this could have an adverse effect on our business, financial condition or results of operations. The loss of access to, or requirement to change, the telephone numbers we provide to our customers could have a material adverse effect on our business.

Our products have lead times of up to several months, and are built to forecasts that are necessarily imprecise. Because of our practice of building our products to necessarily imprecise forecasts, it is likely that, from time to time, we will have either excess or insufficient product inventory. Excess inventory levels would subject us to the risk of inventory obsolescence, while insufficient levels of inventory may negatively affect relations with customers. For instance, our customers rely upon our ability to meet committed delivery dates, and any disruption in the supply of our products could result in legal action from our customers, loss of customers or harm to our ability to attract new customers. Any of these factors could have a material adverse effect on our business, operating results or financial condition.

Many of the potential customers for our Packet8 service have requested that our products and services be designed to interoperate with their existing networks, each of which may have different specifications and use multiple standards. Our customers' networks may contain multiple generations of products from different vendors that have been added over time as their networks have grown and evolved. Our products must interoperate with these products as well as with future products in order to meet our customers' requirements. In some cases, we may be required to modify our product designs to achieve a sale, which may result in a longer sales cycle, increased research and development expense, and reduced operating margins. If our products do not interoperate with existing equipment or software in our customers' networks, installations could be delayed, orders for our products could be canceled or our products could be returned. In addition, contractual obligations may require us to continue to provide services that interoperate whether cost effective or in our interests. Any of these factors could harm our business, financial condition or results of operations.

Our Packet8 service must successfully integrate with products from other vendors, such as gateways to traditional telephone systems. As a result, when problems occur in a network, it may be difficult to identify the source of the problem. The occurrence of hardware and software errors, whether caused by our Packet8 service or another vendor's products, may result in the delay or loss of market acceptance of our products and any necessary revisions may force us to incur significant expenses. The occurrence of some of these types of problems may seriously harm our business, financial condition or results of operations.

We expect our competitors to continue to improve the performance of their current products and introduce new products or new technologies. If our competitors successfully introduce new products or enhance their existing products, this could reduce the sales or market acceptance of our products and services, increase price competition or make our products obsolete. For instance, our competitors, such as local exchange carriers and cable television providers, may be able to bundle services and products that we do not offer together with long distance or VoIP telephony services. These services could include wireless communications, voice and data services, Internet access and cable television. This form of bundling would put us at a competitive disadvantage if these providers can combine a variety of services offerings at a single attractive price. To be competitive, we must continue to invest significant resources in research and development, sales and marketing, and customer support. We may not have sufficient resources to make these investments or to make the technological advances necessary to be competitive, which in turn will cause our business to suffer.

Many of our current and potential competitors have longer operating histories, are substantially larger, and have greater financial, manufacturing, marketing, technical, and other resources. Many also have greater name recognition and a larger installed base of customers than we have. Competition in our markets may result in significant price reductions. As a result of their greater resources, many current and potential competitors may be better able than us to initiate and withstand significant price competition or downturns in the economy. There can be no assurance that we will be able to continue to compete effectively, and any failure to do so would harm our business, operating results or financial condition.

We are entering into new market areas and our success is partly dependent on our ability to forge new marketing and engineering partnerships. VoIP telephony communication systems are extremely complex and few, if any, companies possess all the required technology components needed to build a complete end to end solution. We will likely need to enter into partnerships to augment our development programs and to assist us in marketing complete solutions to our targeted customers. We may not be able to develop such partnerships in the course of our product development. Even if we do establish the necessary partnerships, we may not be able to adequately capitalize on these partnerships to aid in the success of our business.

We rely in part on trademark, copyright, and trade secret law to protect our intellectual property in the United States and abroad. We seek to protect our software, documentation, and other written materials under trade secret and copyright law, which afford only limited protection. We also rely in part on patent law to protect our intellectual property in the United States and internationally. We hold fifty-eight United States patents and have a number of United States and foreign patent applications pending. We cannot predict whether such pending patent applications will result in issued patents that effectively protect our intellectual property. We may not be able to protect our proprietary rights in the United States or internationally (where effective intellectual property protection may be unavailable or limited), and competitors may independently develop technologies that are similar or superior to our technology, duplicate our technology or design around any patent of ours. We have in the past licensed and in the future expect to continue licensing our technology to others; many of whom are located or may be located abroad. There are no assurances that such licensees will protect our technology from misappropriation. Moreover, litigation may be necessary in the future to enforce our intellectual property rights, to determine the validity and scope of the proprietary rights of others, or to defend against claims of infringement or invalidity. Such litigation could result in substantial costs and diversion of management time and resources and could have a material adverse effect on our business, financial condition, and operating results. Any settlement or adverse determination in such litigation would also subject us to significant liability.

There has been substantial litigation in the communications, semiconductor, electronics, and related industries regarding intellectual property rights, and from time to time third parties may claim infringement by us of their intellectual property rights. Our broad range of technology, including systems, digital and analog circuits, software, and semiconductors, increases the likelihood that third parties may claim infringement by us of their intellectual property rights. If we were found to be infringing on the intellectual property rights of any third party, we could be subject to liabilities for such infringement, which could be material. We could also be required to refrain from using, manufacturing or selling certain products or using certain processes, either of which could have a material adverse effect on our business and operating results. From time to time, we have received, and may continue to receive in the future, notices of claims of infringement, misappropriation or misuse of other parties' proprietary rights. There can be no assurance that we will prevail in these discussions and actions or that other actions alleging infringement by us of third party patents will not be asserted or prosecuted against us.

We rely upon certain technology, including hardware and software, licensed from third parties. There can be no assurance that the technology licensed by us will continue to provide competitive features and functionality or that licenses for technology currently utilized by us or other technology which we may seek to license in the future will be available to us on commercially reasonable terms or at all. The loss of, or inability to maintain, existing licenses could result in shipment delays or reductions until equivalent technology or suitable alternative products could be developed, identified, licensed and integrated, and could harm our business. These licenses are on standard commercial terms made generally available by the companies providing the licenses. The cost and terms of these licenses individually are not material to our business.

Circuit-switched telephony networks feature very high reliability, with a guaranteed quality of service. In addition, such networks have imperceptible delay and consistently satisfactory audio quality. Emerging broadband IP networks, such as LANs, WANs, and the Internet, or emerging last mile technologies such as cable, digital subscriber lines, and wireless local loop, may not be suitable for telephony unless such networks and technologies can provide reliability and quality consistent with these standards.

In addition to reliability and quality standards, the market acceptance of telephony over broadband IP networks is dependent upon the adoption of industry standards so that products from multiple manufacturers are able to communicate with each other. Our VoIP telephony products rely heavily on communication standards such as SIP, H.323, MGCP and Megaco and network standards such as TCP/IP and UDP to interoperate with other vendors' equipment. There is currently a lack of agreement among industry leaders about which standard should be used for a particular application, and about the definition of the standards themselves. These standards, as well as audio and video compression standards, continue to evolve. We also must comply with certain rules and regulations of the Federal Communications Commission (FCC) regarding electromagnetic radiation and safety standards established by Underwriters Laboratories, as well as similar regulations and standards applicable in other countries. Standards are continuously being modified and replaced. As standards evolve, we may be required to modify our existing products or develop and support new versions of our products. We must comply with certain federal, state and local requirements regarding how we interact with our customers, including consumer protection, privacy and billing issues, the provision of 911 emergency service and the quality of service we provide to our customers. The failure of our products and services to comply, or delays in compliance, with various existing and evolving standards could delay or interrupt volume production of our VoIP telephony products, subject us to fines or other imposed penalties, or harm the perception and adoption rates of our service, any of which would have a material adverse effect on our business, financial condition or operating results.

Regulatory treatment of VoIP telephony outside the United States varies from country to country. We currently distribute our products and services directly to consumers and through resellers that may be subject to telecommunications regulations in their home countries. The failure of these consumers and resellers to comply with these laws and regulations could reduce our revenue and profitability. Because of our relationship with the resellers, some countries may assert that we are required to register as a telecommunications carrier in that country. In such case, our failure to do so could subject us to fines or penalties. In addition, some countries are considering subjecting VoIP services to the regulations applied to traditional telephone companies. Regulatory developments such as these could have a material adverse effect on our international operation.

In many countries in which we operate or our services are sold, the status of the laws that may relate to our services is unclear. We cannot be certain that our customers, resellers, or other affiliates are currently in compliance with regulatory or other legal requirements in their respective countries, that they or we will be able to comply with existing or future requirements, and/or that they or we will continue to be in compliance with any such requirements. Our failure or the failure of those with whom we transact business to comply with these requirements could have a material adverse effect on our business, operating results or financial condition.

At present there are few laws, regulations or rulings that specifically address access to commerce and communications services on the Internet, including IP telephony. We are unable to predict the impact, if any, that future legislation, legal decisions or regulations concerning the Internet may have on our business, financial condition, and results of operations. Regulation may be targeted towards, among other things, assessing access or settlement charges, imposing taxes related to internet communications and imposing tariffs or regulations based on encryption concerns or the characteristics and quality of products and services, any of which could restrict our business or increase our cost of doing business. The increasing growth of the broadband IP telephony market and popularity of broadband IP telephony products and services heighten the risk that governments or other legislative bodies will seek to regulate broadband IP telephony and the Internet. In addition, large, established telecommunication companies may devote substantial lobbying efforts to influence the regulation of the broadband IP telephony market, which may be contrary to our interests.

Many regulatory actions are underway or are being contemplated by federal and state authorities, including the FCC and other state and local regulatory agencies. On February 12, 2004, the FCC initiated a notice of public rule-making to update FCC policy and consider the appropriate regulatory classification for VoIP and other IP enabled services. On November 9, 2004, the FCC ruled that Vonage DigitalVoice and similar services are jurisdictionally interstate and not subject to state certification, tariffing and other common carrier regulations, including 911. This ruling has been subsequently appealed by several states. On February 11, 2004, the California Public Utilities Commission (CPUC) initiated an investigation into voice over IP providers, including us. As a tentative conclusion of law, the CPUC stated that they believe that VoIP providers are telecommunications providers and should be treated as such from a regulatory standpoint. There is risk that a regulatory agency requires us to conform to rules that are unsuitable for IP communications technologies or rules that cannot be complied with due to the nature and efficiencies of IP routing, or are unnecessary or unreasonable in light of the manner in which Packet8 offers service to its customers. It is not possible to separate the Internet, or any service offered over it, into intrastate and interstate components. While suitable alternatives may be developed in the future, the current IP network does not enable us to identify the geographic nature of the traffic traversing the Internet.

Several U.S. states and municipalities have recently shown an interest in regulating VoIP services, as they do for providers of traditional telephone service. If this trend continues, and if state regulation is not preempted by action by the U.S. federal government, we may become subject to a "patchwork quilt" of state regulations and taxes, which would increase our costs of doing business, and adversely affect our operating results and future prospects.

We have already been contacted by several state regulatory authorities regarding our Packet8 service. On September 11, 2003, we received a letter from the Public Service Commission of Wisconsin, or WPSC, notifying us that the WPSC believes that we, via our Packet8 voice and video communications service, are offering intrastate telecommunications services in the state of Wisconsin without certification of the WPSC. According to the WPSC's letter, it believes that we cannot legally provide Packet8-based resold intrastate services in Wisconsin without certification from the WPSC. In addition, the Commission believes that Packet8 bills for intrastate services to Wisconsin customers are void and not collectible. The letter also states that if we do not obtain certification to offer intrastate telecommunications services, the matter will be referred to the State of Wisconsin Attorney General for enforcement action. The letter also states that even if the Company were certified by the WPSC, the previous operation without certification may still subject the Company to referral to the State of Wisconsin Attorney General for enforcement action and possible forfeitures. We consulted with counsel and have responded to the WPSC and disputed their assertions. While we do not believe that the potential amounts of any forfeitures would be material to us, if we are subject to an enforcement action, we may become subject to liabilities and may incur expenses that adversely affect our results of operations.

On September 17, 2003, we were contacted by the Ohio Public Utilities Commission, or OPUC, and asked to respond to a questionnaire on Voice over IP technologies that the OPUC is conducting. The OPUC inquired as to the nature of our service, how it is provided, and to what Ohio residents the service is made available. The questionnaire did not contain any assertions regarding the legality of the Packet8 service under Ohio law or any statements as to whether the OPUC believes we are subject to regulation by the state of Ohio. We responded to this questionnaire on October 20, 2003.

On September 22, 2003, the California Public Utilities Commission, or CPUC, sent us a letter that alleged that we are offering intrastate telecommunications services for profit in California without having received formal certification from the CPUC to provide such service. The CPUC also requested that we file an application with the CPUC for authority to conduct business as a telecommunications utility no later than October 22, 2003. After consultation with regulatory counsel, we responded to the CPUC, disputed its assertions and did not file the requested application. In our October 22, 2003 response to the CPUC, we disagreed with the CPUC's classification of us as a telephone corporation under the California Public Utilities Code. We asserted that we are an information services provider and not a telecommunications provider. The letter from the CPUC did not indicate, and we cannot predict, what any potential penalties or consequences in failing to obtain certification might be. If we are subjected to penalties, or if we are required to comply with CPUC regulations affecting telecommunications service providers, our business may be adversely affected. On November 13, 2003, the CPUC held a hearing in San Francisco to hear testimony from CPUC staff and industry representatives regarding what course of action the CPUC should take with respect to Internet telephony. A representative from 8x8 testified at the hearing. On February 11, 2004, the CPUC stated that, as a tentative conclusion of law, they believe that VoIP providers are telecommunications providers and should be treated as such from a regulatory standpoint. The CPUC initiated an investigation into appropriate regulation of VoIP providers under state law, and acknowledged that it has not enforced the same regulatory regime over VoIP as applies to telecommunications services. The CPUC is considering a number of potential regulatory requirements, including contribution to state universal service programs, provisioning of 911 services, payment of access charges to interconnect with the PSTN and compliance with NANP protocols and basic consumer protection laws, including California's telecommunications "bill of rights." The CPUC is also considering whether exempting VoIP providers from requirements applicable to traditional providers of voice telephony creates unfair competitive advantages that should be proactively addressed, if the regulatory framework governing the provision of VoIP should vary based on the market served and whether VoIP providers should be subject to the current system of intercompany compensation arrangements. The CPUC has indicated that this process could last up to 18 months, but there is no way for us to predict the timetable or outcome of this process. On April 7, 2005, the CPUC instituted a rulemaking to assess and revise the regulation of all telecommunications utilities in California except for small incumbent local exchange carriers, or ILECs. The primary goal of this proceeding is to develop a uniform regulatory framework for all telecommunications utilities, except small ILECs, to the extent that it is feasible and in the public interest to do so. While not specifically directed at VoIP, it is unclear at this time what impact this new rulemaking will have on the CPUCs classification or treatment of VoIP services.

In May 2004, in response to a 2003 complaint case brought by Frontier Telephone of Rochester against Vonage, the New York State Public Service Commission, or NYPSC, concluded that Vonage is a telephone corporation as defined by New York law and must obtain a Certificate of Public Convenience and Necessity, which represents the authorization of the NYPSC to provide telephone service in New York. The NYPSC will allow a forty- five day period in which Vonage can identify and seek waivers of any rules that it believes should not apply. Vonage will be required to provide 911 service in some form, and will be required to file a schedule of its rates. Currently, this decision applies only to Vonage. In June 2004, a federal judge issued a preliminary injunction enjoining the NYPSC from regulating Vonage as a telecommunications carrier. Vonage has asked the federal district court to make this a permanent injunction, and this request is being considered. While this ruling applies only to Vonage and not to us, if we are subject to regulation by the NYPSC, we may become subject to liabilities and may incur expenses that adversely affect our results of operations.

In July 2004, we received a letter from the Arizona Corporation Commission, or ACC, stating that it was conducting a competitive analysis of the various telecommunications markets in Arizona. The letter requested that we provide answers to a listing of questions as well as certain data. On August 26, 2004, after executing the ACC's standard protective agreement governing the submission of commercially sensitive information, we sent to the ACC answers to some of the questions posed in the initial letter, together with information responsive to certain of the data requests. Inasmuch as the ACC proceeding is a generic docket opened for the purpose of gathering information regarding VoIP, additional information requests are possible, but none has been received to date.

In late 2004 and early 2005, we received notices from multiple municipalities in California that the Packet8 service is subject to utility user taxes, as defined in the respective municipal codes. The notices require that we begin collecting and remitting utility user taxes no later than January 1, 2005. We have responded to these municipalities and disputed their assertions.

In January 2005, we received a letter from an association representing multiple municipalities in South Carolina asserting that we are subject to a business license tax applied to telecommunications companies. We have responded to this association and disputed their assertion.

In May 2005, we began charging a Regulatory Recovery Fee, currently an additional $1.50 per month, on each telephone number that is used by our customers, including toll free and virtual numbers. The Regulatory Recovery Fee is charged monthly to offset costs incurred by us in complying with inquiries and obligations imposed by federal, state and municipal regulatory bodies/governments and the related legal and billing expenses. This fee is not a tax or charge required or assessed by any government.

In May 2005, we received a notice from the City of Chicago that we were being investigated for non-compliance with Chicago tax laws as we are not collecting and remitting Chicago's Telecommunications Tax. We are working with counsel to formulate a response to dispute the applicability of this tax to the Packet8 service.

In accordance with current industry practice, we do not collect state and federal telecommunications taxes, other than federal excise tax, or FET, or other telecommunications surcharges with respect to our Packet8 service. We do not collect Value Added Tax, or VAT, for services that we provide to customers in European Union, or EU, member countries. Future expansion of our Packet8 service, along with other aspects of our evolving business, may result in additional sales and other tax obligations. One or more states or foreign countries may seek to impose sales or other tax collection obligations on out- of-jurisdiction companies that provide telephone service. A successful assertion by one or more states or foreign countries that we should collect sales or other taxes on the sale of merchandise or services could result in substantial tax liabilities for past sales, decrease our ability to compete with traditional telephone companies, and could have a material adverse effect on our business, financial condition or operating results.

To date, the FCC has treated Internet service providers as information service providers. Information service providers are currently exempt from federal and state regulations governing common carriers, including the obligation to pay access charges and contribute to the universal service fund. The FCC is currently examining the status of Internet service providers and the services they provide. If the FCC were to determine that Internet service providers, or the services they provide, are subject to FCC regulation, including the payment of access charges and contribution to the universal service funds, it could have a material adverse effect on our business, financial condition and operating results.

In May 2005, the FCC unanimously adopted an Order and Notice of Proposed Rulemaking, or NPRM, that requires VoIP providers to provide emergency 911, or E911, service. On June 3, 2005, the FCC released the text of the First Report and Order and Notice of Proposed Rulemaking in the VoIP E911 proceeding, or the VoIP E911 Order. As a result of the VoIP E911 Order, VoIP service providers that interconnect to the PSTN, or interconnected VoIP providers, will be required to mimic the 911 emergency calling capabilities offered by traditional landline phone companies. All interconnected VoIP providers must deliver 911 calls to the appropriate local public safety answering point, or PSAP, along with call back number and location, where the PSAP is able to receive that information. E911 must be included in the basic service offering; it cannot be an optional or extra feature. The PSAP delivery obligation, along with call back number and location information must be provided regardless of whether the service is "fixed" or "nomadic." User registration of location is permissible initially, although the FCC is committed to an advanced form of E911 that will determine user location without user intervention, one of the topics of the further NPRM to be released eventually. The VoIP E911 Order mandates that existing and prospective customers must be notified of the capabilities and limitations of VoIP service with respect to emergency calling, and interconnected VoIP providers must obtain and maintain affirmative acknowledgement from each customer that the customer has read and understood the notice of limitations and distribute warning labels or stickers alerting consumers and other potential users of the limitations of VoIP 911 service to each new subscriber prior to the initiation of service. In addition, an interconnected VoIP provider must make it possible for customers to update their address (i.e., change their registered location) via at least one option that requires no equipment other than that needed to access the VoIP service. All interconnected VoIP providers must comply with the requirements of the VoIP E911 Order within one- hundred and twenty days of the publication of the VoIP E911 Order in the Federal Register, which is expected by late June, with the exception that the customer notification obligations must be complied with within thirty days of the publication.

We currently offer E911 service as an option to Packet8 subscribers who choose phone numbers in markets where E911 service is available (our E911 service is only available in a subset of the markets where we provide telephone numbers). We primarily market the Packet8 service to our residential customers as a secondary line service, not a primary line service. We do not encourage our residential customers to use Packet8 as their only telephone service, unless they provision Packet8 E911 service on the telephone line. Even with E911 provisioned, the IP dialtone service provided by Packet8 is only as reliable as a customer's underlying broadband data service and Internet service provider (neither service is provided by us), and may not be suitable for use in all emergency situations. For customers who choose not to or are unable to subscribe to our E911 service, we currently play a recorded message in response to customers who dial 911 from these lines instructing them to hang up and either dial their local police/fire department directly from the phone on the Packet8 service, or to dial 911 from a phone connected to the traditional telephone network.

The operation of our Packet8 service depends on our ability to avoid and mitigate any interruptions in service or reduced capacity for customers. Interruptions in service or performance problems, for whatever reason, could undermine confidence in our services and cause us to lose customers or make it more difficult to attract new ones. In addition, because our services may be critical to the businesses of our customers, any significant interruption in service could result in lost profits or other liability to our customers. Although we attempt to disclaim liability in our service agreements, a court might not enforce a limitation on liability, which could expose us to financial loss. In addition, we may provide our customers with guaranteed service level commitments. If we are unable to meet these guaranteed service level commitments as a result of service interruptions, we may be obligated to provide credits, generally in the form of free service for a short period of time, to our customers, which could negatively affect our operating results.

Consumer access to our websites directly affects our ability to sign new subscribers and the account management and reseller reporting services we offer and thus affects our service revenues. We experience occasional system interruptions that make our websites unavailable or prevent us from efficiently fulfilling orders or providing services to our customers and resellers, which may reduce our service revenues and the attractiveness of our products and services. If we are unable to continually add additional software and hardware and upgrade our systems and network infrastructure in an effective manner, it could cause service interruption and adversely affect our ability to deliver the Packet8 service.

The failure of any equipment or facility on our network, or those of our partners or customers, could result in the interruption of customer service until necessary repairs are made or replacement equipment is installed. Network failures, delays and errors could also result from natural disasters, terrorist acts, power losses, security breaches and computer viruses. These failures, faults or errors could cause delays, service interruptions, expose us to customer liability or require expensive modifications that could have a material adverse effect on our business, financial condition and operating results.

We expect the volume of simultaneous calls to increase significantly as the Packet8 subscriber base grows. Our network hardware and software may not be able to accommodate this additional volume. If we fail to maintain an appropriate level of operating performance, or if our service is disrupted, our reputation could be hurt, we could lose customers and this could have a material adverse effect on our business, financial condition and results of operations.

A fundamental requirement for operating an internet-based, worldwide voice and video communications service and electronically billing our Packet8 customers is the secure transmission of confidential information over public networks. Although we have developed systems and processes that are designed to protect consumer information and prevent fraudulent credit card transactions and other security breaches, failure to mitigate such fraud or breaches may adversely affect our operating results. The law relating to the liability of providers of online payment services is currently unsettled. We rely on third party providers to process and guarantee payments made by Packet8 subscribers up to certain limits, and we may be unable to prevent our customers from fraudulently receiving goods and services. Our liability risk will increase if a larger fraction of our Packet8 transactions involve fraudulent or disputed credit card transactions. Any costs we incur as a result of fraudulent or disputed transactions could harm our business. In addition, the functionality of our current billing system relies on certain third-party vendors delivering services. If these vendors are unable or unwilling to provide services, we will not be able to charge for our Packet8 services in a timely or scalable fashion, which could significantly decrease our revenue and have a material adverse effect on our business, financial condition and operating results.

Subscribers have obtained access to the Packet8 service without paying for monthly service and international toll calls by unlawfully using our authorization codes and submitting fraudulent credit card information. To date, such losses from unauthorized credit card transactions and theft of service have not been significant. We have implemented anti-fraud procedures in order to control losses relating to these practices, but these procedures may not be adequate to effectively limit all of our exposure in the future from fraud. If our procedures are not effective, consumer fraud and theft of service could significantly decrease our revenue and have a material adverse effect on our business, financial condition and operating results.

While we do not know of any technologies that are patented by others that we believe are necessary for us to provide our services, certain necessary technology may in fact be patented by other parties either now or in the future. If such technology were held under patent by another person, we would have to negotiate a license for the use of that certain technology. We may not be able to negotiate such a license at a price that is acceptable. The existence of such a patent, or our inability to negotiate a license for any such technology on acceptable terms, could force us to cease using such technology and offering products and services incorporating such technology.

Products as complex as those we offer frequently contain errors, defects, and functional limitations when first introduced or as new versions are released. We have in the past experienced such errors, defects or functional limitations. We sell products into markets that are extremely demanding of robust, reliable, fully functional products. Therefore, delivery of products with production defects or reliability, quality or compatibility problems could significantly delay or hinder market acceptance of such products, which could damage our credibility with our customers and adversely affect our ability to retain our existing customers and to attract new customers. Moreover, such errors, defects or functional limitations could cause problems, interruptions, delays or a cessation of sales to our customers. Alleviating such problems may require significant expenditures of capital and resources by us. Despite our testing, our suppliers or our customers may find errors, defects or functional limitations in new products after commencement of commercial production. This could result in additional development costs, loss of, or delays in, market acceptance, diversion of technical and other resources from our other development efforts, product repair or replacement costs, claims by our customers or others against us, or the loss of credibility with our current and prospective customers.

As of March 31, 2005, we had cash and cash equivalents, restricted cash and investments of approximately $31.8 million. Unless we achieve and maintain profitability, we will need to raise additional capital. We may not be able to obtain such additional financing as needed on acceptable terms, or at all, which may require us to reduce our operating costs and other expenditures, including reductions of personnel and capital expenditures. If we issue additional equity or convertible debt securities to raise funds, the ownership percentage of our existing stockholders would be reduced and they may experience significant dilution. New investors may demand rights, preferences or privileges senior to those of existing holders of our common stock. If we are not successful in these actions, we may be forced to cease operations.

Our common stock trades on the Nasdaq SmallCap Market, which has certain compliance requirements for continued listing of common stock.

If our minimum closing bid price per share falls below $1.00 for a period of 30 consecutive business days in the future, we may again be subject to delisting procedures. As of the close of business on May 20, 2005, our common stock had a closing bid price of $2.05 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 $50,000,000 market value of listed securities 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 May 20, 2005, based on our closing price as of that day, the market value of our securities approximated $110 million 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 SmallCap listing may:

We have evaluated our internal controls systems in order to allow management to report on, and our independent auditors to attest to, the effectiveness of our internal controls over financial reporting, as required by this legislation. We are required to perform the system and process evaluation and testing (and any necessary remediation) required in an effort to allow our management to assess the effectiveness of our system of internal controls as of the end of each fiscal year. Our independent auditors must then attest to and report on that assessment by our management to comply with the management certification and auditor attestation requirements of Section 404 of the Sarbanes Oxley Act (Section 404). As a result, we have and expect to continue to incur significant additional expenses and diversion of management's time towards Section 404 compliance. In any fiscal year, we may fail to timely complete our evaluation, testing and remediation actions in order to allow for this assessment by our management or our independent auditors may not be able to timely attest to our management's assessment. If we are not able to comply with the requirements of Section 404 in a timely manner or with adequate compliance, we might be subject to sanctions or investigation by regulatory authorities, such as the Securities Exchange Commission or the Nasdaq SmallCap Market. Further, if our independent auditors are not satisfied with our internal control over financial reporting or with the level at which it is documented, designed, operated or reviewed, they may decline to attest to management's assessment or may issue a qualified report identifying a material weakness in our internal controls. Any such action could adversely affect our financial results and could cause our stock price to decline.

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 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 income. Part of this portfolio includes investments in bank issues, corporate bonds and commercial papers. For additional information regarding our investment policy, see note 1 of the Notes to Consolidated Financial Statements in Item 8.

In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of 8x8, Inc. and its subsidiaries at March 31, 2005 and 2004, and the results of their operations and their cash flows for each of the three years in the period ended March 31, 2005 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 
 
                                                                 March 31,
                                                             --------------------
                                                               2005       2004
                                                             ---------  ---------
                          ASSETS
Current assets:
  Cash and cash equivalents................................ $  22,515  $  13,249
  Restricted cash..........................................       250        800
  Short-term investments...................................     9,035         --
  Accounts receivable, net of allowance of
   $68 and $135............................................     1,144        608
  Inventory................................................     1,600         98
  Deferred cost of goods sold..............................     2,122        310
  Other current assets.....................................       363        335
                                                             ---------  ---------
          Total current assets.............................    37,029     15,400
Property and equipment, net................................     1,788        158
Other assets...............................................       263         13
                                                             ---------  ---------
                                                            $  39,080  $  15,571
                                                             =========  =========
           LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Accounts payable......................................... $   4,496  $     854
  Accrued compensation.....................................       515        415
  Accrued warranty.........................................       187        194
  Deferred revenue.........................................     2,602        547
  Other accrued liabilities................................     1,536        559
                                                             ---------  ---------
          Total current liabilities........................     9,336      2,569
                                                             ---------  ---------
Non-current liabilities....................................        --        216
                                                             ---------  ---------
Commitments and contingencies (Note 9)
Stockholders' equity:
  Preferred stock, $0.001 par value:
     Authorized: 5,000,000 shares;
     Issued and outstanding: 1 share at March 31, 2005
      and March 31, 2004...................................        --         --
  Common stock, $0.001 par value:
     Authorized: 100,000,000 shares at March 31, 2005
      and March 31, 2004;
     Issued and outstanding: 53,816,989 shares
      at March 31, 2005 and 38,315,769 shares
      at March 31, 2004....................................        54         38
Additional paid-in capital.................................   200,576    164,469
Deferred compensation......................................        --         (3)
Accumulated other comprehensive loss.......................       (20)        --
Accumulated deficit........................................  (170,866)  (151,718)
                                                             ---------  ---------
          Total stockholders' equity.......................    29,744     12,786
                                                             ---------  ---------
                                                            $  39,080  $  15,571
                                                             =========  =========
 

                                                              Year Ended March 31,
                                                         -------------------------------
                                                           2005       2004       2003
                                                         ---------  ---------  ---------
Product revenues....................................... $   2,389  $   2,679  $   5,739
License and service revenues...........................     9,086      6,629      5,264
                                                         ---------  ---------  ---------
          Total revenues...............................    11,475      9,308     11,003
                                                         ---------  ---------  ---------
 
Operating expenses:
  Cost of product revenues.............................     4,546      1,768      2,781
  Cost of license and service revenues (includes $0,
     $1,164 and $0 of stock-based compensation expense)     5,195      2,594      1,509
  Research and development.............................     3,109      2,747      7,835
  Selling, general and administrative..................    18,534      6,060      7,441
  Restructuring and other charges......................        --         --      3,437
                                                         ---------  ---------  ---------
          Total operating expenses.....................    31,384     13,169     23,003
                                                         ---------  ---------  ---------
Loss from operations...................................   (19,909)    (3,861)   (12,000)
Other income, net......................................       558        822        597
                                                         ---------  ---------  ---------
Loss before benefit for income taxes...................   (19,351)    (3,039)   (11,403)
Benefit for income taxes...............................      (203)        --         --
                                                         ---------  ---------  ---------
Net loss............................................... $ (19,148) $  (3,039) $ (11,403)
                                                         =========  =========  =========
 
Basic and diluted loss per share....................... $   (0.43) $   (0.09) $   (0.40)
                                                         =========  =========  =========
 
Basic and diluted shares outstanding...................    44,373     32,546     28,386
                                                         =========  =========  =========
 

                                                                                     Accumulated
                                                                                       other
                                          Common Stock       Additional   Deferred   Comprehen-
                                       --------------------   Paid-in    Compensa-      sive     Accumulated
                                         Shares     Amount    Capital       tion        Loss      Deficit      Total
                                       -----------  -------  ----------  ----------  ----------  ----------  ---------
Balance at March 31, 2002............  28,228,215  $    27  $  150,612  $      (30) $      (99) $ (137,276) $  13,234
Issuance of common stock under
  stock plans........................     242,772        1          88          --          --          --         89
Common stock no longer
  contingently redeemable............          --       --         144          --          --          --        144
Deferred compensation related
  to stock options...................          --       --         (17)         18          --          --          1
Cumulative translation
  adjustment.........................          --       --          --          --          99          --         --
Net loss.............................          --       --          --          --          --     (11,403)        --
Total comprehensive loss.............          --       --          --          --          --          --    (11,304)
                                       -----------  -------  ----------  ----------  ----------  ----------  ---------
Balance at March 31, 2003............  28,470,987       28     150,827         (12)         --    (148,679)     2,164
Issuance of common stock under
  stock plans........................   1,445,438        2       1,880          --          --          --      1,882
Sale of common stock and warrants in
  financing transactions.............   4,899,773        4       7,896          --          --          --      7,900
Issuance of common stock on exercise
  of warrants........................   3,499,571        4       1,895          --          --          --      1,899
Stock compensation charge............          --       --       1,308          --          --          --      1,308
Common stock no longer
  contingently redeemable............          --       --         669          --          --          --        669
Deferred compensation related
  to stock options...................          --       --          (6)          9          --          --          3
Net loss.............................          --       --          --          --          --      (3,039)        --
Total comprehensive loss.............          --       --          --          --          --          --     (3,039)
                                       -----------  -------  ----------  ----------  ----------  ----------  ---------
Balance at March 31, 2004............  38,315,769       38     164,469          (3)         --    (151,718)    12,786
Issuance of common stock under
  stock plans........................     294,830       --         424          --          --          --        424
Sale of common stock and warrants in
  financing transactions.............  15,206,390       16      35,681          --          --          --     35,697
Stock compensation charge............          --       --           2          --          --          --          2
Deferred compensation related
  to stock options...................          --       --          --           3          --          --          3
Unrealized investment loss...........          --       --          --          --         (20)         --         --
Net loss.............................          --       --          --          --          --     (19,148)        --
Total comprehensive loss.............          --       --          --          --          --          --    (19,168)
                                       -----------  -------  ----------  ----------  ----------  ----------  ---------
Balance at March 31, 2005............  53,816,989  $    54  $  200,576  $       --  $      (20) $ (170,866) $  29,744
                                       ===========  =======  ==========  ==========  ==========  ==========  =========
 

                                                                             Year Ended March 31,
                                                                        -------------------------------
                                                                          2005       2004       2003
                                                                        ---------  ---------  ---------
Cash flows from operating activities:
  Net loss............................................................ $ (19,148) $  (3,039) $ (11,403)
  Adjustments to reconcile net loss to net cash used
    in operating activities:
    Depreciation and amortization.....................................       215        565      1,780
    Stock compensation expense........................................         5      1,311          1
    Non-cash portion of restructuring and other charges...............        --         --      2,273
    Gain on sale of Centile Europe SA.................................        --       (790)        --
    Other.............................................................        32        (69)       204
  Changes in assets and liabilities, net of effects
    of businesses sold:
      Accounts receivable, net........................................      (536)       682        (71)
      Inventory.......................................................    (1,522)       325        298
      Other current and noncurrent assets.............................       (28)       219         64
      Deferred cost of goods sold.....................................    (1,812)      (310)        --
      Accounts payable................................................     3,642        263        104
      Accrued compensation............................................       100       (258)      (249)
      Accrued warranty................................................        (7)      (234)        (1)
      Deferred revenue................................................     2,055          2     (1,876)
      Other current and noncurrent liabilities........................       453       (249)        39
                                                                        ---------  ---------  ---------
         Net cash used in operating activities........................   (16,551)    (1,582)    (8,837)
                                                                        ---------  ---------  ---------
Cash flows from investing activities:
  Acquisitions of property and equipment..............................    (1,588)      (106)      (137)
  Purchase of investments ............................................    (9,665)        --       (208)
  Sales and maturities of short-term investments .....................       611        208         --
  Proceeds from the sale of equipment.................................        --         79         42
  Restricted cash decrease (increase).................................       300       (800)        --
  Proceeds from sale of Centile Europe SA, net........................        --        398         --
                                                                        ---------  ---------  ---------
         Net cash used in investing activities........................   (10,342)      (221)      (303)
                                                                        ---------  ---------  ---------
Cash flows from financing activities:
  Proceeds from equity financing transactions, net....................    35,735      9,799         --
  Proceeds from issuance of common stock under employee benefit plans.       424      1,882         89
                                                                        ---------  ---------  ---------
         Net cash provided by financing activities....................    36,159     11,681         89
                                                                        ---------  ---------  ---------
Net increase (decrease) in cash and cash equivalents..................     9,266      9,878     (9,051)
Cash and cash equivalents, beginning of year..........................    13,249      3,371     12,422
                                                                        ---------  ---------  ---------
Cash and cash equivalents, end of year................................ $  22,515  $  13,249  $   3,371
                                                                        =========  =========  =========
Supplemental and non-cash disclosures:
  Income taxes paid................................................... $      --  $      --  $      36
                                                                        =========  =========  =========
 

                                                        Gross
                                           Adjusted   Unrealized  Estimated
                                            Costs        Loss     Fair Value
                                          ----------  ----------  ----------
Commercial paper........................ $   10,565  $       (2) $   10,563
Federal agency securities...............      5,976          (6)      5,970
Auction rate securities.................      5,500          --       5,500
Corporate bonds.........................      2,563         (12)      2,551
                                          ----------  ----------  ----------
Total available-for-sale investments.... $   24,604  $      (20) $   24,584
                                          ==========  ==========  ==========
 
Reported as (in thousands):
  Cash and cash equivalents..................................... $   15,549
  Short-term investments........................................      9,035
                                                                  ----------
    Total ...................................................... $   24,584
                                                                  ==========

 
Due within one year............................................. $   18,585
Due after one year..............................................        499
Due after five years............................................      5,500
                                                                  ----------
    Total ...................................................... $   24,584
                                                                  ==========

                                                                     March 31,
                                                                --------------------
                                                                  2005       2004
                                                                ---------  ---------
                                                                  (in thousands)
  Raw materials and work-in-process...........................     1,267         57
  Finished goods..............................................       333         41
                                                                ---------  ---------
                                                               $   1,600  $      98
                                                                =========  =========

                                                                     March 31,
                                                                --------------------
                                                                  2005       2004
                                                                ---------  ---------
                                                                  (in thousands)
  Machinery and computer equipment............................ $   3,372  $   4,233
  Furniture and fixtures......................................       121        693
  Licensed software...........................................     1,059      2,613
  Leasehold improvements......................................       172        903
                                                                ---------  ---------
                                                                   4,724      8,442
Less: accumulated depreciation and amortization...............    (2,936)    (8,284)
                                                                ---------  ---------
                                                               $   1,788  $     158
                                                                =========  =========

                                                          Year Ended March 31,
                                                  -------------------------------------
                                                     2005         2004         2003
                                                  -----------  -----------  -----------
Net loss:                                        $   (19,148) $    (3,039) $   (11,403)
Add: Employee stock-based compensation expense
     included in reported net income............           3        1,311            1
Deduct: Total employee stock-based compensation
        determined pursuant to SFAS No.123......      (2,426)      (2,113)      (4,446)
                                                  -----------  -----------  -----------
Pro forma net loss                               $   (21,571) $    (3,841) $   (15,848)
                                                  ===========  ===========  ===========
As reported net loss per share.................. $     (0.43) $     (0.09) $     (0.40)
Pro forma net loss per share.................... $     (0.49) $     (0.12) $     (0.56)

                                                          Year Ended March 31,
                                                   ---------------------------------
                                                      2005        2004       2003
                                                   -----------  ---------  ---------
Common stock options.............................       7,146      6,213      7,615
Warrants.........................................       6,117      2,319         --
                                                   -----------  ---------  ---------
                                                       13,263      8,532      7,615
                                                   ===========  =========  =========

                                                                 Liability              Liability              Liability
                                  Total      Cash    Non-Cash   at March 31,   Cash    at March 31,   Cash    at March 31,
                                 Charges   Payments   Charges      2003      Payments     2004      Payments     2005
                                ---------  --------  ---------  -----------  --------  -----------  --------  -----------
Restructuring Charges:
 Severance.................... $   1,177  $ (1,002) $      --  $       175  $   (175) $        --        --  $        --
 Facility related.............       508      (161)      (273)          74       (33)          41       (33)           8
                                ---------  --------  ---------  -----------  --------  -----------  --------  -----------
   Total restructuring charges     1,685    (1,163)      (273)         249      (208)          41       (33)           8
                                ---------  --------  ---------  -----------  --------  -----------  --------  -----------
Asset Impairments:
 Fixed Assets.................       212        --       (212)          --        --           --        --           --
 Goodwill.....................     1,539        --     (1,539)          --        --           --        --           --
                                ---------  --------  ---------  -----------  --------  -----------  --------  -----------
   Total impairment charges...     1,751        --     (1,751)          --        --           --        --           --
                                ---------  --------  ---------  -----------  --------  -----------  --------  -----------
   Total restructuring and
     impairment charges....... $   3,436  $ (1,163) $  (2,024) $       249  $   (208) $        41       (33) $         8
                                =========  ========  =========  ===========  ========  ===========  ========  ===========

Current:
  Federal........................................ $      (157)
  State..........................................           7
  Foreign........................................         (53)
                                                   -----------
                                                  $      (203)
                                                   ===========

                                                                     March 31,
                                                                --------------------
                                                                  2005       2004
                                                                ---------  ---------
Research and development credit carryforwards................. $   5,711  $   5,667
Net operating loss carryforwards..............................    39,370     31,678
Inventory valuation...........................................       220        457
Reserves and allowances.......................................     1,450        490
Fixed assets and intangibles..................................    14,143     15,898
Other.........................................................        --         --
                                                                ---------  ---------
                                                                  60,894     54,190
Valuation allowance...........................................   (60,894)   (54,190)
                                                                ---------  ---------
          Total............................................... $      --  $      --
                                                                =========  =========

                                                        Year Ended March 31,
                                                   ---------------------------------
                                                      2005        2004       2003
                                                   -----------  ---------  ---------
Benefit at statutory rate........................ $    (6,575) $  (1,033) $  (3,877)
State income tax benefit before valuation
  allowance, net of federal effect...............      (1,127)      (177)      (684)
Non-deductible goodwill..........................          --         --        523
Research and development credits.................         (45)      (208)        --
Change in valuation allowance....................       6,704      3,614      3,245
Release of income taxes previously accrued.......        (203)        --         --
Compensation/option differences..................        (332)    (1,549)        --
Prior year loss carryforward reduction...........       1,216     (1,599)       785
Non-deductible compensation......................           2        522         --
Foreign rate differences.........................          (6)        (8)        --
Other............................................         163        438          8
                                                   -----------  ---------  ---------
                                                  $      (203) $      --  $      --
                                                   ===========  =========  =========

Balance at April 1, 2004......................... $       194
Accruals for warranties..........................         217
Settlements......................................        (121)
Changes in estimates.............................        (103)
                                                   -----------
Balance at March 31, 2005........................ $       187
                                                   ===========

 YEAR ENDING MARCH 31,
 ---------------------
2006..........................................................       408
2007..........................................................       482
2008..........................................................       490
2009..........................................................       493
2010..........................................................       206
                                                                ---------
          Total minimum payments.............................. $   2,079
                                                                =========

                                                                   Weighted
                                                        Shares      Average
                                           Shares     Subject to   Exercise
                                          Available    Options       Price
                                          for Grant  Outstanding   Per Share
                                         ----------- ------------  ---------
Balance at March 31, 2002...............    673,608    9,899,826  $    2.95
Change in options available for grant...  1,370,187           --         --
Granted.................................   (857,800)     857,800       0.48
Exercised...............................         --      (53,040)      0.37
Returned to plan........................  3,089,997   (3,089,997)      3.05
                                         ----------- ------------
Balance at March 31, 2003...............  4,275,992    7,614,589       2.65
Change in options available for grant...    829,488           --         --
Granted................................. (2,420,000)   2,420,000       2.12
Exercised...............................         --   (1,445,438)      1.30
Returned to plan........................  2,375,843   (2,375,843)      2.64
                                         ----------- ------------
Balance at March 31, 2004...............  5,061,323    6,213,308  $    2.77
Change in options available for grant...    975,000           --         --
Granted................................. (1,860,500)   1,860,500       2.39
Exercised...............................         --     (251,610)      1.38
Returned to plan........................    676,462     (676,462)      5.06
                                         ----------- ------------
Balance at March 31, 2005...............  4,852,285    7,145,736  $    2.50
                                         =========== ============

                            Options Outstanding            Options Exercisable
                    ----------------------------------  -------------------------
                                Weighted    Weighted                   Weighted
                                 Average    Average                     Average
                                Exercise   Remaining                   Exercise
 Range of Exercise                Price   Contractual                    Price
      Prices          Shares    Per Share Life (Years)     Shares      Per Share
------------------- ----------  --------- ------------  ------------  -----------
$ 0.01 to $ 3.16... 5,506,344  $    1.74          7.2     2,993,529  $      1.68
$ 3.16 to $ 6.32... 1,341,892       3.72          7.3       753,238         3.76
$ 6.32 to $ 9.49...    96,500       7.92          4.6        96,500         7.92
$ 9.49 to $12.65...   185,000      12.30          5.2       185,000        12.30
$12.65 to $15.81...     6,000      14.87          5.1         6,000        14.87
$15.81 to $31.63...    10,000      18.00          4.9        10,000        18.00
                    ----------                          ------------
                    7,145,736                             4,044,267
                    ==========                          ============

                                                             Weighted
                                                  Shares      Average
                                      Shares    Subject to   Exercise
                                     Available    Options      Price
                                     for Grant  Outstanding  Per Share
                                    ----------- -----------  ---------
 
Balance at March 31, 2002..........  1,956,834   3,043,166  $    0.50
Granted............................   (617,000)    617,000       0.50
Returned to plan...................  1,945,490  (1,945,490)      0.50
                                    ----------- -----------
Balance at March 31, 2003..........  3,285,324   1,714,676       0.50
Returned to plan...................  1,714,676  (1,714,676)      0.50
                                    ----------- -----------
Balance at March 31, 2004..........  5,000,000          --         --
Termination of plan................ (5,000,000)         --         --
                                    ----------- -----------
Balance at March 31, 2005..........         --          --  $      --
                                    =========== ===========

                                                             Weighted
                                                  Shares      Average
                                      Shares    Subject to   Exercise
                                     Available    Options      Price
                                     for Grant  Outstanding  Per Share
                                    ----------- -----------  ---------
 
Balance at March 31, 2002..........  2,235,000   2,265,000  $    0.43
Granted............................    (96,000)     96,000       0.43
Exercised..........................         --          --         --
Returned to plan...................    459,128    (459,128)      0.43
                                    ----------- -----------
Balance at March 31, 2003..........  2,598,128   1,901,872       0.43
Returned to plan...................  1,901,872  (1,901,872)      0.43
                                    ----------- -----------
Balance at March 31, 2004..........  4,500,000          --         --
Termination of plan................ (4,500,000)         --         --
                                    ----------- -----------
Balance at March 31, 2005..........         --          --  $      --
                                    =========== ===========

                                                          Year Ended March 31,
                                                  -------------------------------------
                                                     2005         2004         2003
                                                  -----------  -----------  -----------
Net loss:
  As reported................................... $   (19,148) $    (3,039) $   (11,403)
  Pro forma..................................... $   (21,571) $    (3,841) $   (15,848)
Basic and diluted loss per share:
  As reported................................... $     (0.43) $     (0.09) $     (0.40)
  Pro forma..................................... $     (0.49) $     (0.12) $     (0.56)

                                                          Year Ended March 31,
                                                  -------------------------------------
                                                     2005         2004         2003
                                                  -----------  -----------  -----------
Expected volatility.............................         142%         174%         162%
Expected dividend yield.........................          --           --           --
Risk-free interest rate.........................  3.7% to 4.3% 2.5% to 3.6% 2.8% to 4.7%
Weighted average expected option term...........    5 years     4.9 years    5.1 years
Weighted average fair value of options
  granted....................................... $      2.11  $      2.02  $      0.45

                                                  Year Ended
                                                   March 31,
                                                     2003
                                                  -----------
Expected volatility.............................          81%
Expected dividend yield.........................         0.0%
Risk-free interest rate.........................  2.8% to 4.8%
Weighted average expected option term...........   5.16 years
Netergy weighted average fair value
  of options granted............................ $      0.34
Centile weighted average fair value
  of options granted............................ $      0.29

 
                                                        Year Ended
                                                   March 31,    March 31,
                                                     2005         2003
                                                  -----------  -----------
Expected volatility.............................         141%         162%
Expected dividend yield.........................        0.0%         0.0%
Risk-free interest rate.........................        1.79%        1.53%
Weighted average expected rights term...........  0.5 years     1.25 years
Weighted average fair value of rights
  granted....................................... $      0.33  $      0.30
 

                                                          Year Ended March 31,
                                                  -------------------------------------
                                                     2005         2004         2003
                                                  -----------  -----------  -----------
Revenues:
  Packet8 service, equipment and other..........      10,006        1,306          423
  Semiconductors and related software...........       1,348        7,730        9,719
  Hosted iPBX solutions.........................         121          272          861
                                                  -----------  -----------  -----------
          Total revenues........................ $    11,475  $     9,308  $    11,003
                                                  ===========  ===========  ===========

                                                          Year Ended March 31,
                                                  -------------------------------------
                                                     2005         2004         2003
                                                  -----------  -----------  -----------
United States................................... $    10,472  $     2,728  $     4,218
Europe..........................................         646        1,309        2,657
Taiwan..........................................         157        4,163        1,569
Japan...........................................          --          568          919
Other...........................................         200          540        1,640
                                                  -----------  -----------  -----------
                                                 $    11,475  $     9,308  $    11,003
                                                  ===========  ===========  ===========

                                                                     March 31,
                                                                --------------------
                                                                  2005       2004
                                                                ---------  ---------
                                                                  (in thousands)
 
United States................................................. $   1,784  $     154
France........................................................         4          4
                                                                ---------  ---------
                                                               $   1,788  $     158
                                                                =========  =========

                                                          Balance   Additions
                                                            at      Charged to             Balance
                                                         Beginning  Costs and              at End
Description                                               of Year   Expenses   Deductions  of Year
-------------------------------------------------------  ---------  ---------  ---------  ---------
Year ended March 31, 2003:
   Allowance for doubtful accounts..................... $     286  $      20  $     165  $     141
   Valuation allowance for deferred tax assets.........    47,331      3,245          0     50,576
Year ended March 31, 2004:
   Allowance for doubtful accounts.....................       141          0          6        135
   Valuation allowance for deferred tax assets.........    50,576      3,614          0     54,190
Year ended March 31, 2005:
   Allowance for doubtful accounts.....................       135          0         67         68
   Valuation allowance for deferred tax assets.........    54,190      6,704          0     60,894

                                                                        QUARTER ENDED
                                        ------------------------------------------------------------------------------
                                        March 31, Dec. 31,  Sept. 30, June 30,  March 31, Dec. 31,  Sept. 30, June 30,
                                          2005      2004      2004      2004      2004      2003      2003      2003
                                        --------  --------  --------  --------  --------  --------  --------  --------
Product revenues...................... $    471  $    632  $    690  $    596  $    731  $    337  $    750  $    861
License and service revenues..........    3,440     2,332     1,843     1,471     1,239     2,952     1,676       762
                                        --------  --------  --------  --------  --------  --------  --------  --------
Total revenues........................    3,911     2,964     2,533     2,067     1,970     3,289     2,426     1,623
                                        --------  --------  --------  --------  --------  --------  --------  --------
Operating expenses:
  Cost of product revenues ...........    1,685     1,073       876       912       448       413       544       363
  Cost of license and service revenues    1,703     1,442     1,171       879       651     1,444       108       391
  Research and development............    1,064       784       684       577       525       522       656     1,044
  Selling, general, and
    administrative....................    6,750     5,650     3,622     2,512     1,893     1,672     1,229     1,266
                                        --------  --------  --------  --------  --------  --------  --------  --------
        Total operating expenses......   11,202     8,949     6,353     4,880     3,517     4,051     2,537     3,064
                                        --------  --------  --------  --------  --------  --------  --------  --------
Loss from operations..................   (7,291)   (5,985)   (3,820)   (2,813)   (1,547)     (762)     (111)   (1,441)
Other income (expense), net...........      118       145        71       224        15         8       858       (59)
Benefit for income taxes..............      183        --        --        20        --        --        --        --
                                        --------  --------  --------  --------  --------  --------  --------  --------
Net income (loss)..................... $ (6,990) $ (5,840) $ (3,749) $ (2,569) $ (1,532) $   (754) $    747  $ (1,500)
                                        ========  ========  ========  ========  ========  ========  ========  ========
Net income (loss) per share:
  Basic............................... $  (0.14) $  (0.13) $  (0.09) $  (0.07) $  (0.04) $  (0.02) $   0.02  $  (0.05)
  Diluted.............................    (0.14)    (0.13)    (0.09)    (0.07)    (0.04)    (0.02)     0.02     (0.05)
Shares used in per share calculations:
  Basic...............................   48,988    46,718    43,134    38,690    38,105    33,549    30,069    28,474
  Diluted.............................   48,988    46,718    43,134    38,690    38,105    33,549    31,213    28,474