8x8 2006 Annual Report Download - page 34

31
receivable, including historical bad debts, customer concentrations, customer creditworthiness, current economic
trends and changes in our customer payment terms when evaluating the adequacy of the allowance for doubtful
accounts. The accounts receivable balance was $776,000, net of an allowance for doubtful accounts of $55,000 as of
March 31, 2006, including a reserve for disputed credit card charges. If the financial condition of our customers
were to deteriorate, our actual losses may exceed our estimates, and additional allowances would be required.
Valuation of Inventories
We write down our inventory for estimated obsolescence or unmarketable inventory equal to the difference between
the cost of inventory and the estimated market value based upon assumptions about future demand, market
conditions and replacement costs. If actual future demand or market conditions are less favorable than those
projected by us, additional inventory write-downs may be required.
Income Taxes
As part of the process of preparing our consolidated financial statements we are required to estimate our income
taxes in each of the jurisdictions in which we operate. This process involves us estimating our actual current tax
expense together with assessing temporary differences resulting from differing treatment of items, such as deferred
revenue, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are
included within our consolidated balance sheet. We must then assess the likelihood that our deferred tax assets will
be recovered from future taxable income and to the extent we believe that recovery is not likely, we must establish a
valuation allowance. In the event that we determine that we would be able to realize deferred tax assets in the future
in excess of the net recorded amount, an adjustment to the deferred tax asset would increase income in the period
such determination was made.
Significant management judgment is required in determining the valuation allowance recorded against our net
deferred tax assets, which primarily consist of net operating loss and tax credit carry forwards. We have recorded a
valuation allowance of approximately $71 million as of March 31, 2006, due to uncertainties related to our ability to
utilize most of our deferred tax assets before they expire. The valuation allowance is based on our estimates of
taxable income by jurisdiction in which we operate and the period over which our deferred tax assets will be
recoverable.
Litigation
From time to time, we receive notices that our products or manufacturing processes may be infringing the patent or
intellectual property rights of others. We account for litigation and contingencies in accordance with Statement of
Financial Accounting Standards (SFAS) No. 5, “Accounting for Contingencies” (“SFAS 5”). SFAS No. 5 requires
that we record an estimated loss from a loss contingency when information available prior to issuance of our
financial statements indicates that it is probable that an asset has been impaired or a liability has been incurred at the
date of the financial statements and the amount of loss can be reasonably estimated. At March 31, 2006, liabilities
related to litigation matters were not significant. Because of the uncertainties related to both the amount and range
of loss on pending litigation, management is unable to make a reasonable estimate of the liability that could result
from an unfavorable outcome. As additional information becomes available, we will assess the potential liability, if
any, related to our pending litigation and revise our estimates. Such revisions in our estimates of the potential
liability could materially impact our results of operations, financial position or cash flows.
Key Business Metrics
We periodically review certain key business metrics, within the context of our articulated performance goals, in
order to evaluate the effectiveness of our operational strategies, allocate resources and maximize the financial
performance of our business. The key business metrics include the following:
• Churn: Average monthly subscriber line churn for a particular period is calculated by dividing the number of
lines that terminated during that period by the simple average number of lines during the period and dividing the
result by the number of months in the period. The simple average number of lines during the period is the number of
lines on the first day of the period, plus the number of lines on the last day of the period, divided by two.
Terminations, as used in the calculation of churn statistics, do not include customers terminated during the period if
termination occurred within the first thirty days after purchasing our service. Management reviews this metric to
evaluate whether we are retaining our existing subscribers in accordance with our business plans.