UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549

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FORM 10-K

|(Mark One)                                                    |                                                                                         
|------------------------------------------------------------- | ----------------------------------------------------------------------------------------
|ý                                                             | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934    
|For the fiscal year ended September 30, 2004                 
|OR                                                           
|o                                                             | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|For the transition period
from                             to

Commission File Number 000-27427

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ALTIGEN COMMUNICATIONS, INC.(Exact name of Registrant as specified in its charter)

|DELAWARE(State or other jurisdiction of
incorporation or organization)                                    |  | 94-3204299(I.R.S. Employer
Identification Number)
|--------------------------------------------------------------------------------------------------------- |  | -------------------------------------------------
|4555 Cushing Parkway
Fremont, CA(Address of principal executive offices)                                  |  | 94538(Zip Code)                                  
|Registrant's telephone number, including area code:(510) 252-9712                                        
|Securities registered pursuant to Section 12(b) of the Act:None                                          
|Securities registered pursuant to Section 12(g) of the Act:Common Stock, $0.001 par value(Title of Class)

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Indicate
by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that
the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past
90 days. Yes ý    No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K. o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the
Act). Yes o    No ý

The aggregate market value of the common stock held by non-affiliates of the registrant was approximately $46,327,048 as of March 31, 2004,
based on the closing price of our common stock as reported on The Nasdaq Small Cap Stock Market on such date. Shares of common stock held by each officer and director and by each person known to own
5% or more of our outstanding common stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination
for other purposes. As of March 31, 2004, there were 14,210,081 shares of the our common stock issued and outstanding.

As
of December 22, 2004, there were 14,530,712 shares of our common stock issued and outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Certain sections of AltiGen Communications, Inc.'s definitive Proxy Statement for the 2005 Annual Meeting of Stockholders to be held on February 10,
2005 are incorporated by reference in Part III of this Form 10-K to the extent stated herein.



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TABLE OF CONTENTS

|               |  |                                                                                                |  | Page
|-------------- |  | ---------------------------------------------------------------------------------------------- |  | ----
|PART I        
|Item 1.        |  | Business                                                                                       |  | 3   
|Item 2.        |  | Properties                                                                                     |  | 18  
|Item 3.        |  | Legal Proceedings                                                                              |  | 18  
|Item 4.        |  | Submission of Matters to a Vote of Security Holders                                            |  | 18  
|Item 4A.       |  | Executive Officers of the Registrant                                                           |  | 19  
|PART II       
|Item 5.        |  | Market for Registrant's Common Equity and Related Stockholder Matters                          |  | 20  
|Item 6.        |  | Selected Financial Data                                                                        |  | 20  
|Item 7.        |  | Management's Discussion and Analysis of Financial Condition and Results of Operations          |  | 21  
|Item 7A.       |  | Quantitative and Qualitative Disclosures About Market Risk                                     |  | 41  
|Item 8.        |  | Financial Statements and Supplementary Data                                                    |  | 41  
|Item 9.        |  | Changes in and Disagreements With Accountants on Accounting and Financial Disclosure           |  | 41  
|Item 9A.       |  | Controls and Procedures                                                                        |  | 41  
|PART III      
|Item 10.       |  | Directors and Executive Officers of the Registrant                                             |  | 43  
|Item 11.       |  | Executive Compensation                                                                         |  | 43  
|Item 12.       |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters |  | 43  
|Item 13.       |  | Certain Relationships and Related Transactions                                                 |  | 43  
|Item 14.       |  | Principal Accountant Fees and Services                                                         |  | 43  
|PART IV       
|Item 15.       |  | Exhibits, Financial Statement Schedules                                                        |  | 45  
|SIGNATURES     |  | 66                                                                                            
|CERTIFICATIONS |  |                                                                                               

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PART I

Item 1. Business

INTRODUCTION

AltiGen Communications, Inc.(NASDAQSC: ATGN) is a pioneer and market leader in Internet protocol telephony
systems for small-to-medium sized businesses. We design, manufacture and market next generation, Internet protocol phone systems and contact centers that use both the Internet
and the public telephone network to take advantage of the convergence of voice and data communications. Unlike traditional proprietary phone systems, our systems are designed with open architecture
and are built on an industry standard platform. This adherence to industry standards allows our products to play an important role in the small-to-medium sized business market
by delivering phone systems that can integrate with other technologies and provide integrated voice and data solutions. We believe this enables our customers to implement communication systems that
have an increased return versus past technology investments. We generated net revenues of $14.8 million, for a net profit of $28,000, during fiscal year 2004. As of September 30, 2004,
we had an accumulated deficit of $50.8 million. Net cash used in operating activities was $185,000 for fiscal year 2004.

Our
principal executive offices are located at 4555 Cushing Parkway, Fremont, California 94538. Our telephone number is (510) 252-9712. We were incorporated in
California in May 1994 and we reincorporated into Delaware in June 1999.

We
maintain an Internet website athttp://www.altigen.com. Our most recent annual report on Form 10-K and certain of
our other filings with the Securities and Exchange Commission
(SEC) are available through the Investor Relations section of our website athttp://www.altigen.com/company_investors.html. Our annual reports on
Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and other required filings and amendments to these filings are available
on the SEC website athttp://www.sec.gov, which can be reached from our Investor Relations website. In addition, you may read and copy any material we
file with the SEC at the SEC's Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at
1-800-SEC-0330. The SEC also maintains an Internet site that contains reports, proxy, and information statements, and other information regarding registrants that
file electronically with the SEC athttp://www.sec.gov.

INDUSTRY BACKGROUND

We focus on the small-to-medium sized business and mid enterprise business market, which represents approximately 14 million
businesses in the United States. Our telephony products primarily are sold to small-to-medium sized businesses, multi-site businesses, corporate branch offices and
call centers. Entering 2004, we primarily operated in the Americas and the Asia Pacific region and have begun to penetrate the European community through sales in the United Kingdom and Norway.

The
focus and growth of our call center solution sales and the strengthening of the United States economy overall helped us to counter balance the negative economic effect that the
devastating hurricane season had on the eastern United States this past year. As a result, we reached a significant milestone of a full year of profitability and the posting of strong revenues. The
trends that we believe will continue to positively impact us are the continued acceptance and market growth of Internet protocol telecommunications solutions and telephone systems, like those we sell
in the United States and in the Asia Pacific region. In fiscal 2004, we maintained our effort on the telephone system market while increasing our focus on the small-to-medium
sized call center market. In 2004, we also continued to focus on broadening our product portfolio, increasing our geographic markets and strengthening our channel of distributors and resellers. For
2004, our geographic market expansion strategy included building out our worldwide reseller base and growing our presence throughout Asia Pacific and

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Europe;
including new reseller and distributor relationships with several parties in Asia Pacific that we believe will fuel expansion into the Asian market. Our international business grew
significantly in the past year, with particular strength in China, where we substantially increased our revenues. Based on our financial position, our broad product offerings and assuming the
continued growth of international markets, we believe that we are well positioned to maintain our positive momentum into fiscal year 2005.

Convergence of Voice and Data

Traditionally, businesses have supported two separate, incompatible networks to handle their communications needs. The first network has been the traditional
telephone network, which relies on a technology called "circuit-switching." A circuit-switched network establishes and maintains a dedicated (i.e. not shared) line between calling parties for the
duration of a call. The second type of network on which businesses have traditionally relied is a "packet-switched" network, such as an internal local area network or an external network, like the
Internet, where voice, video, images or data is divided into small Internet protocol packets of information for transmission that are simultaneously combined with other unrelated packets of
information and routed to a final destination where this process is reversed. Packet-switched networks are more efficient than the traditional circuit-switched telephone network, because network paths
are not dedicated to a single user, but instead are available to be shared by all users. As a result, network capacity is allocated more efficiently. It is commonplace for networks installed today to
be able to support both voice and data usage with Internet protocol packet-switching.

A
growing number of businesses have recognized data networks as a valuable and economical medium for internal and public communications. These businesses seek to simplify their
telecommunication systems by moving their voice communications to packet-switched networks, such as corporate intranets and the Internet. Although intra-company voice communications via
packet-switched networks can offer value by lowering the cost of communications between locations and the ability to unify multi-site businesses and better support remote workers,
business-to-business and business-to-consumer communications accomplished by traditional circuit switched telephone networks remain the most prevalent
method for voice communications. Businesses that wish to take advantage of packet-switched networks for voice communications, therefore, must be able to place and receive calls over traditional
telephone networks with customers, suppliers and others who rely solely on the traditional networks for voice communications. Consequently, there is a need for one common switching system that can
interface with both packet-switched networks and traditional, circuit-switched, telephone networks.

Most
existing telecommunications systems do not address the needs of businesses that wish to transmit voice communications over both traditional telephone networks and packet-switching
networks. For example, businesses may wish to route internal calls over their existing voice network and route calls between offices over packet-switched networks, all using the same
telecommunications system. We believe a significant opportunity exists to provide small-to-medium sized and mid-enterprise businesses with an integrated phone
system that delivers the benefits of integrated, multi-function telecommunications systems using Internet protocol packet switching networks as well as traditional circuit-switched telephone networks.

THE ALTIGEN PRODUCT OFFERING

The foundation of every member of the AltiServ product family is an Internet protocol business telephone system and call processing telephony
architecture. The operating system for the AltiServ product family is AltiWare Open Edition. AltiWare's system design can be configured to integrate call processing and
routing with digital, analog and Internet protocol trunks, Internet protocol and analog extensions, voicemail, auto attendants and other voice processing and voice recording resources, including an
integrated call center application, all in a single high performance chassis. We have

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optimized
our Internet protocol telephone system performance in voice over Internet protocol environments by delivering a feature-rich business telephone system that supports the Bellcore
Standards and Internet protocol standards on a single open platform.

The
AltiServ Office family systems are complete Internet protocol business telephone systems that are pre-configured on custom designed and manufactured
industrial telephony server platforms. We pre-load the system with our AltiWare telephony software and Windows based system software, eliminating the need for resellers to
load the appropriate system software from scratch, allowing for faster, smoother installations with higher levels of reliability.

The
AltiServ product family of Internet protocol business telephone systems can be implemented for businesses requiring as few as eight extensions and supporting up to 400
users per individual system. Each individual system offers highly scalable single system growth with the ability to continue to expand by networking multiple local and remote systems together. These
networked systems can be at a single site, a campus environment or multiple locations throughout the world using Internet protocol technology to link them. The AltiServ product family
supports systems with logical stepped increments to allow an affordable entry point while maintaining a strong scalability and system growth. In 2004, we consolidated the AltiServ chassis
options in order to reduce our overall manufacturing costs. At the same time, we offered more flexible foundation platforms to give our resellers greater ability to adapt to the needs of their
customers with cost effective solutions such as the use of additional call processing telephony boards to individual systems to either accommodate system capacity growth or to support additional
telephony applications like conferencing, centralized recording and call center capabilities. These call processing telephony boards are designed to handle specific requirements like supporting
Internet protocol trunks and Internet protocol extensions or analog trunks and extensions. Internet protocol telephony boards can be used to perform Internet protocol gateway functions to tie systems
together over the Internet, a wide area or a local area network. High capacity digital telephony boards can provide communications via T1 or E1 and Integrated Services Digital Network/Primary Rate
Interface connections if desired. A T1 line is a single high capacity digital telephone trunk line that consists of 24 individual channels, each of which supports a transfer rate of 64K bits per
second. The E1 is the European high capacity digital trunk standard that consists of 30 individual channels. With AltiServ systems, all features can be integrated into a single system
chassis for simplicity. The call switching, voicemail, automatic call
distribution, automated attendants, conferencing resources, e-mail integration and computer telephony integration are core capabilities provided by AltiWare at no additional
cost.

In
fiscal 2004, we reached another important milestone by releasing Altiware 5.0 our sixth generation of telephony software. The AltiWare 5.0 software release
is the culmination of a 10 year engineering cycle of innovation on the AltiServ product family AltiWare 5.0 offers our customers both advanced and mature Internet
protocol private branch exchange features and significantly improves the call center capabilities of the AltiServ family of business telephone systems. The AltiServ family of
systems and solutions with AltiWare 5.0 offers resellers greater opportunities to provide solutions to a wider variety of business needs. Resellers can address businesses' needs of an
advanced telecommunications solution, such as AltiServ Voice Over Internet Protocol business telephone systems, and also pursue and deliver successful implementations for businesses
requiring advanced call center solutions, or integrated, centralized call recording, such as our AltiContact Manager.

With
the release of AltiWare 5.0, we continued to deliver meaningful capabilities to the small-to-medium sized business market. In this release we focused on key areas including
mobility, reliability and customer contact applications, which we believe are critical for our customers business success.



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AltiWare
5.0 offers businesses a simplier alternative to the traditional approach of constructing a telephone system or contact center by integrating multiple systems. Until
now, businesses
were required to purchase an entirely separate system for capabilities such as advanced routing, centralized call recording, automated attendants, interactive voice response applications, or telephony
integration with Customer Relationship Management applications. With AltiWare 5.0, these features are now included with an AltiServ system and, through licensing of
additional features, customers can simply turn on select capabilities and functions as needed. The outdated multi-system approach was complex to deploy, difficult to manage and expensive. Our modular
feature licensing allows businesses to add capabilities on a per feature or per user basis. The goal of flexible and modular feature licensing is to offer a reduced up front investment and allows
businesses to affordably implement advanced call center capabilities in even the smallest workgroup configurations.

In
2004, we have also enhanced the overall look and feel of all administrative interfaces and desktop personal computer software. With a focus on ergonomics and usability, all desktop
personal computer software and administration interfaces were redesigned, to include new capabilities for all desktop computer clients (AltiConsole, AltiAgent,
AltiSupervisor, AltiView, AltiContact Manager Administrator).

Also
in 2004, we introduced the AltiTouch 500 telephone and improved our Alti-IP 600 Internet protocol telephone. We believe that these developments
in fiscal year 2004 have prepared us to make further strides in our product and market penetration during fiscal year 2005.

In
2003, we first announced certification of the out-of-the-box integration of AltiServe Contact with Microsoft® customer
relationship management. We feel that this integration is a key contributor in broadening our ability to provide solutions to small-to-medium sized call centers that leverage emerging market
solutions. In 2004, we continued to augment our application integration solution. We provide automated "screen-pop" capabilities that present customer records to an employee's desktop
computer with inbound telephone calls to help businesses reduce transaction times and improve customer service. AltiWare 5.0 provides increased Microsoft customer relationship management
functionality, including a customer relationship management record dial-by-name search and dial facility and adds an integrated "dial-out" button to contact and
account records. Additionally, call history logging to customer relationship management activity records is automatic. In 2004, we had our certification renewed by Microsoft. As a gold certified
independent software vendor there are joint marketing opportunities that include, but are not limited to, our participation in Microsoft events, access to event sponsorship and access to Microsoft
solutions, developer support, its resellers and customers.

Key
benefits of our phone systems include:



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PRODUCTS

The following is a list of our products that are material to our current operations from a financial standpoint:

|Product               |  | Description                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|--------------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|AltiServ SmallOffice |  | The AltiServ SmallOffice system is a complete converged business telephone system targeted at 8 to 25 users. This multi-application Internet protocol telephony system combines a turnkey telephony chassis
with AltiWare telephony system software and a Quantum telephony board. This system includes a wall mountable 6 slot chassis (5 available for expansion). The base configuration can accommodate 8 users and can grow to support
50 users per system. The AltiServ SmallOffice includes the AltiServ Contact Center software module. AltiServ Contact Center provides automatic call distribution, desktop personal computer client interfaces for agents and
supervisors, enhanced call routing and call distribution, real-time detailed workgroup statistical reporting and comprehensive contact center management tools.                                                                                                                                                                            
|AltiServ1 IP         |  | The AltiServ1 IP business systems are comprehensive all Internet protocol configured systems targeted at 8 to 50 users. This multi-application Internet protocol telephony system combines a high performance telephony chassis with
AltiWare telephony system software and Triton VoIP telephony board. This system is unique as it includes 8 AltiGen Internet protocol Alti-IP 600 internet protocol telephones bundled with the base configuration. This system
includes a wall mountable 6 slot chassis (5 available for expansion). The base configuration can accommodate 12 or 30 users (configurable) and can grow to 75 users per system. The AltiServ1 IP includes the AltiServ Contact
Center software module. AltiServ Contact Center provides automatic call distribution, desktop personal computer client interfaces for agents and supervisors, enhanced call routing and call distribution, real-time detailed workgroup statistical
reporting and comprehensive contact center management tools.
|AltiServ Office II   |  | The AltiServ Office II systems are comprehensive mid-sized phone systems targeted at 24 to 100 phone extensions. This multi-application Internet protocol telephony system combines a high performance telephony chassis with
AltiWare telephony system software. This system includes an 11 slot industrial chassis. The AltiServ Office II is a highly scalable voice over Internet protocol telephone system. The AltiServ Office II is custom configured
to accommodate the needs of the customers and can grow to support 150 users per system. The AltiServ1 Office II includes the AltiServ Contact Center software module. AltiServ Contact Center provides automatic call distribution,
desktop personal computer client interfaces for agents and supervisors, enhanced call routing and call distribution, real-time detailed workgroup statistical reporting and comprehensive contact center management tools.                                                                                         
|                      |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           

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|AltiServ Office III     |  | The AltiServ Office III systems are comprehensive high capacity phone systems targeted at 50 to 300 telephone extensions This multi-application Internet protocol telephony system combines a high performance telephony chassis with
AltiWare telephony system software. This system includes a 15 slot industrial chassis. The AltiServ Office III is custom configured to accommodate the needs of the customers and can grow to support 400 users per system. The
AltiServ Office III includes the AltiServ Contact Center software module. AltiServ Contact Center provides automatic call distribution, desktop personal computer client interfaces for agents and supervisors, enhanced call
routing and call distribution, real-time detailed workgroup statistical reporting and comprehensive contact center management tools.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|------------------------ |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|AltiServ Contact Center |  | The AltiServ Contact Center software module provides automatic call distribution, desktop personal computer client interfaces for agents and supervisors, enhanced call routing and call distribution, real-time detailed workgroup statistical
reporting and comprehensive contact center management tools. The AltiServ Contact Center software module is an optional software module for AltiServ systems running versions of telephony software prior to AltiWare 5.0 and is a
standard feature included in 5.0.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|AltiContact Manager     |  | AltiContact Manager call center software module is an optional software module that can be loaded on any AltiServ telephony system running version 5.0 and later of AltiWare telephony software. AltiContact Manager is our most
advanced contact center solution. AltiContact Manager is designed to provide businesses comprehensive, easy-to-use tools and technology designed specifically for a call center to enhance the call routing and call handling capabilities.
AltiContact Manager also provides improved workgroup reporting and management tools to increase agent productivity. AltiContact Manager includes enhanced Automated Call Distribution that includes enhanced call routing and call
distribution, skills-based routing and dynamic call prioritization. AltiContact Manager also provides Interactive Voice Response with the integration of advanced voice messaging into call queuing, auto attendant, centralized and on-demand voice
call recording and desktop personal computer client interfaces for agents and supervisors, real time detailed workgroup statistical reporting and comprehensive contact center management tools. With AltiContact Manager, modular feature licensing
allows businesses to add capabilities on a per feature or per user basis. This flexible and modular feature licensing offers a reduced up-front investment. AltiContact Manager offers a single, integrated telephone system and complete contact
center designed to be managed by an in-house IT staff.
|                         |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            

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|AltiServ HPBX                           |  | AltiServ H-PBX is the AltiGen hosted voice over Internet protocol private branch exchange solution for multi-tenant organizations supporting up to 99 separate organizations and up to 400 users per AltiServ system server.
AltiServ H-PBX is an overlay software application applied AltiServ Office systems running 4.6 and later versions of AltiWare OE telephony software. Larger multi-tenant organizations or installations can network multiple
AltiServ H-PBXs systems to accommodate growth. The AltiServ H-PBX creates a modular implementation allowing each tenant partition to function like an independent voice over Internet protocol telephone system with its own auto attendant,
directory service, operator, business hours, holiday profile, hunt groups, and voicemail. For businesses with contact centers or call center needs, the AltiServ Contact Center is an option call center module that can be added. With this
AltiServ Contact Center option, integrated contact center capabilities can be provided to the multiple individual tenants. Clients can be in the same building, different buildings, remote locations or a combination of geographical
configurations.
|---------------------------------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Alti-IP 600 Internet Protocol Telephone |  | The Alti-IP 600 telephone is an advanced industry standard Internet protocol telephone designed for the AltiServ business telephone systems. This Internet protocol phone is a dynamic, display-based Internet protocol communications phone
that offers traditional telephone functions on an Internet protocol based technology. With an LCD display, speakerphone and both programmable and pre-programmed soft keys, the Alti-IP 600 offers customers one-touch feature buttons to
access functionalities such as voicemail, conference, hold, transfer, intercom, adjust volume, redial, call release, speed dial, and more.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|AltiTouch 500                           |  | The AltiTouch 500 telephone is an executive level speaker display analog telephone, specifically Telephone engineered for the AltiServ IP-PBX to provide high functionality at an affordable price. The AltiTouch 500 telephone is
equipped with a high quality speakerphone and an ultra large font, backlit display with adjustable viewing angle and both programmable and pre-programmed keys, the AltiTouch 500 offers customers one-touch feature buttons to access
functionalities such as voicemail, conference, hold, transfer, intercom, adjust volume, redial, call release, speed dial, and more. This high function telephone has standard features that include a built in analog data port and a RJ-22 amplified
headset jack.                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|AltiWare OE                             |  | Our AltiWare software works with our AltiServ systems and is designed to manage the switching of calls (placing and receive telephone calls) over Internet protocol or public telephone networks. AltiWare manages overall call processing for
the system and includes value added functions such as voicemail, automatic call distribution, automated attendant, unified messaging, call detail recording and built-in integration with popular customer relationship management packages.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|                                         |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  

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|AltiView                    |  | AltiView is a Windows-based desktop application designed to bring call control and visual voice mail management to the desktop in order to improve the ability to manage telephone calls and voicemail. AltiView is designed to allow its
users to receive and place calls, listen to voicemail messages and identify the phone number of the caller and to manage the basic configuration option for each extension such as forwarding and one number access. This desktop personal computer
software productivity application works with all AltiServ Office, AltiServ1 IP, AltiServ H-PBX and AltiContact Manager systems.            
|---------------------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|AltiAgent                   |  | AltiAgent is a Windows-based desktop application to bring call control and workgroup information to contact center agents and is designed to work with both the AltiServ Contact Center and AltiContact Manager systems to improve agent
performance. Users can view the queue, monitor workgroup status, check caller identification, view Interactive Voice Response prompted input, measure performance, review log-on history, receive and place calls, listen to and manage voicemail
messages.                                                                                                                                        
|AltiSupervisor              |  | AltiSupervisor is a Windows-based desktop application for contact center supervisors designed to work with both the AltiServ Contact Center and AltiContact Manager systems. AltiSupervisor is designed to provide information and
tools to help a call center or workgroup supervisor effectively manage a workgroup. AltiSupervisor provides four major real time module views for workgroup management: agent states, agent statistics, group statistics, and queue status with a
quality of services capability. AltiSupervisor allows silent monitoring of agents with barge-in call participation and call recording functionality.
|Triton IP Board             |  | The Triton IP Board is a microprocessor-controlled board supporting voice over Internet protocol communications. This allows voice conversations to be carried over public and private data networks that support Internet protocol. The
Triton IP Board is a 12-port board that can be software configured to 30 ports. The Triton IP Board can be used for Internet protocol trunks connecting multiple networked AltiServ systems or to support voice over
Internet protocol telephones extensions and voice over Internet protocol agent extensions.                                                                                   
|Triton T1, E1, T1/PRI Board |  | The Triton T1, E1, T1/PRI Board is a microprocessor-controlled board that allows AltiServ systems to connect to T1, E1 or T1/PRI digital high-capacity central office telephone lines. This board can be configured with software to
support provisioning for T1, E1 or T1/PRI communication protocols.                                                                                                                                                                                                                                                                                                                                      
|Triton Trunk Board          |  | The Triton Trunk Board is a 12 port, microprocessor-controlled board that allows AltiServ systems to connect to analog central office telephone lines. This allows outbound and inbound calls to be carried over traditional analog
central office telephone lines.                                                                                                                                                                                                                                                                                                                                                                          
|                             |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                

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|Triton Extension Board |  | The Triton Extension Board is a 12 port, microprocessor-controlled board that allows AltiServ systems to support 12 analog telephone extensions with each Triton Extension Board.                                                                                                                                  
|----------------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Quantum Board          |  | The Quantum Board is a 12-port microprocessor-controlled board that comes in 2 combinations of trunk plus extension configurations on the same board. The Quantum Board allows AltiServ systems to connect to analog central office
telephone lines and to support analog telephone extensions with the same board.

AltiGen Hardware and Firmware

We have developed a single base circuit board with high performance digital signal processing technology, which means that the circuit board has an integrated
computer built on it that can run special, high-speed software programs, called firmware. Firmware can receive, send and modify digital information for communications with network
services. Our Triton family of digital signal processing board is designed to allow us to create different circuit boards to meet many communication requirements by simply adding a few
hardware and/or software components to the basic board. For example, the Triton digital signal processing board can become a T1, E1 or Integrated Services Digital Network communication
circuit board or a circuit board supporting voice over Internet protocol with simple changes in on-board software and, in some cases, new circuits.

This
modular design not only enables us to provide new capabilities, but we also feel that it enables our products to achieve a high degree of reliability and cost reduction since the
underlying technology is consistent across our products.

AltiGen Modular Software

Our software products are based on modular software components similar to the concept described above for our hardware and firmware. The service provider layer of
software is composed of separate software components, each of which communicates with a hardware circuit board within the AltiServ system. The middleware layer interacts with all the
service providers in the system and manages their resources. This middleware layer communicates with the hardware and allows application programs to provide specific features. The application program
layer consists of components that implement the application logic, such as voicemail and auto attendant. These applications do not depend on any particular hardware integration.

We
believe that the layered architectural structure of our AltiServ products provides important benefits:



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Net Revenues by Products:

Fiscal Year Ended
September 30,2004

2003

2002Hardware

84
%
87
%
84
%Software

16
%
13
%
16
%


MARKETING, SALES AND CUSTOMER SUPPORT

Marketing

Our marketing efforts currently focus on increasing demand for our products in the Americas, Europe and Asia Pacific. We are working to increase market awareness
of our technology and demand for our products in the small-to-medium sized business and call center markets through public relations, print, email and web campaigns.

Among
our marketing highlights are the following awards:



To
assist our distributors, dealers and strategic partners, we provide market development funds, marketing tools and technical and sales training developed specifically for our products.
We expect that these programs will allow us to leverage the expertise and contacts of the local and regional reseller channel to create strong lead generation.

Sales

We are organized as one operating segment. Our revenues primarily are generated from one geographic area, the Americas.

Net
Revenues by Geographic Area:

Fiscal Year Ended
September 30,2004

2003

2002Americas

90
%
94
%
94
%International

10
%
6
%
6
%


We
currently have sales and support staff in New York, Illinois, Nevada, Florida, Virginia, China and in our headquarters in Fremont, California. Our inside sales force answers incoming
calls from end users and refers new leads to a qualified dealer near each end user's location. The inside sales force also is responsible for account management of our smaller resellers. Our outside
sales force, which is primarily based in the Americas, includes regional directors, regional sales managers and technology solutions managers who work with our larger resellers and recruit new
reseller partners. In fiscal 2004,

14

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we
continued our expansion to a more scalable reseller community by signing on an increasing number of resellers that currently sell traditional and Internet protocol telephone systems manufactured by
companies such as Avaya, 3Com, Nortel, Comdial and NEC.

Customers

Our direct customers primarily are distributors and resellers who sell our products to end-users. We have distribution agreements with AltiSys, Ingram
Micro, Graybar and Synnex in the Americas. Our agreements with AltiSys, Ingram Micro, Graybar and Synnex have initial terms of one year and are renewed automatically for additional
one-year terms, provided that each party shall have the right to terminate the agreement for convenience upon 90 days' written notice prior to the end of the initial term or any
subsequent term of the agreement. In addition, our agreements with AltiSys, Ingram Micro, Graybar and Synnex also provide for termination, with or without cause, by either party upon 30 days'
written notice to the other party without penalty, or upon insolvency or bankruptcy. For a period of 60 days' following termination of the agreement, AltiSys,
Ingram Micro, Graybar and Synnex may distribute any products in their possession at the time of termination or, at their option, return any products to us that are in their inventories. Upon
termination of the distribution agreement, all outstanding invoices for the products will become due and payable within 30 days' of the termination.

Net
Revenues by Customers:

Fiscal Year Ended
September 30,2004

2003

2002AltiSys

14
%
18
%
27
%Ingram Micro

14
%
21
%
25
%Synnex

46
%
48
%
32
%Graybar

8
%





We
also have over 200 authorized resellers who sell our products directly to end-users. We review our resellers quarterly and discontinue distribution through those who do
not meet our revenue or technical standards.

Customer Support

We believe that consistent, high-quality service and support are key factors in attracting and retaining customers. Our customer support groups,
located in California, New York, and Shanghai, coordinate service and technical support of our products and provide service twenty-four hours a day, seven days a week. Our support
personnel assist our distributors and resellers in resolving installation and support issues that arise from their sales to end users and also provide limited support to end-users to
supplement dealer support. Resellers and end user customers also can access technical information and receive technical support through our web site.

RESEARCH AND DEVELOPMENT

The market for our products is characterized by rapidly changing technology, evolving industry standards and frequent product introductions. We believe that our
future success depends in large part upon our ability to continue to enhance the functionality and uses of our core technology. We intend to extend the functionality and uses of our hardware and
software technology and develop new products by continuing to invest in research and development.

We
currently are developing enhancements to our products to provide greater functionality and increased capabilities. We also are developing products that we expect will enable us to
enhance our position in the Internet protocol phone system market space, enter new geographical markets, and allow us to enter the call center market for small-to-medium sized
businesses.

15

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We
currently conduct the majority of our product development in-house. We also use a small number of independent contractors to assist with certain product development and
testing activities. We intend to continue working with our strategic partners to enhance our products. As of September 30, 2004, we employed 50 individuals in engineering, research and
development and support.

During
fiscal 2004, 2003, and 2002, our research and development expense was approximately $3.3 million, $4.0 million, and $4.1 million, respectively.

COMPETITION

The markets for our products are intensely competitive, continually evolving and subject to changing technologies. We currently compete with companies providing
traditional telephone systems and attempting to launch competitive Internet protocol enabled solutions, principally Avaya Communications, NEC and Nortel Networks. We also compete against companies
providing only Internet protocol and Internet protocol-enabled telecommunications systems, such as 3Com Corporation and Cisco Systems, Inc. Many of our competitors are substantially larger than
us and have significantly greater name recognition, financial, sales and marketing, technical, customer support, manufacturing and other resources. These competitors also may have more established
distribution channels and stronger relationships with local, long distance and Internet service providers. These competitors may be able to respond more rapidly to new or emerging technologies and
changes in customer requirements or devote greater resources to the development, promotion and sale of their products.

These
competitors may enter our existing or future markets with products that may be less expensive, that may provide higher performance or additional features or that may be introduced
more quickly than our products. In fiscal 2004, we believe that we continued to be both feature and price competitive. Additionally, we feel we provide a low ongoing cost of ownership. We believe that
our principal competitive advantages include:



INTELLECTUAL PROPERTY

On September 26, 2003, we entered into a royalty free-based object license agreement with Delphi Communication Systems, Inc. The
agreement may be terminated by either party if the other party

16

---



commits
a material breach of the agreement and fails to cure the breach within thirty days after the notice has been given by the other party.

We
generally rely upon patent, copyright, trademark and trade secret laws to protect and maintain our proprietary rights for our technology and products. As of September 30, 2004,
we have been issued three registered trademarks, "AltiGen," "AltiServ" and "Zoomerang." In addition, the AltiGen logo is a trademark of AltiGen in the United States and other jurisdictions.

We
have filed several U.S. patent applications relating to various aspects of our client and server software, mixed-media communications and computer telephony. As of
September 30, 2004, we have been issued seven U.S. patents that expire at various times between 2016 and 2019 and have 11 U.S. patent applications which are pending. We expect to continue to
file patent applications to protect our technology and products. We cannot be sure that our patent applications will result in the issuance of patents, or that any issued patents will provide
commercially significant protection for our technology.

MANUFACTURING AND ASSEMBLY

Our manufacturing operations consist of two phases. In the first phase, we send out the components to a third party assembler. The third party assembler company
auto-inserts the components into the printed circuit boards and returns the assembled circuit board back to us. In the second phase, we insert the assembled circuit boards into the
burn-in process for a minimum of two weeks and after that we perform the final test of the circuit boards. In fiscal year 2004, we engaged All Quality Services and Bestronics in San Jose
as our third party assemblers. During fiscal 2004, four suppliers, Advantech, BCM Computers, Fanstel Corporation, and Avnet Electronics, provided us with approximately 81% of our hardware product
components. We purchase fully-assembled chassises from Advantech. As of September 30, 2004, our in-house manufacturing operations occupied approximately 7,000 square feet of our
corporate headquarters in Fremont, California.

We
test our products after the assembly process using internally developed product assurance testing procedures, which include visual inspection, functional testing and final systems
testing. Although we generally use standard components for our products and try to maintain alternative sources of supply, we purchase some key components from sole source suppliers for which
alternative sources currently are not available. We incorporate the following sole sourced components in our products:



17

---





Loss
of any key component supplier would adversely impact our business.

EMPLOYEES

As of September 30, 2004, we had 96 full-time employees, including 50 in research and development and support, 27 in marketing and sales, 7 in
operations, and 12 in finance and administration. Of these full-time employees, 54 were located in the United States and
42 in China. Our future success will depend, in part, on our ability to continue to attract, retain and motivate highly qualified technical, marketing, engineering and management personnel.

Item 2. Properties

As of September 30, 2004, our headquarters for corporate administration, research and development, manufacturing and sales and marketing occupied 32,000
square feet of space in Fremont, California. The lease expires on February 21, 2009. Outside the United States, we lease approximately 9,400 square feet of a facility in Shanghai, China, where
we conduct administration, research and development, sales and marketing, and another 1,600 square feet of a facility in Beijing, China to serve sales and marketing functions. We believe that our
existing facilities are adequate for our needs through at least the end of year 2005. We believe that any additional space we may need in the future will be available on commercially reasonable terms.

Item 3. Legal Proceedings

On September 6, 2002, Vertical Networks, Inc. filed suit against us in the United States District Court for the Northern District of California,
alleging infringement of Vertical Networks' U.S. Patents Nos. 6,266,341; 6,289,025; 6,292,482; 6,389,009; and 6,396,849. On October 28, 2002, Vertical Networks amended its complaint to add
allegations of infringement of U.S. Patents Nos. 5,617,418 and 5,687,174. Vertical Networks filed a second amended complaint on November 20, 2002 to identify our products and/or activities that
allegedly infringe the seven patents-in-suit. Vertical Networks seeks a judgment of patent infringement and an award of damages, including treble damages for alleged willful
infringement, and attorneys' fees and costs. We filed an answer and counterclaims for declaratory relief on December 9, 2002. On December 26, 2002, Vertical Networks filed its answer to
our counterclaims. Vertical Networks served its preliminary infringement contentions on us on April 9, 2003 and we served Vertical Networks our preliminary invalidity contentions on
June 3, 2003 and July 14, 2003, respectively. To date, the parties have exchanged some discovery, but no depositions have been taken, and no motions are currently pending. On
October 7, 2003, the parties filed a stipulation to stay this action, pending the outcome of the reissue of some of the subject patents before the U.S. Patent and Trademark Office. We believe
we have strong defenses and arguments in this dispute and intend to vigorously litigate our position. Management's view is that any loss from this litigation is not probable or estimable.

From
time to time, we may become party to litigation and subject to claims arising in the ordinary course of our business. To date, these actions have not had a material adverse effect
on our financial position, result of operations or cash flows. Although the results of litigation and claims cannot be predicted with certainty, we believe that the final outcome of such matters would
not have a material adverse effect on our business, financial position, results of operation and cash flows.

Item 4. Submission of Matters to a Vote of Security Holders

None.

18

---



Item 4A. Executive Officers of the Registrant

The following table sets forth certain information with regard to our executive officers and their ages as of September 30, 2004:

|Name                  |  | Age |  | Position                                    
|--------------------- |  | --- |  | --------------------------------------------
|Gilbert Hu            |  | 47  |  | President, Chief Executive Officer, Director
|Philip M. McDermott   |  | 58  |  | Chief Financial Officer                     
|Michael Plumer        |  | 40  |  | Vice President of Sales                     
|Simon Chouldjian      |  | 51  |  | Vice President of Hardware Engineering      
|Tsyr-Yi (Shirley) Sun |  | 44  |  | Vice President of Research and Development  

Gilbert
Hu founded AltiGen and has served as our President, Chief Executive Officer and a director since May 1994. Before founding AltiGen, Mr. Hu was a founder, President
and Chief Executive Officer of Centrum Communications, Inc., a networking company acquired by 3Com Corporation in early 1994. Mr. Hu has also served in technical and managerial roles at
Vitalink Communication Corporation, an internet working equipment manufacturer. He received a Bachelor of Science degree in Electrical Engineering from National Chiao-Tung University in
Taiwan and a Master of Science degree in Electrical Engineering from Arizona State University.

Philip
M. McDermott has served as our Chief Financial Officer since June 1999. From October 1995 to May 1999, Mr. McDermott served as Director of Finance for
Americas Sales for 3Com Corporation. From October 1994 to October 1995, Mr. McDermott served as Vice President of Finance, Operations and Administration for DAVID Systems, a
division of Chipcom Corporation, a public networking company. Chipcom was subsequently acquired by 3Com Corporation. Mr. McDermott received Certified Management Accountant accreditation from
The Society of Management Accounting in Montreal, Canada.

Michael
Plumer has served as our Vice President of Sales since July 2004. Mr. Plumer joined AltiGen in November 1996 to begin building the AltiGen sales channel. In
the past eight years he has held various positions including Senior Director of Sales and National Sales Director. From January 1994 until October 1996, Mr. Plumer worked for
NetManage, Inc. Mr. Plumer received a Bachelor of Arts degree in Journalism and Public Relations from Iowa State University.

Simon
Chouldjian has served as our Vice President of Hardware Engineering since November 2001. Prior to this, he has served as our Vice President of Manufacturing from
June 1997 to November 2001. From July 1984 to June 1997, Mr. Chouldjian was the founder and Vice President of Engineering of Luxcom, Inc., a manufacturer of
communication hub equipment. Mr. Chouldjian has held supervisory and project leader positions in engineering at the Hewlett Packard Company and TRW, Inc. He received a Bachelor of
Science degree in Electrical Engineering from the University of California, Berkeley and a Master of Science degree in Electrical Engineering from Stanford University.

Tsyr-Yi
(Shirley) Sun has served as our Vice President of Research and Development since October 1999. Prior to that role, she served as our Director of Internet
Protocol Telephony from April 1998 to October 1999. From February 1994 to March 1998, Ms. Sun worked for 3Com Corporation as an engineering manager. From
August 1991 to February 1994, Ms. Sun was a founder and an engineering manager with Centrum Communications, Inc., a networking company acquired by 3Com Corporation in early
1994. Ms. Sun received a Bachelor of Science degree in Mechanical Engineering
from National Central University in Taiwan and a Master of Science degree in Computer Science from Utah State University.

19

---





PART II

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters

From October 4, 1999, the date of our initial public offering, to June 11, 2002, our common stock was traded on the Nasdaq National Market under the
symbol "ATGN". Since June 12, 2002, our common stock has traded on the Nasdaq SmallCap Market under the symbol "ATGN." The following table sets forth the range of high and low sales prices for
our common stock for the periods indicated:

Fiscal 2004

Fiscal 2003High

Low

High

Low1st Quarter

$
4.00

$
2.49

$
0.84

$
0.432nd Quarter

$
5.09

$
3.59

$
0.98

$
0.633rd Quarter

$
3.81

$
2.43

$
1.84

$
0.944th Quarter

$
3.43

$
2.35

$
3.81

$
1.30


As
of September 30, 2004, we had approximately 106 stockholders of record of our Common Stock. We have never declared or paid any cash dividends on our capital stock. We currently
expect to retain future earnings, if any, to support operations and to finance the growth and development of our business. We do not expect to pay cash dividends in the foreseeable future.

We
received aggregate net proceeds of approximately $33.3 million from the initial public offering of shares of our common stock in October 1999. As of September 30,
2004, proceeds from our initial public offering have been used for working capital and general corporate purposes, including research and development of new products, sales and marketing efforts,
general and administrative expenses and international expansion. The remaining net proceeds have been invested in cash, cash equivalents and short-term investments.

|Plan category                                              |  | Number of securities to
be issued upon exercise
of outstanding options,
warrants and rights
(a) |  | Weighted-average exercise
price of outstanding
options, warrants
and rights
(b) |      | Number of securities
remaining available for
future issuance under
equity compensation
plans (excluding
securities reflected
in column (a))1
(c)
|---------------------------------------------------------- |  | ----------------------------------------------------------------------------------------------- |  | ------------------------------------------------------------------------------- | ---- | ------------------------------------------------------------------------------------------------------------------------------------------------
|Equity compensation plans approved by security holders     |  | 3,751,814                                                                                       |  | $                                                                               | 3.79 |                                                                                                                                                 
|Equity compensation plans not approved by security holders |  |                                                                                                |  |                                                                                 |     |                                                                                                                                                 
|                                                           |  |                                                                                                 |  |                                                                                 |      |                                                                                                                                                 
|Total                                                      |  | 3,751,814                                                                                       |  | $                                                                               | 3.79 |                                                                                                                                                 
|                                                           |  |                                                                                                 |  |                                                                                 |      |                                                                                                                                                 

---

Item 6. Selected Financial Data

This section presents selected historical financial data of AltiGen Communications, Inc. This section should be read carefully in conjunction with
"Management's Discussion and Analysis of Financial Conditions and Results of Operations" and the consolidated financial statements included in

20

---



this
Form 10-K, including the notes to the consolidated financial statements. The selected data in this section is not intended to replace our consolidated financial statements.

|                                                             |  | Fiscal Year Ended September 30, |        
|------------------------------------------------------------ |  | ------------------------------- | -------
|
|
|Consolidated Statements of Operations Data:                  |  |                                 |        
|Revenues, net                                                |  | $                               | 14,842 
|Cost of revenues                                             |  |                                 | 5,607  
|                                                             |  |                                 |        
|Gross profit                                                 |  |                                 | 9,235  
|Operating expenses:                                          |  |                                 |        
|Research and development                                     |  |                                 | 3,288  
|Sales and marketing                                          |  |                                 | 4,130  
|General and administrative                                   |  |                                 | 1,894  
|Amortization of deferred stock compensation                  |  |                                 |       
|                                                             |  |                                 |        
|Total operating expenses                                     |  |                                 | 9,312  
|                                                             |  |                                 |        
|Loss from operations                                         |  |                                 | (77    
|Write-down of long term investment                           |  |                                 |       
|Interest and other income, net                               |  |                                 | 105    
|                                                             |  |                                 |        
|Net income (loss)                                            |  | $                               | 28     
|                                                             |  |                                 |        
|Basic and diluted net income (loss) per share                |  | $                               | 0.00   
|                                                             |  |                                 |        
|Shares used in computing basic net income (loss) per share   |  |                                 | 14,242 
|Shares used in computing diluted net income (loss) per share |  |                                 | 15,725 
|Consolidated Balance Sheets Data:                            |  |                                 |        
|Cash, cash equivalents and short-term investments            |  | $                               | 10,034 
|Working capital                                              |  |                                 | 10,314 
|Total assets                                                 |  |                                 | 13,516 
|Accumulated deficit                                          |  |                                 | (50,835
|Total stockholders' equity                                   |  |                                 | 10,669 

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

FORWARD-LOOKING INFORMATION

This report contains certain forward-looking statements (within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as
amended) and information relating to us that are based on the beliefs of our management as well as assumptions made by and information currently available to our management. Additional forward looking
statements may be identified by the words "anticipate," "believe," "expect," "intend," "plan," or the negative of such terms, or similar expressions, as they relate to us or our management.

The
forward-looking statements contained herein reflect our judgment as of the date of this report with respect to future events, the outcome of which is subject to certain risks, that
may have a significant impact on our business, operating results or financial condition. You are cautioned that these forward-looking statements are inherently uncertain. Should one or more of these
risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results or outcomes may vary

21

---



materially
from those described herein. Although we believe that the expectations reflected in these forward-looking statements are reasonable, we cannot guarantee future results, levels of activity,
performance or achievements. You should carefully review the cautionary statements contained in this Form 10-K, including the "Certain Factors Affecting Business, Operating Results
and Financial Condition" below.

OVERVIEW

We are a pioneer and market leader in Internet protocol telephony systems for small-to-medium sized businesses. We design, manufacture and
market next generation, Internet protocol phone systems and contact centers that use both the Internet and the public telephone network to take advantage of the convergence of voice and data
communications. Unlike traditional proprietary phone systems, our systems are designed with open architecture and are built on an industry standard platform. This adherence to industry standards
allows our products to play an important role in the small-to-medium sized business market by delivering phone systems that can integrate with other technologies and provide
integrated voice and data solutions. We believe this enables our customers to implement communication systems that have an increased return versus past technology investments. We generated net
revenues of $14.8 million, for a net profit of $28,000, during fiscal year 2004. As of September 30, 2004, we had an accumulated deficit of $50.8 million. Net cash used in
operating activities was $185,000 for fiscal year 2004.

We
derive our revenues from sales of our AltiServ telephone systems. Product revenues consist of sales to end-users (including dealers) and to distributors.
Revenues from product sales to end users and resellers are recognized upon shipment. We defer recognition of revenue for sales to distributors until they resell our products to their customers. Upon
shipment, we also provide a reserve for the estimated cost that may be incurred for product warranty. Under our distribution contracts, a distributor has the right, in certain circumstances, to return
products it determines are overstocked, so long as it provides an offsetting purchase order for products in an amount equal to or greater than the dollar value of the returned products. In addition,
we provide distributors protection from subsequent price reductions.

Our
cost of revenues consists of component and material costs, direct labor costs, provisions for excess and obsolete inventory, warranty costs and overhead related to the manufacturing
of our products. Several factors that have affected and will continue to affect our revenue growth are the state of economy, the market acceptance of our products, our ability to add new resellers and
our ability to design, develop, and release new products. We engage a third-party assemblers, which in fiscal year 2004 were All Quality Services and Bestronics in San Jose, to insert the hardware
components into the printed circuit board. We selected our manufacturing partners with the goals of ensuring a reliable supply of high-quality finished products and lowering per unit
product costs as a result of manufacturing economies of scale. We cannot assure that we will maintain the volumes required to realize these economies of scale or when or if such cost reductions will
occur. The failure to obtain such cost reductions could materially adversely affect our gross margins and operating results.

As
of September 30, 2004, we had cumulative net operating loss carry forwards for federal and California income tax reporting purposes of approximately $42.6 million and
$14.6 million, respectively, available to offset income in future years. The cumulative net operating loss carry forwards will expire in various periods from 2009 to 2024, if they are not
utilized. Under current tax law, net operating loss carry forwards available in any given year may be limited upon the occurrence of certain events, including changes of ownership interest. We have
not recognized any future tax benefits of our cumulative net operating losses due to uncertainty as to future realizability.

We
continue to focus on developing enhancements to our current products to provide greater functionality and increased capabilities, based on our market research, customer feedback and
our competitors' product offerings and creating new product offerings. In particular, we are focusing on

22

---



developing
products that allow us to enhance our position in our target market segment and enter new geographical markets. Additionally, we intend to continue to focus on selling our products to
small-to-medium sized businesses and branch offices of larger corporations, which are business with less than 500 employees, with particular emphasis in the Internet protocol
phone systems segment of the telecommunications market. Also, we plan to continue to recruit additional resellers and distributors that focus on selling phone systems to our target customers. There
can be no assurance, however, that we will be successful in developing any new products or enhancements to existing products, entering new geographical or product markets or expanding our network of
resellers. We believe that the adoption rate for this new technology is much faster with small-to-medium sized businesses because they have no significant investment on their
books for traditional phone systems. Also we believe that small-to-medium sized businesses are looking for call center-type administration to increase the
productivity and efficiency of their contacts with customers. Assuming the continued market trends, successful product enhancements, the continuing acceptance of the call center products, continuing
growth in the marketplaces of China, the United Kingdom and Norway, and the status quo of the North American economy, we expect to see continued revenue growth for fiscal 2005 at a rate equal to this
fiscal year.

CRITICAL ACCOUNTING POLICIES

Revenue recognition.Revenues consist of sales to end users, including resellers, and to distributors. Revenues from sales to
end users are recognized upon shipment, when risk of loss has passed to the customer, collection of the receivable is reasonably assured, persuasive evidence of an arrangement exists, and the price is
fixed and determinable. Sales to distributors are made under terms allowing certain rights of return and protection against subsequent price declines on the our products held by its distributors. Upon
termination, any unsold products may be returned by the distributor for a full refund. These agreements may be canceled by either party based on a specified notice. As a result of the above
provisions, we defer recognition of distributor revenues until such distributors resell our products to their customers. The amounts deferred as a result of this policy are reflected as "deferred
revenue" in the accompanying consolidated balance sheets. The related cost of revenues is also deferred and reported in the consolidated balance sheets as inventory. Our total deferred revenue was
$518,000 and $412,000 as of September 30, 2004 and September 30, 2003, respectively.

Allowance for Doubtful Accounts.The allowance for doubtful accounts is based on our assessment of the collectibility of
specific customer accounts and the aging of the accounts receivable. If there were a deterioration of a major customer's creditworthiness, or actual defaults were higher than our historical
experience, we could be required to increase our allowance and our earnings could be adversely affected. Our allowance for doubtful accounts was $35,000 and $60,000 as of September 30, 2004 and
September 30, 2003, respectively.

Inventory.Inventory is stated at the lower of cost (first-in, first-out method) or market. Our
inventory balance was $1.1 million and $0.9 million as of September 30, 2004 and September 30, 2003, respectively. We regularly review the value of our inventory in detail,
with consideration given to future customer demand for our products, obsolescence from rapidly changing technology, and other factors. If actual market conditions are less favorable than those
projected by management, and our estimates prove to be inaccurate, we could be required to increase our inventory provision and our gross margins could be adversely affected. Our inventory allowance
was $2.6 million and $2.9 million as of September 30, 2004 and September 30, 2003, respectively.

Warranty.We accrue for warranty costs based on estimated product return rates and the expected material and labor costs to
provide warranty services. If actual return rates and repair and replacement costs differ significantly from our estimates, our gross margin could be adversely affected. The liability for product
warranties was $424,000 and $644,000 as of September 30, 2004 and September 30, 2003, respectively.

23

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Results of Operations

The following table sets forth consolidated statements of operations data for the periods indicated as a percentage of net revenues.

|                                            |          | Fiscal Year Ended
September 30, |     
|------------------------------------------- | -------- | ------------------------------- | ----
|
|Consolidated Statements of Operations Data: |          |                                 |     
|Net revenue:                                |          |                                 |     
|                                            | Hardware |                                 | 84.0
|                                            | Software |                                 | 16.0
|                                            |          |                                 |     
|                                            |          | Total net revenue               |     
|Cost of revenues:                           |          |                                 |     
|                                            | Hardware |                                 | 36.5
|                                            | Software |                                 | 1.3 
|                                            |          |                                 |     
|                                            |          | Total cost of revenues          |     
|                                            |          |                                 |     
|Gross profit                                |          | 62.2                            |     
|                                            |          |                                 |     
|Operating expenses:                         |          |                                 |     
|Research and development                    |          | 22.2                            |     
|Sales and marketing                         |          | 27.8                            |     
|General and administrative                  |          | 12.8                            |     
|Amortization of deferred stock compensation |          |                                |     
|                                            |          |                                 |     
|Total operating expenses                    |          | 62.8                            |     
|                                            |          |                                 |     
|Loss from operations                        |          | (0.6                            | )   
|Write-down of long term investment          |          |                                |     
|Interest and other income, net              |          | 0.7                             |     
|                                            |          |                                 |     
|Net income (loss)                           |          | 0.1                             | %   
|                                            |          |                                 |     

Fiscal Year Ended September 30, 2004 Compared to Fiscal Year Ended September 30, 2003

Revenues, net.Revenues consist of sales to end users (including resellers) and distributors.

Net
Revenues by Products:

Fiscal Year Ended
September 30,2004

2003Hardware

84
%
87
%Software

16
%
13
%


Net
Revenues by Geographic Area:

Fiscal Year Ended
September 30,2004

2003Americas

90
%
94
%International

10
%
6
%


24

---



Net
Revenues by Customers:

Fiscal Year Ended
September 30,2004

2003AltiSys

14
%
18
%Ingram Micro

14
%
21
%Synnex

46
%
48
%Graybar

8
%
0
%


Revenues
generated in the Americas accounted for $13.3 million or 90% of revenues in fiscal year 2004 and $11.1 million or 94% of revenues in fiscal year 2003. Net revenues
increased 25% from $11.8 million in fiscal year 2003 to $14.8 million in fiscal year 2004 due to the increased sales in telephone systems as a result of upgrading the quality of our
authorized resellers, selling more products into the call center market space, the sales of larger systems and the doubling of our international revenues, especially in China.

Cost of revenues.Cost of revenues in fiscal year 2004 increased $0.6 million or 12% to $5.6 million from
approximately $5.0 million in fiscal year 2003 due to an increase in overall sales of products and the
requisite increase in product costs. Cost of revenues as a percentage of net revenues decreased from 42% in fiscal year 2003 to 38% in fiscal year 2004. The decrease was caused by the decrease in
warranty reserve of $354,000 due to the decline in the product return rate and the $240,000 adjustment of the inventory allowance associated with the sale of products which were previously reserved.
No additional provision for excess or obsolete inventory was necessary in either fiscal year 2004 and 2003.

Research and development expenses.Research and development expenses consist principally of salaries and related personnel
expenses, consultant fees and prototype expenses related to the design, development and testing of our products and enhancement of our converged telephone system software. Research and development
expenses decreased by approximately $0.7 million or 18% from $4.0 million in fiscal year 2003 to $3.3 million in fiscal year 2004. Research and development expenses as a
percentage of revenue decreased from 34% in fiscal year 2003 to 22% in fiscal year 2004 due in part to the increase in sales volume and the decrease in absolute dollars. The decrease in research and
development expenses in absolute dollars was primarily a result of decreases in headcount-related costs of $536,000 resulting from a reduction in our workforce; a decrease in depreciation cost of
$110,000, and a decrease in office rent expense of $181,000 associated with the facilities change in Fremont, California. We expect research and development expenses to remain relatively flat due to
the uncertainty about customers' spending patterns in the current economic environment. Management continues to monitor research and development expenses in line with revenue opportunities.

Sales and marketing expenses.Sales and marketing expenses consist primarily of salaries, commissions and related expenses
for personnel engaged in marketing, sales and customer support functions, as well as trade shows, advertising, and promotional expenses. Sales and marketing expenses decreased by approximately
$0.5 million or 11% from $4.6 million in fiscal year 2003 to $4.1 million in fiscal year 2004. Sales and marketing expenses as a percentage of revenue decreased from 39% in fiscal
year 2003 to 28% in fiscal year 2004 due in part to the increase in sales volume and the decrease in absolute dollars. The decrease in absolute dollars was primarily a result of: a decrease in
headcount-related costs of $428,000 due to workforce reduction in the sales and marketing group; a decrease in depreciation costs of $73,000, and a decrease in office rent expense of $117,000
associated with the facilities change in Fremont, California. We expect sales and marketing expenses to remain relatively flat due to the uncertainty about customers' spending patterns in the current
economic environment; however, some expenses vary with revenues, such as commissions, which grow with increasing sales.

25

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General and administrative expenses.General and administrative expenses consist of salaries and related expenses for
executive, finance and administrative personnel, facilities, bad debt, legal, and other general corporate expenses. General and administrative expenses remained unchanged at $1.9 million for
fiscal year 2003 and 2004. General and administrative expenses as a percentage of revenue decreased from 16% in fiscal year 2003 to 13% in fiscal year 2004 due to the increase in sales volume. We
expect to maintain general and administrative expenses at the same level. It is unclear at this time what the impact on expenses would be as a result of complying with Section 404 of the
Sarbanes Oxley Act during fiscal year 2005.

Amortization of deferred stock compensation.We had no amortization of deferred stock compensation in fiscal year 2004.
Amortization of deferred stock compensation was $55,000 in fiscal year 2003. Deferred stock compensation expense reflects the amortization of stock compensation charges resulting from granting stock
options prior to our initial public offering at exercise prices below the deemed fair value of our common stock on the dates the options were granted. We amortize these deferred amounts using the
straight-line method over the vesting period of the related stock options. All remaining deferred stock compensation was amortized in fiscal year 2003.

Interest and other income, net.Net interest and other income decreased to $105,000 in fiscal year 2004 from $241,000 in
fiscal year 2003. The decrease was primarily due to the recognition of interest received from full repayment of an outstanding promissory note held by our Chief Executive Officer, Gilbert Hu in fiscal
2003 and a decrease in invested principal due to cash being used in operations. We expect net interest and other income to remain relatively flat with little change in cash available to invest, and
relatively flat interest rates.

Fiscal Year Ended September 30, 2003 Compared to Fiscal Year Ended September 30, 2002

Revenues, net.Revenues consist of sales to end users (including resellers) and distributors.

Net
Revenues by Products:

Fiscal Year Ended
September 30,2003

2002Hardware

87
%
84
%Software

13
%
16
%


Net
Revenues by Geographic Area:

Fiscal Year Ended
September 30,2003

2002Americas

94
%
94
%International

6
%
6
%


Net
Revenues by Customers:

Fiscal Year Ended
September 30,2003

2002AltiSys

18
%
27
%Ingram Micro

21
%
25
%Synnex

48
%
32
%


Revenues
generated in the Americas accounted for $11.1 million or 94% of revenues in fiscal year 2003 and $9.3 million or 94% of revenues in fiscal year 2002. Net revenues
increased 19% from $9.9 million in fiscal year 2002 to $11.8 million in fiscal year 2003 due to the introduction of a new line of AltiServ Office, AltiServ 1IP
and AltiServ 2IP, which offer our customers an all voice over

26

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Internet
protocol phone system. In fiscal year 2003, we started selling our own Internet protocol phone that generated revenue of $0.9 million.

Cost of revenues.Cost of revenues in fiscal year 2003 increased $0.4 million or 9% to $5.0 million from
approximately $4.6 million in fiscal year 2002 due to an increase in overall sales of products and the requisite increase in product costs. Cost of revenues as a percentage of net revenues
decreased from 46% in fiscal year 2002 to 42% in fiscal year 2003. Production overhead and manufacturing and other related costs decreased in fiscal 2003, compared with fiscal 2002, which resulted in
an increase in product gross margin and an increase in net revenues. Production overhead in fiscal 2003 decreased by $115,000 from $627,000 in fiscal 2002 to $512,000. This decrease was primarily
caused by lower labor and overhead expenses. In addition, manufacturing and other related costs in fiscal 2003 decreased by $104,000 from $515,000 in fiscal 2002 to $411,000 resulting from lower
warranty reserve due to the decline in the product return rate, lower depreciation on equipment and facilities charges associated with manufacturing activities. No additional provision for excess or
obsolete inventory was necessary in either fiscal year 2003 and 2002.

Research and development expenses.Research and development expenses consist principally of salaries and related personnel
expenses, consultant fees and prototype expenses related to the design, development and testing of our products and enhancement of our converged telephone system software. Research and development
expenses decreased slightly by approximately $0.1 million or 2% from $4.1 million in fiscal year 2002 to $4.0 million in fiscal year 2003. Research and development expenses as a
percentage of revenue decreased from 41% in fiscal year 2002 to 34% in fiscal year 2003 due in part to the increase in sales volume and the decrease in absolute dollars. The slight decrease in
absolute dollars was primarily a result of decreases in: headcount-related costs of $142,000 resulting from reduction in workforce; depreciation cost of $62,000, partly offset by an increase in
equipment expense and consultant cost of $66,000; and write-off of equipment of $20,000. We expect research and development expenses to remain relatively flat due to the uncertainty about
customers' spending patterns in the current economic environment. Management continues to monitor research and development expenses in line with revenue growth.

Sales and marketing expenses.Sales and marketing expenses consist primarily of salaries, commissions and related expenses
for personnel engaged in marketing, sales and customer support functions, as well as trade shows, advertising, and promotional expenses. Sales and marketing expenses decreased by approximately
$1.2 million or 21% from $5.9 million in fiscal year 2002 to $4.6 million in fiscal year 2003. Sales and marketing expenses as a percentage of revenue decreased from 59% in fiscal
year 2002 to 39% in fiscal year 2003 due in part to the increase in sales volume and the decrease in absolute dollars. The decrease in absolute dollars was primarily a result of: a decrease in
headcount-related costs of
approximately $311,000 due to workforce reduction in the sales and marketing group; a significant cost reduction measures in the areas of travel, advertising, promotional, marketing and other types of
discretionary spending of approximately $904,000; and lower depreciation costs of approximately $51,000. We expect sales and marketing expenses to remain relatively flat due to the uncertainty about
customers' spending patterns in the current economic environment.

General and administrative expenses.General and administrative expenses consist of salaries and related expenses for
executive, finance and administrative personnel, facilities, bad debt, legal, and other general corporate expenses. General and administrative expenses decreased by approximately $0.3 million
or 12% from $2.2 million in fiscal year 2002 to $1.9 million in fiscal year 2003. General and administrative expenses as a percentage of revenue decreased from 22% in fiscal year 2002 to
16% in fiscal year 2003 due in part to the increase in sales volume and the decrease in absolute dollars. The decrease in absolute dollars was primarily due to a reduction in professional fees of
approximately $237,000; slightly lower personnel levels and related expenditures of approximately $90,000, as well as tighter controls over allowable discretionary spending amounts. We expect to
maintain general and administrative expenses at the same level.

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Amortization of deferred stock compensation.Amortization of deferred stock compensation was $55,000 in fiscal year 2003 as
compared to $338,000 in fiscal year 2002. Deferred stock compensation expense reflects the amortization of stock compensation charges resulting from granting stock options at exercise prices below the
deemed fair value of our common stock on the dates the options were granted. We amortize these deferred amounts using the straight-line method over the vesting period of the related stock
options. All remaining deferred stock compensation was amortized in fiscal year 2003.

Write-down of long-term investment.We perform periodic reviews of our investments for impairment.
Our investments are considered impaired when a review of the investees' operations and other indicators of impairment indicate that the carrying value of the investment is not likely to be
recoverable. Such indicators include, but are not limited to, limited capital resources, limited prospects of receiving additional financing, and limited prospects for liquidity of the related
securities. During fiscal year 2002, we recorded a noncash, permanent write-down of $203,000 related to impairments of our investment. No write-down was recorded during fiscal
year 2003.

Interest and other income, net.Net interest and other income decreased to $241,000 in fiscal year 2003 from $284,000 in
fiscal year 2002. The decrease was primarily due to declining interest income caused by a decrease in invested principal due to cash being used in operations. We expect net interest and other income
to continue to decrease as a result of further decreases in cash available to invest and relatively flat or lower interest rates.

Liquidity and Capital Resources

Since inception, we have financed our operations primarily through the sale of equity securities. As of September 30, 2004, we had cash and
short-term investments totaling $10.1 million consisting of cash and cash equivalents of $5.4 million with a maturity of less than 90 days and $4.7 million of
short-term investment with a maturity of greater than 90 days.

|                                                     |                                                         | 2004 |        | 2003   |   | 2002   |       
|---------------------------------------------------- | ------------------------------------------------------- | ---- | ------ | ------ | - | ------ | ------
|
|Cash and cash equivalents                            |                                                         | $    | 5,367  |        | $ | 8,548  |       
|Short-term investments                               |                                                         |      | 4,667  |        |   | 1,598  |       
|                                                     |                                                         |      |        |        |   |        |       
|                                                     | Total cash, cash equivalents and short-term investments |      | $      | 10,034 |   | $      | 10,146
|                                                     |                                                         |      |        |        |   |        |       
|                                                     | Percentage of total assets                              |      |        | 74.2   | % |        | 76.8  
|Cash used in operating activities                    |                                                         | $    | (185   | )      | $ | (2,681 | )     
|Cash (used in) provided by investing activities      |                                                         | $    | (3,349 | )      | $ | 3,263  |       
|Cash provided by (used in) financing activities      |                                                         | $    | 353    |        | $ | 756    |       
|Net (decrease) increase in cash and cash equivalents |                                                         | $    | (3,181 | )      | $ | 1,338  |       

Changes in Cash Flows

During fiscal 2004, net cash used in operating activities was $185,000, which is $2.5 million lower than the cash used in operating activities during
fiscal 2003 due to a net profit being generated for the first time in fiscal year 2004. In fiscal 2004, our use of cash for non-operating activities was primarily attributable to the
$127,000 of capital spending on equipment additions to support our operations, $79,000 for investment in a Korean company and a $74,000 increase in a long-term deposit. As a result, during
the twelve months ended September 30, 2004, our cash, cash equivalents and marketable debt securities remained flat as compared to September 30, 2003.

Net
accounts receivable increased to $1.9 million at September 30, 2004 from $1.5 million at September 30, 2003. The increase in net accounts receivable was
primarily due to increases in sales of our products.

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We ended the fourth quarter of fiscal 2004 with a cash conversion cycle of 59 days as compared to 45 days for the fourth quarter of fiscal 2003. The cash conversion cycle
is the duration between purchase of inventories and services and the collection of the cash from the sale of our products and services and is a metric on which we have focused as we continue to try to
efficiently manage our assets. The cash conversion cycle results from the calculation of days of sales outstanding (DSO) added to days of supply in inventories (DOS), reduced by days of payable
outstanding (DPO).

Inventories
increased to $1.1 million at September 30, 2004 from $0.9 million at September 30, 2003 and our inventory turn rate remained flat at 5.7 times as
of September 30, 2004. Our inventory turn rate represents the number of times inventory is replenished during the year. Inventory management will continue to be an area of focus as we balance
the need to maintain strategic inventory levels to help ensure competitive lead times with the risk of inventory obsolescence due to rapidly changing technology and customer requirements.

Accounts
payable decreased to $798,000 at September 30, 2004 from $873,000 at September 30, 2003. This decrease primarily was due to a decrease in the number of components
purchased at the end of fiscal year 2004 as compared to fiscal year 2003. Our accrued payroll-related liabilities increased to $330,000 at September 30, 2004 from $276,000 at
September 30, 2003, primarily as a result of a increase in incentive compensation, vacation accrual and employee stock purchase plan contribution.

In
fiscal 2004, our net cash used in financing activities was primarily attributable to the $353,000 of proceeds from the exercise of employee stock options and employee stock purchase
plan.

Liquidity and Capital Resources

We intend to invest our cash in excess of current operating requirements in short-term, interest bearing investment-grade securities.

Our
cash needs depend on numerous factors, including market acceptance of and demand for our products, our ability to develop and introduce new products and enhancements to existing
products, the prices at which we can sell our products, the resources we devote to developing, marketing, selling and supporting our products, the timing and expense associated with expanding our
distribution channels, increases in manufacturing costs and the prices of the components we purchase, as well as other
factors. If we are unable to raise additional capital or if sales from our new products or enhancements are lower than expected, we will be required to make additional reductions in operating expenses
and capital expenditures to ensure that we will have adequate cash reserves to fund operations.

Additional
financing, if required, may not be available on acceptable terms, or at all. We also may require additional capital to acquire or invest in complementary businesses or
products, or obtain the right to use complementary technologies. If we cannot raise funds, if needed, on acceptable terms, we may not be able to further develop or enhance our products, take advantage
of future opportunities, or respond to competitive pressures or unanticipated requirements, which could seriously harm our business. Even if additional financing is available, we may be required to
obtain the consent of our stockholders, which we may or may not be able to obtain. In addition, the issuance of equity or equity-related securities will dilute the ownership interest of our
stockholders and the issuance of debt securities could increase the risk or perceived risk of us.

We
do not have any material commitments for capital expenditures as of September 30, 2004. We have a commitment under our noncancellable operating lease in the amount of
$1.5 million as of September 30, 2004. We believe, we have sufficient cash reserves to allow us to continue operations for more than a year assuming our quarterly cash usage rate does
not deteriorate over that period. Our

29

---



cash
and short-term investments totaled $10.0 million as of September 30, 2004, and our quarter ended September 30, 2004 generated $701,000 from operating activities.

|                            |  | Payment Due by Period
|--------------------------- |  | ---------------------
|
|Operating leases obligation |  | $                    
|Capital leases obligation   |  |                      
|                            |  |                      
|Total                       |  | $                    
|                            |  |                      

Recent Accounting Pronouncements

In December 2002, the Emerging Issues Task Force ("EITF") reached a consensus on EITF No. 00-21, "Revenue Arrangements with Multiple
Deliverables." This pronouncement addresses certain aspects of the accounting by a vendor for arrangements under which it will perform multiple revenue-generating activities. The guidance in this
pronouncement was effective for revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The adoption of EITF 00-21 did not have an effect on our
consolidated financial statements.

In
December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based CompensationTransition and Disclosure, an amendment to FASB Statement
No. 123." SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting of stock-based employee compensation. In addition,
SFAS No. 148 amends the disclosure requirements of SFAS No. 123, "Accounting for Stock-Based Compensation," to require prominent disclosure in both annual and interim financial
statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. We adopted the disclosure provisions of SFAS No. 148
effective January 1, 2003.

In
January 2003, the FASB issued SFAS Interpretation No. 46, "Consolidation of Variable Interest Entities," and a revised interpretation of FASB Interpretation
No. 46 (FIN 46R) in December 2003 (collectively FIN 46) which expands upon and strengthens existing accounting guidance concerning when a company should include in its financial
statements the assets, liabilities and activities of another entity. The Company did not have any variable interest entities as of September 30, 2004 and the adoption of FIN 46 did not have a
material impact on the Company's financial position or results of operations.

In
April 2003, the FASB issued SFAS No. 149, "Amendment of SFAS No. 133 on Derivative Instruments and Hedging Activities." SFAS No. 149 amends and clarifies
accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under
SFAS No. 133. SFAS No. 149 was effective for contracts entered into or modified after June 30, 2003 and did not have an impact on our consolidated financial statements.

In
May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." The Statement improves the
accounting for certain financial instruments that, under previous guidance, issuers could account for as equity by requiring that such instruments be classified as liabilities in statements of
financial position. Adoption of SFAS No. 150 did not have an effect on our consolidated financial statements.

In
December 2003, the SEC issued Staff Accounting Bulletin (SAB) 104 which rescinds and updates SAB 101, "Revenue Recognition in Financial Statements." SAB 104's primary purpose
is to rescind accounting guidance contained in SAB 101 related to multiple element revenue arrangements, which was superseded as a result of the issuance of EITF 00-21, "Accounting for
Revenue Arrangements with Multiple Deliverables." While the wording of SAB 104 has changed to reflect the

30

---



issuance
of EITF 00-21, the revenue recognition principles of SAB 101 remain largely unchanged by the issuance of SAB 104. Application of this guidance did not have a material impact on
our financial position or results of operations.

In
March 2004, the EITF reached a consensus on Issue No. 03-01, "The Meaning of Other-Than-Temporary Impairment and Its Application to
Certain Investments" ("EITF No. 03-01"). EITF No. 03-01 provides guidance on recording other-than-temporary impairments of cost method
investments and disclosures about unrealized losses on available-for-sale debt and equity securities. The adoption of this standard did not have a material impact on our
consolidated balance sheet or statement of operations.

In
July 2004, the EITF reached a consensus on Issue No. 02-14, "Whether an Investor Should Apply the Equity Method of Accounting to Investments Other Than
Common Stock" ("EITF No. 02-14"). The consensus was that an investor should only apply the equity method of accounting when it has investments in either common stock (as already
required by Accounting Principles Board Opinion No. 18 ("APB 18")) or in-substance common stock of a corporation, provided that the investor has the ability to exercise significant
influence over the operating and financial policies of the investee. EITF No. 02-14 defines in-substance common stock and provides guidance on determining whether an
investment is substantially similar to the common stock of the investee. EITF No. 02-14 should be applied in the first reporting period beginning after September 15, 2004.
Management has not yet determined the impact of adopting EITF No. 02-14 on our financial position or results of operations.

In
November 2004, the FASB issued SFAS No. 151, "Inventory Costs." The Statement requires that abnormal amounts of idle facility expense, freight handling costs and wasted
material be recognized as current-period expenses. In addition the statement requires that the allocation of production overhead be based on normal capacity. The adoption of this standard in
October 2004 is not expected to have a material impact on our consolidated financial statements.

On
December 17, 2004 the FASB issued SFAS No. 123, "Share-Based Payments (revised 2004)," (SFAS No. 123R). This statement eliminates the option to apply the
intrinsic value measurement provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB Opinion No. 25), to stock compensation awards issued
to employees. Rather the Statement requires companies to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of
the award. That cost will be recognized over the period during which an employee is required to provide services in exchange for the awardthe requisite service period (usually the vesting
period). SFAS No. 123R will also require enterprises to measure the cost of employee services received in exchange for employee stock purchase plan (ESPP) awards and we will be required to
expense the grant-date fair value of our ESPP awards. SFAS No. 123R will be effective for our fiscal quarter beginning July 1, 2005. We have not yet quantified the effect of
the future adoption of SFAS No. 123R on a going forward basis.

31

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CERTAIN FACTORS AFFECTING BUSINESS, OPERATING RESULTS, AND FINANCIAL CONDITION

You should carefully consider the risks described below and all of the information contained in this Form 10-K. If any of the following risks
occur, our business, financial condition and result of operations could be harmed, the trading price of our common stock could decline and you may lose all or part of your investment in our common
stock.

Risks Related to AltiGen

We have had a history of losses and may incur future losses, which may prevent us from maintaining profitability.

We have had a history of operating losses since our inception, and as of September 30, 2004, we had an accumulated deficit of $50.8 million. We may
incur operating losses in the future, and these losses could be substantial and impact our ability to maintain profitability. We do not expect to increase expenditures for product development, general
and administrative expenses, and sales and marketing expenses; however, if we cannot maintain current revenues or revenue growth, we will not maintain profitability or positive operating cash flows.
Even if we achieve profitability and positive operating cash flows, we may not be able to sustain or increase profitability or positive operating cash flows on a quarterly or annual basis.

We have a limited operating history, which makes it difficult to evaluate our business and our future prospects.

We shipped our first products in July 1996. As a result of our limited operating history, we have limited financial data that you can use to evaluate our
business. You must consider our prospects in light of the
risks, expenses and challenges we might encounter because we are at an early stage of development in a new and rapidly evolving market. To address these risks and maintain profitability and increased
sales levels, we must:



We
may not successfully meet any of these challenges, and our failure to do so will seriously harm our business and results of operations. In addition, because of our limited operating
history, we have limited insight into trends that may emerge and harm our business.

Our operating results vary, making future operating results difficult to predict.

Our quarterly and annual operating results have varied significantly in the past and likely will vary significantly in the future. A number of factors, many of
which are beyond our control, may cause our operating results to vary, including:



32

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Our
future projected budgets and commitments are based in part on our expectations of future sales. If our sales do not meet expectations, it will be difficult for us to reduce our
expenses quickly and, consequently, our operating results may suffer.

Our
dealers often require immediate shipment and installation of our products. As a result, we have historically operated with limited backlog, and our sales and operating results in any
quarter primarily depend on orders booked and shipped during that quarter.

Any
of the above factors could harm our business, financial condition and results of operations. We believe that period-to-period comparisons of our results of
operations are not meaningful, and you should not rely upon them as indicators of our future performance.

Our market is highly competitive and we may not have the resources to adequately compete.

The market for our integrated, multifunction telecommunications systems is new, rapidly evolving and highly competitive. We expect competition to intensify in the
future as existing competitors develop new products and new competitors enter the market. We believe that a critical component to success in this market is the ability to establish and maintain strong
partner and customer relationships with a wide variety of domestic and international providers. If we fail to establish or maintain these relationships, we will be at a serious competitive
disadvantage.

We
face competition from companies providing traditional private telephone systems. Our principal competitors that produce these telephone systems are Avaya Communications, NEC and
Nortel Networks. We also compete against providers of multi-function telecommunications systems, including Shoreline Communications, Inc., 3Com Corporation, and Cisco Systems, Inc., as
well as any number of future competitors. Many of our competitors are substantially larger than we are and have significantly greater name recognition, financial resources, sales and marketing teams,
technical and customer support, manufacturing capabilities and other resources. These competitors also may have more established distribution channels and stronger relationships with service
providers. These competitors may be able to respond more rapidly to new or emerging technologies and changes in customer requirements or to devote greater resources to the development, promotion and
sale of their products. These competitors may enter our existing or future markets with products that may be less expensive, provide higher performance or additional features or be introduced earlier
than our phone systems. We also expect that other companies may enter our market with better products and technologies. If any technology that is competing with ours is more reliable, faster, less
expensive or has other advantages over our technology, then the demand for our products and services could decrease and harm our business.

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, our sales or market acceptance of our products and services could be reduced, price competition could decreased or make our products could become obsolete.
To be competitive, therefore, 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

33

---



investments
or to make the technological advances necessary to be competitive, which in turn will cause our business to suffer.

Losing any of our key distributors would harm our business. We also need to establish and maintain relationships
with additional distributors and original equipment manufacturers.

Sales through our four key distributors, Altisys, Ingram Micro Inc., Graybar and Synnex, accounted for 82% of our net revenues in the fiscal year ended
September 30, 2004. Graybar became our distributor starting in June 2003. Our business and operating results will suffer if any one of these distributors does not continue distributing
our products, fails to distribute the volume of our products that it currently distributes or fails to expand our customer base. We also need to establish and maintain relationships with additional
distributors and original equipment manufacturers. We may not be able to establish, or successfully manage, relationships with additional distribution partners. In addition, our agreements with
distributors typically provide for termination by either party upon written notice to the other party. For example, our agreement with Ingram Micro provides for termination, with or without cause, by
either party upon 30 days' written notice to the other party, or upon insolvency or bankruptcy. Generally, these agreements are non-exclusive and distributors sell products that
compete with ours. If we fail to establish or maintain relationships with distributors and original equipment manufacturers, our ability to increase or maintain our sales and our customer base will be
substantially harmed.

We sell our products through dealers and distributors, which limits our ability to control the timing of our
sales, and which makes it more difficult to predict our revenues.

We do not recognize revenue from the sale of our products to our distributors until these products are sold to either resellers or end-users. We have
little control over the timing of product sales to dealers and end users. Our lack of control over the revenue that we recognize from our distributors' sales to resellers and end-users
limits our ability to predict revenue for any given period. Our future projected budgets and commitments are based in part on our expectations of future sales. If our sales do not meet expectations,
it will be difficult for us to reduce our expenses quickly, and consequently our operating results may suffer.

We rely on sole-sourced components and third party technology and products; if these components are
not available, our business may suffer.

We purchase technology from third parties that is incorporated into many of our products, including virtually all of our hardware products. We order
sole-sourced components using purchase orders and do not have supply contracts for them. One sole-sourced component, a TI DSP chip, is particularly important to our business
because it is included in virtually all of our hardware products. If we were unable to purchase an adequate supply of these sole-sourced components on a timely basis, we would be required
to develop alternative products, which could entail qualifying an alternative source or redesigning our products based on different components. Our inability to obtain these sole-sourced
components, especially
the TI DSP chip, could significantly delay shipment of our products, which could have a negative effect on our business, financial condition and results of operations.

We rely on resellers to promote, sell, install and support our products, and their failure to do so may
substantially reduce our sales and thus seriously harm our business.

We rely on resellers who can provide high quality sales and support services. As with our distributors, we compete with other telecommunications systems providers
for our resellers' business as our resellers generally market competing products. If a reseller promotes a competitor's products to the detriment of our products or otherwise fails to market our
products and services effectively, we could lose market share. In addition, the loss of a key reseller or the failure of resellers to provide adequate

34

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customer
service could cause our business to suffer. If we do not properly train our resellers to sell, install and service our products, our business will suffer.

Software or hardware errors may seriously harm our business and damage our reputation, causing loss of customers
and revenues.

Users expect telephone systems to provide a high level of reliability. Our products are inherently complex and may have undetected software or hardware errors. We
have detected and may continue to detect errors and product defects in our installed base of products, new product releases and product upgrades. End users may install, maintain and use our products
improperly or for purposes for which they were not designed. These problems may degrade or terminate the operation of our products, which could cause end users to lose telephone service, cause us to
incur significant warranty and repair costs, damage our reputation and cause significant customer relations problems. Any significant delay in the commercial introduction of our products due to errors
or defects, any design modifications required to correct these errors or defects or any negative effect on customer satisfaction as a result of errors or defects could seriously harm our business,
financial condition and results of operations.

Any
claims brought because of problems with our products or services could seriously harm our business, financial condition and results of operations. We currently offer a
one-year hardware guarantee to end-users. If our products fail within the first year, we face replacement costs. Our insurance policies may not provide sufficient or any
coverage should a claim be asserted. In addition, our introduction of products and systems with reliability, quality or compatibility problems could result in reduced revenues, uncollectible accounts
receivable, delays in collecting accounts receivable, warranties and additional costs. Our customers, end users or employees could find errors in our products and systems after we have begun to sell
them, resulting in product redevelopment costs and loss of, or delay in, their acceptance by the markets in which we compete.
Further, we may experience significant product returns in the future. Any of these events could have a material adverse effect on our business, financial condition and results of operations.

We may face infringement issues that could harm our business by requiring us to license technology on unfavorable
terms or temporarily or permanently cease sales of key products.

We may become parties to litigation in the normal course of our business. Litigation in general, and intellectual property and securities litigation in
particular, can be expensive and disruptive to normal business operations. Moreover, the results of complex litigation are difficult to predict.

On
September 6, 2002, Vertical Networks, Inc. filed suit against us in the United States District Court for the Northern District of California, alleging infringement of
Vertical Networks' U.S. Patents Nos. 6,266,341; 6,289,025; 6,292,482; 6,389,009; and 6,396,849. On October 28, 2002, Vertical Networks amended its complaint to add allegations of infringement
of U.S. Patents Nos. 5,617,418 and 5,687,174. Vertical Networks filed a second amended complaint on November 20, 2002 to identify our products and/or activities that allegedly infringe the
seven patents-in-suit. Vertical Networks seeks a judgment of patent infringement and an award of damages, including treble damages for alleged willful infringement, and
attorneys' fees and costs. We filed an answer and counterclaims for declaratory relief on December 9, 2002. On December 26, 2002, Vertical Networks filed its answer to our counterclaims.
Vertical Networks served its preliminary infringement contentions on us on April 9, 2003 and we served Vertical Networks our preliminary invalidity contentions on June 3, 2003 and
July 14, 2003. To date, the parties have exchanged some discovery, but no depositions have been taken, and no motions are currently pending. On October 7, 2003, the parties filed a
stipulation to stay this action, pending the outcome of the reissue of some of the subject patents before the U.S. Patent and Trademark Office. We believe we have strong defenses and arguments in this
dispute and intend to vigorously litigate our position. Management's view is that any loss from this litigation is not probable or estimable.

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More
generally, litigation related to these types of claims may require us to acquire licenses under third party patents that may not be available on acceptable terms, if at all. We
believe that an increasing portion of our revenues in the future will come from sales of software applications for our hardware products. The software market traditionally has experienced widespread
unauthorized reproduction of products in violation of developers' intellectual property rights. This activity is difficult to detect, and legal proceedings to enforce developers' intellectual property
rights are often burdensome and involve a high degree of uncertainty and substantial costs.

Any failure by us to protect our intellectual property could harm our business and competitive position.

Our success depends, to a certain extent, upon our proprietary technology. We currently rely on a combination of patent, trade secret, copyright and trademark
law, together with non-disclosure and invention assignment agreements, to establish and protect the proprietary rights in the technology used in our products.

Although
we have filed patent applications, we are not certain that our patent applications will result in the issuance of patents, or that any patents issued will provide commercially
significant protection of our technology. In addition, other individuals or companies may independently develop substantially equivalent proprietary information not covered by patents to which we own
rights, may obtain access to our know-how or may claim to have issued patents that prevent the sale of one or more of our products. Also, it may be possible for third parties to obtain and
use our proprietary information without our authorization. Further, the laws of some countries, such as those in Japan, one of our target markets, may not adequately protect our intellectual property
or such protection may be uncertain. Our success also depends on trade secrets that cannot be patented and are difficult to protect. If we fail to protect our proprietary information effectively, or
if third parties use our proprietary technology without authorization, our competitive position and business will suffer.

Our products may not meet the legal standards required for their sale in some countries; if we cannot sell our
products in these countries, our results of operations may be seriously harmed.

The United States and other countries in which we intend to sell our products have standards for safety and other certifications that must be met for our products
to be legally sold in those countries. We have tried to design our products to meet the requirements of the countries where we sell or plan to sell them. We also have obtained or are trying to obtain
the certifications that we believe are required to sell our products in these countries. We cannot, however, guarantee that our products meet all of these standards or that we will be able to obtain
any certifications required. In addition, there is, and will likely continue to be, an increasing number of laws and regulations pertaining to the products we offer and may offer in the future. These
laws or regulations may include, for example, more stringent safety standards, requirements for additional or more burdensome certifications or more stringent consumer protection laws.

If
our products do not meet a country's standards or we do not receive the certifications required by a country's laws or regulations, then we may not be able to sell our products in
that country. This inability to sell our products may seriously harm our results of operation by reducing our sales or requiring us to invest significant resources to conform our products to these
standards.

Our market is subject to changing preferences; failure to keep up with these changes would result in our losing
market share, thus seriously harming our business, financial condition and results of operations.

Our customers and end users expect frequent product introductions and have changing requirements for new products and features. In order to be competitive,
therefore, we need to develop and market new products and product enhancements that respond to these changing requirements on a timely and cost-effective basis. Our failure to do so
promptly and cost effectively would seriously harm

36

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our
business, financial condition and results of operations. Also, introducing new products could require us to write-off existing inventory as obsolete, which could harm our results of
operations.

If we are unable to raise additional capital when needed, we may be unable to develop or enhance our products and
services.

We may seek additional funding in the future. If we cannot raise funds on acceptable terms, we may be unable to develop or enhance our products and services, take
advantage of future opportunities or respond to competitive pressures or unanticipated requirements. We also may be required to reduce operating costs through lay-offs or reduce our sales
and marketing or research and development efforts. If we issue equity securities, stockholders may experience additional dilution or the new equity securities may have rights, preferences or
privileges senior to those of our common stock.

If we do not manage our growth effectively, our business will suffer.

We may not be successful in managing our future growth. We have expanded our operations rapidly since our inception. In order to manage this expansion and grow in
the future, we will need to expand or enhance our management, manufacturing, research and development and sales and marketing capabilities. We may not be able to hire the management, staff or other
personnel required to do so.

We
may not be able to install adequate control systems in an efficient and timely manner, and our current or planned operational systems, procedures and controls may not be adequate to
support our future operations. Difficulties in installing and implementing new systems, procedures and controls may significantly burden our management and our internal resources. Delays in the
implementation of new
systems or operational disruptions when we transition to new systems would impair our ability to accurately forecast sales demand, manage our product inventory and record and report financial and
management information on a timely and accurate basis.

Lead
times for materials and components used in the assembly of our products vary significantly, and depend on factors such as the supplier, contract terms and demand for a component at
a given time. If orders do not match forecasts, we may have excess or inadequate inventory of certain materials and components, which may seriously harm our business, financial condition and results
of operations.

Our planned expansion in international markets will involve new risks that our previous domestic operations have
not prepared us to address; our failure to address these risks could harm our business, financial condition and results of operations.

For the fiscal year 2004, approximately 10% of our net revenues came from customers outside of the United States. We intend to expand our international sales and
marketing efforts. Our efforts are subject to a variety of risks associated with conducting business internationally, any of which could seriously harm our business, financial condition and results of
operations. These risks include:



37

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We depend on attracting and retaining qualified personnel to maintain and expand our business; our failure to
promptly attract and retain qualified personnel may seriously harm our business, financial condition and results of operations.

We depend, in large part, on our ability to attract and retain highly skilled personnel, particularly engineers and sales and marketing personnel. We need highly
trained technical personnel to design and support our server-based telecommunications systems. In addition, we need highly trained sales and marketing personnel to expand our marketing and sales
operations in order to increase market awareness of our products and generate increased revenues. Competition for highly trained personnel is intense, especially in the San Francisco Bay Area where
most of our operations are located. We cannot be certain that we will be successful in our recruitment and retention efforts. If we fail to attract or retain qualified personnel or suffer from delays
in hiring required personnel, our business, financial condition and results of operations may be seriously harmed.

Our facility is vulnerable to damage from earthquakes and other natural disasters and other business
interruptions; any such damage could seriously or completely impair our business.

We perform final assembly, software installation and testing of our products at our facility in Fremont, California. Our facility is located on or near known
earthquake fault zones and may be subject to rolling electrical blackouts and is vulnerable to damage or interruption from fire, floods, earthquakes, power loss, telecommunications failures and
similar events. If such a disaster or interruption occurs, our ability to perform final assembly, software installation and testing of our products at our facility would be seriously, if not
completely, impaired. If we were unable to obtain an alternative place or way to perform these functions, our business, financial condition and results of operations would suffer. The insurance we
maintain may not be adequate to cover our losses against fires, floods, earthquakes and general business interruptions.

Our strategy to outsource assembly and test functions in the future could delay delivery of products, decrease
quality or increase costs.

Based on volume or customer requirements, we may begin outsourcing some assembly and test functions. In addition, we may determine that we need to establish
assembly and test operations overseas to better serve our international customers. Establishing overseas assembly and test operations may be more difficult or take longer than we anticipate. This
outsourcing strategy involves certain risks, including the potential lack of adequate capacity and reduced control over delivery schedules, manufacturing yield, quality and costs. In the event that
any significant subcontractors were to become unable or unwilling to continue to manufacture or test our products in the required volumes, we would have to identify and qualify acceptable
replacements. Finding replacements could take time and we cannot be sure that additional sources would be available to us on a timely basis. Any delay or increase
in costs in the assembly and testing of products by third-party subcontractors could seriously harm our business, financial condition and results of operations.

Compliance with changing regulations of corporate governance and public disclosure may result in additional
expenses.

Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and
Nasdaq National Market rules, are creating uncertainty for companies such as ours. These new or changed laws, regulations and standards are subject to varying interpretations in many cases due to
their lack of specificity, and as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies, which could result in continuing
uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices. As a result, our efforts to comply with evolving laws, regulations
and standards have resulted in, and are likely to continue to

38

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result
in, increased general and administrative expenses and a diversion of management time and attention from revenue-generating activities to compliance activities. In particular, our efforts to
comply with Section 404 of the Sarbanes-Oxley Act of 2002 and the related regulations regarding our required assessment of our internal controls over financial reporting and our external
auditors' audit of that assessment has required the commitment of significant financial and managerial resources. We expect these efforts to require the continued commitment of significant resources.
Further, our board members, chief executive officer, and chief financial officer could face an increased risk of personal liability in connection with the performance of their duties. As a result, we
may have difficulty attracting and retaining qualified board members and executive officers, which could harm our business. If our efforts to comply with new or changed laws, regulations and standards
differ from the activities intended by regulatory or governing bodies due to ambiguities related to practice, our reputation may be harmed.

If, as of the end of our 2005 fiscal year, we are unable to assert that our internal control over financial
reporting is effective, or if our auditors are unable to confirm our assessment, investors could lose confidence in our reported financial information, and the trading price of our stock price and our
business could be adversely affected.

We are in the process of documenting, and plan to test during the current fiscal year, our internal control procedures in order to satisfy the requirements of
Section 404 of the Sarbanes-Oxley Act. Commencing with September 30, 2005, the end of our 2005 fiscal year, the Sarbanes-Oxley Act requires annual management assessments of the
effectiveness of our internal controls over financial reporting and a report by our independent registered public accounting firm addressing these assessments. During the course of our testing we may
identify deficiencies which we may not be able to remediate in time to meet the deadline imposed by the Sarbanes-Oxley Act for compliance with the requirements of
Section 404. In addition, if we fail to achieve and maintain the adequacy of our internal controls, as such standards are modified, supplemented, or amended from time to time, we may not be
able to ensure that we can conclude on an ongoing basis that we have effective internal controls over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act. Effective
internal controls are important to help produce reliable financial reports and to prevent financial fraud. If we are unable to assert that our internal control over financial reporting is effective as
of the end of our 2005 fiscal year, or if our auditors are unable to attest that our management's report is fairly stated or they are unable to express an opinion on our management's evaluation or on
the effectiveness of the internal controls, we could lose investor confidence in the accuracy and completeness of our financial reports, investors could lose confidence in our reported financial
information, and the trading price of our stock and our business could be adversely affected.

FASB's adoption of Statement 123R will cause, and changes to existing accounting pronouncements or taxation rules
or practices may cause, adverse revenue fluctuations, affect our reported results of operations or how we conduct our business.

On October 13, 2004, FASB adopted Statement 123R, "Share-Based Payment," which will require us, starting in the third quarter of fiscal year 2005, to
measure compensation costs for all stock based compensation (including stock options and our employee stock purchase plan, as currently constructed) at fair value and take a compensation charge equal
to that value. This statement will have a future effect on our net income.

Also,
a change in accounting pronouncements or taxation rules or practices can have a significant effect on our reported results and may even affect our reporting of transactions
completed before the change is effective. Other new accounting pronouncements or taxation rules and varying interpretations of accounting pronouncements or taxation practice have occurred and may
occur in the future. This

39

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change
to existing rules, future changes, if any, or the questioning of current practices may adversely affect our reported financial results or the way we conduct our business.

Risks Related to the Industry

Integrated, multifunction telecommunications systems may not achieve widespread acceptance.

The market for integrated, multifunction telecommunications systems is relatively new and rapidly evolving. Businesses have invested substantial resources in the
existing telecommunications infrastructure, including traditional private telephone systems, and may be unwilling to replace these systems in the near term or at all. Businesses also may be reluctant
to adopt integrated, multifunction telecommunications systems because of their concern about the current limitations of data networks, including the Internet. For example, end users sometimes
experience delays in receiving calls and reduced voice quality during calls when routing calls over data networks. Moreover, businesses that begin to route calls over the same networks that currently
carry only their data also may experience these problems if the networks do not have sufficient capacity to carry all of these communications at the same time.

Future regulation or legislation could harm our business or increase our cost of doing business.

In April 1998, the Federal Communications Commission submitted a report to Congress stating that it may regulate certain Internet services if it determines
that such Internet services are functionally equivalent to conventional telecommunications services. The increasing growth of the voice over data network market and the popularity of supporting
products and services, heighten the risk that national governments will seek to regulate the transmission of voice communications over networks such as the Internet. In addition, large
telecommunications companies may devote substantial lobbying efforts to influence the regulation of this market so as to benefit their interests, which may be contrary to our interests. These
regulations may include, for example, assessing access or settlement charges, imposing tariffs or imposing regulations based on encryption concerns or the characteristics and quality of products and
services. Future laws, legal decisions or regulations, as well as changes in interpretations of existing laws and regulations, could require us to expend significant resources to comply with them. In
addition, these future events or changes may create uncertainty in our market that could reduce demand for our products.

Evolving standards may delay our product introductions, increase our product development costs or cause end users
to defer or cancel plans to purchase our products, any of which could adversely affect our business.

The standards in our market are still evolving. These standards are designed to ensure that integrated, multifunction telecommunications products from different
manufacturers can operate together. Some of these standards are proposed by other participants in our market, including some of our competitors, and include proprietary technology. In recent years,
these standards have changed, and new standards have been proposed, in response to developments in our market. Our failure to conform our products to existing or future standards may limit their
acceptance by market participants. We may not anticipate which standards will achieve the broadest acceptance in our market in the future, and we may take a significant amount of time and expense to
adapt our products to these standards. We also may have to pay additional royalties to developers of proprietary technologies that become standards in our market. These delays and expenses may
seriously harm our results of operations. In addition, customers and users may defer or cancel plans to purchase our products due to concerns about the ability of our products to conform to existing
standards or to adapt to new or changed standards, and this could seriously harm our results of operations.

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Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Market Risk.Our interest income is sensitive to changes in the general level of U.S. interest rates, particularly since the
majority of our investments are in cash equivalents and short-term instruments. Due to the short-term nature of our cash equivalents and investments, we have concluded that a
change in interest rates does not pose a material market risk to us.

Item 8. Financial Statements and Supplementary Data

The financial statements required by this item are incorporated by reference from Part IV Item 15(a) 1 and 2 hereof. The selected quarterly supplementary
data is included as part of Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations."

Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

On June 20, 2002, we ended the engagement of Arthur Andersen LLP and retained Deloitte & Touche LLP as our independent auditors. At that time, we
filed a Current Report on Form 8-K dated June 26, 2002, which was later updated by a Current Report on Form 8-K/A dated July 10, 2002. The text of
the Form 8-K/A Report that we filed is as follows:

"This
is an amendment to the Form 8-K filed by AltiGen Communications, Inc. on June 26, 2002.

On
June 20, 2002, the Audit Committee of AltiGen Communications, Inc.'s (the "Company") Board of Directors approved a change in the Company's independent public accountants
for the fiscal year ended September 30, 2002, from Arthur Andersen LLP to Deloitte & Touche LLP. The report of Arthur Andersen LLP for the fiscal year ended September 30, 2001
contained no adverse opinions, disclaimer of opinion or qualification or modification as to uncertainty, audit scope or accounting principles. During the fiscal year ended September 30, 2001,
and the interim period from October 1, 2001 through June 20, 2002, there were no disagreements between the Company and Arthur Andersen LLP on any accounting principles or practices,
financial statement disclosure or auditing scope or procedure, which, if not resolved to the satisfaction of Arthur Andersen LLP, would have caused it to make reference to the subject matter of the
disagreement in connection with its report. No event described in paragraph (a) (1) (v) of Item 304 of Regulation S-K has occurred within the Company's fiscal year
ending September 2001, or the period from October 1, 2001 through June 20, 2002.

The
Company has provided Arthur Andersen LLP with a copy of the foregoing disclosures and has requested a letter from them stating whether Arthur Andersen LLP agrees with such
disclosures. On July 9, 2002, Arthur Andersen LLP informed the Company that they would not provide the requested letter, and further, that they would no longer provide similar letters to former
clients.

The
Company did not consult with Deloitte & Touche LLP during the fiscal years ended September 2001, and the interim period from October 1, 2001 through
June 20, 2002, with respect to the application of accounting principles to a specified transaction, either completed or proposed, or the type of audit opinion that might be rendered on the
Company's financial statements, or any other matters or reportable events listed in paragraphs (a)(2)(i) and (ii) of Item 304 of Regulation S-K."

Item 9A. Controls and Procedures

(a)   Evaluation of disclosure controls and procedures.    Our management evaluated, with the participation of our Chief
Executive Officer
and our Chief Financial Officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Annual Report on Form 10-K. Based on this
evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that our disclosure controls and procedures are effective to ensure that information we are required to disclose
in reports that we file or submit under the Securities Exchange Act of 1934 is

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recorded,
processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.

(b)   Changes in internal control over financial reporting.    There was no change in our internal control over financial
reporting that
occurred during the period covered by this Annual Report on Form 10-K that has materially affected, or is reasonably likely to materially affect, our internal control over financial
reporting.

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PART III

Item 10. Directors and Executive Officers of the Registrant

The information required by this section with respect to our directors is incorporated by reference from the information in the section entitled: "Election of
Directors" in the Company's definitive Proxy Statement for the Annual Meeting of Stockholders to be held on February 10, 2005 (the "Proxy Statement"). The information required by this section
with respect to our executive officers is included in Part I of this Form 10-K under the section titled "Executive Officers of the Registrant."

The
information required by this section with respect to any known late filing or failure by an insider to file a report required by Section 16 of the Exchange Act is
incorporated by reference from the information in the section titled "Section 16(a) Beneficial Ownership Reporting Compliance" in our Proxy Statement.

Our
board of directors adopted a Code of Conduct for all of directors, officers and employees on July 26, 2004. Our Code of Conduct is posted on our website at
http://www.altigen.com/company_investors-conduct.html. We intend to disclose any amendment to, or waivers of, the provision of our Code of Conduct that apply specifically to our Chief Executive
Officer, Chief Financial Officer, Controller or persons performing similar functions by posting such information on our website.

A
copy of our Code of Conduct is also available upon written request and without charge to any stockholder by writing to: Secretary, AltiGen Communications, Inc.,
4555 Cushing Parkway, Fremont, CA 94538.

Item 11. Executive Compensation

The information required by this section is incorporated by reference from the information in the section titled "Executive Compensation and Other Matters" in our
Proxy Statement.

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

The information required by this section is incorporated by reference from the information in the section titled: "Security Ownership of Management; Principal
Stockholders" in our Proxy Statement, Item 13.

Item 13. Certain Relationships and Related Transactions

The information required by this item regarding certain relationships and related transactions is incorporated by reference to the information set forth in the
section titled "Certain Relationships and Related Transactions" in our Proxy Statement.

Item 14. Principal Accountant Fees and Services

Deloitte & Touche LLP's fees for professional services rendered in connection with the audit of our annual financial statements and the review of our
financial statements included in our quarterly reports on Form 10-Q were approximately $205,000 and $149,000 for the fiscal years ended September 30, 2004 and 2003,
respectively. We did not engage Deloitte & Touche LLP to provide advice regarding financial information systems design and implementation during the fiscal years ended September 30, 2004
and 2003. Deloitte & Touche LLP's fees for all other services rendered to us, including tax related services, totaled approximately $28,000 and $26,000 for the fiscal years ended
September 30, 2004 and 2003, respectively.

The
Audit Committee pre-approves all audit and permissible non-audit services provided by the independent auditors. These services may include audit services,
audit-related services, tax services and

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other
services. The Audit Committee has adopted a policy for the pre-approval of services provided by the independent auditors. Under the policy, pre-approval generally is
provided for up to one year and any pre-approval is detailed as to the particular service or category of services and is subject to a specific budget. In addition, the Audit Committee may
also pre-approve particular services on a case-by-case basis. For each proposed service, the independent auditor is required to provide detailed back-up
documentation at the time of approval. The Audit Committee may delegate pre-approval authority to one or more of its members. Such member must report any decisions to the Audit Committee
at the next scheduled meeting.

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PART IV

Item 15. Exhibits and Financial Statement Schedules



1.     FINANCIAL STATEMENTS

|                                                                                                       |  | Page
|------------------------------------------------------------------------------------------------------ |  | ----
|Report of Independent Registered Public Accounting Firm                                                |  | 47  
|Consolidated Balance Sheets as of September 30, 2004 and 2003                                          |  | 48  
|Consolidated Statements of Operations for the years ended September 30, 2004, 2003 and 2002            |  | 49  
|Consolidated Statements of Stockholders' Equity for the years ended September 30, 2004, 2003, and 2002 |  | 50  
|Consolidated Statements of Cash Flows for the years ended September 30, 2004, 2003, and 2002           |  | 51  
|Notes to Consolidated Financial Statements                                                             |  | 52  
|Quarterly Financial Information                                                                        |  | 64  

2.     FINANCIAL STATEMENT SCHEDULES

The following financial statement schedule is submitted herewith:

|                                              |  | Page
|--------------------------------------------- |  | ----
|Schedule II Valuation and Qualifying Accounts |  | 65  

(All
other schedules are omitted because they are not applicable or the required information is shown in the Consolidated Financial Statements or notes thereto.)

3.     EXHIBITS

The following exhibits are included in this Annual Report on Form 10-K (numbered in accordance with Item 601 of
Regulation S-K):

|Exhibit
Number |  | Description                                                                                                                                         
|-------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------
|3.1*           |  | Amended and Restated Certificate of Incorporation.                                                                                                  
|3.2*****       |  | Second Amended and Restated Bylaws.                                                                                                                 
|4.2*           |  | Specimen common stock certificates.                                                                                                                 
|4.3*           |  | Third Amended and Restated Rights Agreement dated May 7, 1999 by and among AltiGen Communications, Inc. and the Investors and Founder named therein.
|10.1*          |  | Form of Indemnification Agreement.                                                                                                                  
|10.2*          |  | 1994 Stock Option Plan, as amended, and form of stock option agreement.                                                                             
|10.3*          |  | 1998 Stock Purchase Plan.                                                                                                                           
|10.4****       |  | 1999 Stock Plan, as amended, and form of stock option agreement.                                                                                    
|10.5***        |  | 1999 Employee Stock Purchase Plan, as amended, and forms of subscription agreement and notice of withdrawal.                                        
|10.8****       |  | Lease agreement: 4555 Cushing Parkway, Fremont, California between VEF III Funding, LLC and AltiGen Communications, Inc., dated October 1, 2003.    
|10.14*++       |  | Distribution Agreement between Ingram Micro Inc. and AltiGen Communications, Inc. dated June 12, 1998.                                              
|10.19*         |  | Employment Agreement by and between the Registrant and Philip McDermott, dated June 8, 1999.                                                        
|               |  |                                                                                                                                                     

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|10.26**++   |  | OEM Agreement between AltiSys Communications and AltiGen Communications, Inc., dated January 18, 1999.                                            
|----------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------
|10.27****++ |  | Distribution Agreement between Synnex Information Technologies, Inc. and AltiGen Communications, Inc. dated December 22, 1999.                    
|10.28****++ |  | Distribution Agreement between Graybar Electric Company, Inc. and AltiGen Communications, Inc. dated June 12, 2003.                               
|21.1*       |  | Subsidiaries of the Registrant.                                                                                                                   
|23.1        |  | Consent of Independent Registered Public Accounting Firm.                                                                                         
|24.1        |  | Power of Attorney (included on signature page).                                                                                                   
|31.1        |  | Certification Pursuant to Section 302 of the Sarbanes-Oxley act of 2002.                                                                          
|31.2        |  | Certification Pursuant to Section 302 of the Sarbanes-Oxley act of 2002.                                                                          
|32.1        |  | Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|32.2        |  | Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

---

46

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To
the Board of Directors and Shareholders of
AltiGen Communications, Inc.:

We
have audited the accompanying consolidated balance sheets of AltiGen Communications, Inc. and subsidiaries as of September 30, 2004 and 2003, and the related
consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended September 30, 2004. Our audits also included the financial statement
schedule listed in the Index at Item 15(a)(2). These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an
opinion on the financial statements and financial statement schedule based on our audits.

We
conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the 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. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our opinion.

In
our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of AltiGen Communications, Inc. and subsidiaries as of
September 30, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 2004, in conformity with accounting
principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken
as a whole, present fairly in all material respects the information set forth therein.

/s/DELOITTE & TOUCHE LLP

San
Jose, California
December 28, 2004

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ALTIGEN COMMUNICATIONS, INC. AND SUBSIDIARY  CONSOLIDATED BALANCE SHEETS  (in thousands, except share and per share amounts)

|                                       |                                                                                                                                                         | September 30,                  |                                           
|-------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------ | ------------------------------------------
|
|ASSETS                                 |                                                                                                                                                         |                                |                                           
|Current assets:                        |                                                                                                                                                         |                                |                                           
|                                       | Cash and cash equivalents                                                                                                                               |                                | $                                         
|                                       | Short-term investments                                                                                                                                  |                                |                                           
|                                       | Accounts receivable, net of allowances of $35 and $60 in 2004 and 2003, respectively                                                                    |                                |                                           
|                                       | Inventories                                                                                                                                             |                                |                                           
|                                       | Prepaid expenses and other current assets                                                                                                               |                                |                                           
|                                       |                                                                                                                                                         |                                |                                           
|                                       |                                                                                                                                                         | Total current assets           |                                           
|                                       |                                                                                                                                                         |                                |                                           
|Property and equipment:                |                                                                                                                                                         |                                |                                           
|                                       | Furniture and equipment                                                                                                                                 |                                |                                           
|                                       | Computer software                                                                                                                                       |                                |                                           
|                                       |                                                                                                                                                         |                                |                                           
|                                       |                                                                                                                                                         |                                | 1,902                                     
|Less: Accumulated depreciation         |                                                                                                                                                         |                                | (1,750                                    
|                                       |                                                                                                                                                         |                                |                                           
|                                       | Net property and equipment                                                                                                                              |                                |                                           
|                                       |                                                                                                                                                         |                                |                                           
|Other non-current assets:              |                                                                                                                                                         |                                |                                           
|                                       | Long-term investments                                                                                                                                   |                                |                                           
|                                       | Long-term deposit                                                                                                                                       |                                |                                           
|                                       |                                                                                                                                                         |                                |                                           
|                                       |                                                                                                                                                         | Total other non-current assets |                                           
|                                       |                                                                                                                                                         |                                |                                           
|                                       |                                                                                                                                                         |                                | Total assets                              
|                                       |                                                                                                                                                         |                                |                                           
|LIABILITIES AND STOCKHOLDERS' EQUITY   |                                                                                                                                                         |                                |                                           
|Current liabilities:                   |                                                                                                                                                         |                                |                                           
|                                       | Accounts payable                                                                                                                                        |                                | $                                         
|                                       | Accrued liabilities:                                                                                                                                    |                                |                                           
|                                       |                                                                                                                                                         | Payroll and related benefits   |                                           
|                                       |                                                                                                                                                         | Warranty (Note 3)              |                                           
|                                       |                                                                                                                                                         | Marketing                      |                                           
|                                       |                                                                                                                                                         | Other                          |                                           
|                                       | Deferred revenue                                                                                                                                        |                                |                                           
|                                       |                                                                                                                                                         |                                |                                           
|                                       |                                                                                                                                                         | Total current liabilities      |                                           
|                                       |                                                                                                                                                         |                                |                                           
|Long-term liabilities                  |                                                                                                                                                         |                                | 145                                       
|Commitments and contingencies (Note 4) |                                                                                                                                                         |                                |                                           
|Stockholders' equity:                  |                                                                                                                                                         |                                |                                           
|                                       | Convertible preferred stock, $0.001 par value; Authorized5,000,000 shares; Outstandingnone at September 30, 2004 and 2003                             |                                |                                           
|                                       | Common stock, $0.001 par value; Authorized50,000,000 shares; Outstanding15,462,506 and 15,054,442 shares at September 30, 2004 and 2003, respectively |                                |                                           
|                                       | Treasury stock at cost1,063,895 shares at September 30, 2004 and 2003                                                                                  |                                |                                           
|                                       | Additional paid-in capital                                                                                                                              |                                |                                           
|                                       | Accumulated other comprehensive loss                                                                                                                    |                                |                                           
|                                       | Accumulated deficit                                                                                                                                     |                                |                                           
|                                       |                                                                                                                                                         |                                |                                           
|                                       |                                                                                                                                                         | Total stockholders' equity     |                                           
|                                       |                                                                                                                                                         |                                |                                           
|                                       |                                                                                                                                                         |                                | Total liabilities and stockholders' equity
|                                       |                                                                                                                                                         |                                |                                           

The accompanying notes are an integral part of these consolidated financial statements.

48

---





ALTIGEN COMMUNICATIONS, INC. AND SUBSIDIARY  CONSOLIDATED STATEMENTS OF OPERATIONS  (in thousands, except per share amounts)

|                                   |                                                                               | Fiscal Year Ended September 30, |      
|---------------------------------- | ----------------------------------------------------------------------------- | ------------------------------- | -----
|
|Net revenue:                       |                                                                               |                                 |      
|                                   | Hardware                                                                      |                                 | $    
|                                   | Software                                                                      |                                 |      
|                                   |                                                                               |                                 |      
|                                   |                                                                               | Total net revenue               |      
|Cost of revenues:                  |                                                                               |                                 |      
|                                   | Hardware                                                                      |                                 |      
|                                   | Software                                                                      |                                 |      
|                                   |                                                                               |                                 |      
|                                   |                                                                               | Total cost of revenues          |      
|                                   |                                                                               |                                 |      
|Gross profit                       |                                                                               |                                 | 9,235
|                                   |                                                                               |                                 |      
|Operating expenses:                |                                                                               |                                 |      
|                                   | Research and development                                                      |                                 |      
|                                   | Sales and marketing                                                           |                                 |      
|                                   | General and administrative                                                    |                                 |      
|                                   | Amortization of deferred stock compensation (Note 6)                          |                                 |      
|                                   |                                                                               |                                 |      
|                                   |                                                                               | Total operating expenses        |      
|                                   |                                                                               |                                 |      
|Loss from operations               |                                                                               |                                 | (77  
|Write-down of long term investment |                                                                               |                                 |     
|Interest and other income, net     |                                                                               |                                 | 105  
|                                   |                                                                               |                                 |      
|Net income (loss)                  |                                                                               | $                               | 28   
|                                   | Basic and diluted net income (loss) per share                                 |                                 | $    
|                                   |                                                                               |                                 |      
|                                   | Weighted average shares used in computing basic net income (loss) per share   |                                 |      
|                                   |                                                                               |                                 |      
|                                   | Weighted average shares used in computing diluted net income (loss) per share |                                 |      
|                                   |                                                                               |                                 |      

The
accompanying notes are an integral part of these consolidated financial statements.

49

---





ALTIGEN COMMUNICATIONS, INC. AND SUBSIDIARY  CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY  (in thousands, except share amounts)

|                                                                         |  | Convertible
Preferred Stock |  |   |   |  |            |  |   |    |  |   |        |   |   |        |   |   |     
|------------------------------------------------------------------------ |  | --------------------------- |  | - | - |  | ---------- |  | - | -- |  | - | ------ | - | - | ------ | - | - | ----
|
|
|
|BALANCE, OCTOBER 1, 2001                                                 |  |                            |  | $ |  |  | 13,772,488 |  | $ | 14 |  | $ | (105   | ) | $ | 61,593 |   | $ | (455
|Exercise of stock options                                                |  |                            |  |   |  |  | 624,197    |  |   |   |  |   |       |   |   | 111    |   |   |    
|Issuance of common stock in connection with Employee Stock Purchase Plan |  |                            |  |   |  |  | 146,921    |  |   |   |  |   |       |   |   | 98     |   |   |    
|Purchase of treasury stock                                               |  |                            |  |   |  |  |           |  |   |   |  |   | (909   | ) |   |       |   |   |    
|Amortization of deferred stock compensation                              |  |                            |  |   |  |  |           |  |   |   |  |   |       |   |   |       |   |   | 338 
|Cancellation of employee stock options                                   |  |                            |  |   |  |  |           |  |   |   |  |   |       |   |   | (62    | ) |   | 62  
|Net loss                                                                 |  |                            |  |   |  |  |           |  |   |   |  |   |       |   |   |       |   |   |    
|                                                                         |  |                             |  |   |   |  |            |  |   |    |  |   |        |   |   |        |   |   |     
|BALANCE, SEPTEMBER 30, 2002                                              |  |                            |  |   |  |  | 14,543,606 |  |   | 14 |  |   | (1,014 | ) |   | 61,740 |   |   | (55 
|                                                                         |  |                             |  |   |   |  |            |  |   |    |  |   |        |   |   |        |   |   |     
|Exercise of stock options                                                |  |                            |  |   |  |  | 365,431    |  |   | 1  |  |   |       |   |   | 347    |   |   |    
|Issuance of common stock in connection with Employee Stock Purchase Plan |  |                            |  |   |  |  | 145,405    |  |   |   |  |   |       |   |   | 65     |   |   |    
|Amortization of deferred stock compensation                              |  |                            |  |   |  |  |           |  |   |   |  |   |       |   |   |       |   |   | 55  
|Net loss                                                                 |  |                            |  |   |  |  |           |  |   |   |  |   |       |   |   |       |   |   |    
|                                                                         |  |                             |  |   |   |  |            |  |   |    |  |   |        |   |   |        |   |   |     
|BALANCE, SEPTEMBER 30, 2003                                              |  |                            |  |   |  |  | 15,054,442 |  |   | 15 |  |   | (1,014 | ) |   | 62,152 |   |   |    
|                                                                         |  |                             |  |   |   |  |            |  |   |    |  |   |        |   |   |        |   |   |     
|Exercise of stock options                                                |  |                            |  |   |  |  | 229,075    |  |   |   |  |   |       |   |   | 241    |   |   |    
|Issuance of common stock in connection with Employee Stock Purchase Plan |  |                            |  |   |  |  | 178,989    |  |   |   |  |   |       |   |   | 112    |   |   |    
|Unrealized loss from investments                                         |  |                            |  |   |  |  |           |  |   |   |  |   |       |   |   |       |   |   |    
|Net income                                                               |  |                            |  |   |  |  |           |  |   |   |  |   |       |   |   |       |   |   |    
|                                                                         |  |                             |  |   |   |  |            |  |   |    |  |   |        |   |   |        |   |   |     
|Comprehensive income                                                     |  |                            |  |   |  |  |           |  |   |   |  |   |       |   |   |       |   |   |    
|                                                                         |  |                             |  |   |   |  |            |  |   |    |  |   |        |   |   |        |   |   |     
|BALANCE, SEPTEMBER 30, 2004                                              |  |                            |  | $ |  |  | 15,462,506 |  | $ | 15 |  | $ | (1,014 | ) | $ | 62,505 |   | $ |    
|                                                                         |  |                             |  |   |   |  |            |  |   |    |  |   |        |   |   |        |   |   |     

The accompanying notes are an integral part of these consolidated financial statements.

50

---





ALTIGEN COMMUNICATIONS, INC. AND SUBSIDIARY  CONSOLIDATED STATEMENTS OF CASH FLOWS  (in thousands)

|                                                     |                   | Fiscal Year Ended September 30,                                                      |                                                               
|---------------------------------------------------- | ----------------- | ------------------------------------------------------------------------------------ | --------------------------------------------------------------
|
|CASH FLOWS FROM OPERATING ACTIVITIES:                |                   |                                                                                      |                                                               
|                                                     | Net income (loss) |                                                                                      | $                                                             
|                                                     |                   | Adjustments to reconcile net income (loss) to net cash used in operating activities: |                                                               
|                                                     |                   |                                                                                      | Depreciation                                                  
|                                                     |                   |                                                                                      | Amortization of deferred stock compensation                   
|                                                     |                   |                                                                                      | Write-down of long term investment                            
|                                                     |                   |                                                                                      | Write-off of property and equipment                           
|                                                     |                   | Changes in operating assets and liabilities:                                         |                                                               
|                                                     |                   |                                                                                      | Accounts receivable                                           
|                                                     |                   |                                                                                      | Inventories                                                   
|                                                     |                   |                                                                                      | Prepaid expenses and other assets                             
|                                                     |                   |                                                                                      | Accounts payable                                              
|                                                     |                   |                                                                                      | Accrued liabilities                                           
|                                                     |                   |                                                                                      | Deferred revenue                                              
|                                                     |                   |                                                                                      | Deferred rent                                                 
|                                                     |                   |                                                                                      |                                                               
|                                                     |                   |                                                                                      |                                                               
|                                                     |                   |                                                                                      |                                                               
|CASH FLOWS FROM INVESTING ACTIVITIES:                |                   |                                                                                      |                                                               
|                                                     |                   |                                                                                      | Purchases of short-term investments                           
|                                                     |                   |                                                                                      | Proceeds from sale of short-term investments                  
|                                                     |                   |                                                                                      | Increase in long-term investments                             
|                                                     |                   |                                                                                      | Changes in non-other current asset                            
|                                                     |                   |                                                                                      | Purchases of property and equipment                           
|                                                     |                   |                                                                                      |                                                               
|                                                     |                   |                                                                                      |                                                               
|                                                     |                   |                                                                                      |                                                               
|CASH FLOWS FROM FINANCING ACTIVITIES:                |                   |                                                                                      |                                                               
|                                                     |                   |                                                                                      | Proceeds from issuances of common stock, net of issuance costs
|                                                     |                   |                                                                                      | Collection of promissory note from officer/stockholder        
|                                                     |                   |                                                                                      | Purchase of treasury stock                                    
|                                                     |                   |                                                                                      |                                                               
|                                                     |                   |                                                                                      |                                                               
|                                                     |                   |                                                                                      |                                                               
|NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS |                   |                                                                                      | (3,181                                                        
|CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR         |                   |                                                                                      | 8,548                                                         
|                                                     |                   |                                                                                      |                                                               
|CASH AND CASH EQUIVALENTS, END OF YEAR               |                   | $                                                                                    | 5,367                                                         
|                                                     |                   |                                                                                      |                                                               

The
accompanying notes are an integral part of these consolidated financial statements.

51

---





ALTIGEN COMMUNICATIONS, INC. AND SUBSIDIARY  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. ORGANIZATION OF THE COMPANY:

We are a pioneer and market leader in Internet protocol telephony systems for small-to-medium sized businesses. We design, manufacture and
market next generation, Internet protocol phone systems and contact centers that use both the Internet and the public telephone network to take advantage of the convergence of voice and data
communications. Unlike traditional proprietary phone systems, our systems are designed with open architecture and are built on an industry standard platform. This adherence to industry standards
allows our products to play an important role in the small-to-medium sized business market by delivering phone systems that can integrate with other technologies and provide
integrated voice and data solutions. We believe this enables our customers to implement communication systems that have an increased return versus past technology investments. We generated net
revenues of $14.8 million, for a net profit of $28,000, during fiscal year 2004. As of September 30, 2004, we had an accumulated deficit of $50.8 million. Net cash used in
operating activities was $185,000 for fiscal year 2004. We were incorporated in California in May 1994 and we reincorporated into Delaware in June 1999.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

Principles of Presentation

Our consolidated financial statements reflect the operations of AltiGen Communications, Inc. and our wholly-owned subsidiary. The subsidiary is located in
Shanghai, China and was incorporated in November 1998. As of September 30, 2004, we had approximately $11,000 in long lived assets in China.
All significant intercompany transactions and balances have been eliminated. Our fiscal year end is September 30. Unless otherwise stated, all references to fiscal years 2004, 2003, and 2002
refer to the twelve months ended September 30 of that year. Certain amounts from prior years have been reclassified to conform to current year presentation. These reclassifications did not
change previously reported total assets, liabilities, stockholders' equity or net loss.

Use of Estimates in Preparation of Financial Statements

The preparation of the financial statements in conformity with generally accepted accounting principles in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reported periods. Key estimates include provisions for excess and obsolete inventories, warranty, doubtful account reserve, valuation on tax assets and
long-term investments. Actual results could differ from those estimates.

Concentration of Risk

Financial instruments that potentially subject us to a concentration of credit risk consist principally of trade receivables. We perform ongoing credit
evaluations of our customers' financial condition and require letters of credit whenever deemed necessary to help reduce our credit risk. Additionally, we establish an allowance for doubtful accounts
based upon factors surrounding the credit risk of specific customers, historical trends related to past losses and other information. As of September 30, 2004 approximately 88% of our account
receivable were concentrated with four distributors, compared to approximately 93% concentrated with three distributors as of September 30, 2003.

Our
purchases are concentrated with four suppliers and certain key chip components of our products are sole sourced. For fiscal years 2004 and 2003 these four suppliers provided 81% and
84%,

52

---



respectively,
of all raw materials purchased. Loss of one of these suppliers could adversely impact our operations.

Cash and Cash Equivalents and Short-term Investments

We consider all highly liquid investments with an original maturity of three months or less from the date of purchase to be cash equivalents.
Short-term investments are in highly liquid financial instruments with original maturities greater than three months but less than one year and are classified as
"available-for-sale" investments. Investments are reported at their fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of
stockholders' equity. As of September 30, 2004, our cash and cash equivalents consisted of commercial paper and cash deposited in checking and money market accounts. For fiscal years 2004,
2003, and 2002, we did not make any cash payments for interest or income taxes.

Unrealized
loss from short-term investments were $2,000 and $0 at September 30, 2004 and 2003, respectively.

Inventories

Inventories (which include costs associated with components assembled by third-party assembly manufacturers, as well as internal labor and allocable overhead) are
stated at the lower of standard cost (which approximates actual cost on a first-in, first-out method) or market value. Provisions, when required, are made to reduce excess and
obsolete inventories to their estimated net realizable values. We regularly monitor inventory quantities on hand and record a provision for excess and obsolete inventories based primarily on our
estimated forecast of product demand and production requirements for the next six months. We did not record any provision for excess and obsolete inventories for fiscal years 2004, 2003, or 2002. The
components of inventories include (in thousands):

September 30,2004

2003Raw materials

$
68

$
35Work-in-progress


95


184Finished goods


895


691$
1,058

$
910


Property and Equipment

Property and equipment are stated at cost. Depreciation is provided using the straight-line method over the estimated useful lives of the assets,
which is three years. Depreciation expense for fiscal years 2004, 2003, and 2002, was approximately $218,000, $427,000, and $587,000, respectively. All repairs and maintenance costs are expensed as
incurred.

At
September 30, 2004, equipment with a net book value of $9,000 (net of accumulated depreciation of $15,000), has been leased under capital leases.

Long-Term Investments

As of September 30, 2004, we held an investment of common stock of private Taiwanese telecommunication company valued at approximately $195,000 accounted
for using the cost method. Our interest in the company is approximately 2%, which interest does not allow us to exercise significant influence.

53

---



In
July 2004, we purchased common stock of a private Korean telecommunications company for $79,000. As a result of this investment, we acquired approximately 23% of the voting
power of the company and have the right to nominate and have elected one of the three members of the company's current board of directors. We are accounting for this investment using the equity method
and will record our minority interest of their results in future periods.

We
perform periodic reviews of our investments for impairment. Our investments are considered impaired when a review of the investees' operations and other indicators of impairment
indicate that
the carrying value of the investment is not likely to be recoverable. Such indicators include, but are not limited to, limited capital resources, limited prospects of receiving additional financing,
and limited prospects for liquidity of the related securities. During fiscal year 2002, we recorded a noncash, permanent write-down of $203,000 related to impairments of an investment in
Taiwan. No write-downs were recorded during fiscal years 2004 or 2003.

Software Development Costs

In accordance with Statement of Financial Accounting Standards ("SFAS") No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased, or
Otherwise Marketed," the Company capitalizes eligible computer software development costs upon the establishment of technological feasibility, which it has defined as completion of a working model.
The amount of costs eligible for capitalization, after consideration of factors such as realizable value, were not material and, accordingly, all software development costs have been charged to
research and development expense in the accompanying consolidated statements of operations.

Stock-Based Compensation

We account for stock-based compensation in accordance with the provisions of APB No. 25, "Accounting for Stock Issued to Employees," and comply with the
disclosure provisions of SFAS No. 123 as amended by SFAS No. 148, "Accounting for Stock-Based CompensationTransition and Disclosures." Deferred compensation recognized under
APB No. 25 is amortized to expense using the graded vesting method. We account for stock options issued to non-employees in accordance with the provisions of SFAS No. 123 and
EITF No. 96-18 under the fair value based method.

We
adopted the disclosure-only provisions of SFAS No. 123, and accordingly, no expense has been recognized for options granted to employees under the various Plans. We
amortize deferred stock-based compensation over the vesting periods of the applicable stock purchase rights and stock options, generally four years. Had compensation expense been determined based on
the fair value at the grant date for awards, consistent with the provisions of SFAS No. 123, the Company's pro forma net loss and net loss per share would be as follows (in thousands, except
per share data):

|                                               |                                                                                                        | Fiscal Year Ended
September 30, |  
|---------------------------------------------- | ------------------------------------------------------------------------------------------------------ | ------------------------------- | -
|
|                                               | Reported net income (loss)                                                                             |                                 | $
|                                               | Add: stock-based employee compensation expense included in reported net income (loss) under APB No. 25 |                                 |  
|                                               | Deduct: Total stock-based compensation determined under fair value based method for all awards         |                                 |  
|                                               |                                                                                                        |                                 |  
|                                               | Pro forma net loss under SFAS No. 123                                                                  |                                 |  
|Basic and diluted net income (loss) per share: |                                                                                                        |                                 |  
|                                               | As reported                                                                                            |                                 | $
|                                               | Pro forma                                                                                              |                                 |  

54

---



The
fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model, and is not subject to revaluation as a result of subsequent stock
price fluctuations. The following weighted-average assumptions are used:

|                         |  | Employee Stock Option Plans
Fiscal Year
Ended September 30, |   | Employee Stock Purchase Plan
Fiscal Year
Ended September 30, |  
|------------------------ |  | ----------------------------------------------------------- | - | ------------------------------------------------------------ | -
|
|Expected Life (in years) |  | 5                                                           |   | 5                                                            |  
|Risk-free interest rate  |  | 3.3-3.7                                                     | % | 2.9-3.4                                                      | %
|Volatility               |  | 105                                                         | % | 111                                                          | %
|Expected dividend        |  | 0.0                                                         | % | 0.0                                                          | %

The
Black-Scholes option pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition,
option pricing models require the input of highly subjective assumptions, including the expected stock price volatility. We use projected volatility rates, which are based upon historical volatility
rates since our initial public offering, trended into future years. Because our employee stock options have characteristics significantly different from those of traded options and because changes in
the subjective input assumptions can
materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of our options.

Revenue Recognition

We account for the recognition of revenues in accordance with Statement of Position ("SOP") 97-2, "Software Revenue Recognition." Revenues consist of
sales to end-users, including resellers, and to distributors. Revenues from sales to end-users are recognized upon shipment, when risk of loss has passed to the customer,
collection of the receivable is reasonably assured, persuasive evidence of an arrangement exits, and the price is fixed and determinable. Sales to distributors are made under terms allowing certain
rights of return and protection against subsequent price declines on the Company's products held by its distributors. Upon termination, any unsold products may be returned by the distributor for a
full refund. These agreements may be canceled by either party based on a specified notice. As a result of the above provisions, we defer recognition of distributor revenues until such distributors
resell our products to their customers. The amounts deferred as a result of this policy are reflected as "deferred revenue" in the accompanying consolidated balance sheets. The related cost of revenue
is also deferred and reported in the consolidated balance sheets as inventory.

Software
components are generally not sold separately from our hardware components. Software revenues consist of license revenues that are recognized upon the delivery of application
products. We provide limited post-contract customer support ("PCS"), consisting primarily of technical support and "bug" fixes. In accordance with SOP 97-2, revenue earned on
software arrangements involving multiple elements is allocated to each element based upon the relative fair values of the elements. Although we provide PCS, the revenue allocated to this element is
recognized together with the initial licensing fee on delivery of the software because: (1) the PCS fee is included with the initial licensing fee; (2) the PCS included with the initial
license fee is for one year or less; (3) the estimated cost of providing PCS during the arrangement is insignificant; and (4) unspecified upgrades/enhancements offered for minimal or no
cost during PCS arrangements historically have been and are expected to continue to be minimal and infrequent. All estimated costs of providing the services, including upgrades and enhancements are
accrued for at the time of delivery.

55

---



For
fiscal years 2004, 2003, and 2002, the following customers accounted for approximately 82%, 87% and 84% of net revenues, respectively:

Fiscal Year Ended
September 30,2004

2003

2002AltiSys

14
%
18
%
27
%Ingram Micro

14
%
21
%
25
%Synnex

46
%
48
%
32
%Graybar

8
%





Revenues
derived from sales to customers outside of the Americas, primarily in China, Norway and the United Kingdom accounted for approximately 10%, 6% and 6% of our net revenues for
fiscal years 2004, 2003 and 2002, respectively.

Computation of Basic and Diluted Net Income (Loss) Per Share

Historical net income (loss) per share has been calculated under SFAS No. 128, "Earnings per Share." SFAS No. 128 requires companies to compute
earnings per share under two methods (basic and diluted). Basic net income (loss) per share is calculated by dividing net income (loss) by the weighted average shares of common stock outstanding
during the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock.
Fiscal 2003, 2002 basic and diluted net loss per share numbers are identical as potential common shares resulting from the exercise of stock options are antidilutive.

Basic
and diluted income (loss) per share for each of the three years in the period ended September 30, 2004 are as follows (in thousands):

|                                                                         |                                     | Fiscal Year Ended
September 30, |   
|------------------------------------------------------------------------ | ----------------------------------- | ------------------------------- | --
|
|Reported net income (loss)                                               |                                     | $                               | 28
|Computation of common shares outstandingbasic income (loss) per share:  |                                     |                                 |   
|                                                                         |                                     | Weighted average common stock   |   
|                                                                         |                                     |                                 |   
|                                                                         | Basic net income (loss) per share   |                                 |   
|                                                                         |                                     |                                 |   
|Computation of common shares outstandingdilute income (loss) per share: |                                     |                                 |   
|                                                                         |                                     | Weighted average common stock   |   
|                                                                         |                                     |                                 |   
|                                                                         | Diluted net income (loss) per share |                                 |   
|                                                                         |                                     |                                 |   

Comprehensive Loss

Comprehensive loss for the Company consists of net loss plus the effect of foreign currency translation adjustments and other unrealized gains and losses.

Segment Reporting

We are organized and operate as one operating segment. We operate primarily in one geographic area, the Americas.

56

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Recent Accounting Pronouncements

In December 2002, the Emerging Issues Task Force ("EITF") reached a consensus on EITF No. 00-21, "Revenue Arrangements with Multiple
Deliverables." This pronouncement addresses certain aspects of the accounting by a vendor for arrangements under which it will perform multiple revenue-generating activities. The guidance in this
pronouncement was effective for revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The adoption of EITF 00-21 did not have an effect on our
consolidated financial statements.

In
December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based CompensationTransition and Disclosure, an amendment to FASB Statement
No. 123." SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting of stock-based employee compensation. In addition,
SFAS No. 148 amends the disclosure requirements of SFAS No. 123, "Accounting for Stock-Based Compensation," to require prominent disclosure in both annual and interim financial
statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. We adopted the disclosure provisions of SFAS No. 148
effective January 1, 2003.

In
January 2003, the FASB issued SFAS Interpretation No. 46, "Consolidation of Variable Interest Entities," and a revised interpretation of FASB Interpretation
No. 46 (FIN 46R) in December 2003 (collectively FIN 46) which expands upon and strengthens existing accounting guidance concerning when a company should include in its financial
statements the assets, liabilities and activities of another entity. The Company did not have any variable interest entities as of September 30, 2004 and the adoption of FIN 46 did not have a
material impact on the Company's financial position or results of operations.

In
April 2003, the FASB issued SFAS No. 149, "Amendment of SFAS No. 133 on Derivative Instruments and Hedging Activities." SFAS No. 149 amends and clarifies
accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under
SFAS No. 133. SFAS No. 149 was effective for contracts entered into or modified after June 30, 2003 and did not have an impact on our consolidated financial statements.

In
May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." The Statement improves the
accounting for certain financial instruments that, under previous guidance, issuers could account for as equity by requiring that such instruments be classified as liabilities in statements of
financial position. Adoption of SFAS No. 150 did not have an effect on our consolidated financial statements.

In
December 2003, the SEC issued Staff Accounting Bulletin (SAB) 104, which rescinds and updates SAB 101, "Revenue Recognition in Financial Statements." SAB 104's primary purpose
is to rescind accounting guidance contained in SAB 101 related to multiple element revenue arrangements, which was superseded as a result of the issuance of EITF 00-21, "Accounting for
Revenue Arrangements with Multiple Deliverables." While the wording of SAB 104 has changed to reflect the issuance of EITF 00-21, the revenue recognition principles of SAB 101 remain
largely unchanged by the issuance of SAB 104. Application of this guidance did not have a material impact on our financial position or results of operations.

In
March 2004, the EITF reached a consensus on Issue No. 03-01, "The Meaning of Other-Than-Temporary Impairment and Its Application to
Certain Investments" ("EITF No. 03-01"). EITF No. 03-01 provides guidance on recording other-than-temporary impairments of cost method
investments and disclosures about unrealized losses on available-for-sale debt and equity securities. The adoption of this standard did not have a material impact on our
consolidated balance sheet or statement of operations.

57

---



In
July 2004, the EITF reached a consensus on Issue No. 02-14, "Whether an Investor Should Apply the Equity Method of Accounting to Investments Other Than
Common Stock" ("EITF No. 02-14"). The consensus was that an investor should only apply the equity method of accounting when it has investments in either common stock (as already
required by Accounting Principles Board Opinion No. 18 ("APB 18")) or in-substance common stock of a corporation, provided that the investor has the ability to exercise significant
influence over the operating and financial policies of the investee. EITF No. 02-14 defines in-substance common stock and provides guidance on determining whether an
investment is substantially similar to the common stock of the investee. EITF No. 02-14 should be applied in the first reporting period beginning after September 15, 2004.
Management has not yet determined the impact of adopting EITF No. 02-14 on our financial position or results of operations.

In
November 2004, the FASB issued SFAS No. 151, "Inventory Costs". The Statement requires that abnormal amounts of idle facility expense, freight handling costs and wasted
material be recognized as current-period expenses. In addition the statement requires that the allocation of production overhead be based on normal capacity. The adoption of this standard in
October 2004 is not expected to have a material impact on our consolidated financial statements.

On
December 17, 2004 the FASB issued SFAS No. 123, "Share-Based Payments (revised 2004)," (SFAS No. 123R). This statement eliminates the option to apply the
intrinsic value measurement provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB Opinion No. 25), to stock compensation awards issued
to employees. Rather the Statement requires companies to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of
the award. That cost will be recognized over the period during which an employee is required to provide services in exchange for the awardthe requisite service period (usually the vesting
period). SFAS No. 123R will also require enterprises to measure the cost of employee services received in exchange for employee stock purchase plan (ESPP) awards and we will be required to
expense the grant-date fair value of our ESPP awards. SFAS No. 123R will be effective for our fiscal quarter beginning July 1, 2005. We have not yet quantified the effect of
the future adoption of SFAS No. 123R on a going forward basis.

3. WARRANTY:

The Company provides a one year warranty for hardware products starting upon shipment to end users. We historically have experienced minimal warranty costs.
Factors that affect our warranty liability include the number of installed units, historical experience and management's judgment regarding anticipated rates of warranty claims and cost per claim. We
assess the adequacy of our recorded warranty liability every quarter and make adjustments to the liability if necessary.

Changes
in our warranty liability for the fiscal year ended September 30, 2004 and 2003, are as follows (in thousands):

September 30,2004

2003Beginning balance

$
644

$
590Provisions for warranty liability


147


307Other adjustments


(193
)

Warranty cost including labor, components and scrap


(174
)

(253
)Ending balance

$
424

$
644


Other
adjustments were the result of a significant decline in the product return rate caused by changes in the Company's management of the return programs.

58

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4. COMMITMENTS AND CONTINGENCIES:

Commitments

We lease our facilities under various operating lease agreements expiring on various dates through February 2009. In December 2003, we leased
approximately 32,000 square feet to serve as our headquarters for corporate administration, research and development, manufacturing, and sales and marketing facility in Fremont, California. The lease
for our headquarters expires on February 21, 2009. Rent expense for all operating leases totaled approximately $510,000, $818,000, and $756,000, for fiscal years 2004, 2003, and 2002,
respectively. In addition, the Company leases certain equipment under capital lease arrangements. Minimum future lease payments under all noncancellable capital and operating leases as of
September 30, 2004 are as follows (in thousands):

Fiscal Year Ending September 30,

Capital
Leases

Operating
Leases2005

$
5

$
3932006


2


3952007


2


3602008





2722009





92Total minimum lease payment


9

$
1,512Amount representing interest


1Present value of minimum lease payment


8Current portion


5Long-term portion

$
3


Contingencies

We may become party to litigation in the normal course of our business. Litigation in general, and intellectual property and securities litigation in particular,
can be expensive and disruptive to normal business operations. Moreover, the results of complex litigation are difficult to predict.

On
September 6, 2002, Vertical Networks, Inc. filed suit against us in the United States District Court for the Northern District of California, alleging infringement of
Vertical Networks' U.S. Patents Nos. 6,266,341; 6,289,025; 6,292,482; 6,389,009; and 6,396,849. On October 28, 2002, Vertical Networks amended its complaint to add allegations of infringement
of U.S. Patents Nos. 5,617,418 and 5,687,174. Vertical Networks filed a second amended complaint on November 20, 2002 to identify our products and/or activities that allegedly infringe the
seven patents-in-suit. Vertical Networks seeks a judgment of patent infringement and an award of damages, including treble damages for alleged willful infringement, and
attorneys' fees and costs. We filed an answer and counterclaims for declaratory relief on December 9, 2002. On December 26, 2002, Vertical Networks filed its answer to our counterclaims.
Vertical Networks served its preliminary infringement contentions on us on April 9, 2003 and we served Vertical Networks our preliminary invalidity contentions on June 3, 2003 and
July 14, 2003. To date, the parties have exchanged some discovery, but no depositions have been taken, and no motions are currently pending. On October 7, 2003, the parties filed a
stipulation to stay this action, pending the outcome of the reissue of some of the subject patents before the U.S. Patent and Trademark Office. We believe we have strong defenses and arguments in this
dispute and intend to vigorously litigate our position. Management's view is that any loss from this litigation is not probable or estimable.

59

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5. CAPITAL STOCK:

Common Stock

We are authorized to issue 50,000,000 shares of common stock. At September 30, 2004, we had reserved the following shares of common stock for future
issuance:

1994 Stock Option Plan

1,043,3691999 Employee Stock Purchase Plan

696,5241999 Stock Option Plan

4,327,7576,115,272


Stock Option Plans

In October 1994, we adopted the 1994 Stock Option Plan (the "1994 Plan") and authorized the issuance of 2,096,246 shares to employees, directors, and
consultants. During fiscal 1999, we adopted the 1999 Stock Option Plan (the "1999 Plan") and authorized the issuance of 2,096,247 shares to employees, directors and consultants. The number of share
will be increased on the first day of the Company's fiscal year equal to the lessor of (i) 1,796,783 shares or (ii) 5% of the outstanding shares on that date or (iii) a lesser
amount as determined by the Board of Directors. Under the Plans, the Board of Directors may grant incentive and nonqualified stock options to employees, directors and consultants of the Company. The
exercise price per share for an incentive stock option cannot be less than 100% of the fair market value, as determined by the Board of Directors, on the date of grant. The exercise price per share
for a nonqualified stock option cannot be less than 85% of the fair market value, as determined by the Board of Directors, on the date of grant. Also, the exercise price of options granted to a
greater than 10% stockholder may not be less than 110% of the fair market value on the date of grant. The value of common stock subject to incentive stock options that become exercisable by any one
employee in any calendar year may not exceed $100,000. Options under these Plan generally vest over a four-year period and generally expire ten years after the date of grant.

60

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Option
activity under the 1994 and 1999 Plans ("the Plans") was as follows:

|                                  |                                                   | Options available
for grant |          | Options outstanding |          | Weighted Average
Exercise Price
|--------------------------------- | ------------------------------------------------- | --------------------------- | -------- | ------------------- | -------- | -------------------------------
|Balance as of October 1, 2001     |                                                   | 1,713,215                   |          | 4,133,050           |          | $                              
|                                  | Authorized for grant                              |                             | 688,624  |                     |         |                                
|                                  | Granted (weighted average of fair value of $0.71) |                             | (531,155 | )                   | 531,155  |                                
|                                  | Exercised                                         |                             |         |                     | (624,197 | )                              
|                                  | Canceled                                          |                             | 494,237  |                     | (494,237 | )                              
|                                  |                                                   |                             |          |                     |          |                                
|Balance as of September 30, 2002  |                                                   | 2,364,921                   |          | 3,545,771           |          |                                
|                                  | Authorized for grant                              |                             | 673,985  |                     |         |                                
|                                  | Granted (weighted average of fair value of $0.51) |                             | (873,000 | )                   | 873,000  |                                
|                                  | Exercised                                         |                             |         |                     | (365,431 | )                              
|                                  | Canceled                                          |                             | 451,055  |                     | (451,055 | )                              
|                                  |                                                   |                             |          |                     |          |                                
|Balance as of September 30, 2003  |                                                   | 2,616,961                   |          | 3,602,285           |          |                                
|                                  | Authorized for grant                              |                             | 699,527  |                     |         |                                
|                                  | Granted (weighted average of fair value of $0.51) |                             | (808,000 | )                   | 808,000  |                                
|                                  | Exercised                                         |                             |         |                     | (229,075 | )                              
|                                  | Canceled                                          |                             | 429,411  |                     | (429,396 | )                              
|                                  |                                                   |                             |          |                     |          |                                
|Balance as of September 30, 2004  |                                                   | 2,937,899                   |          | 3,751,814           |          | $                              
|                                  |                                                   |                             |          |                     |          |                                
|Exercisable at September 30, 2002 |                                                   |                             |          | 2,030,433           |          | $                              
|Exercisable at September 30, 2003 |                                                   |                             |          | 2,508,791           |          | $                              

The
following table summarizes information concerning outstanding and exercisable options at September 30, 2004:

|  |            |  | Options Outstanding |  | Options Exercisable
|- | ---------- |  | ------------------- |  | -------------------
|
|$ | 0.17-$0.71 |  | 659,280             |  | 7.65               
|  | 0.72-0.92  |  | 631,386             |  | 6.33               
|  | 0.93-2.42  |  | 737,849             |  | 6.68               
|  | 2.43-3.81  |  | 82,946              |  | 7.44               
|  | 3.82-4.33  |  | 715,500             |  | 9.27               
|  | 4.34-12.69 |  | 924,853             |  | 5.15               
|  |            |  |                     |  |                    
|  |            |  | 3,751,814           |  | 6.92               
|  |            |  |                     |  |                    

Deferred Stock Compensation

In connection with the issuance of certain stock options to employees in fiscal years 1999 and 1998, we recorded deferred stock compensation in the aggregate
amount of approximately $3,892,000, representing the difference between the deemed fair value of our common stock and the exercise price of stock options at the date of grant prior to our initial
public offering. For fiscal years 2003 and 2002, amortization of deferred stock compensation expense was approximately $55,000 and $338,000, respectively. We fully amortized the deferred stock
compensation in fiscal year 2003.

61

---



1999 Employee Stock Purchase Plan

Under the 1999 Employee Stock Purchase Plan (the "1999 Purchase Plan"), 696,524 shares of common stock are reserved for issuance at September 30, 2004 to
eligible employees at a price of 85% of the lower of the fair market value of the common stock on the first day of the offering period or a specified exercise date (last trading day in April or
October). The number of reserved shares will be increased on the first day of each fiscal year by the lesser of (i) 598,928 shares, (ii) 2% of the outstanding shares on that date or
(iii) a lesser amount determined by the Board of Directors. Participants under the 1999 Purchase Plan generally may not purchase shares on any exercise date to the extent that, immediately
after the grant, the participant would own stock totaling 5% or more of the total combined voting power of all stock of the Company, or greater than $25,000 worth of stock in any calendar year. In
addition, no more than 5,989 shares may be purchased by any participant during any offering period. In the event of a sale or merger of the Company, the Board may accelerate the exercise date of the
current purchase period to a date prior to the change of control, or the acquiring company may assume or replace the outstanding purchase rights under the 1999 Purchase Plan. On October 1,
2004, we increased the number of shares reserved for the Employee Stock Purchase Plan in the amount of 279,811 shares. In fiscal year 2004, 178,989 shares were purchased by and distributed to
employees at a price ranging from of $0.47 to $2.35 per share.

Stock Repurchase Program

On April 24, 2001, our Board of Directors authorized a stock repurchase program to buy back our outstanding common stock in the open market. Under this
repurchase program, we repurchased $909,490 and $105,009 during fiscal 2002 and 2001, respectively, of common stock. The stock repurchased program ended on January 2002.

6. DEFERRED STOCK COMPENSATION:

Amortization of deferred stock compensation relates to the following items in the accompanying consolidated statements of operations (in thousands):

Fiscal Year Ended
September 30,2004

2003

2002Research and development

$


$
23

$
143Sales and marketing





27


104General and administrative





5


91$


$
55

$
338


7. INCOME TAXES:

We account for income taxes pursuant to SFAS No. 109, "Accounting for Income Taxes." SFAS No. 109 requires recognition of deferred tax liabilities
and assets for the expected future tax

62

---



consequences
of events that have been included in the financial statements or tax returns. The following is a summary of the significant components of the our deferred tax asset (in thousands):

September 30,2004

2003Net operating loss carryforwards

$
15,752

$
15,420Reserve and other cumulative temporary differences


2,100


101Research and development credit carryforward


1,087


1,160Net capitalized research and development expenses


698


88419,637


17,565Valuation allowance


(19,637
)

(17,565
)Net deferred tax asset

$


$



A
reconciliation between the Company's effective tax rate and the U.S. statutory rate is as follows:

Fiscal Year Ended
September 30,2004

2003

2002Tax at federal statutory rate

35.0
%
(35.0
)%
(35.0
)%Tax exempt investment incomeChange in valuation allowance

(94.0
)
34.7

34.8Other

59.0

1.3

1.8Tax credits



(1.0
)
(1.6
)Provision for income taxes

0.0
%
0.0
%
0.0
%


As
of September 30, 2004, we had cumulative net operating loss carryforwards for federal and state income tax reporting purposes of approximately $42.6 million and
$14.6 million, respectively, which expire on various dates from 2009 to 2024. Under current tax law, net operating loss carryforwards available in any given year may be limited upon the
occurrence of certain events, including significant changes in ownership interest. The annual use of our net operating loss and credit carryforwards would be limited according to these provisions.
Management has not yet determined the extent of such limitations. Such limitations may result in the loss of carryforwards benefits due to their expiration.

A
valuation allowance has been recorded for the entire deferred tax asset as a result of uncertainties regarding realization of the asset, including limited operating history of the
Company, lack of profitability to date and uncertainty over future operating profitability and taxable income. As of September 30, 2004 and 2003 we had no significant deferred tax liabilities.

8. RELATED PARTY TRANSACTION:

In July 2004, we purchased common stock of a private Korean telecommunications company for$79,000. As a
result of this investment, we acquired approximately 23% of the voting power of the company and have the right to nominate and have elected one of the three members of the company's current board of
directors. We are accounting for this investment using the equity method and will record our minority interest of their results in future periods. We had revenue from product sales to this company of
$100,000 in fiscal 2004. We did not have any accounts receivable at September 30, 2004.

63

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9. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED):

The following is a summary of our unaudited quarterly financial results:

|                                              |  | First Quarter |       | Second Quarter |   | Third Quarter |   | Fourth Quarter |      
|--------------------------------------------- |  | ------------- | ----- | -------------- | - | ------------- | - | -------------- | -----
|
|Fiscal Year Ended September 30,               |  |               |       |                |   |               |   |                |      
|2004:                                         |  |               |       |                |   |               |   |                |      
|Revenues, net                                 |  | $             | 3,630 |                | $ | 3,293         |   | $              | 3,883
|Gross profit                                  |  |               | 2,192 |                |   | 2,043         |   |                | 2,403
|Net income (loss)                             |  |               | (46   | )              |   | (246          | ) |                | 185  
|Basic and diluted net income (loss) per share |  |               | (0.00 | )              |   | (0.02         | ) |                | 0.01 
|2003:                                         |  |               |       |                |   |               |   |                |      
|Revenues, net                                 |  | $             | 2,890 |                | $ | 2,355         |   | $              | 3,401
|Gross profit                                  |  |               | 1,560 |                |   | 1,341         |   |                | 2,004
|Net loss                                      |  |               | (985  | )              |   | (1,453        | ) |                | (629 
|Basic and diluted net loss per share          |  |               | (0.07 | )              |   | (0.11         | ) |                | (0.05

64

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ALTIGEN COMMUNICATIONS, INC. AND SUBSIDIARY  SCHEDULE IIVALUATION AND QUALIFYING ACCOUNTS

|Classification                   |  | Balance at
Beginning of
Fiscal Year |       | Charged to
Costs and
Expenses |   | Deductions |   | Balance at
End of
Fiscal Year
|-------------------------------- |  | ----------------------------------- | ----- | ----------------------------- | - | ---------- | - | -----------------------------
|
|Allowance for doubtful accounts: |  |                                     |       |                               |   |            |   |                              
|2004                             |  | $                                   | 60    |                               | $ | 35         |   | $                            
|2003                             |  | $                                   | 227   |                               | $ | (3         | ) | $                            
|2002                             |  | $                                   | 403   |                               | $ | (183       | ) | $                            
|Inventory reserve:               |  |                                     |       |                               |   |            |   |                              
|2004                             |  | $                                   | 2,918 |                               | $ |           |   | $                            
|2003                             |  | $                                   | 3,319 |                               | $ |           |   | $                            
|2002                             |  | $                                   | 3,596 |                               | $ |           |   | $                            

65

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.

|Date: December 29, 2004 |  | ALTIGEN COMMUNICATIONS, INC.
|----------------------- |  | ----------------------------
|                        |  | By:                         

POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENT, that each person whose signature appears below constitutes and appoints Gilbert Hu and Philip McDermott, jointly and severally,
his attorneys-in-fact, each with the power of substitution, for him in any and all capacities, to sign any amendments to this report on Form 10-K, and to
file the same, with exhibits thereto and other documents in connection therewith with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said
attorneys-in-fact, or his substitute or substitutes may do or cause to be done by virtue hereof.

Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the
dates indicated.

|Signature                                   |  | Title                                                                |  | Date             
|------------------------------------------- |  | -------------------------------------------------------------------- |  | -----------------
|/s/GILBERT HUGilbert Hu                     |  | Chief Executive Officer (principal executive officer) and Director   |  | December 29, 2004
|/s/PHILIP MCDERMOTTPhilip McDermott         |  | Chief Financial Officer (principal financial and accounting officer) |  | December 29, 2004
|/s/KENNETH TAIKenneth Tai                   |  | Director                                                             |  | December 29, 2004
|/s/RICHARD BLACKRichard Black               |  | Director                                                             |  | December 29, 2004
|/s/TACHENG CHESTER WANGTacheng Chester Wang |  | Director                                                             |  | December 29, 2004
|/s/MIKE MON YEN TSAIMike Mon Yen Tsai       |  | Director                                                             |  | December 29, 2004

66

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AltiGen Communications, Inc.  Exhibit Index

|Exhibit
Number |  | Description                                                                                                                                         
|-------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------
|3.1*           |  | Amended and Restated Certificate of Incorporation.                                                                                                  
|3.2*****       |  | Second Amended and Restated Bylaws.                                                                                                                 
|4.2*           |  | Specimen common stock certificates.                                                                                                                 
|4.3*           |  | Third Amended and Restated Rights Agreement dated May 7, 1999 by and among AltiGen Communications, Inc. and the Investors and Founder named therein.
|10.1*          |  | Form of Indemnification Agreement.                                                                                                                  
|10.2*          |  | 1994 Stock Option Plan, as amended, and form of stock option agreement.                                                                             
|10.3*          |  | 1998 Stock Purchase Plan.                                                                                                                           
|10.4****       |  | 1999 Stock Plan, as amended, and form of stock option agreement.                                                                                    
|10.5***        |  | 1999 Employee Stock Purchase Plan, as amended, and forms of subscription agreement and notice of withdrawal.                                        
|10.8****       |  | Lease agreement: 4555 Cushing Parkway, Fremont, California between VEF III Funding, LLC and AltiGen Communications, Inc., dated October 1, 2003.    
|10.14*++       |  | Distribution Agreement between Ingram Micro Inc. and AltiGen Communications, Inc. dated June 12, 1998.                                              
|10.19*         |  | Employment Agreement by and between the Registrant and Philip McDermott, dated June 8, 1999.                                                        
|10.26**++      |  | OEM Agreement between AltiSys Communications and AltiGen Communications, Inc., dated January 18, 1999.                                              
|10.27****++    |  | Distribution Agreement between Synnex Information Technologies, Inc. and AltiGen Communications, Inc. dated December 22, 1999.                      
|10.28****++    |  | Distribution Agreement between Graybar Electric Company, Inc. and AltiGen Communications, Inc. dated June 12, 2003.                                 
|21.1*          |  | Subsidiaries of the Registrant.                                                                                                                     
|23.1           |  | Consent of Independent Registered Public Accounting Firm.                                                                                           
|24.1           |  | Power of Attorney (included on signature page).                                                                                                     
|31.1           |  | Certification Pursuant to Section 302 of the Sarbanes-Oxley act of 2002.                                                                            
|31.2           |  | Certification Pursuant to Section 302 of the Sarbanes-Oxley act of 2002.                                                                            
|32.1           |  | Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.  
|32.2           |  | Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.  

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