UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549










FORM
10-Q





ý QUARTERLY REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934


FOR
THE QUARTERLY PERIOD ENDED JUNE 30, 2009


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







ALTIGEN
COMMUNICATIONS, INC.


(Exact
name of Registrant as specified in its charter)





DELAWARE
              
              94-3204299(State
      or other jurisdiction of
                incorporation
      or organization)
              
              (I.R.S.
      Employer
                Identification
      Number)410
      East Plumeria Drive
                San
      Jose, CA
              
              95134(Address
      of principal executive offices)
              
              (Zip
      Code)





Registrant’s
telephone number, including area code: (408) 597-9000









Former
name, former address and former fiscal year, if changed since last report:
N/A





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 whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding
12 months (or for such shorter period that the registrant was required to submit
and post such files).    Yes  ̈    NO  o





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
definition of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.  (Check
one):  Large accelerated filer o   Accelerated
filer o   Non-accelerated
filer o  (Do not
check if a smaller reporting company)   Smaller reporting company
ý





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).    Yes  ̈    No  ý





The
number of shares of our common stock outstanding as of August 11, 2009 was:
15,960,614 shares.










ALTIGEN
COMMUNICATIONS, INC.


QUARTERLY
REPORT ON FORM 10-Q


FOR
THE QUARTERLY PERIOD ENDED JUNE 30, 2009


TABLE OF CONTENTS





PART
      I.  FINANCIAL INFORMATIONItem
      1.
                            Condensed
      Consolidated Financial Statements (Unaudited)Condensed
      Consolidated Balance Sheets as of June 30, 2009 and September 30,
      2008
                            3Condensed
      Consolidated Statements of Operations for the Nine Months Ended June 30,
      2009 and 2008
                            4Condensed
      Consolidated Statements of Cash Flows for the Nine Months Ended June 30,
      2009 and 2008
                            5Notes
      to Condensed Consolidated Financial Statements
                            6Item
      2.
                            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                            15Item
      3.
                            Quantitative
      and Qualitative Disclosures about Market Risk
                            23Item
      4T.
                            Controls
      and Procedures
                            23PART
      II.  OTHER INFORMATIONItem
      1.
                            Legal
      Proceedings
                            24Item
      1A
                            Risk Factors
                            24Item
      2.
                            Unregistered
      Sale of Equity Securities and Use of Proceeds
                            32Item
      4.
                            Submission
      of Matters to a Vote of Security Holders
                            32Item
      6.
                            Exhibits
                            33SIGNATURE
                            34EXHIBIT INDEX
                            35


2


PART
I.  FINANCIAL INFORMATION





Item
      1.
            Condensed
      Consolidated Financial Statements





ALTIGEN
COMMUNICATIONS, INC. AND SUBSIDIARY


CONDENSED
CONSOLIDATED BALANCE SHEETS


(UNAUDITED)


(In
thousands, except per share data)


June
      30,
                                                                  
                                                                  
                                                                  September30,2009
                                                                  
                                                                  
                                                                  2008ASSETSCurrent
      assets:Cash
      and cash equivalents
                                                                  
                                                                  $
                                                                  7,390
                                                                  
                                                                  
                                                                  $
                                                                  9,467Short-term
      investments
                                                                  
                                                                  
                                                                  —
                                                                  
                                                                  
                                                                  
                                                                  400Accounts
      receivable, net of allowances of $68 and $19 at June 30, 2009 and
      September 30, 2008, respectively.
                                                                  
                                                                  
                                                                  1,370
                                                                  
                                                                  
                                                                  
                                                                  2,423Inventories
                                                                  
                                                                  
                                                                  1,334
                                                                  
                                                                  
                                                                  
                                                                  1,594Prepaid
      expenses and other current assets
                                                                  
                                                                  
                                                                  230
                                                                  
                                                                  
                                                                  
                                                                  176Total
      current assets
                                                                  
                                                                  
                                                                  10,324
                                                                  
                                                                  
                                                                  
                                                                  14,060Property
      and equipment, less accumulated depreciation and amortization of $2,710
      and $2,534, respectively
                                                                  
                                                                  
                                                                  516
                                                                  
                                                                  
                                                                  
                                                                  423Other
      non-current assets:Long-term
      investments
                                                                  
                                                                  
                                                                  202
                                                                  
                                                                  
                                                                  
                                                                  211Long-term
      deposits
                                                                  
                                                                  
                                                                  282
                                                                  
                                                                  
                                                                  
                                                                  82Total
      other non-current assets
                                                                  
                                                                  
                                                                  484
                                                                  
                                                                  
                                                                  
                                                                  293Total
      assets
                                                                  
                                                                  $
                                                                  11,324
                                                                  
                                                                  
                                                                  $
                                                                  14,776LIABILITIES
      AND STOCKHOLDERS' EQUITYCurrent
      liabilities:Accounts
      payable
                                                                  
                                                                  $
                                                                  736
                                                                  
                                                                  
                                                                  $
                                                                  1,234Accrued
      liabilities:Payroll
      and related benefits
                                                                  
                                                                  
                                                                  561
                                                                  
                                                                  
                                                                  
                                                                  550Warranty
                                                                  
                                                                  
                                                                  126
                                                                  
                                                                  
                                                                  
                                                                  137Marketing
                                                                  
                                                                  
                                                                  111
                                                                  
                                                                  
                                                                  
                                                                  136Accrued
      expense
                                                                  
                                                                  
                                                                  547
                                                                  
                                                                  
                                                                  
                                                                  200Other
      current liabilities
                                                                  
                                                                  
                                                                  505
                                                                  
                                                                  
                                                                  
                                                                  628Deferred
      revenue short-term
                                                                  
                                                                  
                                                                  2,735
                                                                  
                                                                  
                                                                  
                                                                  2,489Total
      current liabilities
                                                                  
                                                                  
                                                                  5,321
                                                                  
                                                                  
                                                                  
                                                                  5,374Long-term
      liabilities
                                                                  
                                                                  
                                                                  127
                                                                  
                                                                  
                                                                  
                                                                  105Stockholders'
      equity:Convertible
      preferred stock, $0.001 par value; Authorized—5,000,000 shares;
      Outstanding—none at June 30, 2009 and September 30, 2008
                                                                  
                                                                  
                                                                  —
                                                                  
                                                                  
                                                                  
                                                                  —Common
      stock, $0.001 par value; Authorized—50,000,000 shares;
      Outstanding—15,960,614 shares at June 30, 2009 and 15,777,303 shares at
      September 30, 2008
                                                                  
                                                                  
                                                                  16
                                                                  
                                                                  
                                                                  
                                                                  16Treasury
      stock at cost — 1,318,830 shares at June 30, 2009 and 1,295,030 shares at
      September 30, 2008
                                                                  
                                                                  
                                                                  (1,400
                                                                  )
                                                                  
                                                                  
                                                                  (1,381
                                                                  )Additional
      paid-in capital
                                                                  
                                                                  
                                                                  67,312
                                                                  
                                                                  
                                                                  
                                                                  66,690Accumulated
      other comprehensive income
                                                                  
                                                                  
                                                                  173
                                                                  
                                                                  
                                                                  
                                                                  3Accumulated
      deficit
                                                                  
                                                                  
                                                                  (60,225
                                                                  )
                                                                  
                                                                  
                                                                  (56,031
                                                                  )Total
      stockholders' equity
                                                                  
                                                                  
                                                                  5,876
                                                                  
                                                                  
                                                                  
                                                                  9,297Total
      liabilities and stockholders' equity
                                                                  
                                                                  $
                                                                  11,324
                                                                  
                                                                  
                                                                  $
                                                                  14,776


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


3





ALTIGEN
COMMUNICATIONS, INC. AND SUBSIDIARY


CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS


(UNAUDITED)


(In thousands, except per share
data)


Three
      Months Ended
                  June
      30,
              
              
              Nine
      Months Ended
                  June
      30,2009
              
              
              2008
              
              
              2009
              
              
              2008Net
      revenue:Hardware
              
              $
              3,560
              
              
              $
              4,117
              
              
              $
              10,858
              
              
              $
              11,875Software
              
              
              522
              
              
              
              695
              
              
              
              1,661
              
              
              
              1,909Total
      net revenue
              
              
              4,082
              
              
              
              4,812
              
              
              
              12,519
              
              
              
              13,784Cost
      of revenue:Hardware
              
              
              1,533
              
              
              
              1,896
              
              
              
              4,893
              
              
              
              5,704Software
              
              
              4
              
              
              
              89
              
              
              
              12
              
              
              
              227Total
      cost of revenue
              
              
              1,537
              
              
              
              1,985
              
              
              
              4,905
              
              
              
              5,931Gross
      profit
              
              
              2,545
              
              
              
              2,827
              
              
              
              7,614
              
              
              
              7,853Operating
      expenses:Research
      and development
              
              
              1,126
              
              
              
              1,137
              
              
              
              3,594
              
              
              
              3,087Sales
      and marketing
              
              
              1,431
              
              
              
              1,926
              
              
              
              5,355
              
              
              
              5,530General
      and administrative
              
              
              980
              
              
              
              838
              
              
              
              2,762
              
              
              
              2,598Total
      operating expenses
              
              
              3,537
              
              
              
              3,901
              
              
              
              11,711
              
              
              
              11,215Loss
      from operations
              
              
              (992
              )
              
              
              (1,074
              )
              
              
              (4,097
              )
              
              
              (3,362
              )Equity
      in net loss of investee
              
              
              (3
              )
              
              
              (1
              )
              
              
              (9
              )
              
              
              (4
              )Interest
      and other income, net
              
              
              50
              
              
              
              46
              
              
              
              110
              
              
              
              240Net
      loss before income taxes
              
              
              (945
              )
              
              
              (1,029
              )
              
              
              (3,996
              )
              
              
              (3,126
              )Income
      tax provision
              
              
              —
              
              
              
              —
              
              
              
              15
              
              
              
              —Net
      loss
              
              $
              (945
              )
              
              $
              (1,029
              )
              
              $
              (3,981
              )
              
              $
              (3,126
              )Basic
      and diluted net loss per share
              
              $
              (0.06
              )
              
              $
              (0.07
              )
              
              $
              (0.25
              )
              
              $
              (0.20
              )Weighted
      average shares used in computing basic and diluted net loss per
      share
              
              
              15,923
              
              
              
              15,697
              
              
              
              15,869
              
              
              
              15,734





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


4





ALTIGEN
COMMUNICATIONS, INC. AND SUBSIDIARY


CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS


(UNAUDITED)


(In
thousands)


Nine
      Months Ended
                  June
      30,2009
              
              
              2008CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      loss
              
              $
              (3,981
              )
              
              $
              (3,127
              )Adjustments
      to reconcile net loss to net cash used in operating
      activities:Depreciation
              
              
              176
              
              
              
              187Stock-based
      compensation
              
              
              501
              
              
              
              696Equity
      in net income (loss) of investee
              
              
              9
              
              
              
              (1
              )Change
      in allowance for bad debt
              
              
              49
              
              
              
              13Changes
      in operating assets and liabilities:Accounts
      receivable
              
              
              1,004
              
              
              
              447Inventories
              
              
              260
              
              
              
              (391
              )Prepaid
      expenses and other current assets
              
              
              (54
              )
              
              
              (135
              )Accounts
      payable
              
              
              (498
              )
              
              
              216Accrued
      liabilities
              
              
              199
              
              
              
              110Deferred
      revenue short-term
              
              
              246
              
              
              
              1,732Other
      long-term liabilities
              
              
              22
              
              
              
              (47
              )Net
      cash used in operating activities
              
              
              (2,067
              )
              
              
              (300
              )CASH
      FLOWS FROM INVESTING ACTIVITIES:Purchases
      of short-term investments
              
              
              (5,460
              )
              
              
              (33,786
              )Proceeds
      from sale of short-term investments
              
              
              5,817
              
              
              
              35,680Changes
      in long-term deposits
              
              
              (200
              )
              
              
              86Purchases
      of property and equipment
              
              
              (269
              )
              
              
              (145
              )Net
      cash provided by (used in) investing activities
              
              
              (112
              )
              
              
              1,835CASH
      FLOWS FROM FINANCING ACTIVITIES:Proceeds
      from issuances of common stock, net of issuance costs
              
              
              121
              
              
              
              280Repurchase
      of treasury stock
              
              
              (19
              )
              
              
              (346
              )Net
      cash provided by (used in) financing activities
              
              
              102
              
              
              
              (66
              )NET
      CHANGE IN CASH AND CASH EQUIVALENTS DURING PERIOD
              
              
              (2,077
              )
              
              
              1,469CASH
      AND CASH EQUIVALENTS, BEGINNING OF PERIOD
              
              
              9,467
              
              
              
              6,111CASH
      AND CASH EQUIVALENTS, END OF PERIOD
              
              $
              7,390
              
              
              $
              7,580





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


5


ALTIGEN
COMMUNICATIONS, INC. AND SUBSIDIARY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS





1.  SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES





BASIS
OF PRESENTATION





AltiGen
Communications, Inc. (“we” or the “Company”) is a leader and market innovator in
Voice over Internet Protocol (VoIP) telephone systems. We design, deliver and
support VoIP phone systems and call center solutions that combine high
reliability with integrated IP communications applications. As one of the first
companies to offer VoIP solutions, AltiGen has been deploying systems since
1996. We have more than 10,000 customers worldwide with over 15,000 systems in
use. Our telephony solutions are primarily used by small- to medium-sized
businesses, companies with multiple locations, corporate branch offices, and
call centers.




AltiGen’s
systems are designed with an open architecture, built on industry standard
IntelTM based servers, SIPTM compliant phones, and Microsoft WindowsTM based IP
applications. This adherence to widely used standards allows our solutions to
both integrate with and leverage a company's existing technology investment.
AltiGen’s award winning, integrated IP applications suite provides customers
with a complete business communications solution. Voicemail, Unified Messaging,
Automatic Call Distribution, Call Recording, Call Activity Reporting, and
Mobility solutions take advantage of the convergence of voice and data
communications to achieve superior business results.




The
accompanying unaudited condensed consolidated financial statements have been
prepared in conformity with generally accepted accounting principles for interim
financial information and with the instructions for Form 10-Q and Article 10 of
Regulation S-X. Accordingly, certain information and footnote disclosures
normally included in financial statements prepared in accordance with generally
accepted accounting principles have been condensed, or omitted, pursuant to the
rules and regulations of the Securities and Exchange Commission (the “SEC”).
These unaudited condensed consolidated financial statements reflect the
operations of the Company and its wholly-owned subsidiary located in Shanghai,
China. All significant intercompany transactions and balances have been
eliminated. In our opinion, these unaudited condensed consolidated financial
statements include all adjustments necessary (which are of a normal and
recurring nature) for a fair presentation of the Company’s financial position,
results of operations and cash flows for the periods presented. Certain
immaterial amounts in prior periods have been reclassified to conform with
current period presentation.




These
financial statements should be read in conjunction with our audited consolidated
financial statements for the fiscal year ended September 30, 2008, included in
the Company’s 2008 Annual Report on Form 10-K filed with the SEC on December 29,
2008. The Company’s results of operations for any interim period are not
necessarily indicative of the results of operations for any other interim period
or for a full fiscal year.





CASH
AND CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS





We
consider all highly liquid investments purchased with an initial maturity of
three months or less to be cash equivalents. Cash and cash equivalents are
invested in various investment grade institutional money market accounts, U.S.
Agency securities and commercial paper. 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. The Company's investment policy requires investments to be
rated single-A or better.


6


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 basis) 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 record a
write-down for product and component inventories that have become obsolete or
are in excess of anticipated demand or net realizable value. Raw material
inventory is considered obsolete and is fully reserved if it has not moved in
365 days. During the nine months ended June 30, 2009, we disposed of
fully-reserved inventory with a carrying value of $0 and an original cost at
$176,000. The disposal of such inventory had no material impact on our revenue,
gross margins and net loss for the three and nine months ended June 30, 2009.
For the nine months ended June 30, 2009, we recognized a provision of $44,000
for excess and obsolete inventories. The components of inventories, net of
inventory reserves, include (in thousands):





June
      30,
                  
                  
                  September
      30,2009
                  
                  
                  2008Raw
      materials
                  
                  $
                  575
                  
                  
                  $
                  479Work-in-progress
                  
                  
                  16
                  
                  
                  
                  197Finished
      goods
                  
                  
                  743
                  
                  
                  
                  918Total
                  
                  $
                  1,334
                  
                  
                  $
                  1,594





REVENUE
RECOGNITION





The
Company recognizes revenue software in accordance with Statement of Position
(“SOP”) 97-2, Software Revenue
Recognition (“SOP 97-2”). Revenue consists of sales to end-users,
resellers, and distributors. Revenue from sales to end-users and resellers is
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 of such distribution agreements, any unsold
products may be returned by the distributor for a full refund. These agreements
may be canceled by either party for convenience following a specified notice
period. As a result of these provisions, the Company defers recognition of
distributor revenue 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
ASSURANCE





Effective
September 4, 2007, we introduced our Software Assurance Program which provides
our customers with the latest updates, new releases, and technical support for
the applications they are licensed to use (“Software Assurance”). In fiscal year
2008, we initiated our Premier Service Plan, which includes software assurance
and extended hardware warranty. The program is an annual subscription and can
range from one to three years. Sales from the software assurance program are
recorded as deferred revenue and recognized as revenue over the terms of the
subscriptions.




Software
components are generally not sold separately from our hardware components.
Software revenue consists of license revenue that is recognized
upon delivery of the application products or features. We provide Software
Assurance consisting primarily of the latest software updates, patches, new
releases and technical support. In accordance with SOP 97-2, revenue earned on
software arrangements involving multiple elements is allocated to each element
based upon the relative fair value of the elements. The revenue allocated on
this element is recognized with the initial licensing fee on delivery of the
software. This Software Assurance revenue is in addition to the initial
license fee and is recognized over a period of one to three years. The estimated
cost of providing Software Assurance during the arrangement is insignificant
and the upgrades and enhancements offered at no cost during Software
Assurance arrangements have historically been, and are expected to continue to
be, minimal and infrequent. All estimated costs of providing the services,
including upgrades and enhancements, are spread over the life of the Software
Assurance term.





STOCK–BASED
COMPENSATION





The
Company accounts for stock based compensation under the provisions of Statement
of Financial Accounting Standard (“SFAS”) No. 123(R), Share Based Compensation
(“SFAS No. 123(R)”), which requires all share-based compensation, including
grants of stock options, to be recognized in the income statement as an
operating expense, based on their fair market values. The Company adopted SFAS
No. 123(R) using the modified prospective method. Under this transition method,
stock based compensation cost recognized subsequent to October 1, 2005 included:
(i) compensation cost for all share-based awards granted prior to but not yet
vested as of September 30, 2005, based on the grant-date fair value estimated in
accordance with SFAS No. 123(R) and (ii) compensation cost for all
share-based awards granted subsequent to September 30, 2005, based on the
grant-date fair value estimated in accordance with SFAS No. 123(R). In
accordance with the modified prospective method, the Company has not restated
its results of operations and financial position for prior
periods.


7


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 price volatility of our stock.
The Company estimates the expected price volatility of our stock based on
historical volatility rates since our initial public offering, which rates are
trended into future years. Because the Company’s 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. The Company
bases the risk-free interest rate for periods within the contractual life of the
option upon the U.S. Treasury yield.





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 Company estimated the fair value of
stock option awards in accordance with the provisions of SFAS 123(R) by using
the Black-Scholes option valuation model with the following
assumptions:





Three
      Months Ended
                    June
      30,
                
                
                Nine
      Months Ended
                    June
      30,2009
                
                
                2008
                
                
                2009
                
                
                2008Employee
      Stock Option Plan:
                
                
                (1)Expected
      Life (in years)
                
                
                —
                
                
                
                5
                
                
                
                5
                
                
                
                5Risk-free
      interest rate
                
                
                —
                
                
                
                2.8
                %
                
                
                1.9
                %
                
                
                2.8
                %Volatility
                
                
                —
                
                
                
                88
                %
                
                
                139
                %
                
                
                88
                %Expected
      dividend
                
                
                —
                
                
                
                0.0
                %
                
                
                0.0
                %
                
                
                0.0
                %Employee
      Stock Purchase Plan:Expected
      Life (in years)
                
                
                0.5
                
                
                
                0.5
                
                
                
                0.5
                
                
                
                0.5Risk-free
      interest rate
                
                
                0.4
                %
                
                
                1.6
                %
                
                
                0.4
                %
                
                
                1.6
                %Volatility
                
                
                139
                %
                
                
                88
                %
                
                
                139
                %
                
                
                88
                %Expected
      dividend
                
                
                0.0
                %
                
                
                0.0
                %
                
                
                0.0
                %
                
                
                0.0
                %


(1)   Employee
stock options were not granted during the three months ended June 30,
2009.





The
following table shows total stock-based compensation expense included in the
consolidated statements of operations for the three and nine months ended June
30, 2009 and June 30, 2008 with respect to the plans mentioned above (in
thousands):





Three
      Months Ended
                    June
      30,
                
                
                Nine
      Months Ended
                    June
      30,2009
                
                
                2008
                
                
                2009
                
                
                2008Cost
      of goods sold
                
                $
                2
                
                
                $
                5
                
                
                $
                9
                
                
                $
                14Research
      and development
                
                
                23
                
                
                
                50
                
                
                
                115
                
                
                
                143Selling,
      general and administrative
                
                
                66
                
                
                
                161
                
                
                
                377
                
                
                
                539Total
                
                $
                91
                
                
                $
                216
                
                
                $
                501
                
                
                $
                696


8


The
following table summarizes the Company’s stock option plan as of October 1, 2008
and changes during the nine months ended June 30, 2009:





Number
      of Shares
                
                
                Weighted-
                    Average
                    Exercise
      Price
                
                
                Weighted
                    Average
                    Remaining
                    Contractual
      Life
                    (in
      years)Outstanding
      at October 1, 2008
                
                
                4,551,822
                
                
                $
                3.14Granted
                
                
                94,500
                
                
                
                0.68Exercised
                
                
                (13,700
                )
                
                
                0.60Forfeitures
      and cancellations
                
                
                (434,038
                )
                
                
                4.34Outstanding
      at June 30, 2009
                
                
                4,198,584
                
                
                $
                2.97
                
                
                
                4.80Vested
      and expected to vest at June 30, 2009
                
                
                3,878,669
                
                
                $
                3.10
                
                
                
                4.52Exercisable
      at June 30, 2009
                
                
                3,354,491
                
                
                $
                3.38
                
                
                
                3.92





On March
10, 2009, our 1999 Stock Plan and our 1999 Employee Stock Purchase Plan (the
“1999 Purchase Plan”) expired.  These plans will, however, continue to
govern the securities previously granted under them.  On April 21,
2009, our Board of Directors approved a 2009 Equity Incentive Plan (the “2009
Stock Plan”) and a 2009 Employee Stock Purchase Plan (the “2009 Purchase Plan”),
which were both approved by our stockholders on June 18,
2009.  Currently, there are no options outstanding under the 2009
Stock Plan.





At June
30, 2009, the aggregate intrinsic value of outstanding stock options was
$41,000. The total vested and expected to vest stock options represented 3.8
million shares, the weighted average exercise price was $3.10, the aggregate
intrinsic value was $40,000, and the weighted average remaining contractual term
was 4.5 years. The total exercisable stock options represented approximately 3.4
million shares, the aggregate intrinsic value was $38,000, the weighted average
exercise price was $3.38, and the weighted average remaining contractual term
was 3.92 years.





At June
30, 2009, expected future compensation expense relating to options outstanding
at that date is $208,000, which will be amortized over a weighted-average period
of 4 years.





Under the
1999 Purchase Plan, we had reserved, as of March 10, 2009, 1,189,274 shares of
common stock for issuance to eligible employees at a price equal to 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 each year). From October 1, 2008 until the expiration of the 1999
Purchase Plan place on March 10, 2009, 193,411 shares were purchased by and
distributed to employees at a price of $0.59 per share. Under the 2009 Purchase
Plan, we had reserved, as of June 18, 2009, 1,500,000 shares of common stock for
issuance to eligible employees at a price equal to equal to 85% of the lower of
the fair market value of the common stock on (i) the offering date,
or (ii) the last day of the offering period (last trading day in May or November
each year).





COMPUTATION
OF BASIC AND DILUTED NET LOSS PER SHARE




The
Company bases its basic earnings per share upon the weighted average number of
common shares outstanding during the period in accordance with SFAS
No. 128, Earnings per
Share(“SFAS No. 128”). Basic earnings per common share is computed
by dividing income available to common shareholders by the weighted-average
number of shares of common stock outstanding during the period. Diluted earnings
per share reflect the potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted into common
stock.





Basic and
diluted loss per share for each of the three and nine month periods ended June
30, 2009 and 2008 were as follows (in thousands, except per share
data):





Three
      Months Ended
                  June
      30,
              
              
              Nine
      Months Ended
                  June
      30,2009
              
              
              2008
              
              
              2009
              
              
              2008Net
      loss
              
              $
              (945
              )
              
              $
              (1,029
              )
              
              $
              (3,981
              )
              
              $
              (3,126
              )Weighted
      average shares outstanding – basic loss per share
              
              
              15,923
              
              
              
              15,697
              
              
              
              15,869
              
              
              
              15,734Weighted
      average shares outstanding  – diluted loss per
    share
              
              
              15,923
              
              
              
              15,697
              
              
              
              15,869
              
              
              
              15,734Basic
      loss per share
              
              $
              (0.06
              )
              
              $
              (0.07
              )
              
              $
              (0.25
              )
              
              $
              (0.20
              )Diluted
      loss per share
              
              $
              (0.06
              )
              
              $
              (0.07
              )
              
              $
              (0.25
              )
              
              $
              (0.20
              )


9


Options
to purchase 4.2 million and 4.5 million shares of common stock were
outstanding as of June 30, 2009 and 2008, respectively, and were excluded from
the computation of diluted net loss per share for these periods because their
effect would have been antidilutive.





COMPREHENSIVE
LOSS





Comprehensive
income consists of two components--net income and other comprehensive income.
Other comprehensive income refers to revenue, expenses, gains, and losses that
under U.S. generally accepted accounting principles are recorded as an element
of stockholders' equity but are excluded from net income. The Company's other
comprehensive income consists of unrealized gains and losses on marketable
securities categorized as available-for-sale and foreign exchange gains and
losses. There were no material differences between net loss and comprehensive
loss for the three and nine months ended June 30, 2009 and 2008.




RECENT
ACCOUNTING PRONOUNCEMENTS





In May
2009, the FASB issued SFAS No. 165, Subsequent
Events (“SFAS No. 165”).  SFAS 165 establishes general standards of
accounting for and disclosures of events that occur after the balance sheet date
but before financial statements are issued or are available to be issued. 
It requires the disclosure of the date through which an entity has evaluated
subsequent events and the basis for that date.  SFAS 165 was effective for
interim or annual financial periods ended after June 15, 2009.  The
adoption of SFAS 165 did not have any impact on the Company’s consolidated
financial statements.





In June
2009, the FASB issued SFAS No. 168, “The FASB Accounting Standards Codification
and the Hierarchy of Generally Accepted Accounting Principles – a replacement of
FASB Statement No. 162.”  The Codification will become the source of
authoritative GAAP recognized by the FASB to be applied by nongovernmental
entities.  Rules and interpretive releases of the SEC under authority of
federal securities laws are also sources of authoritative GAAP for SEC
registrants.  On the effective date of SFAS 168, the Codification will
supersede all then-existing non-SEC accounting and reporting standards. 
All other nongrandfathered non-SEC accounting literature not included in the
Codification will become nonauthoritative.  SFAS 168 is effective for
financial statements issued for interim and annual periods ending after
September 15, 2009.  SFAS 168 is not expected to have a material impact on
the Company’s consolidated financial statements.





FAIR
VALUE MEASUREMENTS





Effective
October 1, 2008, we adopted SFAS No. 157, Fair Value Measurements
(“SFAS No. 157”). The Company did not record an adjustment to retained
earnings as a result of the adoption of SFAS 157, and the adoption did not have
a material effect on the Company’s results of operations. SFAS No. 157
defines fair value, establishes a framework for measuring fair value under
generally accepted accounting principles and enhances disclosures about fair
value measurements. Fair value is defined under SFAS No. 157 as the
exchange price that would be received for an asset or paid to transfer a
liability (an exit price) in the principal or most advantageous market for the
asset or liability in an orderly transaction between market participants on the
measurement date. Valuation techniques used to measure fair value under SFAS
No. 157 must maximize the use of observable inputs and minimize the use of
unobservable inputs. The standard describes a fair value hierarchy based on
three levels of inputs, of which the first two are considered observable and the
last unobservable, that may be used to measure fair value which are the
following:





Level 1 - Financial
instruments for which quoted market prices for identical instruments are
available in active markets.





Level 2 - Inputs other than
Level 1 that are observable, either directly or indirectly, such as quoted
prices for similar assets or liabilities; quoted prices in markets that are not
active; or other inputs that are observable or can be corroborated by observable
market data for substantially the full term of the assets or
liabilities.





Level 3 - Unobservable inputs
that are supported by little or no market activity and that are significant to
the fair value of the assets or liabilities.





The
adoption of this statement with respect to our financial assets and liabilities,
did not impact our consolidated results of operations and financial condition,
but requires additional disclosure for assets and liabilities measured at fair
value.  In accordance with SFAS No. 157, the following table
represents our fair value hierarchy for our financial assets (cash equivalents
and investments) measured at fair value on a recurring basis as of June 30,
2009.  Level 1 available-for-sale investments are primarily comprised of
investments in U.S. Agency securities.  These securities are valued
using market prices on active markets.  The Company had no material Level 2
or Level 3 measurements for the quarter ended June 30, 2009.


10


Assets measured at fair value as of
June 30, 2009 and September 30, 2008 are summarized as
follows:





(In
      thousands)
                        
                        Quoted
      Prices in Active Markets for Identical
                          Instruments
                          (Level
      1)As of June 30, 2009
                        
                        
                        As of September 30, 2008Cash
      equivalents (1)Money
      market funds
                        
                        $
                        4,825
                        
                        
                        $
                        1,017Investments
      (2)Agency
      discount notes
                        
                        
                        —
                        
                        
                        
                        5,494Commercial
      paper
                        
                        
                        —
                        
                        
                        
                        250Cash
      equivalents and investments
                        
                        $
                        4,825
                        
                        
                        $
                        6,761





(1)
            Included
      in cash and cash equivalents on our condensed consolidated balance
      sheet.


(2)
            Included
      in short-term investments in marketable securities on our condensed
      consolidated balance sheet.





The
Company's policy is to invest in highly-rated securities with strong liquidity
and requires investments to be rated single-A or better. Our investment
portfolio consists principally of investment grade institutional money market
funds, bank term deposits, U.S. Agency securities, corporate bonds and notes and
commercial paper. We consider all highly liquid investments purchased with an
initial maturity of three months or less to be cash equivalents. Short-term
investments are highly liquid financial instruments with original maturities
greater than three months but less than one year and are classified as
"available-for-sale" investments. We classify our available-for-sale securities
as current assets and report them at their fair value. Further, we recognize
unrealized gains and losses related to these securities as an increase or
reduction in shareholders' equity. We evaluate our available-for-sale securities
for impairment quarterly. During the three and nine months ended June 30, 2009,
we did not record any impairment on outstanding securities.





The
following table summarizes the fair value of the Company's available-for-sale
securities held in its short-term investment portfolio, recorded short-term
investments:




Available
for Sale Securities:


As
      of June 30, 2009(In
      thousands)Security
      Description
                        
                        Amortized
                          Cost
                        
                        
                        Unrealized
                          Gains
                        
                        
                        Unrealized
                          Losses
                        
                        
                        Fair
      Market
                          ValueAgency
      discount notes
                        
                        $
                        —
                        
                        
                        $
                        —
                        
                        
                        $
                        —
                        
                        
                        $
                        —Commercial
      paper
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        —Total
                        
                        $
                        —
                        
                        
                        $
                        —
                        
                        
                        $
                        —
                        
                        
                        $
                        —





Security
      Description
                                                                      
                                                                      As
      of September 30, 2008(In
      thousands)Amortized
                                                                        Cost
                                                                      
                                                                      
                                                                      Unrealized
                                                                        Gains
                                                                      
                                                                      
                                                                      Unrealized
                                                                        Losses
                                                                      
                                                                      
                                                                      Fair Market
                                                                        ValueAgency
      discount notes
                                                                      
                                                                      $
                                                                      5,474
                                                                      
                                                                      
                                                                      $
                                                                      20
                                                                      
                                                                      
                                                                      $
                                                                      —
                                                                      
                                                                      
                                                                      $
                                                                      5,494Commercial
      paper
                                                                      
                                                                      
                                                                      247
                                                                      
                                                                      
                                                                      
                                                                      3
                                                                      
                                                                      
                                                                      
                                                                      —
                                                                      
                                                                      
                                                                      
                                                                      250Total
                                                                      
                                                                      $
                                                                      5,721
                                                                      
                                                                      
                                                                      $
                                                                      23
                                                                      
                                                                      
                                                                      $
                                                                      —
                                                                      
                                                                      
                                                                      $
                                                                      5,744


11


SEGMENT
REPORTING





The
Company manages its business primarily on a geographic basis. Accordingly, the
Company determined its operating segments, which are generally based on the
nature and location of its customers, to be the Americas and International. The
Company's two geographical segments, sell the same products to the same types of
customers. The Company's reportable operating segments are comprised of the
Americas and International operations. The Americas segment includes the United
States, Canada, Mexico, Central America and the Caribbean. The International
segment is comprised of China, the United Kingdom and Norway.





The
following table sets forth percentages of net revenue by geographic region with
respect to such revenue for the periods indicated:





Three
      Months Ended
                    June
      30,
                
                
                Nine
      Months Ended
                    June
      30,2009
                
                
                2008
                
                
                2009
                
                
                2008Americas
                
                
                90
                %
                
                
                87
                %
                
                
                87
                %
                
                
                86
                %International
                
                
                10
                %
                
                
                13
                %
                
                
                13
                %
                
                
                14
                %Total
                
                
                100
                %
                
                
                100
                %
                
                
                100
                %
                
                
                100
                %





CUSTOMERS





Our
customers are primarily end-users, resellers and distributors. We have
distribution agreements with Altisys Communications, Inc., Synnex Corporation
and Jenne Distributors, Inc., in the Americas. Our agreements with Altisys and
Synnex have initial terms of one year and our agreement with Jenne had an
initial term of two years. Each of these agreements are renewed automatically
for additional one year terms, provided that each party shall have the right to
terminate the agreement for convenience upon ninety (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, Synnex and Jenne also
provide for termination, with or without cause and without penalty, by either
party upon 30 days' written notice to the other party or upon insolvency or
bankruptcy. For a period of 60 days' following termination of the
agreement, Altisys, Synnex and Jenne 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.





In June
2009, we provided a notice to terminate our distribution agreement with Jenne
Distributors, Inc., effective September 30, 2009. As of June 30, 2009, the
balances outstanding with Jenne were $231,000 in accounts receivable and
$199,000 in inventory.





The
following table sets forth our net revenue by customers that individually
accounted for more than 10% of our revenue for the periods
indicated:





Three
      Months Ended
                    June
      30,
                
                
                Nine
      Months Ended
                    June
      30,2009
                
                
                2008
                
                
                2009
                
                
                2008Synnex
                
                
                31
                %
                
                
                33
                %
                
                
                30
                %
                
                
                34
                %Jenne(1)
                
                
                17
                %
                
                
                12
                %
                
                
                17
                %
                
                
                9
                %Altisys
                
                
                7
                %
                
                
                10
                %
                
                
                7
                %
                
                
                14
                %Graybar(2)
                
                
                —
                
                
                
                5
                %
                
                
                —
                
                
                
                11
                %Total
                
                
                55
                %
                
                
                60
                %
                
                
                54
                %
                
                
                68
                %


(1)  In
June 2009, we provided a notice to terminate our distribution agreement with
Jenne Distributors, Inc., effective September 30, 2009.





(2)   In
April 2008, we terminated our distribution agreement with Graybar. The
termination of our relationship with Graybar did not have a material impact on
our business.


12


2.
WARRANTY





The
Company provides a warranty for hardware products for a period of one year
following shipment to end users. We have historically experienced minimal
warranty costs. Factors that affect our reserves for 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 reserves for warranty liability every quarter and make
adjustments to those reserves if necessary.





Changes
in the reserves for our warranty liability for the three and nine months ended
June 30, 2009 and 2008, respectively, are as follows (in
thousands):





Three
      Months Ended
                    June
      30,
                
                
                Nine
      Months Ended
                    June
      30,2009
                
                
                2008
                
                
                2009
                
                
                2008Beginning
      balance
                
                $
                109
                
                
                $
                145
                
                
                $
                137
                
                
                $
                148Provision
      for warranty liability
                
                
                23
                
                
                
                36
                
                
                
                81
                
                
                
                116Warranty
      cost including labor, components and scrap
                
                
                (6
                )
                
                
                (40
                )
                
                
                (92
                )
                
                
                (123
                )Ending
      balance
                
                $
                126
                
                
                $
                141
                
                
                $
                126
                
                
                $
                141





3.  COMMITMENTS
AND CONTINGENCIES





Commitments





We lease
our facilities under various operating lease agreements expiring on various
dates through December 2014. Generally, these leases have multiple options to
extend for a period of years upon termination of the original lease term. We
believe that our facilities are adequate for our present needs in all material
respects.





In April
2009, the Company entered into a lease for a new corporate headquarters for a
period of five years with one consecutive option to extend for an additional
five years. This facility is leased through June 2014 and serves as our
headquarters for corporate administration, research and development,
manufacturing, and sales and marketing facility in San Jose, California. The
terms of the lease include rent escalations and a tenant allowance for certain
leasehold improvements.  Under the terms of the lease agreement, total
rent payment is approximates $1.4 million for a period of five years commencing
on June 12, 2009.  As of June 30, 2009, no deferred rent was recorded
as we believe the amount is immaterial for the overall financial presentation.
The Company reserved $200,000 as collateral for an irrevocable and negotiable
standby letter of credit (the "Letter of Credit") as security for the
facility lease. The $200,000 is restricted by the bank and recorded as part of
the long-term deposit in the accompanying balance sheet as of June 30, 2009.
Under the terms of the agreement, the Letter of Credit will expire in July
2014.  We believe that the new facility will be suitable, adequate and
sufficient to meet the needs of the Company through July 2014.





During
the three month ended June 30, 2009, the Company’s facility in Fremont,
California expired. There were no significant costs incurred associated with the
expiration of this lease.


13




Rent
expense for all operating leases totaled approximately $180,000 and $540,000 for
the three and nine months ended June 30, 2009, respectively as compared to
$175,000 and $513,000 for the three and nine months ended June 30, 2008,
respectively. We also lease certain equipment under capital lease arrangements,
which are reflected as property and equipment in our balance sheets as of June
30, 2009 and September 30, 2008. The minimum future lease payments under all
noncancellable capital and operating leases as of June 30, 2009 are shown in the
following table (in thousands):





Capital
                                Leases
                              
                              
                              Operating
                                LeasesFiscal
      Years Ending September 30, Remainder of 2009
                              
                              $
                              11
                              
                              
                              $
                              1412010
                              
                              
                              33
                              
                              
                              
                              5832011
                              
                              
                              —
                              
                              
                              
                              3022012
                              
                              
                              
                              
                              
                              
                              3022013
                              
                              
                              
                              
                              
                              
                              3182014
                              
                              
                              
                              
                              
                              
                              248Total
      contractual lease obligation
                              
                              $
                              44
                              
                              
                              $
                              1,894Amount
      representing interest
                              
                              $
                              2Present
      value of minimum lease payment
                              
                              $
                              42Current
      portion
                              
                              $
                              42Long-term
      portion
                              
                              
                              —Total
      capital lease commitments
                              
                              $
                              42





Contingencies





From time
to time, 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.





4.  STOCK
REPURCHASE PROGRAM





On
October 23, 2007, our Board of Directors approved the repurchase of up to $2.0
million of our common stock in the open market through November 12, 2008. On
November 11, 2008, our Board of Directors extended the repurchase program by
another year to November 14, 2009. Stock repurchases under this program may be
made from time to time at our management’s discretion through November 14, 2009.
When exercising such discretion, management will consider a variety of factors
such as our stock price, general business and market conditions and other
investment opportunities. The repurchase will be made in the open market and
will be funded from available working capital. Pursuant to the 2007 authority,
we repurchased $0 and 231,135 shares during the three and nine months ended June
30, 2008 at an aggregate cost of $0 and $367,000, respectively. Pursuant to the
2008 authority, we repurchased 23,800 shares in the nine months ended June 30,
2009 at an aggregate cost of $19,000. In April 2009, we suspended further
purchases of stock under this program.





5.
SPECIAL PROXY MEETING OF STOCKHOLDERS





At the
special meeting of stockholders on June 18, 2009, our stockholders approved the
adoption of the 2009 Stock Plan and the 2009 Purchase Plan. The 2009 Stock Plan
and the 2009 Purchase Plan were previously approved by the Company’s Board of
Directors, subject to stockholder approval. Copies of the 2009 Stock Plan and
the 2009 Purchase Plan are included as Appendix A and Appendix B, respectively,
in the Company’s Schedule 14A filed with the SEC on April 27, 2009.





Under the
2009 Stock Plan, we had reserved, as of June 18, 2009, 6,548,291 shares of
common stock for issuance to eligible employees. Under the 2009 Purchase Plan,
we had reserved as of June 18, 2009, 1,500,000 shares of common stock for
issuance.


14


Item
2. Management’s Discussion and Analysis of Financial Condition and Results of
Operations





FORWARD-LOOKING
INFORMATION





This
Quarterly Report on Form 10-Q includes "forward-looking statements" within the
meaning of Section 27A of the Securities Act and Section 21E of the Exchange
Act.  All statements other than statements of historical fact are
"forward-looking statements" for purposes of these provisions, including any
statements regarding: projections of revenues, future research and development
expenses, future selling, general and administrative expenses, other expenses,
gross profit, gross margin, or other financial items; the plans and objectives
of management for future operations; our exposure to interest rate risk; future
economic conditions or performance; plans to focus on cost control; In some
cases, forward-looking statements can be identified by the use of terminology
such as "may," "will," "expects," "plans," "anticipates," "estimates,"
"potential," or "continue," or the negative thereof or other comparable
terminology.  Although we believe that the expectations reflected in
the forward-looking statements contained herein are reasonable, there can be no
assurance that such expectations or any of the forward-looking statements will
prove to be correct, and actual results could differ materially from those
projected or assumed in the forward-looking statements.  Our future
financial condition and results of operations, as well as any forward-looking
statements, are subject to risks and uncertainties, including but not limited to
the factors set forth below and elsewhere in this report.  All
forward-looking statements and reasons why results may differ included in this
Quarterly Report are made as of the date hereof, and we assume no obligation to
update any such forward-looking statement or reason why actual results may
differ.





You
should also carefully review the cautionary statements contained in our Annual
Report on Form 10-K for the year ended September 30, 2008, including those set
forth in Item 1A “Risk Factors” of that report as well as in Item IA “Risk
Factors” of this report.





OVERVIEW





AltiGen
Communications, Inc. (“we” or the “Company”) is a leader and market innovator in
Voice over Internet Protocol (VoIP) telephone systems. We design, deliver and
support VoIP phone systems and call center solutions that combine high
reliability with integrated IP communications applications.  As one of
the first companies to offer VoIP solutions, AltiGen has been deploying systems
since 1996. We have more than 10,000 customers worldwide with over 15,000
systems in use. Our telephony solutions are primarily used by small- to
medium-sized businesses, companies with multiple locations, corporate branch
offices, and call centers.




AltiGen’s
systems are designed with an open architecture, built on industry standard
IntelTM based servers, SIPTM compliant phones, and Microsoft WindowsTM based IP
applications. This adherence to widely used standards allows our solutions to
both integrate with and leverage a company's existing technology investment.
AltiGen’s award winning, integrated IP applications suite provides customers
with a complete business communications solution. Voicemail, Unified Messaging,
Automatic Call Distribution, Call Recording, Call Activity Reporting, and
Mobility solutions take advantage of the convergence of voice and data
communications to achieve superior business results. We believe this enables our
customers to implement communication systems solutions that have an increased
return on investment versus past technology investments.





We
generated net revenue of $4.1 million and $12.5 million for the three and nine
months ended June 30, 2009, respectively, compared to net revenue of $4.8
million and $13.8 million for the three and nine months ended June 30, 2008,
respectively. As of June 30, 2009, we had an accumulated deficit of $60.2
million compared to $55.2 million as of June 30, 2008. Net cash used in
operating activities was $2.0 million for the nine months ended June 30, 2009
compared to $300,000 for the nine months ended June 30, 2008.





We derive
our revenue from sales of our telephone systems. Product revenue is comprised of
direct sales to end-users and resellers and sales to distributors. Revenue 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 revenue 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 the 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 third-party
assemblers, which for the nine months ended June 30, 2009 were All Quality
Services in Fremont, California and ISIS Surface Mounting, Inc. in San Jose,
California to insert the hardware components into the printed circuit board. We
purchase fully-assembled chassis from Advantech Corporation, analog phones from
Fanstel Corporation, Internet protocol phones from BCM Communications, Inc.,
single board computers for our MAX product from AAEON Electronics, Inc. and raw
material components from Avnet Electronics. 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 you 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.


15


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, as well as creating
new product offerings to both enhance our position in our target market segment
and enter new geographical markets. Additionally, we intend to continue selling
our products to small- to medium-sized businesses, enterprise businesses,
multisite businesses, corporate and branch offices and call centers. Also, we
plan to continue to recruit additional resellers and distributors to focus on
selling phone systems to our target customers. We believe that the adoption rate
for this Internet telephony is much faster with small- to medium-sized
businesses because many of these businesses have not yet made a significant
investment for a traditional phone system. 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.





CRITICAL
ACCOUNTING POLICIES





Revenue Recognition.Net
sales consist primarily of revenue from direct sales to end-users, resellers and
distributors. We recognize revenue pursuant to SEC Staff Accounting Bulletin
(“SAB”) No. 104, Revenue
Recognition, (“SAB No. 104”). Revenue from sales to end-users is
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 sales price is fixed and determinable. We provide
for estimated sales returns and allowances and warranty costs related to such
sales at the time of shipment in accordance with SFAS No. 48, Revenue Recognition when Right of
Return Exists (“SFAS No. 48”).  Net revenue consists of
product revenue reduced by estimated sales returns and allowances. Sales to
distributors are made under terms allowing certain rights of return and
protection against subsequent price declines on our products held by the
distributors. Upon termination of such distribution agreements, any unsold
products may be returned by the distributor for a full refund. These agreements
may be canceled without cause for convenience following a specified notice
period. As a result of the above provisions, we defer recognition of distributor
revenue 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. As
of June 30, 2009, our total deferred revenue was $2.7 million compared to $2.3
million for the same period in fiscal 2008, an increase of $438,000, or 19% over
the same period in the prior year. The increase was primarily the result of
continued growth of our new recurring revenue programs. These plans include both
the Software Assurance Program, which provides our customers with new software
releases and support for an annual fee, and the Premier Service Plan, which
includes software assurance and extended hardware warranty.





Service Support Plans. In
September 2007, we introduced our Software Assurance Program which provides our
customers with the latest updates, new releases, and technical support for the
applications they are licensed to use. In fiscal 2008, we initiated our Premier
Service Plan, which includes software assurance and extended hardware warranty.
These programs have an annual subscription and can range from one to three
years. Sales from our service support programs are recorded as deferred revenue
and recognized as revenue over the terms of their subscriptions. As of June 30,
2009, our service support deferred revenue was approximately $2.2 million
compared to $1.4 million for the same period in fiscal 2008, an increase of
$868,000, or 64% over the same period in the prior year. Our new service plan
offering remains a significant growth opportunity as we continue to add new
service customers.





Software
components are generally not sold separately from our hardware components.
Software revenue consists of license revenue that is recognized
upon delivery of the application products or features. We provide Software
Assurance consisting primarily of the latest software updates, patches, new
releases and technical support. In accordance with SOP 97-2, revenue earned on
software arrangements involving multiple elements is allocated to each element
based upon the relative fair value of the elements. The revenue allocated on
this element is recognized with the initial licensing fee on delivery of the
software. This Software Assurance revenue is in addition to the initial
license fee and is recognized over a period of one to three years. The estimated
cost of providing Software Assurance during the arrangement is insignificant,
and unspecified upgrades and enhancements offered at no cost during
Software Assurance arrangements have historically been, and are expected to
continue to be, minimal and infrequent. All estimated costs of providing the
services, including upgrades and enhancements, are spread over the life of the
Software Assurance term.





Cash and Cash Equivalent.We
consider all highly liquid investments purchased with an initial maturity of
three months or less to be cash equivalents. Cash and cash equivalents are
invested in various investment grade institutional money market accounts, U.S.
Agency securities and commercial paper. The Company's investment policy requires
investments to be rated single-A or better.





Short-Term Investment.The
Company’s policy is to invest in highly-rated securities with strong liquidity
and requires investments to be rated single-A or better. Short-term investments
are comprised of U.S. Agency securities and commercial paper. Short-term
investments are highly liquid financial instruments with original maturities
greater than three months but less than one year and are classified as
“available-for-sale” investments. We classify our available-for-sale securities
as current assets and report them at their fair value. Further, we recognize
unrealized gains and losses related to these securities as an increase or
reduction in stockholders’ equity.


16


Inventory.  Inventory
is stated at the lower of cost (first-in, first-out method) or market. Our
inventory balance for the nine months ended June 30, 2009 was $1.3 million
compared to $2.0 million for the nine months ended June 30, 2008. We perform a
detailed review of inventory each fiscal quarter, with consideration given to
future customer demand for our products, obsolescence from rapidly changing
technology, product development plans, and other factors. If future demand or
market conditions for our products are less favorable than those projected by
management, or if our estimates prove to be inaccurate due to unforeseen
technological changes, we may be required to record additional inventory
provision which would negatively affect gross margins in the period when the
write-downs were recorded. In prior periods, we had established a reserve to
write off excess inventory that management believed would not be sold. For the
nine months ended June 30, 2009, we disposed of fully-reserved inventory with a
carrying value of $0 and an original cost at $176,000. The disposal of such
inventory had no material impact on our revenue, gross margins and net loss for
the three and nine months ended June 30, 2009. For the nine months ended June
30, 2009, we recognized a provision of $44,000 for excess and obsolete
inventories as compared to $53,000 during the same period in the prior year.
Inventory allowance was $699,000 as of June 30, 2009 compared to $850,000 as of
September 30, 2008. The change in inventory allowance was primarily attributable
to the disposal of fully-reserved inventory with a carrying value of $0 and an
original cost of $176,000.





Warranty Cost.  We
accrue for warranty costs based on estimated product return rates and the
expected material and labor costs to provide warranty services. If actual
products return rates, repair cost or replacement costs differ significantly
from our estimates, then our gross margin could be adversely affected. The
reserve for product warranties was $126,000 and $137,000 as of June 30, 2009
and September 30, 2008, respectively.





Results
of Operations





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





Three
      Months Ended
                      June
      30,
                  
                  
                  Nine
      Months Ended
                      June
      30,2009
                  
                  
                  2008
                  
                  
                  2009
                  
                  
                  2008Consolidated
      Statements of Operations Data:Net
      revenue:Hardware
                  
                  
                  87.2
                  %
                  
                  
                  85.6
                  %
                  
                  
                  86.2
                  %
                  
                  
                  86.7
                  %Software
                  
                  
                  12.8
                  
                  
                  
                  14.4
                  
                  
                  
                  13.8
                  
                  
                  
                  13.3Total
      net revenue
                  
                  
                  100.0
                  
                  
                  
                  100.0
                  
                  
                  
                  100.0
                  
                  
                  
                  100.0Cost
      of revenue:Hardware
                  
                  
                  37.6
                  
                  
                  
                  39.4
                  
                  
                  
                  41.4
                  
                  
                  
                  39.1Software
                  
                  
                  0.1
                  
                  
                  
                  1.8
                  
                  
                  
                  1.6
                  
                  
                  
                  0.1Total
      cost of revenue
                  
                  
                  37.7
                  
                  
                  
                  41.2
                  
                  
                  
                  43.0
                  
                  
                  
                  39.2Gross
      profit
                  
                  
                  62.3
                  
                  
                  
                  58.8
                  
                  
                  
                  57.0
                  
                  
                  
                  60.8Operating
      expenses:Research
      and development
                  
                  
                  27.6
                  
                  
                  
                  23.6
                  
                  
                  
                  22.4
                  
                  
                  
                  28.7Sales
      and marketing
                  
                  
                  35.1
                  
                  
                  
                  40.0
                  
                  
                  
                  40.1
                  
                  
                  
                  42.8General
      and administrative
                  
                  
                  24.0
                  
                  
                  
                  17.4
                  
                  
                  
                  18.8
                  
                  
                  
                  22.1Total
      operating expenses
                  
                  
                  86.7
                  
                  
                  
                  81.0
                  
                  
                  
                  81.3
                  
                  
                  
                  93.6Loss
      from operations
                  
                  
                  (24.4
                  )
                  
                  
                  (22.2
                  )
                  
                  
                  (24.3
                  )
                  
                  
                  (32.8
                  )Equity
      in net loss of investee
                  
                  
                  (0.1
                  )
                  
                  
                  (0.0
                  )
                  
                  
                  (
      0.0
                  )
                  
                  
                  (
      0.1
                  )Interest
      and other income, net
                  
                  
                  1.2
                  
                  
                  
                  1.0
                  
                  
                  
                  1.7
                  
                  
                  
                  0.9Net
      loss before income taxes
                  
                  
                  (23.3
                  )
                  
                  
                  (21.2
                  )
                  
                  
                  (22.6
                  )
                  
                  
                  (32.0
                  )Provision
      for income taxes
                  
                  
                  (
      0.0
                  )
                  
                  
                  (
      0.0
                  )
                  
                  
                  (
      0.0
                  )
                  
                  
                  0.1Net
      loss
                  
                  
                  (23.3
                  )%
                  
                  
                  (21.2
                  )%
                  
                  
                  (22.6
                  )%
                  
                  
                  (31.9
                  )%


17


Net
Revenue





Net sales
consist primarily of revenue from direct sales to end-users and resellers and
sales to distributors.





We are
organized and operate as two operating segments, the Americas and International.
The Americas is comprised of the United States, Canada, Mexico, Central America
and the Caribbean. The International segment is comprised of China, the United
Kingdom and Norway.





The
following table sets forth percentages of net revenue by geographic region with
respect to such revenue for the periods indicated:





Three
      Months Ended
                    June
      30,
                
                
                Nine
      Months Ended
                    June
      30,2009
                
                
                2008
                
                
                2009
                
                
                2008Americas
                
                
                90
                %
                
                
                87
                %
                
                
                87
                %
                
                
                86
                %International
                
                
                10
                %
                
                
                13
                %
                
                
                13
                %
                
                
                14
                %Total
                
                
                100
                %
                
                
                100
                %
                
                
                100
                %
                
                
                100
                %





Net
revenue by customers that individually accounted for more than 10% of our
revenue for the three and nine months ended June 30, 2009 and 2008,
respectively, were as follows:





Three
      Months Ended
                    June
      30,
                
                
                Nine
      Months Ended
                    June
      30,2009
                
                
                2008
                
                
                2009
                
                
                2008Synnex
                
                
                31
                %
                
                
                33
                %
                
                
                30
                %
                
                
                34
                %Jenne(1)
                
                
                17
                %
                
                
                12
                %
                
                
                17
                %
                
                
                9
                %Altisys
                
                
                7
                %
                
                
                10
                %
                
                
                7
                %
                
                
                14
                %Graybar(2)
                
                
                —
                
                
                
                5
                %
                
                
                —
                
                
                
                11
                %Total
                
                
                55
                %
                
                
                60
                %
                
                
                54
                %
                
                
                68
                %


(1)   In
June 2009, we provided a notice to terminate our distribution agreement with
Jenne Distributors, Inc., effective September 30, 2009. We believe the
termination of our relationship with Jenne will not have a material impact on
our business because we anticipate that revenue from other distributors will
offset a portion of the lost revenue.





(2)   In
April 2008, we terminated our distribution agreement with Graybar. The
termination of our relationship with Graybar did not have a material impact on
our business.





The
following table sets forth percentage of net revenue by product type with
respect to such revenue for the periods indicated:





Three
      Months Ended
                    June
      30,
                
                
                Nine
      Months Ended
                    June
      30,2009
                
                
                2008
                
                
                2009
                
                
                2008Hardware
                
                
                69
                %
                
                
                86
                %
                
                
                71
                %
                
                
                86
                %Software
                
                
                13
                %
                
                
                14
                %
                
                
                13
                %
                
                
                14
                %Service
      Support Plans(1)
                
                
                18
                %
                
                
                5
                %
                
                
                16
                %
                
                
                3
                %Total
                
                
                100
                %
                
                
                100
                %
                
                
                100
                %
                
                
                100
                %





(1) In
the quarter ended June 30, 2008, revenue generated from these service support
plans accounted for less than 10% of our total revenue. Our hardware revenue in
the condensed consolidated statements of operations includes service support
revenue generated primarily from our service support plans starting in September
2007.


18


Net
revenue for the three months ended June 30, 2009 was $4.1 million as compared to
$4.8 million for the three months ended June 30, 2008. Revenue generated in the
Americas segment accounted for $3.7 million, or 90% of our total net
revenue for the three months ended June 30, 2009, as compared to $4.2 million,
or 87% of our total net revenue, for the three months ended June 30, 2008.
Revenue generated in the International segment accounted for $402,000, or 10% of
our total net revenue for the three months ended June 30, 2009, as compared to
$646,000, or 13% of our total net revenue, for the three months ended June 30,
2008. In the Americas segment, during the three months ended June 30, 2009, we
generated $787,000 in non-system related revenue, which is primarily revenue
generated from our service support plans. The decrease in net revenue excluding
non-system related revenue was approximately 23%.  The decrease in net
revenue in the Americas segment was primarily attributable to a change in our
product mix. The number of systems shipped was approximately 34% lower than the
corresponding period in the previous year. However, the average revenue per
system was higher by approximately 12% because sales of our smaller systems,
with lower profit margins, decreased while sales of our larger systems, with
higher profit margins, increased. The decrease in net revenue for both the
Americas and the International segments is primarily due to reduced incoming
orders because of the global economic downturn.





Net
revenue for the nine months ended June 30, 2009 was $12.5million as compared to
$13.8 million for the nine months ended June 30, 2008. Revenue generated in the
Americas segment accounted for $10.9 million, or 87% of our total net revenue,
as compared to $11.9 million, or 86% of our total net revenue, for the nine
months ended June 30, 2009 and June 30, 2008, respectively. Revenue generated in
the International segment accounted for $1.6 million, or 13% of our total net
revenue, as compared to $1.9 million, or 14% of our total net revenue, for the
nine months ended June 30, 2009 and June 30, 2008, respectively. In the Americas
segment, during the nine months ended June 30, 2009, we generated approximately
$2.1 million in non-system related revenue. Our non-system related revenue is
primarily comprised of revenue generated from our service support
plans.  The change in net revenue excluding non-system related revenue
was a decrease of approximately 22%. The decrease in net revenue in the Americas
segment was primarily attributable to a change in our product mix. The number of
systems shipped was approximately 27% lower than the corresponding period in the
previous year. However, the average revenue per system was higher by
approximately 4% because sales of our smaller systems, with lower profit
margins, decreased 37% while sales of our larger systems, with higher profit
margins, increased 5%. The decrease in net revenue for both the Americas and the
International segments is primarily due to reduced incoming orders because of
the global economic downturn. Although we intend to focus on increasing
international sales, we expect that sales to enterprise customers in the United
States will continue to comprise the significant majority of our
sales.





Cost of Revenue





Our cost
of product revenue consists primarily 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. The majority of these
costs vary with the unit volumes of product sold.





Cost of
revenue decreased to $1.5 million and $4.9 million for the three and nine months
ended June 30, 2009, respectively, as compared to $1.9 million and $5.9 million
for the three months ended June 30, 2008, respectively.  This decrease
was primarily caused by a shift in our product mix in the period and the impact
of lower sales volume over the prior year quarter. Cost of revenue as a
percentage of net revenue decreased to 37% and 39% for the three and nine months
ended June 30, 2009, respectively, as compared to 40% and 43% for the three and
nine months ended June 30, 2008, respectively. This change was primarily
attributable to an increase of our non-system related revenue.





Research
and Development


Research
and development expenses consist primarily of costs related to personnel and
overhead expenses, consultant expenses and other costs associated with the
design, development, prototyping and testing of our products and enhancements of
our converged telephone system software. For both the three months ended June
30, 2009 and 2008, respectively, research and development expenses were
$1.1 million. Research and development as a percentage of net revenue
increased to 27% for the nine months ended June 30, 2009 from 24% for the same
period in the previous fiscal year. Research and development expenses increased
to $3.6 million, or 29% of net revenue, for the nine months ended June 30, 2009
from $3.1 million, or 22% of net revenue, for the same period in fiscal 2008.
This increase in absolute dollars was driven by an increase in personnel-related
and overhead expenses of approximately $230,000, and an increase of $132,000 in
consulting related services. Additionally, research and development expenses
increased in Shanghai, primarily as a result of an increase of $70,000 in
personnel-related and overhead expenses.





We intend
to continue to make investments in our research and development and we believe
that focused investments in research and development are critical to the future
growth and our ability to enhance our competitive position in the marketplace.
We believe that our ability to develop and meet enterprise customer requirements
is essential to our success. Accordingly, we have assembled a team of engineers
with expertise in various fields, including voice and IP communications, unified
communications network design, data networking and software engineering. Our
principal research and development activities are conducted in San Jose,
California and our subsidiary in Shanghai, China. Management continues to focus
on cost control until business conditions improve. If business conditions
deteriorate or the rate of improvement does not meet our expectations, we may
implement additional cost-cutting actions.


19


Sales
and Marketing





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. For
the third quarter of fiscal 2009, sales and marketing expenses were $1.4
million, or 34% of net revenue, compared to $1.9 million, or 40% of net revenue
for the third quarter of fiscal 2008. This expense decrease in absolute dollars
was driven by a decrease of $92,000 in personnel-related expenses, a decrease of
$89,000 in advertising expenses, a decrease of $81,000 in travel related
expenses, a decrease of $90,000 in service related expenses, and a decrease of
$49,000 in partner conference expenses. Sales and marketing expenses decreased
to $5.4 million, or 43% of net revenue, from approximately $5.5 million, or 40%
net revenue, for the same period in fiscal 2008. This decrease in absolute
dollars was primarily attributable to a decrease of $109,000 in partner
conference expenses.





We
anticipate that sales and marketing expenses will decrease but will remain the
largest category of our operating expenses in future periods over the short
term. We plan to continue investing in our domestic and international marketing
activities to help build brand awareness and create sales leads for our channel
partners.  Management continues to focus on cost control until
business conditions improve. If business conditions deteriorate or the rate of
improvement does not meet our expectations, we may implement additional
cost-cutting actions.





General
and Administrative





General
and administrative expenses consist of salaries and related expenses for
executive, finance and administrative personnel, facilities, allowance for
doubtful accounts, legal and other general corporate expenses. For the third
quarter of fiscal 2009, general and administrative expenses were $980,000, or
24% of net revenue, compared to $838,000, or 17% of net revenue for the third
quarter of fiscal 2008. The increase in absolute dollars in general and
administrative was primarily attributable to an increase of $162,000 in legal
expenses associated with corporate governance matters, such as expenses related
to our special meeting of stockholders held on June 18, 2009, the adoption of
our 2009 Stock Plan and our 2009 Purchase Plan, and the preferred stock rights
agreement filed with the SEC on April 23, 2009. These increased expenses were
partially offset by a decrease of $28,000 in general and administrative expenses
in China. General and administrative expenses for the nine months ended June 30,
2009 increased to $2.7 million, or 22% of net revenue, from $2.6 million, or 19%
of net revenue, for the nine months ended June 30, 2008. This was mainly the
result of a $268,000 increase in legal expenses associated with corporate
governance matters, such as expenses related to our special meeting of
stockholders held on June 18, 2009, the adoption of our 2009 Stock Plan and our
2009 Purchase Plan, and the preferred stock rights agreement filed with the SEC
on April 23, 2009. This increase was offset by a decrease of $140,000 in
non-cash stock based compensation expense, as required by SFAS No.
123(R).





Management
continues to focus on cost control until business conditions improve. If
business conditions deteriorate or the rate of improvement does not meet our
expectations, we may implement cost-cutting actions.





Equity
Investment in Common Stock of Private Company





In July
2004, we purchased common stock of a private Korean telecommunications company
for approximately $79,000. As a result of this investment, we acquired
approximately 23% of the voting power of the company. This gives us the right to
nominate and elect one of the three members of the investee’s current board of
directors. We are accounting for this investment using the equity method. For
the three months ended June 30, 2009, the total equity loss with respect to this
company was approximately $3,000 compared to net loss of $1,000 for the same
period in fiscal 2008. For the nine months ended June 30, 2009 and 2008, the
total equity loss with respect to this company was approximately $9,000 and
$4,000, respectively.





Interest
Expense and Other Income, Net





Interest
expense primarily consists of interest incurred on our capital lease commitments
and other income primarily consists of interest earned on cash, cash equivalents
and short-term investments. Net interest and other income decreased to $50,000
and $110,000 for the three and nine months ended June 30, 2009, respectively,
from $46,000 and $240,000 for the same periods in fiscal 2008. The decrease in
interest and other income, net for the three and nine month periods ended June
30, 2009 as compared with the same periods of the prior year was a combination
of lower invested balances, reduced cash balances and reduced rates of interest
available for cash and investments in financial assets in fiscal 2009. In the
longer term, we may generate less interest income if our total invested balance
decreases and these decreases are not offset by rising interest rates or
increased cash generated from operations or other sources.





Liquidity
and Capital Resources





Since
inception, we have financed our operations primarily through the sale of equity
securities. As of June 30, 2009, we held cash and cash equivalents totaling $7.4
million.  Total cash and cash equivalents represents approximately 71%
of total current assets for the quarter ended June 30, 2009.


20


During
the nine months ended June 30, 2009, our net cash used in operating activities
was $2.0million compared to $300,000 during the same period in fiscal 2008. This
was primarily attributable to our net loss of $3.9 million, a decrease of $1.1
million in accounts receivable, a decrease of $260,000 in net inventories, a
decrease of $498,000 in accounts payable, an increase of $246,000 in deferred
revenue short-term and an increase of $199,000 in accrued liabilities in the
nine-month period ended June 30, 2009. The cash impact of the loss for the nine
months ended June 30, 2009 was partially offset by a non-cash expense of
$501,000 in stock-based compensation expense and $176,000 in depreciation and
amortization costs. Generally, as sales levels fall, we expect accounts
receivable and accounts payable, and to a lesser extent inventories, to
decrease. Inventories react more slowly because we outsource much of our
production, and reduced demand takes time to be reflected back through our
supply chain. Further, there will be routine fluctuations in these accounts from
period to period that may be significant in amount. The increase in deferred
revenue for the nine months ended June 30, 2009 was primarily due to an increase
of $421,000 from our service support plans offset by a decrease of $175,000 in
deferred channel revenue; due to the volume of products sold as opposed to what
was shipped to distribution.  We work closely with our distributors to
monitor channel inventory levels and attempt to ensure that appropriate levels
of products are available to resellers and end users. Net cash used in operating
activities of $300,000 in the nine months ended June 30, 2008 was primarily a
result of net loss of $3.1 million, a decrease of $460,000 in accounts
receivable, an increase of $391,000 in net inventories, an increase of $216,000
in accounts payable, an increase of $1.7 million in deferred revenue and an
increase of $110,000 in accrued liabilities in the nine-month period ended June
30, 2009. The cash impact of the loss for the nine months ended June 30, 2008
was partially offset by non-cash adjustments of $187,000 in depreciation and
amortization costs and non-cash stock-based compensation expense of
$696,000.





Net
accounts receivable decreased 43% from $2.4 million at September 30, 2008 to
$1.3 million at June 30, 2009. Quarterly accounts receivable days sales
outstanding (DSO) decreased from 43 days as of September 30, 2008 to 30 days as
of June 30, 2009. Net accounts receivable and DSO decrease was primarily due to
lower shipments and good collections during the third quarter of fiscal
2009.





Net
inventories decrease 16% from $1.6 million at September 30, 2008 to
$1.3 million at June 30, 2009. The decrease in net inventories during this
period was the result of routine period to period fluctuations. Our annualized
inventory turn rate, which represents the number of times inventory is
replenished during the year, decreased from 5.3 turns as of September 30, 2008
to 4.6 turns as of June 30, 2009. 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.





We ended
the third quarter of fiscal 2009 with a cash conversion cycle of 65 days, as
compared to 83 days for the third quarter of fiscal 2008. 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 (a) the days
of sales outstanding added to (b) the days of supply in inventories and reduced
by (c) the days of payable outstanding.  The decrease in our cash
conversion cycle was primarily due to good collections during the third quarter
of fiscal 2009.





For the
nine months ended June 30, 2009, net cash used in investing activities was
$112,000 as compared to net cash provided by investing activities of $1.8
million during the same period in fiscal 2008. This was directly related to
proceeds from maturities of short-term investments of approximately $5.8 million
and purchases of short-term investments of approximately $5.4 million during the
first nine months of fiscal 2009 as compared to proceed from maturities of
short-term investments of approximately $36,000 and purchases of short-term
investments of approximately $34,000 during fiscal 2008. The maturities of the
Company’s short term investments are staggered throughout the year so that cash
requirements are met. For the nine month period ended June 30, 2009, the Company
spent approximately $269,000 on purchases of property and equipment compared to
$145,000 for the nine month period ended June 30, 2008.  Additionally,
for the third quarter of fiscal 2009, the Company reserved $200,000 as
collateral for an irrevocable and negotiable standby letter of credit (the
"Letter of Credit") as security for a facility lease. The $200,000 is recorded
as part of the long-term deposit in the accompanying balance sheet as of June
30, 2009.





Net cash
provided by financing activities for the nine months ended June 30, 2009 was
approximately $102,000, as compared to net cash used in financing activities of
$66,000 during the same period in fiscal 2008. This change was primarily
attributable to the repurchase of our treasury stock of approximately $19,000
for the nine months ended June 30, 2009 as compared to $346,000 during the same
period in fiscal 2008. During the nine months of fiscal 2009, proceeds from
exercise of employee stock options represented approximately $121,000 as
compared to $279,000 during the same period in the prior year.


21


On
October 23, 2007, our Board of Directors approved the repurchase of up to $2.0
million of our common stock in the open market through November 12, 2008. On
November 11, 2008, our Board of Directors extended the repurchase program by
another year to November 14, 2009. Stock repurchases under this program may be
made from time to time at our management’s discretion through November 14, 2009.
When exercising such discretion, management will consider a variety of factors
such as our stock price, general business and market conditions and other
investment opportunities. The repurchase will be made in the open market and
will be funded from available working capital. Pursuant to the 2007 authority,
we repurchased $0 and 231,135 shares during the three and nine months ended June
30, 2008 at an aggregate cost of $0 and $367,000, respectively. Pursuant to the
2008 authority, we repurchased 23,800 shares in the nine months ended June 30,
2009 at an aggregate cost of $19,000. In April 2009, we suspended further
purchases of stock under this program. For additional information, refer to
note 4 to the accompanying unaudited consolidated financial
statements.





The
following table presents selected financial information for each of the fiscal
periods indicated below (in thousands):





June
      30,
                    2009
                
                
                September
      30,
                  2008Cash
      and cash equivalents
                
                $
                7,390
                
                
                $
                9,467Short-term
      investments
                
                
                —
                
                
                
                400Total
      cash, cash equivalents, short-term investments and time
      deposit
                
                $
                7,390
                
                
                $
                9,867Nine
      Months Ended
                    June
      30,2009
                
                
                2008Net
      cash used in operating activities
                
                $
                (2,067
                )
                
                $
                (300
                )Net
      cash provided by (used in) investing activities
                
                $
                (112
                )
                
                $
                1,835Net
      cash provided by (used in) financing activities
                
                $
                102
                
                
                $
                (66
                )Net
      change in cash, cash equivalents, end of period
                
                $
                (2,077
                )
                
                $
                1,469





As of
June30, 2009, our principal sources of liquidity included cash and cash
equivalents of approximately $7.4 million.





We
believe our existing balances of cash, cash equivalents and short-term
investments, as well as cash expected to be generated from operating activities,
will be sufficient to satisfy our working capital needs, capital expenditures
and other liquidity requirements associated with our existing operations over
the next 12 months.





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 to obtain the right to use complementary technologies.
If we cannot raise additional funds in the future if needed, on acceptable
terms, we may not be able to further develop or enhance our products, take
advantage of 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 investing in our securities.





We did
not have any material commitments for capital expenditures as of June 30, 2009.
We had total outstanding commitments on noncancelable capital and operating
leases of $1.9 million as of June 30, 2009. Lease terms on our existing facility
operating leases generally range from three to nine years. We believe that we
have sufficient cash reserves to allow us to continue our current operations for
more than a year.


22


Contractual
Obligations




The
following table presents certain payments due by us under contractual
obligations with minimum firm commitments as of June 30, 2009 (in
thousands):





Payment
      Due by PeriodContractual
      Obligations
                        
                        Total
                        
                        
                        Payments
      Due
                          in
      Less
                          Than
      1 Year
                        
                        
                        Payments
                          Due
      in
                          1
      – 3 Years
                        
                        
                        Payments
                          Due
      in
                          3
      – 5 Years
                        
                        
                        Payments
      Due
                          in
      More
                          Than
      5 YearsOperating
      leases obligation
                        
                        $
                        1,894
                        
                        
                        $
                        141
                        
                        
                        $
                        1,187
                        
                        
                        $
                        556
                        
                        
                        $
                        —Capital
      leases obligation
                        
                        
                        44
                        
                        
                        
                        11
                        
                        
                        
                        33
                        
                        
                        
                        —
                        
                        
                        
                        —Total
      contractual lease obligation
                        
                        $
                        1,938
                        
                        
                        $
                        152
                        
                        
                        $
                        1,220
                        
                        
                        $
                        556
                        
                        
                        $
                        —





Effects
of Recently Issued Accounting Pronouncements





There
were several critical recently issued accounting standards, described in our
2008 Annual Report, which we have adopted as of October 1, 2008. These included
SFAS 159, “The Fair Value Option for Financial Assets and Financial Liabilities
– Including an Amendment of FASB Statement No. 115,” and SFAS 157, “Fair Value
Measurements.” None of these accounting standards have materially impacted the
financial conditions, results of operations, or cash flow of the
Company.




Item
3. Quantitative and Qualitative Disclosures About Market Risk





Market
Interest Rate Risk





At June
30, 2009, our investment portfolio consisted primarily of cash and cash
equivalents of $4.8 million. These securities are subject to interest rate risk
and will decline in value if market interest rates increase. Our interest income
and expense is most sensitive to fluctuations in the general level of U.S.
interest rates. As such, changes in U.S. interest rates affect the interest
earned on our cash, cash equivalents and short-term investments, and the fair
value of those investments. Due to the short duration and conservative nature of
these instruments, we do not believe that we have a material exposure to
interest rate risk. For example, if market interest rates were to increase
immediately and uniformly by 10% from levels as of June 30, 2009, the decline in
the fair value of the portfolio would not have a material effect on our results
of operations over the next fiscal year.





Foreign
Currency Exchange Risk




We
transact a portion of our business in non-U.S. currencies, primarily the Chinese
Yuan (Renminbi). In the short term, we do not foresee foreign exchange currency
fluctuations to pose a material market risk to us. In future periods over the
long term, we anticipate we will be exposed to fluctuations in foreign currency
exchange rates on accounts receivable from sales in these foreign currencies and
the net monetary assets and liabilities of the related foreign subsidiary
located in Shanghai, China. A hypothetical 10% favorable or unfavorable change
in foreign currency exchange rates would not have a material impact on our
results of operations.





Item
4T. Controls and Procedures





Evaluation
of Disclosure Controls and Procedures





Our
management carried out an evaluation, under the supervision and with the
participation of our President and Chief Executive Officer and our Chief
Financial Officer, of the effectiveness of our disclosure controls and
procedures as of the end of our quarter ended June 30, 2009 pursuant to Exchange
Act Rule 13a-15 and 15d-15. The term “disclosure controls and procedures”
is defined under the Exchange Act and means controls and other procedures of a
company that are designed to ensure that information required to be disclosed by
a company in the reports that it files or submits under the Exchange Act is
recorded, processed, summarized and reported within the time periods specified
in the Securities and Exchange Commission’s rules and forms. Disclosure controls
and procedures include, without limitation, controls and procedures designed to
ensure that information required to be disclosed by a company in the reports
that it files or submits under the Exchange Act is accumulated and communicated
to the company’s management, including its principal executive and principal
financial officers, or persons performing similar functions, as appropriate to
allow timely decisions regarding required disclosure. Based upon that
evaluation, our President and Chief Executive Officer and our Chief Financial
Officer concluded that, as of the end of our quarter ended June 30, 2009, our
disclosure controls and procedures were effective.





Changes
in Internal Control Over Financial Reporting





There
have been no changes in our internal controls over financial reporting during
the Company’s fiscal quarter ended June 30, 2009 that have materially affected,
or are reasonably likely to materially affect, our internal controls over
financial reporting.


23


PART
II. OTHER INFORMATION





Item
1.  Legal Proceedings





From time
to time, we may become party to litigation and subject to various routine claims
and legal proceedings that arise 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
1A.  Risk Factors




CERTAIN
FACTORS AFFECTING BUSINESS, OPERATING RESULTS, AND FINANCIAL
CONDITION





In
addition to other information contained in this Form 10-Q, investors should
carefully consider the following factors that could adversely affect our
business, financial condition and operating results as well as adversely affect
the value of an investment in our common stock.





Business-Related Risks





Our
business could be harmed by adverse global economic conditions in our target
markets or reduced spending on information technology and telecommunication
products.





Current
uncertainty in global economic conditions pose a risk to the overall economy as
consumers and businesses may defer purchases in response to tighter credit and
negative financial news, which could negatively affect product demand and other
related matters.  Our business depends on the overall demand for
information technology, and in particular for telecommunications
systems.  The market we serve is emerging and the purchase of our
products involves significant upfront expenditures.  In addition, the
purchase of our products can be discretionary and may involve a significant
commitment of capital and other resources.  Weak economic conditions
in our target markets, or a reduction in information technology or
telecommunications spending even if economic conditions improve, would likely
adversely impact our business, operating results and financial condition in a
number of ways, including longer sales cycles, lower prices for our products and
reduced unit sales.





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





We have
had a history of operating losses since our inception and, as of June 30, 2009,
we had an accumulated deficit of $60.2 million.  We may incur
operating losses in the future, and these losses could be substantial and impact
our ability to attain profitability.  We do not expect to
significantly increase expenditures for product development, general and
administrative expenses, and sales and marketing expenses; however, if we cannot
maintain current revenue or revenue growth, we will not achieve or sustain
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.





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, have caused and may cause our operating
results to vary, including:





·
            our
      ability to respond effectively to competitive pricing
      pressures;


·
            our
      ability to establish or increase market acceptance of our technology,
      products and systems;


·
            our
      success in expanding our network of distributors, dealers and companies
      that buy our products in bulk, customize them for particular applications
      or customers, and resell them under their own
  names;


·
            market
      acceptance of products and systems incorporating our technology and
      enhancements to our product applications on a timely
  basis;


·
            our
      success in supporting our products and
systems;


·
            our
      sales cycle, which may vary substantially from customer to
      customer;


·
            unfavorable
      changes in the prices and delivery of the components we
      purchase;


·
            the
      size and timing of orders for our products, which may vary depending on
      the season, and the contractual terms of the
  orders;


·
            the
      size and timing of our expenses, including operating expenses and expenses
      of developing new products and product
  enhancements;


·
            deferrals
      of customer orders in anticipation of new products, services or product
      enhancements introduced by us or by our competitors;
  and


24


·
            our
      ability to attain and maintain production volumes and quality levels for
      our products.





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 3Com Corporation, Shoretel and Cisco Systems, 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 be increased or our products could become
obsolete.  To remain 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 investments or to make the technological advances necessary to be
competitive, which in turn will cause our business to suffer.





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 revenue.





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 resellers 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 resellers to promote, sell, install and support our products, and their
failure to do so or our inability to recruit or retain resellers 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 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.


25


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





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 revenue,
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.





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, 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 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.





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 revenue.  Competition for highly trained personnel
can at times be 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.





If
we fail to establish and maintain proper and effective internal control over
financial reporting, our operating results and our ability to operate our
business could be harmed.





The
Sarbanes-Oxley Act of 2002 requires, among other things, that we establish and
maintain internal control over financial reporting and disclosure controls and
procedures.  In particular, under the current rules of the SEC,
beginning with the year ended September 30, 2010, we must perform system and
process evaluation and testing of our internal control over financial reporting
to allow management to report on the effectiveness of our internal control over
financial reporting, as required by Section 404 of the Sarbanes-Oxley
Act.  Our independent registered public accounting firm is also
required to report on our internal control over financing
reporting.  We have incurred and we expect to continue to incur
substantial accounting and auditing expense and expend significant management
time in complying with the requirements of Section 404.  If we are not
able to comply with the requirements of Section 404 in a timely manner, or if we
or our independent registered public accounting firm identify deficiencies in
our internal control over financial reporting that are deemed to be material
weaknesses, the market price of our stock could decline and we could be subject
to investigations or sanctions by the SEC, The NASDAQ Capital Market, or NASDAQ,
or other regulatory authorities or subject to litigation.  To the
extent any material weaknesses in our internal control over financial reporting
are identified in the future, we could be required to expend significant
management time and financial resources to correct such material weaknesses or
to respond to any resulting regulatory investigations or
proceedings.





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 three key distributors, Altisys Communications, Inc., Synnex
Corporation and Jenne Distributors, Inc., accounted for 55% of our net revenue
in the quarter ended June 30, 2009.  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. In June 2009, we provided a notice to
terminate our distribution agreement with Jenne Distributors, Inc., effective
September 30, 2009. We believe the termination of our relationship with Jenne
will not have a material impact on our business because we anticipate that
revenue from other distributors will offset a portion of the lost
revenue.


26


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





We
purchase technology that is incorporated into many of our products, including
virtually all of our hardware products, from a single third-party
supplier.  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.





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 new SEC regulations and NASDAQ National Market rules,
creates 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 result in, increased general and administrative expenses
and a diversion of management time and attention from revenue-generating
activities to compliance activities. 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.





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 San Jose, 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 could delay delivery of
products, decrease quality or increase costs.





We
outsource a substantial amount of our product assembly and test
functions.  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.





Our
expansion in international markets has been slow and steady.  However,
our plan is to accelerate this growth rate and 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.





In the
quarter ended June 30, 2009, approximately 10% of our net revenue came from
customers outside of the Americas.  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:


27


·
            tariffs,
      duties, price controls or other restrictions on foreign currencies or
      trade barriers, such as import or export licensing imposed by foreign
      countries, especially on
technology;


·
            potential
      adverse tax consequences, including restrictions on repatriation of
      earnings;


·
            fluctuations
      in foreign currency exchange rates, which could make our products
      relatively more expensive in foreign markets;
  and


·
            conflicting
      regulatory requirements in different countries that may require us to
      invest significant resources customizing our products for each
      country.





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 been issued sixteen patents and expect to continue to file 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 the 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.





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.





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.  We were previously a defendant in a patent
infringement suit brought by Vertical Networks.  On October 4, 2007,
the parties entered into a stipulation dismissing the lawsuit in its entirety
without prejudice.  Consequently, Vertical Networks may reassert these
or related claims in one or more separate proceedings.





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
revenue 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.





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 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.


28


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.





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.





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.





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





The
Federal Communications Commission (FCC) has 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.  In February 2004, the FCC found that an entirely Internet
based voice over Internet protocol service was an unregulated information
service.  At the same time, the FCC began a broader proceeding to
examine what its role should be in this new environment of increased consumer
choice and what can be done to meet its role of safeguarding the public
interest.  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.





Risks
Related to Ownership of our Common Stock





Our
stock price may be volatile.





The
trading price of our common stock has been and may continue to be volatile and
could be subject to wide fluctuations in response to various factors, some of
which are beyond our control. Factors that could affect the trading price of our
common stock could include:





·
            variations
      in our operating results;


·
            announcements
      of technological innovations, new products or product enhancements,
      strategic alliances or significant agreements by us or by our
      competitors;


·
            the
      gain or loss of significant
customers;


·
            recruitment
      or departure of key personnel;


·
            the
      impact of unfavorable worldwide economic and market conditions, including
      the restricted credit environment impacting credit of our
      customers;


·
            changes
      in estimates of our operating results or changes in recommendations by any
      securities analysts who follow our common
stock;


29


·
            significant
      sales, or announcement of significant sales, of our common stock by us or
      our stockholders; and


·
            adoption
      or modification of regulations, policies, procedures or programs
      applicable to our business.





In
addition, the stock market in general, and the market for technology companies
in particular, has experienced extreme price and volume fluctuations that have
often been unrelated or disproportionate to the operating performance of those
companies. Broad market and industry factors may seriously affect the market
price of our common stock, regardless of our actual operating performance. In
addition, in the past, following periods of volatility in the overall market and
the market price of a particular company’s securities, securities class action
litigation has often been instituted against these companies. This litigation,
if instituted against us, could result in substantial costs and a diversion of
our management’s attention and resources.





If
securities or industry analysts do not publish research or reports about our
business, or if they issue an adverse or misleading opinion regarding our stock,
our stock price and trading volume could decline.





The
trading market for our common stock will be influenced by the research and
reports that industry or securities analysts publish about us or our business.
If any of the analysts who cover us issue an adverse or misleading opinion
regarding our stock, our stock price would likely decline. If one or more of
these analysts cease coverage of our company or fail to publish reports on us
regularly, we could lose visibility in the financial markets, which in turn
could cause our stock price or trading volume to decline.





We
may choose to raise additional capital. Such capital may not be available, or
may be available on unfavorable terms, which would adversely affect our ability
to operate our business.





We expect
that our existing cash balances will be sufficient to meet our working capital
and capital expenditure needs for the foreseeable future. If we choose to raise
additional funds, due to unforeseen circumstances or material expenditures, we
cannot be certain that we will be able to obtain additional financing on
favorable terms, if at all, and any additional financings could result in
additional dilution to our existing stockholders.





Provisions
in our charter documents, Delaware law, employment arrangements with certain of
our executive officers and Preferred Stock Rights Agreement could discourage a
takeover that stockholders may consider favorable.





Provisions
in our certificate of incorporation and bylaws may have the effect of delaying
or preventing a change of control or changes in our management. These provisions
include but are not limited to the following:





·
            our
      board of directors has the right to increase the size of the board of
      directors and to elect directors to fill a vacancy created by the
      expansion of the board of directors or the resignation, death or removal
      of a director, which prevents stockholders from being able to fill
      vacancies on our board of
directors;


·
            our
      board of directors is staggered into three (3) classes and each member is
      elected for a term of 3 years, which prevents stockholders from being able
      to assume control of the board of
directors;


·
            our
      stockholders may not act by written consent  and are limited in
      their ability to call special stockholders’ meetings; as a result, a
      holder, or holders, controlling a majority of our capital stock would be
      limited in their ability to take certain actions other than at annual
      stockholders’ meetings or special stockholders’ meetings called by the
      board of directors, the chairman of the board or the
      president;


·
            our
      certificate of incorporation prohibits cumulative voting in the election
      of directors, which limits the ability of minority stockholders to elect
      director candidates;


·
            stockholders
      must provide advance notice to nominate individuals for election to the
      board of directors or to propose matters that can be acted upon at a
      stockholders’ meeting, which may discourage or deter a potential acquiror
      from conducting a solicitation of proxies to elect the acquiror’s own
      slate of directors or otherwise attempting to obtain control of our
      company; and


·
            our
      board of directors may issue, without stockholder approval, shares of
      undesignated preferred stock; the ability to issue undesignated preferred
      stock makes it possible for our board of directors to issue preferred
      stock with voting or other rights or preferences that could impede the
      success of any attempt to acquire
us.





As a
Delaware corporation, we are also subject to certain Delaware anti-takeover
provisions. Under Delaware law, a corporation may not engage in a business
combination with any holder of 15% or more of its capital stock unless the
holder has held the stock for three years or, among other things, the board of
directors has approved the transaction. Our board of directors could rely on
Delaware law to prevent or delay an acquisition of us.





Certain
of our executive officers may be entitled to accelerated vesting of their
options pursuant to the terms of their employment arrangements upon a change of
control of AltiGen. In addition to the arrangements currently in place with some
of our executive officers, we may enter into similar arrangements in the future
with other officers. Such arrangements could delay or discourage a potential
acquisition of AltiGen.


30


Our board
of directors declared a dividend of one (1) right for each share of Common Stock
under the terms and conditions of a Preferred Stock Rights Agreement by and
between AltiGen and Computershare Trust Company, N.A. dated April 21, 2009,
which right is exercisable for shares of AltiGen’s Preferred Stock after the
date on which a hostile acquiror obtains, or announces a tender offer for, 15%
or more of the Company’s Common Stock.  If an acquiror obtains 15% or
more of the Company’s Common Stock, each stockholder (except the acquiror) may
purchase either our Common Stock or in certain circumstances, the acquiror’s
Common Stock, at a discount, resulting in substantial dilution to the acquiror’s
interest.  Such rights could delay or discourage a potential
acquisition of AltiGen.





Our
common stock could be delisted from the NASDAQ Capital Market.





The price
of our common stock has traded below $1.00 per share for a significant period of
time. If the bid price of our common stock remains below $1.00 per share for 30
consecutive trading days, we may fail to meet the minimum bid price requirement
of $1.00, which may result in the delisting of our common stock from the NASDAQ
Capital Market. The minimum bid requirement of $1.00 has until recently been
suspended, but on August 3, 2009, the requirement was reinstated. We cannot
assure you that we will be able to maintain out listing on the NASDAQ Capital
Market.





If our
common stock is delisted from the NASDAQ Capital Market, trading, if any, in our
common stock may then continue to be conducted in the over-the-counter market in
what are commonly referred to as the electronic bulletin board and the “pink
sheets.” As a result, investors may find it more difficult to dispose of or
obtain accurate quotations as to the market value of our common stock. In
addition, we would be subject to rules promulgated by the SEC that, if we fail
to meet criteria set forth in such rules, impose various practice requirements
on broker-dealers who sell securities governed by those rules to persons other
than established customers and accredited investors. Consequently, those rules
may have a material adverse effect on the ability of broker-dealers to sell our
securities, which may materially limit the market liquidity of our common stock
and the ability of our stockholders to sell our securities in the secondary
market.





A
delisting of our common stock will also make us ineligible to use Form S-3 to
register the sale of shares of our common stock or to register the resale of our
securities with the SEC, thereby making it more difficult and expensive for us
to register our common stock or other securities and raise additional
capital.


31


Item
2. Unregistered Sales of Equity Securities and Use of Proceeds





On
October 23, 2007, our Board of Directors approved the repurchase of up to $2.0
million of our common stock in the open market through November 12, 2008. On
November 11, 2008, our Board of Directors extended the repurchase program by
another year to November 14, 2009. Stock repurchases under this program may be
made from time to time at our management’s discretion through November 14, 2009.
When exercising such discretion, management will consider a variety of factors
such as our stock price, general business and market conditions and other
investment opportunities. The repurchase will be made in the open market and
will be funded from available working capital. Pursuant to the 2007 authority,
we repurchased $0 and 231,135 shares during the three and nine months ended June
30, 2008 at an aggregate cost of $0 and $367,000, respectively. Pursuant to the
2008 authority, we repurchased 23,800 shares in the nine months ended June 30,
2009 at an aggregate cost of $19,000. In April 2009, we suspended further
purchases of stock under this program. For additional information, refer to
note 4 to the accompanying unaudited consolidated financial
statements.





Repurchases
of our common stock under the latest Board of Directors’ authorization is
represented in the following table:





Period
                    
                    Total
      Number
                      of
      Shares
                      Purchased
                    
                    
                    Average
      Price
                      Paid
      per Share
                    
                    
                    Shares Purchased
                      as Part of Publicly
                      Announced Program
                    
                    
                    Approximate
      Dollar
                      Value
      of
                      Shares that May Yet
                      be Purchased as
      Part of
                      the ProgramNovember
      1, 2007 through November 30, 2007
                    
                    
                    16,413
                    
                    
                    $
                    1.59
                    
                    
                    
                    16,413
                    
                    
                    $
                    1,973,965December
      1, 2007 through December 31, 2007
                    
                    
                    92,965
                    
                    
                    
                    1.60
                    
                    
                    
                    92,965
                    
                    
                    
                    1,825,685February
      1, 2008 through February 29, 2008
                    
                    
                    80,218
                    
                    
                    
                    1.66
                    
                    
                    
                    80,218
                    
                    
                    
                    1,692,660March
      1, 2008 through March 31, 2008
                    
                    
                    23,919
                    
                    
                    
                    1.61
                    
                    
                    
                    23,919
                    
                    
                    
                    1,654,084August
      1, 2008 through August 31, 2008
                    
                    
                    7,211
                    
                    
                    
                    1.21
                    
                    
                    
                    7,211
                    
                    
                    
                    1,645,374September
      1, 2008 through September 30, 2008
                    
                    
                    10,409
                    
                    
                    
                    1.16
                    
                    
                    
                    10,409
                    
                    
                    
                    1,633,338December
      1, 2008 through December 31, 2008
                    
                    
                    10,400
                    
                    
                    
                    0.77
                    
                    
                    
                    10,400
                    
                    
                    
                    1,625,311January
      1, 2009 through January 31, 2009
                    
                    
                    4,275
                    
                    
                    
                    0.79
                    
                    
                    
                    4,275
                    
                    
                    
                    1,621,953February
      1, 2009 through February 28, 2009
                    
                    
                    3,325
                    
                    
                    
                    0.87
                    
                    
                    
                    3,325
                    
                    
                    
                    1,619,045March
      1, 2009 through March 31, 2009
                    
                    
                    5,800
                    
                    
                    
                    0.79
                    
                    
                    
                    5,800
                    
                    
                    
                    1,614,461April
      1, 2009 through June 30, 2009
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —Total
                    
                    
                    254,935
                    
                    
                    $
                    1.51
                    
                    
                    
                    254,935
                    
                    
                    $
                    1,614,461





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





The
following matters were submitted to a vote of security holders at our special
meeting of stockholders held on June 18, 2009:





Proposal One:





To
approve the 2009 Equity Incentive Plan:





Votes
      For
              
              Votes
      Against
              
              Abstentions____7,602,823__
              
              3,414,964
              
              31,531





Proposal Two





To
approve the 2009 Employee Stock Purchase Plan:





Votes
      For
              
              Votes
      Against
              
              Abstentions8,447,887
              
              2,553,275
              
              48,156


32





Item
6. Exhibits.





Please
refer to the Exhibit Index of this Quarterly Report on Form
10-Q.


33





SIGNATURE





Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.





ALTIGEN
      COMMUNICATIONS, INC.Date:
      August 13, 2009
              By:
              /s/
      Philip M. McDermottPhilip
      M. McDermottChief
      Financial Officer


34


EXHIBIT
INDEX





Exhibit
                    Number
                  
                  Description3.1
      (1)
                  
                  Amended
      and Restated Certificate of Incorporation.3.2
      (2)
                  
                  Second
      Amended and Restated Bylaws.3.3(3)
                  
                  Certificate
      of Designation of Rights, Preferences and Privileges of Series A
      Participating Preferred Stock of AltiGen Communications,
    Inc.4.1(4)
                  
                  Preferred
      Stock Rights Agreement, dated as of April 21, 2009, between AltiGen
      Communications, Inc. and Computershare Trust Company, N.A., including the
      Certificate of Designation, the form of Rights Certificate and the Summary
      of Rights attached thereto as Exhibits A, B and C,
      respectively.10.1(5)
                  
                  2009
      Equity Incentive Plan and forms of agreements
  thereunder.10.2(6)
                  
                  2009
      Employee Stock Purchase Plan.31.1
                  
                  Certification
      of Principal Executive Officer, filed herewith.31.2
                  
                  Certification
      of Principal Financial Officer, filed herewith.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, filed
      herewith.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, filed
      herewith.


___________________________________________





(1)
              
              Incorporated
      by reference to exhibit filed with the Registrant's Registration Statement
      on Form S-1 (No. 333-80037) declared effective on
      October 4, 1999.(2)
              
              Incorporated
      by reference to exhibit filed with the Registrant's Quarterly Report on
      Form 10-Q for the quarter ended March 31, 2004.(3)
              
              Incorporated
      by reference to exhibit filed with the Registrant's Registration Statement
      on Form 8-A on April 23, 2009.(4)
              
              Incorporated
      by reference to exhibit filed with the Registrant's Current Report on Form
      8-K on April 23, 2009.(5)
              
              Incorporated
      by reference to exhibit filed with the Registrant's Registration Statement
      on Form S-8 on June 29, 2009.(6)
              
              Incorporated
      by reference to exhibit filed with the Registrant's Registration Statement
      on Form S-8 on June 29,
2009.


35