UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549











FORM
10-Q





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


FOR
THE QUARTERLY PERIOD ENDED December 31, 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 x 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 o    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 x





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





The
number of shares of our common stock outstanding as of February 8, 2009 was:
16,429,355 shares.














ALTIGEN
COMMUNICATIONS, INC.


QUARTERLY
REPORT ON FORM 10-Q


FOR
THE QUARTERLY PERIOD ENDED DECEMBER 31, 2009


TABLE OF CONTENTS




PART
      I.  FINANCIAL INFORMATIONItem
      1.
                      Condensed
      Consolidated Financial Statements (Unaudited)
                      3Condensed
      Consolidated Balance Sheets as of December 31, 2009 and September 30,
      2009
                      3Condensed
      Consolidated Statements of Operations for the Three Months Ended December
      31, 2009 and 2008
                      4Condensed
      Consolidated Statements of Cash Flows for the Three Months Ended December
      31, 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
                      24Item
      4.
                      Controls
      and Procedures
                      24PART
      II.  OTHER INFORMATIONItem
      1.
                      Legal
      Proceedings
                      25Item
      1A
                      Risk
      Factors
                      25Item
      2.
                      Unregistered
      Sale of Equity Securities and Use of Proceeds
                      33Item
      6.
                      Exhibits
                      34SIGNATURE
                      35EXHIBIT
      INDEX
                      36




2





PART
I.  FINANCIAL INFORMATION





Item
      1.
            Condensed
      Consolidated Financial Statements





ALTIGEN
COMMUNICATIONS, INC. AND SUBSIDIARY


CONDENSED
CONSOLIDATED BALANCE SHEETS


(UNAUDITED)





December 31,
                
                
                September 30,2009
                
                
                2009(In thousands, except share and per
                  share amounts)ASSETSCurrent
      assets:Cash
      and cash equivalents
                
                $
                7,629
                
                
                $
                7,397Accounts
      receivable, net of allowances of $34 and $35 at December 31, 2009
      and  September 30, 2009, respectively
                
                
                1,083
                
                
                
                1,545Inventories,
      net
                
                
                1,088
                
                
                
                1,266Prepaid
      expenses and other current assets
                
                
                218
                
                
                
                128Total
      current assets
                
                
                10,018
                
                
                
                10,336Property,
      plant and equipment, net
                
                
                464
                
                
                
                501Long-term
      investments
                
                
                202
                
                
                
                202Long-term
      deposit
                
                
                226
                
                
                
                292Total
      assets
                
                $
                10,910
                
                
                $
                11,331LIABILITIES
      AND STOCKHOLDERS' EQUITYCurrent
      liabilities:Accounts
      payable
                
                $
                1,214
                
                
                $
                1,165Accrued
      liabilities:Payroll
      and related benefits
                
                
                475
                
                
                
                672Warranty
                
                
                111
                
                
                
                122Marketing
                
                
                111
                
                
                
                111Accrued
      expenses
                
                
                281
                
                
                
                215Other
      accrued liabilities
                
                
                458
                
                
                
                484Total
      accrued liabilities
                
                
                1,436
                
                
                
                1,604Deferred
      revenue, short-term
                
                
                2,330
                
                
                
                2,573Total
      current liabilities
                
                
                4,980
                
                
                
                5,342Other
      long-term liabilities
                
                
                281
                
                
                
                232Commitments
      and contingencies (Note 3)Stockholders'
      equity:Convertible
      preferred stock, $0.001 par value; Authorized—5,000,000 shares;
      Outstanding—none at December 31, 2009 and September 30,
      2008
                
                
                —
                
                
                
                —Common
      stock, $0.001 par value; Authorized—50,000,000 shares;
      Outstanding—16,429,355 shares at December 31, 2009 and 16,188,857 shares
      at September 30, 2009
                
                
                18
                
                
                
                17Treasury
      stock at cost—1,318,830 shares at December 31, 2009 and September 30,
      2009
                
                
                (1,400
                )
                
                
                (1,400
                )Additional
      paid-in capital
                
                
                68,083
                
                
                
                67,716Accumulated
      other comprehensive income
                
                
                159
                
                
                
                165Accumulated
      deficit
                
                
                (61,211
                )
                
                
                (60,741
                )Total
      stockholders' equity
                
                
                5,649
                
                
                
                5,757Total
      liabilities and stockholders' equity
                
                $
                10,910
                
                
                $
                11,331




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)





Three Months Ended
                    December 31,2009
                  
                  
                  2008(In thousands, except per
                    share amounts)Net
      revenue:Hardware
                  
                  $
                  2,774
                  
                  
                  $
                  3,566Software
                  
                  
                  580
                  
                  
                  
                  665Service
      support
                  
                  
                  867
                  
                  
                  
                  629Total
      net revenue
                  
                  
                  4,221
                  
                  
                  
                  4,860Cost
      of revenue:Hardware
                  
                  
                  1,408
                  
                  
                  
                  1,894Software
                  
                  
                  3
                  
                  
                  
                  4Service
      support (1)
                  
                  
                  —
                  
                  
                  
                  —Total
      cost of revenue
                  
                  
                  1,411
                  
                  
                  
                  1,898Gross
      profit
                  
                  
                  2,810
                  
                  
                  
                  2,962Operating
      expenses:Research
      and development
                  
                  
                  1,147
                  
                  
                  
                  1,225Sales
      and marketing
                  
                  
                  1,379
                  
                  
                  
                  2,084General
      and administrative
                  
                  
                  775
                  
                  
                  
                  971Total
      operating expenses
                  
                  
                  3,301
                  
                  
                  
                  4,280Loss
      from operations
                  
                  
                  (491
                  )
                  
                  
                  (1,318
                  )Equity
      in net loss of investee
                  
                  
                  —
                  
                  
                  
                  (3
                  )Interest
      and other income, net
                  
                  
                  22
                  
                  
                  
                  37Net
      loss before taxes
                  
                  
                  (469
                  )
                  
                  
                  (1,284
                  )Income
      taxes
                  
                  
                  (1
                  )
                  
                  
                  16Net
      loss
                  
                  $
                  (470
                  )
                  
                  $
                  (1,268
                  )Basic
      and diluted net loss per share
                  
                  $
                  (0.03
                  )
                  
                  $
                  (0.08
                  )Weighted
      average shares used in computing basic and diluted net loss per
      share
                  
                  
                  16,293
                  
                  
                  
                  15,838





(1)
Service support cost represents less than 1% of our total cost of
revenue.





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)





Three Months Ended
                            December 31,2009
                          
                          
                          2008(In thousands)Cash flows from operating activities:Net
      loss
                          
                          $
                          (470
                          )
                          
                          $
                          (1,268
                          )Adjustments
      to reconcile net loss to net cash (used in) provided by operating
      activities:Depreciation
      and amortization
                          
                          
                          50
                          
                          
                          
                          50Stock-based
      compensation
                          
                          
                          318
                          
                          
                          
                          286Equity
      in net income of investee
                          
                          
                          —
                          
                          
                          
                          3Changes
      in operating assets and liabilities:Accounts
      receivable
                          
                          
                          462
                          
                          
                          
                          430Inventories,
      net
                          
                          
                          178
                          
                          
                          
                          (257
                          )Prepaid
      expenses and other current assets
                          
                          
                          (90
                          )
                          
                          
                          (78
                          )Accounts
      payable
                          
                          
                          49
                          
                          
                          
                          236Accrued
      liabilities
                          
                          
                          (168
                          )
                          
                          
                          (55
                          )Deferred
      revenue, short-term
                          
                          
                          (243
                          )
                          
                          
                          135Other
      long-term liabilities
                          
                          
                          49
                          
                          
                          
                          301Net
      cash (used in) provided by operating activities
                          
                          
                          135
                          
                          
                          
                          (217
                          )Cash
      flows from investing activities:Purchases
      of short-term investments
                          
                          
                          —
                          
                          
                          
                          (5,460
                          )Proceeds
      from sale of short-term investments
                          
                          
                          —
                          
                          
                          
                          867Changes
      in long-term deposits
                          
                          
                          66
                          
                          
                          
                          —Purchases
      of property and equipment
                          
                          
                          (13
                          )
                          
                          
                          (68
                          )Net
      cash (used in) provided by investing activities
                          
                          
                          53
                          
                          
                          
                          (4,661
                          )Cash
      flows from financing activities:Proceeds
      from issuances of common stock, net of issuance costs
                          
                          
                          50
                          
                          
                          
                          63Repurchase
      of treasury stock
                          
                          
                          —
                          
                          
                          
                          (8
                          )Net
      cash provided by financing activities
                          
                          
                          50
                          
                          
                          
                          55Effect
      of exchange rate changes on cash and cash equivalents
                          
                          
                          (6
                          )
                          
                          
                          —Net
      change in cash and cash equivalents during period
                          
                          
                          232
                          
                          
                          
                          (4,823
                          )Cash
      and cash equivalents, beginning of period
                          
                          
                          7,397
                          
                          
                          
                          9,467Cash
      and cash equivalents, end of period
                          
                          $
                          7,629
                          
                          
                          $
                          4,644





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 leading provider of 100
percent Microsoft-based Voice over Internet Protocol (VoIP) business phone
systems and Unified Communications solutions. 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 to current
period presentation.





These
financial statements should be read in conjunction with our audited consolidated
financial statements for the fiscal year ended September 30, 2009, included in
the Company’s 2009 Annual Report on Form 10-K filed with the SEC on December 28,
2009. 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





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 to shareholders' equity as a component of other comprehensive income
(loss). We evaluate our available-for-sale securities for impairment quarterly.
During the three months ended December 31, 2009, we did not record any
impairment on outstanding securities held. The Company did not hold any
short-term investments at December 31, 2009.





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 materials
inventory is considered obsolete and is fully reserved if it has not been used
in 365 days. For the three months ended December 31, 2009 and 2008, we disposed
of fully-reserved inventory with a carrying value of $0 and an original cost of
$33,000 and 176,000, respectively. The disposal of such inventory had no
material impact on our revenue, gross margins and net loss. For the three months
ended December 31, 2009 and 2008, we recognized a provision of $3,000 and
$28,000, respectively, for excess and obsolete inventories. The components of
inventories, net of inventory reserves, include (in thousands):





December 31,
                  
                  
                  September 30,2009
                  
                  
                  2009Raw
      materials
                  
                  $
                  308
                  
                  
                  $
                  450Work-in-progress
                  
                  
                  113
                  
                  
                  
                  29Finished
      goods
                  
                  
                  667
                  
                  
                  
                  787Total
                  
                  $
                  1,088
                  
                  
                  $
                  1,266





REVENUE
RECOGNITION





Revenue
consists of direct 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 exists, and the sales price is fixed and
determinable. Net revenue consists of hardware and software 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 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
without cause 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. We do not
recognize revenue derived from sales to customers in China until both of the
following elements are satisfied: customer has taken ownership upon shipment and
AltiGen has received payment for the purchase.





SERVICE
SUPPORT PROGRAMS





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 year 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 service support revenue over the terms of their
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. 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 contract
term.





7





STOCK-BASED
COMPENSATION





The
Company accounts for stock-based compensation, including grants of stock
options, as an operating expense in the income statement at fair market value.
The Company has estimated the fair value of stock-based compensation for stock
options at the date of the grant using the Black-Scholes option-pricing model.
The Black-Scholes option-pricing model incorporates various assumptions
including expected volatility, expected life and interest rate. The Company uses
historical data to estimate option forfeitures. Expected volatility is based on
historical volatility and the risk-free interest rate is based on U.S. Treasury
yield in effect at the time of the grant for the expected life of the options.
The Company does not anticipate paying any dividends in the foreseeable future
and therefore used an expected dividend yield of zero in the option valuation
model.





The
underlying weighted-average assumptions used in the Black-Scholes model and the
resulting estimates of fair value per share were as follows for options granted
during the three months ended December 31, 2009 and December 31,
2008:





Employee Stock Option Plans
                    Three Months Ended December 31,
                
                
                Employee Stock Purchase Plan
                    Three Months Ended December 31,2009
                
                
                2008
                
                
                2009
                
                
                2008Expected
      life (in years)
                
                
                6
                
                
                
                6
                
                
                
                0.5
                
                
                
                0.5Risk-free
      interest rate
                
                
                2.2
                %
                
                
                2.3
                %
                
                
                0.15
                %
                
                
                1.2
                %Volatility
                
                
                90
                %
                
                
                141
                %
                
                
                90
                %
                
                
                140
                %Forfeiture
      rate
                
                
                16.74
                %
                
                
                15.99
                %
                
                
                —
                
                
                
                —Expected
      dividend
                
                
                0.0
                %
                
                
                0.0
                %
                
                
                0.0
                %
                
                
                0.0
                %





The
following table summarizes stock-based compensation expense related to employee
and director stock options, employee stock purchases and stock awards for the
three months ended December 31, 2009 and December 31, 2008:





Three Months Ended
                    December 31,2009
                
                
                2008(In thousands)Cost
      of revenue
                
                $
                8
                
                
                $
                5Research
      and development
                
                
                128
                
                
                
                65Sales
      and marketing
                
                
                109
                
                
                
                85General
      and administrative
                
                
                73
                
                
                
                131Total
                
                $
                318
                
                
                $
                286





The
following table summarizes the Company’s stock option plan as of October 1, 2009
and changes during the three months ended December 31, 2009:





Number of
                      Shares
                  
                  
                  Weighted-Average
                      Exercise Price
                  
                  
                  Weighted
                      Average
                      Remaining
                      Contractual Life
                      (in years)Outstanding
      at October 1, 2009
                  
                  
                  4,362,891
                  
                  
                  $
                  0.91Granted
                  
                  
                  44,000
                  
                  
                  
                  0.90Exercised
                  
                  
                  (3,489
                  )
                  
                  
                  0.68Forfeitures
      and cancellations
                  
                  
                  (14,722
                  )
                  
                  
                  0.76Outstanding
      at December 31, 2009
                  
                  
                  4,388,680
                  
                  
                  $
                  0.91
                  
                  
                  
                  7.91Vested
      and expected to vest at December 31, 2009
                  
                  
                  3,471,954
                  
                  
                  $
                  0.92
                  
                  
                  
                  7.51Exercisable
      at December 31, 2009
                  
                  
                  1,773,297
                  
                  
                  $
                  0.96
                  
                  
                  
                  5.64





At
December 31, 2009, the aggregate intrinsic value of stock options outstanding
was $674,630. Total stock options vested and expected to vest at December 31,
2009 were 3.4 million shares with a weighted average exercise price of
$0.92, aggregate intrinsic value of $549,231, and a weighted average remaining
contractual term of 7.5 years. The total exercisable stock options as of
December 31, 2009 were 1.8 million shares with an aggregate intrinsic value
of $313,508, weighted average exercise price of $0.96, and a weighted average
remaining contractual term of 5.6 years.





The
Company has unamortized stock-based compensation expense relating to options
outstanding of $819,000, which will be amortized to expense over a weighted
average period of 4 years.





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 and a 2009 Employee Stock
Purchase Plan (the “2009 Purchase Plan”), which were both approved by our
stockholders on June 18, 2009.  The 2009 Purchase Plan allows eligible
employees to purchase shares of Company stock at a discount through payroll
deductions. The 2009 Purchase Plan consists of six-month offering periods
commencing on June 1st and
December 1st, each
year. Employees purchase shares in the purchase period at 85% of the market
value of the Company’s common stock at either the beginning of the offering
period or the end of the offering period, whichever price is lower.





8





Participants
under the 2009 Purchase Plan generally may not purchase shares on any exercise
date to the extent that, immediately after the grant, the participant would own
stock totaling 5% or more of the total combined voting power of all stock of the
Company, or greater than $25,000 worth of stock in any calendar year. The
maximum number of shares of common stock that any employee may purchase under
the 2009 Purchase Plan during any offering period is 10,000
shares.





The
Company reserved 1.5 million shares of the Company’s common stock for future
issuance under the 2009 Purchase Plan. From October 1, 2008 until the expiration
of the 1999 Purchase Plan on March 10, 2009, 193,411 shares were purchased by
and distributed to employees at a price of $0.59 per share. During the three
months ended December 31, 2009, 74,735 shares were purchased by and distributed
to employees under the 2009 Purchase Plan at a price of $0.62 per
share.




Issuance
of Common Stock as Bonuses





In July
2009, our Board of Directors approved the issuance of our common stock to
employees as bonuses. The stock bonuses would be granted in four quarterly
installments based on the evaluation of the Company’s overall financial
performance for each respective quarter. The stock awards are immediately vested
on the date of grant. We recorded stock-based compensation expense for these
stock award bonuses based on the closing fair market value of the Company’s
common stock on the date of grant. During the three months ended December 31,
2009, we issued 162,274 shares of our common stock to employees and recorded
total expense of $146,046 for bonus awards earned in the forth quarter of fiscal
year 2009. During the first quarter of fiscal year 2010, our Board of Directors
suspended further issuance of common stock as bonus under this
program.





COMPUTATION
OF BASIC AND DILUTED NET LOSS PER SHARE





The
Company bases its basic net loss per share upon the weighted average number of
common shares outstanding during the period. Basic net loss per common share is
computed by dividing the net loss 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.





The
following table sets forth the computation of basic and diluted net loss per
share (in thousands, except net loss per share amounts):





Three Months Ended
                      December 31,2009
                  
                  
                  2008Net
      loss
                  
                  $
                  (470
                  )
                  
                  $
                  (1,268
                  )Divided
      by: weighted average shares outstanding—basic and diluted
                  
                  
                  16,293
                  
                  
                  
                  15,838Basic
      and diluted net loss per share
                  
                  $
                  (0.03
                  )
                  
                  $
                  (0.08
                  )





Options
to purchase 4.4 million and 4.5 million shares of common stock were outstanding
as of December 31, 2009 and 2008, respectively, and were excluded from the
computation of diluted net earnings per share for these periods because their
effect would have been antidilutive.





COMPREHENSIVE
INCOME (LOSS)





Comprehensive
income (loss) consists of two components—net income (loss) and other
comprehensive income (loss). Other comprehensive income (loss) 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 (loss)
consists of unrealized gains and losses on marketable securities categorized as
available-for-sale and foreign exchange gains and losses.





As of
December 31, 2009, accumulated other comprehensive income consists of $159,000
of accumulated foreign currency translation gains. The amounts comprising
unrealized gains and losses on marketable securities and the related changes as
of December 31, 2009 and 2008 were immaterial.




FAIR
VALUE MEASUREMENTS




In
October 2008, the Company adopted FASB ASC 820-10, Fair Value Measurements and
Disclosures – Overall (“ASC 820-10”) with respect to its financial assets
and liabilities. In February 2008, the FASB issued updated guidance related to
fair value measurements, which is included in the Codification in ASC 820-10-55,
Fair Value Measurements and
Disclosures – Overall – Implementation Guidance and Illustrations. The
updated guidance provided a one year deferral of the effective date of ASC
820-10 for non-financial assets and non-financial liabilities, except those that
are recognized or disclosed in the financial statements at fair value at least
annually. The adoption did not have a material impact on the Company’s Condensed
Consolidated Financial Statements as it relates only to disclosures. The
required disclosures are included in Note 1 of Notes to Condensed Consolidated
Financial Statements.





9




In
October 2009, the Company adopted the fair value disclosure provision that
requires the reporting of interim disclosures about the fair value of financial
instruments previously only disclosed on an annual basis. The adoption did not
have any impact on the Company’s Condensed Consolidated Financial Statements as
it relates only to disclosures. The required disclosures are included in Note 1
of Notes to Condensed Consolidated Financial Statements.




The
Company did not record an adjustment to retained earnings as a result of the
adoption of this accounting standard, and the adoption did not have a material
effect on the Company’s results of operations. Fair value is defined 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 this
standard 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 standard 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 this standard, 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 December 31, 2009
and September 30, 2009 (in thousands):





Balance at
                          December 31, 2009
                      
                      
                      Quoted Prices in
                          Active Markets for
                          Identical Instruments
                          (Level 1)Cash
      equivalents:Money
      market mutual funds
                      
                      $
                      4,628
                      
                      
                      $
                      4,628Total
      assets measured at fair value
                      
                      $
                      4,628
                      
                      
                      $
                      4,628




Balance at
                      September 30, 2009
                  
                  
                  Quoted Prices in
                      Active Markets for
                      Identical Instruments
                      (Level 1)Cash
      equivalents:Money
      market mutual funds
                  
                  $
                  4,628
                  
                  
                  $
                  4,628Total
      assets measured at fair value
                  
                  $
                  4,628
                  
                  
                  $
                  4,628





10





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, United Kingdom, Italy and Holland.





The
following table shows our sales by geographic region as percentage of total
sales for the periods indicated:





Three Months Ended
                      December 31,2009
                  
                  
                  2008Americas
                  
                  
                  83
                  %
                  
                  
                  86
                  %International
                  
                  
                  17
                  %
                  
                  
                  14
                  %Total
                  
                  
                  100
                  %
                  
                  
                  100
                  %





The
following table sets forth a measure of profit or loss for each operating
segment for the periods indicated (in thousands):





Three Months Ended
                    December 31,2009
                
                
                2008Americas
                
                $
                (364
                )
                
                $
                (1,238
                )International
                
                $
                (106
                )
                
                $
                (30
                )Total
                
                $
                (470
                )
                
                $
                (1,268
                )





The
following table sets forth the total assets for each operating segment as of the
periods indicated (in thousands):





December 31,
                
                
                September 30,2009
                
                
                2009Americas
                
                $
                7,709
                
                
                $
                8,060International
                
                $
                3,201
                
                
                $
                3,271Total
                
                $
                10,910
                
                
                $
                11,331





CUSTOMERS





Our
customers are primarily end-users, resellers and distributors. We have
distribution agreements with Altisys Communications, Inc., and Synnex
Corporation, in the Americas. Our agreements with Altisys and Synnex have
initial terms of one year. 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, and Synnex also provide for
termination, with or without cause and without penalty, by either party upon
thirty (30) days' written notice to the other party or upon insolvency or
bankruptcy. For a period of sixty (60) days' following termination of the
agreement, Altisys and Synnex may distribute any products in their possession at
the time of termination or, at their option, return any products to us that are
in their inventories. Upon termination of the distribution agreement, all
outstanding invoices for the products will become due and payable within thirty
(30) days' of the termination.





In the
Americas, we have a reseller agreement with Fiserv Solutions, Inc. Our agreement
with Fiserv has an initial term of ten years ending on August 28, 2019, and
shall be renewed automatically for additional five year terms unless either
party provides the other party with ninety (90) days’ written notice prior to
the end of the initial term or any subsequent term of the agreement. The
agreement can also be terminated for, among other things, material breach or
insolvency of either party. Upon termination, AltiGen would continue to have
support obligations for products that Fiserv distributed subject to Fiserv's
obligation to remain current on maintenance fees.





11





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
                    December 31,2009
                
                
                2008Synnex
                
                
                34
                %
                
                
                31
                %Altisys
      (1)
                
                
                11
                %
                
                
                4
                %Fiserv
      (2)
                
                
                9
                %
                
                
                7
                %Jenne
      (3)
                
                
                1
                %
                
                
                21
                %Total
                
                
                55
                %
                
                
                63
                %





(1)
            In
      the quarter ended December 31, 2008, revenue generated from Altisys was
      less than 10% of our total revenue.


(2)
            In
      the quarter ended December 31, 2009 and 2008, revenue generated from
      Fiserv was less than 10% of our total
revenue.


(3)
            In
      September 2009, we terminated our distribution agreement with Jenne. The
      Termination of our relationship with Jenne did not have a material impact
      on our business. Additionally, for the three months ended December 31,
      2009, revenue generated from Jenne was less than 10% of our total
      revenue.





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 Company's warranty liability for the three months ended December 31, 2009
and 2008, respectively, are as follows (in thousands):





Three Months Ended
                    December 31,2009
                
                
                2008(In thousands)Accrued
      warranty, beginning of period
                
                $
                122
                
                
                $
                137Provision
      for warranty liability
                
                
                43
                
                
                
                33Warranty
      cost including labor, components and scrap
                
                
                (54
                )
                
                
                (42
                )Accrued
      warranty, end of period
                
                $
                111
                
                
                $
                128





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 approximately $1.4 million for a period of five years commencing on
June 12, 2009. Additionally, under the terms of the lease agreement, the Company
received up to $100,000 cash incentive as moving allowance. As of December 31,
2009, the Company recorded $100,000 of this allowance as part of deferred rent
liability to be amortized over the term of the lease. 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 our
consolidated balance sheet as of December 31, 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.





Rent
expense for all operating leases totaled approximately $188,262 and $175,304 for
the three months ended December 31, 2009 and 2008, respectively. We also lease
certain equipment under capital lease arrangements, which are reflected as
property and equipment in our balance sheets as of December 31, 2009 and
September 30, 2009. The minimum future lease payments under all non-cancellable
capital and operating leases as of December 31, 2009 are shown in the following
table (in thousands):





Capital
                    Leases
                
                
                Operating
                    LeasesFiscal Years Ending September 30,2010
                
                $
                22
                
                
                $
                4422011
                
                
                —
                
                
                
                3022012
                
                
                —
                
                
                
                3022013
                
                
                —
                
                
                
                3182014
                
                
                —
                
                
                
                248Total
      contractual lease obligation
                
                $
                22
                
                
                $
                1,612Amount
      representing interest
                
                $
                1Present
      value of minimum lease payment
                
                $
                21





13





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 were
made from time to time at our management’s discretion through November 14, 2009.
When exercising such discretion, management considered a variety of factors such
as our stock price, general business and market conditions and other investment
opportunities. The repurchases were made in the open market and funded from
available working capital. Pursuant to the 2007 authority, we repurchased
231,135 shares during the twelve months ended September 30, 2008 at an aggregate
cost of $367,000. Pursuant to the 2008 authority, we repurchased 23,800 shares
during the twelve months ended September 30, 2009 at an aggregate cost of
$19,000. In April 2009, we suspended further purchases of stock under this
program.





5.
SUBSEQUENT EVENTS





The
Company has performed an evaluation of subsequent events through February 10,
2010, the date on which this Quarterly Report on Form 10-Q was filed with the
SEC. No material subsequent events have occurred since December 31, 2009 that
required recognition or disclosure in these unaudited condensed consolidated
financial statements.





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, 2009, 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 leading provider of 100%
Microsoft-based Voice over Internet Protocol (VoIP) business phone systems
and Unified Communications solutions. 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 medium and enterprise 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 $4.2 million and $4.9 million for the three months
ended December 31, 2009 and 2008, respectively. As of December 31, 2009, we had
an accumulated deficit of $61.2 million.  Net cash provided by operating
activities was $135,000 for the three months ended December 31,
2009.





We derive
our revenue from sales of our VoIP communications systems and call center
solutions. 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 in fiscal year 2009 and the three month period ended December
31, 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, 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. Revenue
consists of direct 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 exists, and the sales price is fixed and
determinable. We provide for estimated sales returns and allowances and warrant
costs related to such sales at the time of shipment. 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 these 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. We
do not recognize revenue derived from sales to customers in China until both of
the following elements are satisfied: customer has taken ownership upon shipment
and AltiGen has received payment for the purchase. Our short-term deferred
revenue was $2.3 million as of December 31, 2009 compared to $2.6 million
for the same period in fiscal 2009. Our long-term deferred revenue was $164,000
as of December 31, 2009 compared to $385,000 for the same period in fiscal 2009.
The decrease in short-term deferred revenue was primarily attributable to
deferred channel revenue, which decreased due to the volume of products sold as
apposed to products shipped to distribution. Additionally, in September 2009, we
terminated our distribution agreement with Jenne Distribution Inc., which
resulted in lower deferred channel revenue in the first quarter of fiscal year
2010. 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.





Service Support Programs.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 December 31, 2009, our service support deferred revenue was
approximately $2.3 million compared to $2.1 million for the same period in
fiscal 2009, an increase of 9% 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. 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. We also hold a total
of $2.5 million in cash in China of which $2.2 million is held in a bank term
deposit account.





Short-Term Investments.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 was for the three months ended December 31, 2009 was
$1.1million compared to $1.9 for the three months ended December 31, 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. During the three months ended December 31, 2009, we disposed of
fully-reserved inventory with a carrying value of zero and an original cost at
$33,000. The disposal of such inventory had no material impact on our revenue,
gross margins and net loss for the three months ended December 31, 2009. For the
three months ended December 31, 2009, we recognized a provision of $3,000 for
excess and obsolete inventories compared to $28,000 during the same period in
the prior year. Inventory allowance was $661,000 and $703,000 as of December 31,
2009 and 2008, respectively.





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 $111,000 and $122,000 as of December 31, 2009
and September 30, 2009, respectively.





Stock-Based Compensation. The
Company has estimated the fair value of stock-based compensation for stock
options at the date of the grant using the Black-Scholes option-pricing model.
The Black-Scholes option-pricing model incorporates various assumptions
including expected volatility, expected life and interest rate. The Company uses
historical data to estimate option forfeitures. Expected volatility is based on
historical volatility and the risk-free interest rate is based on U.S. Treasury
yield in effect at the time of the grant for the expected life of the options.
The Company does not anticipate paying any dividends in the foreseeable future
and therefore used an expected dividend yield of zero in the option valuation
model.





17





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
                          December 31,2009
                        
                        
                        2008Consolidated
      Statements of Operations Data:Net
      revenue:Hardware
                        
                        
                        65.8
                        %
                        
                        
                        73.4
                        %Software
                        
                        
                        13.7
                        
                        
                        
                        13.7Service
      support
                        
                        
                        20.5
                        
                        
                        
                        12.9Total
      net revenue
                        
                        
                        100.0
                        
                        
                        
                        100.0Cost
      of revenue:Hardware
                        
                        
                        33.4
                        
                        
                        
                        39.0Software
                        
                        
                        0.1
                        
                        
                        
                        0.1Service
      support (1)
                        
                        
                        —
                        
                        
                        
                        —Total
      cost of revenue
                        
                        
                        33.5
                        
                        
                        
                        39.1Gross
      profit
                        
                        
                        66.5
                        
                        
                        
                        60.9Operating
      expenses:Research
      and development
                        
                        
                        27.2
                        
                        
                        
                        25.2Sales
      and marketing
                        
                        
                        32.7
                        
                        
                        
                        42.9General
      and administrative
                        
                        
                        18.4
                        
                        
                        
                        20.0Total
      operating expenses
                        
                        
                        78.3
                        
                        
                        
                        88.1Loss
      from operations
                        
                        
                        (11.8
                        )
                        
                        
                        (27.2
                        )Equity
      in net loss of investee
                        
                        
                        —
                        
                        
                        
                        (0.1
                        )Interest
      and other income, net
                        
                        
                        0.5
                        
                        
                        
                        0.8Net
      loss before income taxes
                        
                        
                        (11.3
                        )
                        
                        
                        (26.5
                        )Income
      taxes
                        
                        
                        —
                        
                        
                        
                        0.3Net
      loss
                        
                        
                        (11.3
                        )%
                        
                        
                        (26.2
                        )%





(1)
Service support cost represents less than 1% of our total cost of
revenue.





Net
Revenue





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





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





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




Three Months Ended
                    December 31,2009
                
                
                2008Americas
                
                
                83
                %
                
                
                86
                %International
                
                
                17
                %
                
                
                14
                %Total
                
                
                100
                %
                
                
                100
                %





18





Net
revenue by customers that individually accounted for more than 10% of our
revenue for the three months ended December 31, 2009 and 2008, respectively,
were as follows:





Three Months Ended
                    December 31,2009
                
                
                2008Synnex
                
                
                34
                %
                
                
                31
                %Altisys
      (1)
                
                
                11
                %
                
                
                4
                %Fiserv
      (2)
                
                
                9
                %
                
                
                7
                %Jenne
      (3)
                
                
                1
                %
                
                
                21
                %Total
                
                
                55
                %
                
                
                63
                %





(1)
            In
      the quarter ended December 31, 2008, revenue generated from Altisys was
      less than 10% of our total revenue.


(2)
            In
      the quarter ended December 31, 2009 and 2008, revenue generated from
      Fiserv was less than 10% of our total
revenue.


(3)
            In
      September 2009, we terminated our distribution agreement with Jenne. The
      Termination of our relationship with Jenne did not have a material impact
      on our business. Additionally, for the three months ended December 31,
      2009, revenue generated from Jenne was less than 10% of our total
      revenue.





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





Three Months Ended
                    December 31,2009
                
                
                2008Hardware
                
                
                66
                %
                
                
                74
                %Software
                
                
                14
                %
                
                
                14
                %Service
      Support Plans
                
                
                20
                %
                
                
                12
                %Total
                
                
                100
                %
                
                
                100
                %





Net
revenue for the three months ended December 31, 2009 was $4.2 million as
compared to $4.9 million for the three months ended December 31, 2008. Revenue
generated in the Americas segment accounted for $3.5 million, or 83% of our
total net revenue, as compared to $4.2 million, or 86% of our total net revenue,
for the three months ended December 31, 2009 and 2008, respectively. Revenue
generated in the International segment accounted for $704,000, or 17% of our
total net revenue, as compared to $687,000, or 14% of our total net revenue, for
the three months ended December 31, 2009 and 2008, respectively. In the Americas
segment, during the three months ended December 31, 2009, we generated $855,000
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 24%. This 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 35% lower than the corresponding period in the
previous year. However, the average revenue per system was higher by
approximately 16% because sales of our smaller systems, with lower profit
margins, decreased while sales of our larger systems, with higher profit
margins, increased. Sales in all markets continued to be affected by the global
economic recession. To combat the sales decline we are experiencing, we will
continue to focus our sales efforts on larger enterprise customers. To the
extent we are successful in penetrating larger enterprise customer, we believe
that that sales of our product will increase and this will allow us to take
market share from our competitors.





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 $1.4 million for the three months ended December 31, 2009
as compared to $1.9 million for the same period of the previous fiscal year.
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 goods
sold for the three months ending December 31, 2009 decreased to 33% of net
revenue, compared to 39% of net revenue for the three months ending December 31,
2008. This change was primarily attributable to an increase of our non-system
related revenue.





19




Research
and Development Expenses




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 the three months ended December 31,
2009, research and development expenses were $1.1 million, or 27% of net
revenue, as compared to $1.2 million, or 25% of net revenue for the first
quarter of fiscal 2009. This decrease in absolute dollars was driven by a
decrease of $51,000 in consulting related services.





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.





Sales
and Marketing Expenses





Sales and
marketing expenses consist primarily of salaries, commissions and related
expenses for personnel engaged in marketing, sales and customer support
functions, as well as trade shows, advertising, and promotional expenses. Sales
and marketing expenses for the three months ended December 31, 2009 decreased
34% when compared to the same period of the previous fiscal year. For the three
months ended December 31, 2009, sales and marketing expenses were $1.4 million,
or 32% of net revenue, as compared to $2.1 million, or 42% of net revenue for
the same period in fiscal 2009. This expense decrease in absolute dollars
was driven by a decrease of $331,000 in personnel-related expenses, a decrease
of $115,000 in advertising and promotional expenses, a decrease of $93,000 in
travel related expenses, a decrease of $126,000 in service related expenses and
a decrease of $32,000 in non-cash stock-based compensation expenses. A number of
these reductions stem from our cost cutting initiatives implemented in April
2009.





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 Expenses





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. General and
administrative expenses decreased in the three months ended December 31, 2009,
compared to three month period ended December 31, 2008. General and
administrative expenses were $775,000, or 18% of net revenue for the three month
period ended December 31, 2009, compared to $971,000, or 20% of net revenue for
the three month period ended December 31, 2008. The decrease in absolute dollars
in general and administrative was primarily attributable to a decrease of
$17,000 in legal expenses associated with corporate governance matters, a
decrease of $93,000 in personnel-related expenses and a decrease of $82,000 in
non-cash stock-based compensation expenses.





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.




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 and
record our minority interest of their results in our results of operations. For
the three months end December 31, 2009 and 2008, product sales revenue from this
company was approximately $2,000 and $0, respectively. Our accounts receivable
from this company was $19,000 and $18,000 as of December 31, 2009 and 2008,
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 $22,000
for the three months ended December 31, 2009 from $37,000 for the same period in
fiscal year 2009. The decrease in interest and other income, net in fiscal year
2010, as compared to fiscal year 2009 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 year 2010. 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.





20




Liquidity
and Capital Resources





Since
inception, we have financed our operations primarily through the sale of equity
securities. As of December 31, 2009, we held cash and cash equivalents totaling
$7.6 million. Total cash and cash equivalents represents approximately 76% of
total current assets for the three month period ended December 31,
2009.





The
following table shows the major components of our consolidated statements of
cash flows for the fiscal periods indicated below:





Three Months Ended
                    December 31,2009
                
                
                2008(In
      thousands)Cash
      and equivalents, beginning of period
                
                $
                7,397
                
                
                $
                9,467Cash
      (used in) provided by operating activities
                
                
                135
                
                
                
                (217
                )Cash
      (used in) provided by investing activities
                
                
                53
                
                
                
                (4,661
                )Cash
      provided by financing activities
                
                
                50
                
                
                
                55Effect
      of exchange rate changes on cash and cash equivalents
                
                
                (6
                )
                
                
                —Cash
      and equivalents, end of period
                
                $
                7,629
                
                
                $
                4,644





During
the three months ended December 31, 2009, our net cash provided by operating
activities was $135,000, as compared to net cash used in operating activities of
$217,000 during the same period in fiscal year 2009. This was primarily
attributable to our net loss of $470,000, a decrease of $462,000 in accounts
receivable, a decrease of $178,000 in net inventories, a decrease of $168,000 in
accrued liabilities and a decrease of $194,000 in deferred revenue and long-term
liabilities. The cash impact of the loss for the three months ended December 31,
2009 was partially offset by a non-cash expense of $318,000 in stock-based
compensation expense and $50,000 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 change in deferred revenue was primarily driven by a
decrease of $279,000 in deferred channel revenue; due to the volume of products
sold as opposed to what was shipped to distribution. Additionally, in September
2009, we terminated our distribution agreement with Jenne Distribution Inc.,
which resulted in lower deferred channel revenue in the first quarter of fiscal
year 2010. The decrease in deferred channel revenue was offset by an increase of
$36,000 in short-term deferred revenue derived from our service support plans.
The increase in short-term deferred revenue was primarily the result of
continued growth of our 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.





Net
accounts receivable decreased 30% from $1.5 million at September 30, 2009 to
$1.1 million at December 31, 2009. Quarterly accounts receivable days sales
outstanding (DSO) decreased from 29 days as of September 30, 2009 to 23 days as
of December 31, 2009. Net accounts receivable and DSO decrease was primarily due
to lower shipments and good collections during the three month period ended
December 31, 2009.





Net
inventories decrease 14% from $1.2 million at September 30, 2009 to
$1.1 million at December 31, 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 5.5 turns as of September 30,
2009 to 5.2 turns as of December 31, 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 first quarter of fiscal year 2010 with a cash conversion cycle of 15 days,
as compared to 55 days for the first quarter of fiscal 2009. 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 first quarter
of fiscal year 2010.





For the
three months ended December 31, 2009, net cash provided by investing activities
was $53,000, as compared to net cash used in provided by investing activities of
$4.6 million during the same period in fiscal 2009. For the three months ended
December 31, 2009, the Company spent approximately $13,000 on purchases of
property and equipment compared to $68,000 for the three month period ended
December 31, 2008.  Additionally, for the three month period ended December
31, 2009, we reclassified our Shanghai facilities-related deposit of $66,000
from long-term deposit to short-term deposit.


21





Net cash
provided by financing activities for the three months ended December 31, 2009
was approximately $50,000, as compared to $55,000 during the same period in
fiscal year 2009. For the fist quarter of fiscal year 2010, proceeds from
issuance of common stock under employee stock plans represented approximately
$50,000 as compared to $63,000 for the same period in fiscal year 2009.
Additionally, during the first quarter of fiscal year 2009, repurchase of our
treasury stock was approximately $8,000.





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 were be
made from time to time at our management’s discretion through November 14, 2009.
When exercising such discretion, management considered a variety of factors such
as our stock price, general business and market conditions and other investment
opportunities. The repurchases were made in the open market and funded from
available working capital. Pursuant to the 2007 authority, we repurchased
231,135 shares during the twelve months ended September 30, 2008 at an aggregate
cost of $367,000. Pursuant to the 2008 authority, we repurchased 23,800 shares
during the twelve months ended September 30, 2009 at an aggregate cost of
$19,000. In April 2009, we suspended further purchases of stock under this
program.





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 December 31,
2009. We had total outstanding commitments on noncancelable capital and
operating leases of $1.6 million as of December 31, 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.




Contractual
Obligations




The
following table presents certain payments due by us under contractual
obligations with minimum firm commitments as of December 31, 2009:




Payments 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 Years(In
      thousands)Operating
      leases obligation
                
                $
                1,612
                
                
                $
                442
                
                
                $
                922
                
                
                $
                248
                
                
                $
                —Capital
      leases obligation
                
                
                22
                
                
                
                22
                
                
                
                —
                
                
                
                —
                
                
                
                —Total
      contractual lease obligation
                
                $
                1,634
                
                
                $
                464
                
                
                $
                922
                
                
                $
                248
                
                
                $
                —


22


Effects
of Recently Issued Accounting Pronouncements





In
September 2009, FASB issued ASU 2009-13, Revenue Recognition (Topic 605):
Multiple-Deliverable Revenue Arrangements. As summarized in ASU
2009-13, ASC Topic 605 has been amended (1) to provide updated guidance on
whether multiple deliverables exist, how the deliverables in an arrangement
should be separated, and the consideration allocated; (2) to require an
entity to allocate revenue in an arrangement using estimated selling prices of
deliverables if a vendor does not have vendor-specific objective evidence
(“VSOE”) or third-party evidence of selling price; and (3) to eliminate the
use of the residual method and require an entity to allocate revenue using the
relative selling price method. The accounting changes summarized in ASU 2009-14
and ASU 2009-13 are both effective for fiscal years beginning on or after
June 15, 2010, with early adoption permitted. Adoption may either be on a
prospective basis or by retrospective application. The Company is currently
assessing the impact of this guidance to its consolidated financial
statements.





In
October 2009, FASB issued ASU 2009-14, Software (Topic 985)—Certain Revenue
Arrangements That Include Software Elements.This standard changes the
accounting model for revenue arrangements that include both tangible products
and software elements. Under this guidance, tangible products containing
software components and non-software components that function together to
deliver the tangible product's essential functionality are excluded from the
software revenue guidance in Subtopic 985-605, Software-Revenue Recognition. In
addition, hardware components of a tangible product containing software
components are always excluded from the software revenue guidance. FASB
Accounting Standards Updates 2009-14 is effective prospectively for revenue
arrangements entered into or materially modified in fiscal years beginning on or
after June 15, 2010. Early adoption is permitted. The Company is currently
assessing the impact of this guidance to its consolidated financial
statements.




In
October 2008, the Company adopted FASB ASC 820-10, Fair Value Measurements and
Disclosures – Overall (“ASC 820-10”) with respect to its financial assets
and liabilities. In February 2008, the FASB issued updated guidance related to
fair value measurements, which is included in the Codification in ASC 820-10-55,
Fair Value Measurements and
Disclosures – Overall – Implementation Guidance and Illustrations. The
updated guidance provided a one year deferral of the effective date of ASC
820-10 for non-financial assets and non-financial liabilities, except those that
are recognized or disclosed in the financial statements at fair value at least
annually. The adoption did not have a material impact on the Company’s Condensed
Consolidated Financial Statements as it relates only to disclosures. The
required disclosures are included in Note 1 of Notes to Condensed Consolidated
Financial Statements.




In
October 2009, the Company adopted the fair value disclosure provision that
requires the reporting of interim disclosures about the fair value of financial
instruments previously only disclosed on an annual basis. The adoption did not
have any impact on the Company’s Condensed Consolidated Financial Statements as
it relates only to disclosures. The required disclosures are included in Note 1
of Notes to Condensed Consolidated Financial Statements.


23


Item
3. Quantitative and Qualitative Disclosures About Market Risk




Market
Interest Rate Risk





At
December 31, 2009, our investment portfolio consisted primarily of cash and cash
equivalents of $7.6 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 December 31, 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
4. 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 December 31, 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 December 31, 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 December 31, 2009 that have materially
affected, or are reasonably likely to materially affect, our internal controls
over financial reporting.


24


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.




Risks Related to Ownership of our Common
Stock





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. On September 15, 2009, we received notification from the NASDAQ Capital
Market that the bid price of our common stock has been below $1.00 per share for
30 consecutive trading days. We have been granted 180 days, or until March 14,
2010, to regain compliance with the minimum bid requirement by maintaining a
closing bid price of $1.00 per share or higher for a minimum of 10 consecutive
trading days.  If we fail to meet the minimum bid price requirement of
$1.00 for 10 consecutive trading dates, our common stock may be delisted from
the NASDAQ Capital Market. Alternatively,
we may in the future determine that it is in the best interest of our
stockholders to voluntarily delist in advance of being delisted by
NASDAQ.





If our
common stock is delisted from the NASDAQ Capital Market for either of the
foregoing reasons, 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.





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;


·
            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.


25


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.





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.


26




Risks
Related to Our Business




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 December 31,
2009, we had an accumulated deficit of $61.2 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


·
            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.


27




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 and Mitel Networks Corporation.  We also compete
against providers of multi-function telecommunications systems, including
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 the majority of 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.




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.


28




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.




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 two key distributors, Altisys Communications, Inc., and Synnex
Corporation accounted for 45% of our net revenue in the quarter ended December
31, 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 September 2009,
we terminated our distribution agreement with Jenne Distributors, Inc. We
believe the termination of our relationship with Jenne Distributors, Inc. 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.





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 the Sarbanes-Oxley Act of 2002, new SEC regulations and
NASDAQ National Market rules, are creating uncertainty for companies such as
ours.  These new or changed laws, regulations and standards are subject to
varying interpretations in many cases due to their lack of specificity, and as a
result, their application in practice may evolve over time as new guidance is
provided by regulatory and governing bodies, which could result in continuing
uncertainty regarding compliance matters and higher costs necessitated by
ongoing revisions to disclosure and governance practices.  As a result, our
efforts to comply with evolving laws, regulations and standards have resulted
in, and are likely to continue to result in, increased general and
administrative expenses and a diversion of management time and attention from
revenue-generating activities to compliance activities.  In particular, our
efforts to comply with Section 404 of the Sarbanes-Oxley Act of 2002 and
the related regulations regarding our required assessment of our internal
controls over financial reporting and beginning with the year ended
September 30, 2010, our external auditor's audit of the effectiveness of
our internal controls over financial reporting has required the commitment of
significant financial and managerial resources.  We expect these efforts to
require the continued commitment of significant resources.  Further, our
board members, chief executive officer, and chief financial officer could face
an increased risk of personal liability in connection with the performance of
their duties.  As a result, we may have difficulty attracting and retaining
qualified board members and executive officers, which could harm our
business.  If our efforts to comply with new or changed laws, regulations
and standards differ from the activities intended by regulatory or governing
bodies due to ambiguities related to practice, our reputation may be
harmed.




29




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 in the future could delay
delivery of products, decrease quality or increase costs.





We may
begin to 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.





For the
first quarter of fiscal year 2010, approximately 17% 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:





·
            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 cash
      or 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.


30




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





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




Risks
Related to the Industry




Integrated,
multifunction telecommunications systems may not achieve widespread
acceptance.





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




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.


31




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.


32


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 were
made from time to time at our management’s discretion through November 14, 2009.
When exercising such discretion, management considered a variety of factors such
as our stock price, general business and market conditions and other investment
opportunities. The repurchases were made in the open market and funded from
available working capital. Pursuant to the 2007 authority, we repurchased
231,135 shares during the twelve months ended September 30, 2008 at an aggregate
cost of $367,000. Pursuant to the 2008 authority, we repurchased 23,800 shares
during the twelve months ended September 30, 2009 at an aggregate cost of
$19,000. In April 2009, we suspended further purchases of stock under this
program.





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 December 31, 2009
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —Total
                
                
                254,935
                
                
                $
                1.51
                
                
                
                254,935
                
                
                $
                1,614,461


33





Item
6. Exhibits.





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


34





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:
      February 10, 2010
              By:
              /s/ Philip M. McDermottPhilip
      M. McDermottChief
      Financial Officer


35





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.4.2(1)
              
              Specimen
      common stock certificates.4.3(1)
              
              Third
      Amended and Restated Rights Agreement dated May 7, 1999 by and among
      AltiGen Communications, Inc. and the Investors and Founder named
      therein.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 Registration Statement
      on Form 8-K on April 23,
2009.


36