UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549








FORM
10-Q





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


FOR
THE QUARTERLY PERIOD ENDED MARCH  31, 2009


OR


 ̈
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)4555
      Cushing Parkway
                Fremont,
      CA
              
              94538(Address
      of principal executive offices)
              
              (Zip
      Code)





Registrant’s
telephone number, including area code: (510) 252-9712








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.   YESxNO ̈





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





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 ̈Accelerated filer ̈Non-accelerated filer ̈(Do not check if a smaller
reporting company)   Smaller reporting companyx





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





The
number of shares of our common stock outstanding as of May 12, 2009 was:
15,866,680 shares.









ALTIGEN
COMMUNICATIONS, INC.


QUARTERLY
REPORT ON FORM 10-Q


FOR
THE QUARTERLY PERIOD ENDED MARCH 31, 2009


TABLE OF CONTENTS




PART
      I.  FINANCIAL INFORMATIONItem
      1.
                Condensed
      Consolidated Financial Statements (Unaudited)Condensed
      Consolidated Balance Sheets as of March 31, 2009 and September 30,
      2008
                3Condensed
      Consolidated Statements of Operations for the Six Months Ended March 31,
      2009 and 2008
                4Condensed
      Consolidated Statements of Cash Flows for the Six Months Ended March 31,
      2009 and 2008
                5Notes
      to Condensed Consolidated Financial Statements
                6Item
      2.
                Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                14Item
      3.
                Quantitative
      and Qualitative Disclosures about Market Risk
                23Item
      4T.
                Controls
      and Procedures
                23PART
      II.  OTHER INFORMATIONItem
      1.
                Legal
      Proceedings
                24Item 1A
                Risk
      Factors
                24Item
      2.
                Unregistered
      Sale of Equity Securities and Use of Proceeds
                32Item
      6.
                Exhibits
                33SIGNATURE
                34EXHIBIT
      INDEX
                35
  2


PART
I.  FINANCIAL INFORMATION





Item
1.Condensed Consolidated Financial Statements




ALTIGEN
COMMUNICATIONS, INC. AND SUBSIDIARY


CONDENSED
CONSOLIDATED BALANCE SHEETS


(UNAUDITED)


(In
thousands, except per share data)





March 31,
                                                                                        
                                                                                        
                                                                                        September 30,2009
                                                                                        
                                                                                        
                                                                                        2008ASSETSCurrent
      assets:Cash
      and cash equivalents
                                                                                        
                                                                                        $
                                                                                        5,955
                                                                                        
                                                                                        
                                                                                        $
                                                                                        9,467Short-term
      investments
                                                                                        
                                                                                        
                                                                                        2,500
                                                                                        
                                                                                        
                                                                                        
                                                                                        400Accounts
      receivable, net of allowances of $38 and $19 at March 31, 2009 and
      September 30, 2008, respectively.
                                                                                        
                                                                                        
                                                                                        1,098
                                                                                        
                                                                                        
                                                                                        
                                                                                        2,423Inventories,
      net
                                                                                        
                                                                                        
                                                                                        1,971
                                                                                        
                                                                                        
                                                                                        
                                                                                        1,594Prepaid
      expenses and other current assets
                                                                                        
                                                                                        
                                                                                        282
                                                                                        
                                                                                        
                                                                                        
                                                                                        176Total
      current assets
                                                                                        
                                                                                        
                                                                                        11,806
                                                                                        
                                                                                        
                                                                                        
                                                                                        14,060Property
      and equipment:Furniture
      and equipment
                                                                                        
                                                                                        
                                                                                        2,149
                                                                                        
                                                                                        
                                                                                        
                                                                                        2,009Computer
      software
                                                                                        
                                                                                        
                                                                                        948
                                                                                        
                                                                                        
                                                                                        
                                                                                        9483,097
                                                                                        
                                                                                        
                                                                                        
                                                                                        2,957Less:
      Accumulated depreciation
                                                                                        
                                                                                        
                                                                                        (2,645
                                                                                        )
                                                                                        
                                                                                        
                                                                                        (2,534
                                                                                        )Net
      property and equipment
                                                                                        
                                                                                        
                                                                                        452
                                                                                        
                                                                                        
                                                                                        
                                                                                        423Other
      non-current assets:Long-term
      investments
                                                                                        
                                                                                        
                                                                                        205
                                                                                        
                                                                                        
                                                                                        
                                                                                        211Long-term
      deposit
                                                                                        
                                                                                        
                                                                                        82
                                                                                        
                                                                                        
                                                                                        
                                                                                        82Total
      other non-current assets
                                                                                        
                                                                                        
                                                                                        287
                                                                                        
                                                                                        
                                                                                        
                                                                                        293Total
      assets
                                                                                        
                                                                                        $
                                                                                        12,545
                                                                                        
                                                                                        
                                                                                        $
                                                                                        14,776LIABILITIES
      AND STOCKHOLDERS' EQUITYCurrent
      liabilities:Accounts
      payable
                                                                                        
                                                                                        $
                                                                                        1,344
                                                                                        
                                                                                        
                                                                                        $
                                                                                        1,234Accrued
      liabilities:Payroll
      and related benefits
                                                                                        
                                                                                        
                                                                                        411
                                                                                        
                                                                                        
                                                                                        
                                                                                        550Warranty
                                                                                        
                                                                                        
                                                                                        109
                                                                                        
                                                                                        
                                                                                        
                                                                                        137Marketing
                                                                                        
                                                                                        
                                                                                        120
                                                                                        
                                                                                        
                                                                                        
                                                                                        136Accrued
      expense
                                                                                        
                                                                                        
                                                                                        404
                                                                                        
                                                                                        
                                                                                        
                                                                                        200Other
      current liabilities
                                                                                        
                                                                                        
                                                                                        474
                                                                                        
                                                                                        
                                                                                        
                                                                                        628Deferred
      revenue short-term
                                                                                        
                                                                                        
                                                                                        2,864
                                                                                        
                                                                                        
                                                                                        
                                                                                        2,489Total
      current liabilities
                                                                                        
                                                                                        
                                                                                        5,726
                                                                                        
                                                                                        
                                                                                        
                                                                                        5,374Other
      long-term liabilities.........
                                                                                        
                                                                                        
                                                                                        126
                                                                                        
                                                                                        
                                                                                        
                                                                                        105Stockholders'
      equity:Convertible
      preferred stock, $0.001 par value; Authorized—5,000,000 shares;
      Outstanding—none at March 31, 2009 and September 30, 2008
                                                                                        
                                                                                        
                                                                                        —
                                                                                        
                                                                                        
                                                                                        
                                                                                        —Common
      stock, $0.001 par value; Authorized—50,000,000 shares;
      Outstanding—15,861,680 shares at March 31, 2009 and 15,777,303 shares at
      September 30, 2008
                                                                                        
                                                                                        
                                                                                        17
                                                                                        
                                                                                        
                                                                                        
                                                                                        17Treasury
      stock at cost — 1,318,830 shares at March 31, 2009 and 1,295,030 shares at
      September 30, 2008
                                                                                        
                                                                                        
                                                                                        (1,400
                                                                                        )
                                                                                        
                                                                                        
                                                                                        (1,381
                                                                                        )Additional
      paid-in capital
                                                                                        
                                                                                        
                                                                                        67,162
                                                                                        
                                                                                        
                                                                                        
                                                                                        66,689Accumulated
      other comprehensive income
                                                                                        
                                                                                        
                                                                                        194
                                                                                        
                                                                                        
                                                                                        
                                                                                        3Accumulated
      deficit
                                                                                        
                                                                                        
                                                                                        (59,280
                                                                                        )
                                                                                        
                                                                                        
                                                                                        (56,031
                                                                                        )Total
      stockholders' equity
                                                                                        
                                                                                        
                                                                                        6,693
                                                                                        
                                                                                        
                                                                                        
                                                                                        9,297Total
      liabilities and stockholders' equity
                                                                                        
                                                                                        $
                                                                                        12,545
                                                                                        
                                                                                        
                                                                                        $
                                                                                        14,776





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


3




ALTIGEN
COMMUNICATIONS, INC. AND SUBSIDIARY


CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS


(UNAUDITED)


(In thousands, except per share
data)


Three Months Ended
                    March 31,
                  
                  
                  Six Months Ended
                    March 31,2009
                  
                  
                  2008
                  
                  
                  2009
                  
                  
                  2008Net
      revenue:Hardware
                  
                  $
                  3,103
                  
                  
                  $
                  4,130
                  
                  
                  $
                  7,298
                  
                  
                  $
                  7,758Software
                  
                  
                  474
                  
                  
                  
                  582
                  
                  
                  
                  1,139
                  
                  
                  
                  1,214Total
      net revenue
                  
                  
                  3,577
                  
                  
                  
                  4,712
                  
                  
                  
                  8,437
                  
                  
                  
                  8,972Cost
      of revenue:Hardware
                  
                  
                  1,466
                  
                  
                  
                  2,017
                  
                  
                  
                  3,360
                  
                  
                  
                  3,808Software
                  
                  
                  4
                  
                  
                  
                  76
                  
                  
                  
                  8
                  
                  
                  
                  139Total
      cost of revenue
                  
                  
                  1,470
                  
                  
                  
                  2,093
                  
                  
                  
                  3,368
                  
                  
                  
                  3,947Gross
      profit
                  
                  
                  2,107
                  
                  
                  
                  2,619
                  
                  
                  
                  5,069
                  
                  
                  
                  5,025Operating
      expenses:Research
      and development
                  
                  
                  1,243
                  
                  
                  
                  1,035
                  
                  
                  
                  2,468
                  
                  
                  
                  1,950Sales
      and marketing
                  
                  
                  1,840
                  
                  
                  
                  1,841
                  
                  
                  
                  3,924
                  
                  
                  
                  3,604General
      and administrative
                  
                  
                  811
                  
                  
                  
                  946
                  
                  
                  
                  1,782
                  
                  
                  
                  1,760Total
      operating expenses
                  
                  
                  3,894
                  
                  
                  
                  3,822
                  
                  
                  
                  8,174
                  
                  
                  
                  7,314Loss
      from operations
                  
                  
                  (1,787
                  )
                  
                  
                  (1,203
                  )
                  
                  
                  (3,105
                  )
                  
                  
                  (2,289
                  )Equity
      in net loss of investee
                  
                  
                  (3
                  )
                  
                  
                  (6
                  )
                  
                  
                  (6
                  )
                  
                  
                  (3
                  )Interest
      and other income, net
                  
                  
                  23
                  
                  
                  
                  82
                  
                  
                  
                  59
                  
                  
                  
                  194Net
      loss before income taxes
                  
                  
                  (1,767
                  )
                  
                  
                  (1,127
                  )
                  
                  
                  (3,052
                  )
                  
                  
                  (2,098
                  )Income
      tax provision
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  16
                  
                  
                  
                  —Net
      loss
                  
                  $
                  (1,767
                  )
                  
                  $
                  (1,127
                  )
                  
                  $
                  (3,036
                  )
                  
                  $
                  (2,098
                  )Basic
      and diluted net loss per share
                  
                  $
                  (0.11
                  )
                  
                  $
                  (0.07
                  )
                  
                  $
                  (0.19
                  )
                  
                  $
                  (0.13
                  )Weighted
      average shares used in computing basic net loss per share
                  
                  
                  15,862
                  
                  
                  
                  15,708
                  
                  
                  
                  15,842
                  
                  
                  
                  15,753Weighted
      average shares used in computing diluted net loss per
share
                  
                  
                  15,862
                  
                  
                  
                  15,708
                  
                  
                  
                  15,842
                  
                  
                  
                  15,753





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




4




ALTIGEN
COMMUNICATIONS, INC. AND SUBSIDIARY


CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS


(UNAUDITED)


(In
thousands)




Six Months Ended
                      March 31,2009
                    
                    
                    2008CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      loss
                    
                    $
                    (3,036
                    )
                    
                    $
                    (2,098
                    )Adjustments
      to reconcile net loss to net cash used in operating
      activities:Depreciation
                    
                    
                    110
                    
                    
                    
                    124Stock-based
      compensation
                    
                    
                    410
                    
                    
                    
                    480Equity
      in net income (loss) of investee
                    
                    
                    6
                    
                    
                    
                    3Changes
      in operating assets and liabilities:Accounts
      receivable
                    
                    
                    1,325
                    
                    
                    
                    (71
                    )Inventories,
      net
                    
                    
                    (377
                    )
                    
                    
                    (439
                    )Prepaid
      expenses and other current assets
                    
                    
                    (106
                    )
                    
                    
                    (130
                    )Accounts
      payable
                    
                    
                    110
                    
                    
                    
                    490Accrued
      liabilities
                    
                    
                    (133
                    )
                    
                    
                    132Deferred
      revenue short-term
                    
                    
                    375
                    
                    
                    
                    1,324Other
      long-term liabilities
                    
                    
                    21
                    
                    
                    
                    (36
                    )Net
      cash used in operating activities
                    
                    
                    (1,295
                    )
                    
                    
                    (221
                    )CASH
      FLOWS FROM INVESTING ACTIVITIES:Purchases
      of short-term investments
                    
                    
                    (5,460
                    )
                    
                    
                    (22,718
                    )Proceeds
      from sale of short-term investments
                    
                    
                    3,338
                    
                    
                    
                    26,106Changes
      in long-term deposits
                    
                    
                    —
                    
                    
                    
                    87Purchases
      of property and equipment
                    
                    
                    (139
                    )
                    
                    
                    (101
                    )Net
      cash provided by (used in) investing activities
                    
                    
                    (2,261
                    )
                    
                    
                    3,374CASH
      FLOWS FROM FINANCING ACTIVITIES:Proceeds
      from issuances of common stock, net of issuance costs
                    
                    
                    63
                    
                    
                    
                    156Repurchase
      of treasury stock
                    
                    
                    (19
                    )
                    
                    
                    (346
                    )Net
      cash provided by (used in) financing activities
                    
                    
                    44
                    
                    
                    
                    (190
                    )NET
      CHANGE IN CASH AND CASH EQUIVALENTS DURING PERIOD
                    
                    
                    (3,512
                    )
                    
                    
                    2,963CASH
      AND CASH EQUIVALENTS, BEGINNING OF PERIOD
                    
                    
                    9,467
                    
                    
                    
                    6,111CASH
      AND CASH EQUIVALENTS, END OF PERIOD
                    
                    $
                    5,955
                    
                    
                    $
                    9,074





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 pioneer and market leader in
Internet protocol telephony systems for small-to medium-sized businesses. We
design, manufacture and market next generation, Internet protocol phone systems
and contact centers that use both the Internet and the public telephone network
to take advantage of the convergence of voice and data communications. Unlike
traditional proprietary phone systems, our systems are designed with open
architecture and are built on an industry standard platform.  This
adherence to industry standards allows our products to play an important role in
the small- to medium- sized business market by delivering phone systems that can
interface with other technologies and provide integrated voice and data
solutions.





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.





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





CASH
AND CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS





We
consider all highly liquid investments purchased with an initial maturity of
three months or less to be cash equivalents. Cash and cash equivalents are
invested in various investment grade institutional money market accounts, U.S.
Agency securities and commercial paper. Short-term investments are in highly
liquid financial instruments with original maturities greater than three months
but less than one year and are classified as “available-for-sale” investments.
Investments are reported at their fair value, with unrealized gains and losses
excluded from earnings and reported as a separate component of stockholders’
equity. The Company's investment policy requires investments to be rated
single-A or better.





INVENTORIES





Inventories
(which include costs associated with components assembled by third-party
assembly manufacturers, as well as internal labor and allocable overhead) are
stated at the lower of standard cost (which approximates actual cost on a
first-in, first-out basis) or market value. Provisions, when required, are made
to reduce excess and obsolete inventories to their estimated net realizable
values. We regularly monitor inventory quantities on hand and record a provision
for excess and obsolete inventories based primarily on our estimated forecast of
product demand and production requirements for the next six months. We record a
write-down for product and component inventories that have become obsolete or
are in excess of anticipated demand or net realizable value. Raw material
inventory is considered obsolete and is fully reserved if it has not moved in
365 days. During the six months ended March 31, 2009, we disposed of
fully-reserved inventory with a carrying value of zero and an original cost at
$176,000. We attribute this overall reduction in obsolete inventory to
physically disposing of a portion of the reserved inventory. The disposal of
such inventory had no material impact on our revenue, gross margins and net
loss. For the six months ended March 31, 2009, we recognized a provision of
$67,000 for excess and obsolete inventories. The components of inventories
include (in thousands):




March 31,
                  
                  
                  September 30,2009
                  
                  
                  2008Raw
      materials
                  
                  $
                  578
                  
                  
                  $
                  479Work-in-progress
                  
                  
                  62
                  
                  
                  
                  197Finished
      goods
                  
                  
                  1,331
                  
                  
                  
                  918Total
                  
                  $
                  1,971
                  
                  
                  $
                  1,594




6


REVENUE
RECOGNITION





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





SOFTWARE
ASSURANCE





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




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





STOCK–BASED
COMPENSATION





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


7


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





The fair
value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model and is not subject to revaluation as a result
of subsequent stock price fluctuations. The Company estimated the fair value of
stock option awards in accordance with the provisions of SFAS 123(R) by using
the Black-Scholes option valuation model with the following
assumptions:




Six
      Months Ended
                        March
      31,
                      
                      
                      Six
      Months Ended
                        March
      31,2009
                      
                      
                      2008Employee
      Stock Option Plan:Expected
      Life (in years)
                      
                      
                      7
                      
                      
                      
                      7Risk-free
      interest rate
                      
                      
                      1.6
                      %
                      
                      
                      3.0
                      %Volatility
                      
                      
                      141
                      %
                      
                      
                      88
                      %Expected
      dividend
                      
                      
                      0.0
                      %
                      
                      
                      0.0
                      %Employee
      Stock Purchase Plan:Expected
      Life (in years)
                      
                      
                      0.5
                      
                      
                      
                      0.5Risk-free
      interest rate
                      
                      
                      0.4
                      %
                      
                      
                      1.5
                      %Volatility
                      
                      
                      139
                      %
                      
                      
                      87
                      %Expected
      dividend
                      
                      
                      0.0
                      %
                      
                      
                      0.0
                      %





The
following table shows total stock-based compensation expense included in the
consolidated statements of operations for the three and six months ended March
31, 2009 and March 31, 2009 with respect to the plans mentioned above (in
thousands):





Three
      Months Ended
                    March
      31,
                
                
                Six
      Months Ended
                    March
      31,2009
                
                
                2008
                
                
                2009
                
                
                2008Cost
      of goods sold
                
                $
                2
                
                
                $
                6
                
                
                $
                7
                
                
                $
                9Research
      and development
                
                
                27
                
                
                
                57
                
                
                
                92
                
                
                
                93Selling,
      general and administrative
                
                
                95
                
                
                
                188
                
                
                
                311
                
                
                
                378Total
                
                $
                124
                
                
                $
                251
                
                
                $
                410
                
                
                $
                480




8


The
following table summarizes the Company’s stock option plan as of October 1, 2008
and changes during the six months ended March 31, 2009:





Number of Shares
                    
                    
                    Weighted-
                      Average
                      Exercise Price
                    
                    
                    Weighted
                      Average
                      Remaining
                      Contractual Life
                      (in years)Outstanding
      at October 1, 2008
                    
                    
                    4,551,822
                    
                    
                    $
                    3.14Granted
                    
                    
                    94,500
                    
                    
                    
                    0.68Exercised
                    
                    
                    —
                    
                    
                    
                    —Forfeitures
      and cancellations
                    
                    
                    (277,549
                    )
                    
                    
                    2.82Outstanding
      at March 31, 2009
                    
                    
                    4,368,773
                    
                    
                    $
                    3.11
                    
                    
                    
                    4.89Vested
      and expected to vest at March 31, 2009
                    
                    
                    4,026,071
                    
                    
                    $
                    3.26
                    
                    
                    
                    4.58Exercisable
      at March 31, 2009
                    
                    
                    3,430,090
                    
                    
                    $
                    3.59
                    
                    
                    
                    3.87





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.  We intend to
adopt a new stock plan and employee stock purchase plan in the third quarter of
fiscal 2009.





At March
31, 2009, the aggregate intrinsic value of outstanding stock options was
$56,000. The total vested and expected to vest stock options represented 4.0
million shares, the weighted average exercise price was $3.26, the aggregate
intrinsic value was $54,000, and the weighted average remaining contractual term
was 4.5 years. The total exercisable stock options represented approximately 3.4
million shares, the aggregate intrinsic value was $50,000, the weighted average
exercise price was $3.59, and the weighted average remaining contractual term
was 3.87 years.





At March
31, 2009, expected future compensation expense relating to options outstanding
at that date is $272,000, which will be amortized over a weighted-average period
of 4 years.





Under the
1999 Purchase Plan, we had reserved, as of March 10, 2009, 364,882 shares of
common stock for issuance to eligible employees at a price equal to 85% of the
lower of the fair market value of the common stock on the first day of the
offering period or a specified exercise date (last trading day in April or
October each year). From October 1, 2008 until the expiration of the 1999
Purchase Plan place on March 10, 2009, 108,177 shares were purchased by and
distributed to employees at a price of $0.59 per share.





COMPUTATION
OF BASIC AND DILUTED NET LOSS PER SHARE




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





Basic and
diluted loss per share for each of the three and six month periods ended March
31, 2009 and 2008 were as follows (in thousands, except per share
data):





Three Months Ended
                  March 31,
                
                
                Six Months Ended
                  March 31,2009
                
                
                2008
                
                
                2009
                
                
                2008Net
      loss
                
                $
                (1,767
                )
                
                $
                (1,127
                )
                
                $
                (3,036
                )
                
                $
                (2,098
                )Weighted
      average shares outstanding – basic loss per share
                
                
                15,862
                
                
                
                15,708
                
                
                
                15,842
                
                
                
                15,753Weighted
      average shares outstanding  – diluted loss per
    share
                
                
                15,862
                
                
                
                15,708
                
                
                
                15,842
                
                
                
                15,753Basic
      loss per share
                
                $
                (0.11
                )
                
                $
                (0.07
                )
                
                $
                (0.19
                )
                
                $
                (0.13
                )Diluted
      loss per share
                
                $
                (0.11
                )
                
                $
                (0.07
                )
                
                $
                (0.19
                )
                
                $
                (0.13
                )





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


9


Comprehensive
Loss





Comprehensive
income consists of two components—net income and other comprehensive income.
Other comprehensive income refers to revenue, expenses, gains, and losses that
under U.S. generally accepted accounting principles are recorded as an element
of stockholders' equity but are excluded from net income. The Company's other
comprehensive income consists of unrealized gains and losses on marketable
securities categorized as available-for-sale and foreign exchange gains and
losses.





FAIR
VALUE MEASUREMENTS





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





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





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





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





The
adoption of this statement with respect to our financial assets and liabilities,
did not impact our consolidated results of operations and financial condition,
but requires additional disclosure for assets and liabilities measured at fair
value.  In accordance with SFAS No. 157, the following table
represents our fair value hierarchy for our financial assets (cash equivalents
and investments) measured at fair value on a recurring basis as of March 31,
2009.  Level 1 available-for-sale investments are primarily comprised of
investments in U.S. Agency securities.  These securities are valued
using market prices on active markets.  The Company had no material Level 2
or Level 3 measurements for the quarter ended March 31, 2009.





Assets measured at fair value as of
March 31, 2009 are summarized as follows:




(In thousands)
            
            Quoted Prices in Active
              Markets for Identical
              Instruments
              (Level 1)Cash
      equivalents (1)Money
      market funds
            
            $
            3,0213,021Investments
      (2)Agency
      discount notes
            
            
            2,500Cash
      equivalents and investments
            
            $
            5,521




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


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


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, the United Kingdom and Norway.





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





Three Months Ended
                      March 31,
                    
                    
                    Six Months Ended
                      March 31,2009
                    
                    
                    2008
                    
                    
                    2009
                    
                    
                    2008Americas
                    
                    
                    86
                    %
                    
                    
                    88
                    %
                    
                    
                    86
                    %
                    
                    
                    87
                    %International
                    
                    
                    14
                    %
                    
                    
                    12
                    %
                    
                    
                    14
                    %
                    
                    
                    13
                    %Total
                    
                    
                    100
                    %
                    
                    
                    100
                    %
                    
                    
                    100
                    %
                    
                    
                    100
                    %




CUSTOMERS





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




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
                        March 31,
                      
                      
                      Six Months Ended
                        March 31,2009
                      
                      
                      2008
                      
                      
                      2009
                      
                      
                      2008Synnex
                      
                      
                      28
                      %
                      
                      
                      34
                      %
                      
                      
                      30
                      %
                      
                      
                      35
                      %Jenne
                      
                      
                      14
                      %
                      
                      
                      11
                      %
                      
                      
                      18
                      %
                      
                      
                      7
                      %AltiSys
                      
                      
                      9
                      %
                      
                      
                      15
                      %
                      
                      
                      6
                      %
                      
                      
                      16
                      %Graybar(*)
                      
                      
                      —
                      
                      
                      
                      15
                      %
                      
                      
                      —
                      
                      
                      
                      14
                      %Total
                      
                      
                      51
                      %
                      
                      
                      75
                      %
                      
                      
                      54
                      %
                      
                      
                      72
                      %




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


11


2.
WARRANTY





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





Changes
in the reserves for our warranty liability for the three and six months ended
March 31, 2009 and 2008, respectively, are as follows (in
thousands):





Three Months Ended
                        March 31,
                      
                      
                      Six Months Ended
                        March 31,2009
                      
                      
                      2008
                      
                      
                      2009
                      
                      
                      2008Beginning
      balance
                      
                      $
                      128
                      
                      
                      $
                      145
                      
                      
                      $
                      137
                      
                      
                      $
                      148Provision
      for warranty liability
                      
                      
                      25
                      
                      
                      
                      40
                      
                      
                      
                      58
                      
                      
                      
                      80Warranty
      cost including labor, components and scrap
                      
                      
                      (44
                      )
                      
                      
                      (40
                      )
                      
                      
                      (86
                      )
                      
                      
                      (83
                      )Ending
      balance
                      
                      $
                      109
                      
                      
                      $
                      145
                      
                      
                      $
                      109
                      
                      
                      $
                      145





3.  COMMITMENTS
AND CONTINGENCIES





Commitments





We lease
our facilities under various operating lease agreements expiring on various
dates through December 2011. The Company leases approximately 32,000 square feet
to serve as our headquarters for corporate administration, research and
development, manufacturing, and sales and marketing facility in Fremont,
California. Generally, these leases have multiple options to extend for a period
of years upon termination of the original lease term. The lease for our
headquarters expired on February 21, 2009, although we continue to occupy the
premises on a month-to-month basis in accordance with the terms of that lease.
In April 2009, the Company entered into a lease for a new corporate headquarters
in San Jose, California for a period of five years. In the third quarter of
fiscal 2009, we expect to vacate our Fremont office and transition into our new
facility.




Rent
expense for all operating leases totaled approximately $185,000 and $360,000 for
the three and six months ended March 31, 2009, respectively as compared to
$170,000 and $338,000 for the three and six months ended March 31, 2008,
respectively. We also lease certain equipment under capital lease arrangements.
The minimum future lease payments under all noncancellable capital and operating
leases as of March 31, 2009 are shown in the following table (in
thousands):




Fiscal
      Years Ending September 30,
                          
                          Capital
                            Leases
                          
                          
                          Operating
                            LeasesRemainder
      of 2009
                          
                          $
                          22
                          
                          
                          $
                          1792010
                          
                          
                          33
                          
                          
                          
                          3572011
                          
                          
                          —
                          
                          
                          
                          16Total
      contractual lease obligation
                          
                          $
                          55
                          
                          
                          $
                          552Amount
      representing interest
                          
                          $
                          3Present
      value of minimum lease payment
                          
                          $
                          52Current
      portion
                          
                          $
                          41Long-term
      portion
                          
                          
                          11Total
      capital lease commitments
                          
                          $
                          52





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.





On
September 6, 2002, Vertical Networks, Inc. filed suit against us in the United
States District Court for the Northern District of California,
alleging infringement of U.S. Patents Nos. 6,266,341, 6,289,025, 6,292,482,
6,389,009, and 6,396,849.  On October 28, 2002, Vertical Networks amended
its complaint to add allegations of infringement of U.S. Patents Nos. 5,617,418
and 5,687,174.  Vertical Networks filed a second amended complaint on
November 20, 2002 to identify products and/or activities that allegedly infringe
the seven patents-in-suit.  Vertical Networks' Complaint seeks
an injunction against future patent infringement, an award of damages,
including treble damages for alleged willful infringement, and attorneys' fees
and costs.  On December 9, 2002, we filed an answer and counterclaims
for declaratory relief, and on December 26, 2002, Vertical Networks filed its
reply to those counterclaims.  On October 4, 2007, the parties entered into
a stipulation dismissing the lawsuit in its entirety without
prejudice.


12




4.  STOCK
REPURCHASE PROGRAM





On
October 23, 2007, our Board of Directors approved the repurchase of up to $2.0
million of our common stock in the open market through November 12, 2008. On
November 11, 2008, our Board of Directors extended the repurchase program by
another year to November 14, 2009. Stock repurchases under this program may be
made from time to time at our management’s discretion through November 14, 2009.
When exercising such discretion, management will consider a variety of factors
such as our stock price, general business and market conditions and other
investment opportunities. The repurchase will be made in the open market and
will be funded from available working capital. Pursuant to the 2007 authority,
we repurchased 231,135 shares in fiscal 2008 at an aggregate cost of $367,000.
Pursuant to the 2008 authority, we repurchased 23,800 shares in the six months
ended March 31, 2009 at an aggregate cost of $19,000. In April 2009, we
suspended further purchases of stock under this program. For additional
information, refer to note 5 to the accompanying unaudited consolidated
financial statements.




5.  SUBSEQUENT
EVENTS





Lease
Agreement





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 will serve as our
headquarters for corporate administration, research and development,
manufacturing, and sales and marketing facility in San Jose, California. Under
the terms of the lease agreement, we will pay rent of approximately $1.5 million
for a period of five years. Concurrently with the execution of the lease, the
Company reserved $100,000 as collateral for an irrevocable and negotiable
standby letter of credit (the "Letter of Credit") as security for a facility
lease. 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.





Stock Repurchase
Program





In April
2009, we suspended further purchases of stock under the repurchase program. For
additional information regarding stock repurchase program, refer to the Stock
Repurchase Program discussion section of this Quarterly Report on Form
10-Q.




Salary
Reduction
  In April
2009, we implemented a mandatory salary reduction for all of our employees,
including our executive officers. These salary reductions ranged between 5% and
15%, depending on several factors, including, but not limited to, participation
in commission plans and the original base salary. The salaries of all of our
executive officers were reduced by 15%.


13


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





FORWARD-LOOKING
INFORMATION





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





The
forward-looking statements contained herein reflect our judgment as of the date
of this report with respect to future events, the outcome of which is subject to
certain risks that may have a significant impact on our business, operating
results or financial condition. You are cautioned that these forward-looking
statements are inherently uncertain. Should one or more of these risks or
uncertainties materialize, or should underlying assumptions prove incorrect,
actual results or outcomes may vary materially from those described herein.
Although we believe that the expectations reflected in these forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements, or the outcome of present and future
litigation, regulatory developments or other contingencies. You should carefully
review the cautionary statements contained in our Annual Report on Form 10-K for
the year ended September 30, 2008, including those set forth in Item 1A. “Risk
Factors” of that report.





OVERVIEW





We are a
pioneer and market leader in Internet protocol telephony systems for small- to
medium-sized businesses. We design, manufacture and market next generation,
Internet protocol phone systems and contact centers that use both the Internet
and the public telephone network to take advantage of the convergence of voice
and data communications. Unlike traditional proprietary phone systems, our
systems are designed with open architecture and are built on an industry
standard platform.  This adherence to industry standards allows our
products to play an important role in the small- to medium-sized business market
by delivering phone systems that can interface with other technologies and
provide integrated voice and data solutions.  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 $3.6 million and $8.4 million for the three and six
months ended March 31, 2009, respectively, compared to net revenue of $4.7
million and $9.0 million for the three and six months ended March 31, 2008,
respectively. As of March 31, 2009, we had an accumulated deficit of $59.3
million. Net cash used in operating activities was $1.3 million for the six
months ended March 31, 2009.





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





Our cost
of revenue consists of component and material costs, direct labor costs,
provisions for excess and obsolete inventory, warranty costs and overhead
related to the manufacturing of our products. Several factors that have affected
and will continue to affect our revenue growth are the state of the economy, the
market acceptance of our products, our ability to add new resellers and our
ability to design, develop, and release new products. We engage third-party
assemblers, which for the six months ended March 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, analog phones from
Fanstel Corporation, Internet protocol phones from BCM Communications, Inc.,
single board computers for our MAX product from AAEON Electronics, Inc. and raw
material components from Avnet Electronics. We selected our manufacturing
partners with the goals of ensuring a reliable supply of high-quality finished
products and lowering per unit product costs as a result of manufacturing
economies of scale. We cannot assure you that we will maintain the volumes
required to realize these economies of scale or when or if such cost reductions
will occur. The failure to obtain such cost reductions could materially
adversely affect our gross margins and operating results.





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.


14




CRITICAL
ACCOUNTING POLICIES





Revenue Recognition.Net
sales consist primarily of revenue from direct sales to end-users, resellers and
distributors. We recognize revenue pursuant to SEC Staff Accounting Bulletin
(“SAB”) No. 104, Revenue
Recognition, (“SAB No. 104”). Revenue from sales to end-users is
recognized upon shipment, when risk of loss has passed to the customer,
collection of the receivable is reasonably assured, persuasive evidence of an
arrangement exists, and the sales price is fixed and determinable. We provide
for estimated sales returns and allowances and warranty costs related to such
sales at the time of shipment in accordance with SFAS No. 48, Revenue Recognition when Right of
Return Exists (“SFAS No. 48”).  Net revenue consists of
product revenue reduced by estimated sales returns and allowances. Sales to
distributors are made under terms allowing certain rights of return and
protection against subsequent price declines on our products held by the
distributors. Upon termination of such distribution agreements, any unsold
products may be returned by the distributor for a full refund. These agreements
may be canceled without cause for convenience following a specified notice
period. As a result of the above provisions, we defer recognition of distributor
revenue until such distributors resell our products to their customers. The
amounts deferred as a result of this policy are reflected as “deferred revenue”
in the accompanying consolidated balance sheets. The related cost of revenue is
also deferred and reported in the consolidated balance sheets as inventory. As
of March 31, 2009, our total deferred revenue was $2.9 million compared to $1.9
million for the same period in fiscal 2008, an increase of $1.0 million over the
same period in the prior year. The increase was primarily the result of
continued growth of our new recurring revenue programs. These plans include both
the Software Assurance Program, which provides our customers with new software
releases and support for an annual fee, and the Premier Service Plan, which
includes software assurance and extended hardware warranty.





Service Support Plans. In
September 2007, we introduced our Software Assurance Program which provides our
customers with the latest updates, new releases, and technical support for the
applications they are licensed to use. In fiscal 2008, we initiated our Premier
Service Plan, which includes software assurance and extended hardware warranty.
These programs have an annual subscription and can range from one to three
years. Sales from our service support programs are recorded as deferred revenue
and recognized as revenue over the terms of their subscriptions. As of March 31,
2009, our deferred revenue was approximately $2.1 million compared to $722,000
for the same period in fiscal 2008. Our new service plan offering remains a
significant growth opportunity as we continue to add new service
customers.





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





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





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





Inventory.  Inventory
is stated at the lower of cost (first-in, first-out method) or market. Our
inventory balance for both the six months ended March 31, 2009 and March 30,
2008 was $2.0 million. We perform a detailed review of inventory each fiscal
quarter, with consideration given to future customer demand for our products,
obsolescence from rapidly changing technology, product development plans, and
other factors. If future demand or market conditions for our products are less
favorable than those projected by management, or if our estimates prove to be
inaccurate due to unforeseen technological changes, we may be required to record
additional inventory provision which would negatively affect gross margins in
the period when the write-downs were recorded. In prior periods, we had
established a reserve to write off excess inventory that management believed
would not be sold. For the six months ended March 31, 2009, we disposed of
fully-reserved inventory with a carrying value of zero and an original cost at
$176,000. We attribute this overall reduction in obsolete inventory to
physically disposing of a portion of the reserved inventory. The disposal of
such inventory had no material impact on our revenue, gross margins and net
loss. For the six months ended March 31, 2009, we recognized a provision of
$67,000 for excess and obsolete inventories as compared to a reduction of $1,000
during the same period in the prior year. Inventory allowance was $722,000 as of
March 31, 2009 compared to $850,000 as of September 30, 2008. The change in
inventory allowance was primarily attributable to the disposal of fully-reserved
inventory with a carrying value of zero and an original cost of
$176,000.


15




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 $109,000 as of March 31, 2009 compared to
$137,000 as of September 30, 2008. This change was the result of a significant
decline in the product return rate caused by changes in our management of the
return programs. As a consequence of the Company’s standardized manufacturing
processes and product testing procedures, returns of defective product are
infrequent and the quantities have not been significant. Accordingly, historical
warranty costs have not been material.





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
                                March 31,
                              
                              
                              Six Months Ended
                                March 31,2009
                              
                              
                              2008
                              
                              
                              2009
                              
                              
                              2008Consolidated
      Statements of Operations Data:Net
      revenue:Hardware
                              
                              
                              86.7
                              %
                              
                              
                              87.6
                              %
                              
                              
                              86.5
                              %
                              
                              
                              86.5
                              %Software
                              
                              
                              13.3
                              
                              
                              
                              12.4
                              
                              
                              
                              13.5
                              
                              
                              
                              13.5Total
      net revenue
                              
                              
                              100.0
                              
                              
                              
                              100.0
                              
                              
                              
                              100.0
                              
                              
                              
                              100.0Cost
      of revenue:Hardware
                              
                              
                              41.0
                              
                              
                              
                              42.8
                              
                              
                              
                              39.8
                              
                              
                              
                              42.4Software
                              
                              
                              0.1
                              
                              
                              
                              1.6
                              
                              
                              
                              0.1
                              
                              
                              
                              1.5Total
      cost of revenue
                              
                              
                              41.1
                              
                              
                              
                              44.4
                              
                              
                              
                              39.9
                              
                              
                              
                              43.9Gross
      profit
                              
                              
                              58.9
                              
                              
                              
                              55.6
                              
                              
                              
                              60.1
                              
                              
                              
                              56.1Operating
      expenses:Research
      and development
                              
                              
                              34.7
                              
                              
                              
                              22.0
                              
                              
                              
                              29.3
                              
                              
                              
                              21.7Sales
      and marketing
                              
                              
                              51.4
                              
                              
                              
                              39.1
                              
                              
                              
                              46.5
                              
                              
                              
                              40.2General
      and administrative
                              
                              
                              22.7
                              
                              
                              
                              20.1
                              
                              
                              
                              21.1
                              
                              
                              
                              19.6Total
      operating expenses
                              
                              
                              108.8
                              
                              
                              
                              81.2
                              
                              
                              
                              96.9
                              
                              
                              
                              81.5Loss
      from operations
                              
                              
                              (49.9
                              )
                              
                              
                              (25.6
                              )
                              
                              
                              (36.8
                              )
                              
                              
                              (25.4
                              )Equity
      in net loss of investee
                              
                              
                              (0.1
                              )
                              
                              
                              (0.1
                              )
                              
                              
                              (
      0.1
                              )
                              
                              
                              (
      0.0
                              )Interest
      and other income, net
                              
                              
                              0.6
                              
                              
                              
                              1.7
                              
                              
                              
                              0.7
                              
                              
                              
                              2.2Net
      loss before income taxes
                              
                              
                              (49.4
                              )
                              
                              
                              (24.0
                              )
                              
                              
                              (36.2
                              )
                              
                              
                              (23.2
                              )Provision
      for income taxes
                              
                              
                              (
      0.0
                              )
                              
                              
                              (
      0.0
                              )
                              
                              
                              0.2
                              
                              
                              
                              (
      0.0
                              )Net
      loss
                              
                              
                              (49.4
                              )%
                              
                              
                              (24.0
                              )%
                              
                              
                              (36.0
                              )%
                              
                              
                              (23.2
                              )%




16


Net
Revenue





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





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





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





Three Months Ended
                    March 31,
                  
                  
                  Six Months Ended
                    March 31,2009
                  
                  
                  2008
                  
                  
                  2009
                  
                  
                  2008Americas
                  
                  
                  86
                  %
                  
                  
                  88
                  %
                  
                  
                  86
                  %
                  
                  
                  87
                  %International
                  
                  
                  14
                  %
                  
                  
                  12
                  %
                  
                  
                  14
                  %
                  
                  
                  13
                  %Total
                  
                  
                  100
                  %
                  
                  
                  100
                  %
                  
                  
                  100
                  %
                  
                  
                  100
                  %




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





Three Months Ended
                      March 31,
                    
                    
                    Six Months Ended
                      March 31,2009
                    
                    
                    2008
                    
                    
                    2009
                    
                    
                    2008Synnex
                    
                    
                    28
                    %
                    
                    
                    34
                    %
                    
                    
                    30
                    %
                    
                    
                    35
                    %Jenne
                    
                    
                    14
                    %
                    
                    
                    11
                    %
                    
                    
                    18
                    %
                    
                    
                    7
                    %AltiSys
                    
                    
                    9
                    %
                    
                    
                    15
                    %
                    
                    
                    6
                    %
                    
                    
                    16
                    %Graybar(*)
                    
                    
                    —
                    
                    
                    
                    15
                    %
                    
                    
                    —
                    
                    
                    
                    14
                    %Total
                    
                    
                    51
                    %
                    
                    
                    75
                    %
                    
                    
                    54
                    %
                    
                    
                    72
                    %


_______________________


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




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





Three Months Ended
                    March 31,
                  
                  
                  Six Months Ended
                    March 31,2009
                  
                  
                  2008
                  
                  
                  2009
                  
                  
                  2008Hardware
                  
                  
                  69
                  %
                  
                  
                  88
                  %
                  
                  
                  72
                  %
                  
                  
                  86
                  %Software
                  
                  
                  13
                  %
                  
                  
                  12
                  %
                  
                  
                  14
                  %
                  
                  
                  14
                  %Service
      Support Plans (1)
                  
                  
                  18
                  %
                  
                  
                  —
                  
                  
                  
                  14
                  %
                  
                  
                  —Total
                  
                  
                  100
                  %
                  
                  
                  100
                  %
                  
                  
                  100
                  %
                  
                  
                  100
                  %




(1)
            In
      the quarter ended March 31, 2008, revenue generated from these service
      support plans accounted for less than 10% of our total
      revenue.  For the same period, our hardware revenue includes
      service support revenue generated primarily from our service support plans
      starting in September 2007.


17


Net
revenue for the three months ended March 31, 2009 was $3.6 million as compared
to $4.7 million for the three months ended March 31, 2008. Revenue generated in
the Americas segment accounted for $3.1 million, or 86% of our total net
revenue, as compared to $4.1 million, or 88% of our total net revenue, for the
three months ended March 31, 2009 and March 31, 2008, respectively. Revenue
generated in the International segment accounted for $489,000, or 14% of our
total net revenue, as compared to $576,000, or 12% of our total net revenue, for
the three months ended March 31, 2009 and March 31, 2008, respectively. In the
Americas segment, during the three months ended March 31, 2009 and 2008, we
generated $664,000 and $183,000, respectively, in non-system related revenue.
Non-system related revenue is primarily comprised of revenue generated from our
service support plans. In the Americas segment, the decrease in net revenue
excluding non-system related revenue was approximately 39%. This decrease was
primarily attributable to a lower number of systems shipped during the three
months ended March 31, 2009 as compared to the corresponding period in the
previous year.





Net
revenue for the six months ended March 31, 2009 was $8.4 million as compared to
$9.0 million for the six months ended March 31, 2008. Revenue generated in the
Americas segment accounted for $7.2 million, or 86% of our total net revenue, as
compared to $7.8 million, or 87% of our total net revenue, for the six months
ended March 31, 2009 and March 31, 2008, respectively. Revenue generated in the
International segment accounted for $1.2 million, or 14% of our total net
revenue, as compared to $1.2 million, or 13% of our total net revenue, for the
six months ended March 31, 2009 and March 31, 2008, respectively. In the
Americas segment, during the six months ended March 31, 2009 and 2008, we
generated approximately $1.3 million and $241,000, respectively, in non-system
related revenue. Non-system related revenue is primarily comprised of revenue
generated from our service support plans. In the Americas segment, the decrease
in net revenue excluding non-system related revenue was approximately 21%. This
decrease in this segment was primarily attributable to change in our product
mix. During the six months ended March 31, 2009, the number of systems shipped
was approximately 23% lower than the corresponding period in the previous year
but the average revenue per system was higher by approximately 1.7%. The average
revenue per system was higher as result of a decrease in our smaller systems of
approximately 33% and an increase in our larger systems of approximately 11%,
reflecting a higher number of extensions per system shipped.





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 as a percentage of net revenue decreased to 41% for the three months
ended March 31, 2009 as compared to 44% 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. For
the six months ended March 31, 2009 and 2008, cost of revenue as a percentage of
net revenue decreased from 44% to 40%, respectively. This change was primarily
attributable to an increase of our non-system related revenue.





Research
and Development




Research
and development expenses consist primarily of costs related to personnel and
overhead expenses, consultant expenses and other costs associated with the
design, development, prototyping and testing of our products and enhancements of
our converged telephone system software. For the second quarter of fiscal 2009,
research and development expenses were $1.2 million, or 35% of net revenue,
compared to $1.0 million, or 22% of net revenue, for the second quarter of
fiscal 2008. The increase in absolute dollars was primarily attributable to an
increase of $52,000 in personnel-related expenses, an increase of $56,000 in
project related expenses and an increase of $53,000 in consulting related
services. Research and development expenses increased to $2.4 million, or 29% of
net revenue, for the six months ended March 31, 2009 from $1.9 million, or 22%
of net revenue, for the same period in fiscal 2008. This increase in absolute
dollars reflects increased personnel-related and overhead expenses of
approximately $134,000, an increase of $144,000 in project related expenses and
an increase of $121,000 in consulting related services. Additionally, research
and development activities increased in Shanghai, which resulted in an increase
of $68,000 in overall expenses.





We intend
to continue to make investments in our research and development and we believe
that focused investments in research and development are critical to the future
growth and our ability to enhance our competitive position in the marketplace.
We believe that our ability to develop and meet enterprise customer requirements
is essential to our success. Accordingly, we have assembled a team of engineers
with expertise in various fields, including voice and IP communications, unified
communications network design, data networking and software engineering. Our
principal research and development activities are conducted in Fremont,
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.


18


Sales
and Marketing





Sales and
marketing expenses consist primarily of salaries, commissions and related
expenses for personnel engaged in marketing, sales and customer support
functions, as well as trade shows, advertising, and promotional expenses. For
the second quarter of fiscal 2009 and 2008, sales and marketing expenses were
$1.8 million. Sales and marketing as a percentage of net revenue increased
to 51% for the three months ended March 31, 2009 from 39% for the same period in
the previous fiscal year. Sales and marketing expenses increased to $3.9
million, or 46% of net revenue, for the six months ended March 31, 2009 from
$3.6 million, or 40% of net revenue, for the same period in fiscal 2008. This
increase in absolute dollars was driven by an increase in personnel-related and
overhead expenses of $287,000, primarily as a result of increased headcount of
approximately 12%.





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





General
and Administrative





General
and administrative expenses consist of salaries and related expenses for
executive, finance and administrative personnel, facilities, allowance for
doubtful accounts, legal and other general corporate expenses. For the second
quarter of fiscal 2009, general and administrative expenses were $811,000 or 23%
of revenue, compared to $946,000 or 20% of revenue for the second quarter of
fiscal 2008. The decrease in absolute dollars in general and administrative was
attributable to decreased non-cash stock-based compensation expenses of $62,000
and decreased consulting related services of $54,000. For the six months ended
March 31, 2009 and 2008, general and administrative expenses were $1.8 million.
As a percentage of net revenue, general and administrative increased to 21% for
the six months ended March 31, 2009 from 20% for the same period in the previous
fiscal year.





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 company’s current board of
directors. We are accounting for this investment using the equity method. For
the three months ended March 31, 2009, the total equity loss with respect to
this company was approximately $3,000 compared to net loss of $6,000 for the
same period in fiscal 2008. For the six months ended March 31, 2009 and 2008,
the total equity loss with respect to this company was approximately $6,000 and
$3,000, respectively.





Interest
Expense and Other Income, Net





Interest
expense primarily consists of interest incurred on our capital lease commitments
and other income primarily consists of interest earned on cash, cash equivalents
and short-term investments. Net interest and other income decreased to $23,000
and $59,000 for the three and six months ended March 31, 2009, respectively,
from $82,000 and $194,000 for the same periods in fiscal 2008. The decrease in
interest and other income, net for the three and six month periods ended March
31, 2009 as compared with the same periods of the prior year was a combination
of lower invested balances, reduced cash balances and reduced rates of interest
available for cash and investments in financial assets in fiscal 2009. In the
longer term, we may generate less interest income if our total invested balance
decreases and these decreases are not offset by rising interest rates or
increased cash generated from operations or other sources.





Liquidity
and Capital Resources





Since
inception, we have financed our operations primarily through the sale of equity
securities. As of March 31, 2009, we held cash, cash equivalents and short-term
investments totaling $8.5 million.  Total cash, cash equivalents and
short-term investments represents approximately 72% of total current assets for
the quarter ended March 31, 2009. As of March 31, 2009, $6.0 million of our
total assets are classified as cash and cash equivalents compared with $9.4
million at September 30, 2008. Short-term investments were approximately $2.5
million and $400,000 at March 31, 2009 and September 30, 2008,
respectively.




19


For the
six months ended March 31, 2009, net cash used in investing activities was $2.3
million as compared net cash provided by investing activities of $3.4 million
during the same period in fiscal 2008. This was directly related to proceeds
from maturities of short-term investments of approximately $3.3 million and
purchases of short-term investments of approximately $5.4 million during the
first six months of fiscal 2009 as compared to proceed from maturities of
short-term investments of approximately $26.1million and purchases of short-term
investments of approximately $22.7 million during fiscal 2008. The maturities of
the Company’s short term investments are staggered throughout the year so that
cash requirements are met.   For the six month period ended March 31,
2009, the Company spent approximately $139,000 on purchases of property and
equipment compared to $101,000 million for the six month period ended March 31,
2008.





Net cash
provided by financing activities for the six months ended March 31, 2009 was
approximately $44,000, as compared to net cash used in financing activities of
$190,000 during the same period in fiscal 2008. This change was primarily
attributable to the repurchase of our treasury stock of approximately $19,000
for the six months ended March 31, 2009 as compared to $346,000 during the same
period in fiscal 2008. During the six months of fiscal 2009, proceeds from
exercise of employee stock options represented approximately $63,000 as compared
to $156,000 during the same period in the prior year.





On
October 23, 2007, our Board of Directors approved the repurchase of up to $2.0
million of our common stock in the open market through November 12, 2008. On
November 11, 2008, our Board of Directors extended the repurchase program by
another year to November 14, 2009. Stock repurchases under this program may be
made from time to time at our management’s discretion through November 14, 2009.
When exercising such discretion, management will consider a variety of factors
such as our stock price, general business and market conditions and other
investment opportunities. The repurchase will be made in the open market and
will be funded from available working capital. Pursuant to the 2007 authority,
we repurchased 231,135 shares in fiscal 2008 at an aggregate cost of $367,000.
Pursuant to the 2008 authority, we repurchased 23,800 shares in the six months
ended March 31, 2009 at an aggregate cost of $19,000. In April 2009, we
suspended further purchases of stock under this program. For additional
information, refer to note 5 to the accompanying unaudited consolidated
financial statements.





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.





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





March 31,
                              2008
                            
                            
                            September 30,
                              2008Cash
      and cash equivalents
                            
                            $
                            5,955
                            
                            
                            $
                            9,467Short-term
      investments
                            
                            
                            2,500
                            
                            
                            
                            400Total
      cash, cash equivalents and short-term investments
                            
                            $
                            8,455
                            
                            
                            $
                            9,867Six
      Months Ended
                              March 31,2009
                            
                            
                            2008Net
      cash used in operating activities
                            
                            $
                            (1,295
                            )
                            
                            $
                            (221
                            )Net
      cash provided by (used in) investing activities
                            
                            $
                            (2,261
                            )
                            
                            $
                            3,374Net
      cash provided by (used in) financing activities
                            
                            $
                            44
                            
                            
                            $
                            (190
                            )Net
      decrease in cash, cash equivalents, end of period
                            
                            $
                            (3,512
                            )
                            
                            $
                            2,963





Changes
in Cash Flows





During
the six months ended March 31, 2009, our net cash used in operating activities
was $1.3 million compared to $221,000 during the same period in fiscal 2008.
This was primarily attributable to our net loss of $3.0 million, a decrease of
$1.3 million in accounts receivable, an increase of $377,000 in net inventories,
an increase of $110,000 in accounts payable, an increase of $375,000 in deferred
revenue short-term and an increase of $106,000 in prepaid expenses. The cash
impact of the loss for the six months ended March 31, 2009 was partially offset
by a non-cash expense of $410,000 in stock-based compensation expense and
$110,000 in depreciation and amortization costs. The decrease in accounts
receivable was primarily due to lower shipments and good collections during the
second quarter of fiscal 2009. Accounts payable increased due to timing of
payments to vendors. Inventories increased mostly due to inventory that was not
consumed during the period due to decreased sales in second quarter. The
increase in deferred revenue for the six months ended March 31, 2009 was
primarily due to an increase of $264,000 from our service support plans and an
increase of $111,000 in deferred channel revenue; due to the volume of products
shipped to distribution as apposed to what was sold.  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.




20


Net
accounts receivable decreased 54% from $2.4 million at September 30, 2008 to
$1.1 million at March 31, 2009. Quarterly accounts receivable days sales
outstanding (DSO) decreased from 43 days as of September 30, 2008 to 28 days as
of March 31, 2009. Net accounts receivable and DSO decrease was primarily due to
lower shipments and good collections during the second quarter of fiscal
2009.





Net
inventories increased 24% from $1.6 million at September 30, 2008 to
$1.9 million at March 31, 2009. The increase in net inventories was mostly
due to inventory that was not consumed during the period due to decreased sales
in the second quarter. Our annualized inventory turn rate, which represents the
number of times inventory is replenished during the year decreased from 5.3
turns as of September 30, 2008 to 3.0 turns as of March 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
second quarter of fiscal 2009 with a cash conversion cycle of 66 days, as
compared to 82 days for second quarter of fiscal 2008. The cash conversion cycle
is the duration between purchase of inventories and services and the collection
of the cash from the sale of our products and services and is a metric on which
we have focused as we continue to try to efficiently manage our assets. The cash
conversion cycle results from the calculation of (a) the days of sales
outstanding added to (b) the days of supply in inventories and reduced by (c)
the days of payable outstanding.





Liquidity
and Capital Resources





As of
March 31, 2009, our principal sources of liquidity included cash, cash
equivalents and short-term investments of approximately $8.5 million. The
maturities of our short-term investments are staggered throughout the year to
ensure we meet our cash requirements.





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 March 31, 2009.
We had total outstanding commitments on noncancelable capital and operating
leases of $607,000 as of March 31, 2009. Lease terms on our existing facility
operating leases generally range from three to nine years. The lease for our
headquarters expired on February 21, 2009. In April 2009, the Company entered
into a lease for a new corporate headquarters in San Jose, California for a
period of five years. In the third quarter of fiscal 2009, we expect to vacate
our Fremont office and transition into our new facility.





Contractual
Obligations




The
following table presents certain payments due by us under contractual
obligations with minimum firm commitments as of March 31, 2009 (in
thousands):





Payment
      Due by PeriodContractual
      Obligations
                        
                        Total
                        
                        
                        Payments
      Due
                          in
      Less
                          Than
      1 Year
                        
                        
                        Payments
                          Duein
                          1
      – 3 Years
                        
                        
                        Payments
                          Due
      in
                          3
      – 5 Years
                        
                        
                        Payments
      Due
                          in
      More
                          Than
      5 YearsOperating
      leases obligation
                        
                        $
                        552
                        
                        
                        $
                        179
                        
                        
                        $
                        373
                        
                        
                        $
                        —
                        
                        
                        $
                        —Capital
      leases obligation
                        
                        
                        55
                        
                        
                        
                        22
                        
                        
                        
                        33
                        
                        
                        
                        —
                        
                        
                        
                        —Total
      contractual lease obligation
                        
                        $
                        607
                        
                        
                        $
                        201
                        
                        
                        $
                        406
                        
                        
                        $
                        —
                        
                        
                        $
                        —


21





Effects
of Recently Issued Accounting Pronouncements





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





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





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





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





Assets measured at fair value as of
March 31, 2009 are summarized as follows:





(In
      thousands)
                          
                          Quoted
      Prices in Active
                            Markets
      for Identical
                            Instruments
                            (Level
      1)Cash
      equivalents (1)Money
      market funds
                          
                          $
                          3,0213,021Investments
      (2)Agency
      discount notes
                          
                          
                          2,500Cash
      equivalents and investments
                          
                          $
                          5,521





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


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




22


Item
3. Quantitative and Qualitative Disclosures About Market Risk





Market
Interest Rate Risk





At March
31, 2009, our investment portfolio consisted primarily of fixed income
securities, excluding those classified as cash and cash equivalents of $3.0
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 March 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
4T. Controls and Procedures





Evaluation
of Disclosure Controls and Procedures





Our
management carried out an evaluation, under the supervision and with the
participation of our President and Chief Executive Officer and our Chief
Financial Officer, of the effectiveness of our disclosure controls and
procedures as of the end of our quarter ended March 31, 2009 pursuant to
Exchange Act Rule 13a-15(e) and 15d-15(e). 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 March 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 March 31, 2009 that have materially affected,
or are reasonably likely to materially affect, our internal controls over
financial reporting.


23


PART
II. OTHER INFORMATION





Item
1.  Legal Proceedings





On
September 6, 2002, Vertical Networks, Inc. filed suit against us in the United
States District Court for the Northern District of California,
alleging infringement of U.S. Patents Nos. 6,266,341, 6,289,025, 6,292,482,
6,389,009, and 6,396,849.  On October 28, 2002, Vertical Networks amended
its complaint to add allegations of infringement of U.S. Patents Nos. 5,617,418
and 5,687,174.  Vertical Networks filed a second amended complaint on
November 20, 2002 to identify products and/or activities that allegedly infringe
the seven patents-in-suit.  Vertical Networks' complaint seeks
an injunction against future patent infringement, an award of damages,
including treble damages for alleged willful infringement, and attorneys' fees
and costs.  On December 9, 2002, we filed an answer and counterclaims
for declaratory relief, and on December 26, 2002, Vertical Networks filed its
reply to those counterclaims.  On October 4, 2007, the parties entered into
a stipulation dismissing the lawsuit in its entirety without
prejudice.





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.  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.





Business-Related Risks





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





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





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





We have had a history of operating losses since our
inception and, as of March 31, 2009,we had an accumulated deficit of $59.3
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.


24





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.





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





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





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





We expect our competitors to continue to improve the
performance of their current products and introduce new products or new
technologies.  If our competitors successfully introduce new products
or enhance their existing products, our sales or market acceptance of our
products and services could be reduced, price competition could 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.


25





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





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





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





We rely on resellers who can provide high quality sales
and support services.  As with our distributors, we compete with other
telecommunications systems providers for our resellers' business as our
resellers generally market competing products.  If a reseller promotes
a competitor's products to the detriment of our products or otherwise fails to
market our products and services effectively, we could lose market
share.  In addition, the loss of a key reseller or the failure of
resellers to provide adequate customer service could cause our business to
suffer.  If we do not properly train our resellers to sell, install
and service our products, our business will suffer.





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





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





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





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





Our customers and end users expect frequent product
introductions and have changing requirements for new products and
features.  In order to be competitive, we need to develop and market
new products and product enhancements that respond to these changing
requirements on a timely and cost-effective basis.  Our failure to do
so promptly and cost effectively would seriously harm our business, financial
condition and results of operations.  Also, introducing new products
could require us to write-off existing inventory as obsolete, which could harm
our results of operations.





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





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





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


26





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





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





We have experienced a period of rapid growth in our
headcount and operation over the last two years; we have substantially increased
our workforce and expanded our channel partner network and the number and size
of enterprise customers implementing our systems.  In the event our
products obtain greater market acceptance, we may be required to expand our
operations.  This growth has placed, and anticipated future growth
will place, a significant strain on our management, administrative, operational
and financial infrastructure.  Our success will depend in part upon
our ability to manage this growth effectively.  To manage the expected
growth of our operations and personnel, we will need to continue to improve our
operational, financial and management controls and our reporting systems and
procedures.  Failure to effectively manage growth could result in
difficulty in filling enterprise customer orders, declines in product quality or
customer satisfaction, increases in costs or other production and distribution
difficulties, and any of these difficulties could adversely impact our business
performance and results of operations.





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





Sales through our three key distributors, Altisys,
Synnex and Jenne, accounted for 51% of our net revenue in the quarter ended
March 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.





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.


27





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





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





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





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.





In the
quarter ended March 31, 2009, approximately 14% 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
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.


28





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.





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.


29





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





The Federal Communications Commission (FCC) has
submitted a report to Congress stating that it may regulate certain Internet
services if it determines that such Internet services are functionally
equivalent to conventional telecommunications services.  The
increasing growth of the voice over data network market and the popularity of
supporting products and services, heighten the risk that national governments
will seek to regulate the transmission of voice communications over networks
such as the Internet.  In addition, large telecommunications companies
may devote substantial lobbying efforts to influence the regulation of this
market so as to benefit their interests, which may be contrary to our
interests.  These regulations may include, for example, assessing
access or settlement charges, imposing tariffs or imposing regulations based on
encryption concerns or the characteristics and quality of products and
services.  In February 2004, the FCC found that an entirely Internet
based voice over Internet protocol service was an unregulated information
service.  At the same time, the FCC began a broader proceeding to
examine what its role should be in this new environment of increased consumer
choice and what can be done to meet its role of safeguarding the public
interest.  Future laws, legal decisions or regulations, as well as
changes in interpretations of existing laws and regulations, could require us to
expend significant resources to comply with them.  In addition, these
future events or changes may create uncertainty in our market that could reduce
demand for our products.





Risks Related to Ownership of our Common
Stock





Our stock price may be volatile.





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





·
            variations in our operating
      results;


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


·
            the gain or loss of significant
      customers;


·
            recruitment or departure of key
      personnel;


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


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


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


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





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





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





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





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





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


30





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.


31


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





On
October 23, 2007, our Board of Directors approved the repurchase of up to $2.0
million of our common stock in the open market through November 12, 2008. On
November 11, 2008, our Board of Directors extended the repurchase program by
another year to November 14, 2009. Stock repurchases under this program may be
made from time to time at our management’s discretion through November 14, 2009.
When exercising such discretion, management will consider a variety of factors
such as our stock price, general business and market conditions and other
investment opportunities. The repurchase will be made in the open market and
will be funded from available working capital. Pursuant to the 2007 authority,
we repurchased 231,135 shares in fiscal 2008 at an aggregate cost of $367,000.
Pursuant to the 2008 authority, we repurchased 23,800 shares in the six months
ended March 31, 2009 at an aggregate cost of $19,000. In April 2009, we
suspended further purchases of stock under this program. For additional
information, refer to note 5 to the accompanying unaudited consolidated
financial statements.





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





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




32





Item
6. Exhibits.





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


33





SIGNATURE





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





ALTIGEN
      COMMUNICATIONS, INC.Date:
      May 14, 2009
              By:
              /s/
      Philip M. McDermottPhilip
      M. McDermottChief
      Financial Officer




34





EXHIBIT
INDEX





Exhibit
              Number
            
            Description3.1
      (1)
            
            Amended
      and Restated Certificate of Incorporation.3.2
      (2)
            
            Second
      Amended and Restated Bylaws.3.3(3)
            
            Certificate
      of Designation of Rights, Preferences and Privileges of Series A
      Participating Preferred Stock of AltiGen Communications,
    Inc.4.1(4)
            
            Preferred
      Stock Rights Agreement, dated as of April 21, 2009, between AltiGen
      Communications, Inc. and Computershare Trust Company, N.A., including the
      Certificate of Designation, the form of Rights Certificate and the Summary
      of Rights attached thereto as Exhibits A, B and C,
      respectively.10.19(5)
            
            Amended
      and Restated Executive Employment Agreement by and between Philip
      McDermott and the Company, dated March 6, 2009.10.20
            
            Executive
      Employment Agreement by and between Jeremiah J. Fleming and the Company,
      dated December 18, 2007.10.21(6)
            
            Executive
      Employment Agreement by and between Gilbert Hu and the Company, dated
      March 6, 2009.31.1
            
            Certification
      of Principal Executive Officer, filed herewith.31.2
            
            Certification
      of Principal Financial Officer, filed herewith.32.1
            
            Certification
      of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted
      Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed
      herewith.32.2
            
            Certification
      of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted
      Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed
      herewith.








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


35