**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**WASHINGTON,
      D.C. 20549**







**FORM
      10-Q**





**x QUARTERLY
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                ACT OF
                1934****FOR
                THE QUARTERLY PERIOD ENDED MARCH 31, 2008****OR****o TRANSITION
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                ACT OF
                1934****FOR
                THE TRANSITION PERIOD
                FROM                      TO****Commission
                File Number 000-27427**







**ALTIGEN
      COMMUNICATIONS, INC.**


(Exact
      name of Registrant as specified in its charter)





**DELAWARE**
            
            **94-3204299**(State
                or other jurisdiction of
              incorporation
                or organization)
            
            (I.R.S.
                Employer
              Identification
                Number)**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.   YES x NO  o





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





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





The
      number of shares of our common stock outstanding as of May 12, 2008
      was: 15,732,636 shares














**ALTIGEN
      COMMUNICATIONS, INC.**


**QUARTERLY
      REPORT ON FORM 10-Q**


**FOR
      THE QUARTER ENDED MARCH 31, 2008**


**TABLE
      OF CONTENTS**




**PART
                  I. FINANCIAL INFORMATION**Item
                  1.
              Condensed
                  Consolidated Financial Statements (Unaudited)Condensed
                  Consolidated Balance Sheets as of March 31, 2008 and September
                  30,
                  2007
              3Condensed
                  Consolidated Statements of Operations for the Three and Six Months
                  Ended
                  March 31, 2008 and 2007
              4Condensed
                  Consolidated Statements of Cash Flows for the Six Months Ended
                  March 31,
                  2008 and 2007
              5Notes
                  to Condensed Consolidated Financial Statements
              6Item
                  2.
              Management’s
                  Discussion and Analysis of Financial Condition and Results of
                  Operations
              13Item
                  3.
              Quantitative
                  and Qualitative Disclosures about Market Risk
              22Item
                  4.
              Controls
                  and Procedures
              22**PART
                  II. OTHER INFORMATION**Item
                  1.
              Legal
                  Proceedings
              23Item
                  2.
              Unregistered
                  Sale of Equity Securities and Use of Proceeds
              23Item
                  6.
              Exhibits
              24**SIGNATURE**
              25**EXHIBIT
                  INDEX**
              26





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,****2008**
              
              **2007****ASSETS**Current
                  assets:Cash
                  and cash equivalents
              
              $
              9,074
              
              $
              6,111Short-term
                  investments
              
              
              404
              
              
              3,796Accounts
                  receivable, net of allowances of $34 and $33 at March 31, 2008
                  and
                  September 30, 2007, respectively.
              
              
              2,727
              
              
              2,656Inventories,
                  net
              
              
              2,006
              
              
              1,567Prepaid
                  expenses and other current assets
              
              
              364
              
              
              237Total
                  current assets
              
              
              14,575
              
              
              14,367Property
                  and equipment:Furniture
                  and equipment
              
              
              1,938
              
              
              1,837Computer
                  software
              
              
              939
              
              
              9382,877
              
              
              2,775Less:
                  Accumulated depreciation
              
              
              (2,394
              )
              
              (2,269
              )Net
                  property and equipment
              
              
              483
              
              
              506Other
                  non-current assets:Long-term
                  investments
              
              
              209
              
              
              209Long-term
                  deposit
              
              
              81
              
              
              168Total
                  other non-current assets
              
              
              290
              
              
              377Total
                  assets
              
              $
              15,348
              
              $
              15,250**LIABILITIES
                  AND STOCKHOLDERS' EQUITY**Current
                  liabilities:Accounts
                  payable
              
              $
              1,311
              
              $
              821Accrued
                  liabilities:Payroll
                  and related benefits
              
              
              500
              
              
              459Warranty
              
              
              145
              
              
              148Marketing
              
              
              98
              
              
              79Accrued
                  expense
              
              
              368
              
              
              322Other
              
              
              451
              
              
              422Deferred
                  revenue
              
              
              1,889
              
              
              565Total
                  current liabilities
              
              
              4,762
              
              
              2,816Long-term
                  deferred rent and other
              
              
              53
              
              
              89Stockholders'
                  equity:Convertible
                  preferred stock, $0.001 par value; Authorized—5,000,000
                  shares; Outstanding—none
                  at March 31, 2008 and September 30, 2007
              
              
              —
              
              
              —Common
                  stock, $0.001 par value; Authorized—50,000,000
                  shares; Outstanding—16,902,056
                  shares at March 31, 2008 and16,733,552
                  shares at September 30, 2007
              
              
              17
              
              
              16Treasury
                  stock at cost—1,277,410 shares at March 31, 2008 and 1,063,895 shares at September
                  30,
                  2007
              
              
              (1,360
              )
              
              (1,014
              )Additional
                  paid-in capital
              
              
              66,069
              
              
              65,434Accumulated
                  other comprehensive income
              
              
              (1
              )
              
              3Accumulated
                  deficit
              
              
              (54,192
              )
              
              (52,094
              )Total
                  stockholders' equity
              
              
              10,533
              
              
              12,345Total
                  liabilities and stockholders' equity
              
              $
              15,348
              
              $
              15,250


See
      Notes
      to 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,****2008**
            
            **2007**
            
            **2008**
            
            **2007**Net
                revenue:Hardware
            
            $
            4,130
            
            $
            3,842
            
            $
            7,758
            
            $
            7,801Software
            
            
            582
            
            
            303
            
            
            1,214
            
            
            716Total
                net revenue
            
            
            4,712
            
            
            4,145
            
            
            8,972
            
            
            8,517Cost
                of revenue:Hardware
            
            
            2,017
            
            
            1,876
            
            
            3,808
            
            
            3,860Software
            
            
            76
            
            
            28
            
            
            139
            
            
            55Total
                cost of revenue
            
            
            2,093
            
            
            1,904
            
            
            3,947
            
            
            3,915Gross
                profit
            
            
            2,619
            
            
            2,241
            
            
            5,025
            
            
            4,602Operating
                expenses:Research
                and development
            
            
            1,035
            
            
            825
            
            
            1,950
            
            
            1,642Sales
                and marketing
            
            
            1,841
            
            
            1,109
            
            
            3,604
            
            
            2,278General
                and administrative
            
            
            946
            
            
            590
            
            
            1,760
            
            
            1,172Total
                operating expenses
            
            
            3,822
            
            
            2,524
            
            
            7,314
            
            
            5,092Loss
                from operations
            
            
            (1,203
            )
            
            (283
            )
            
            (2,289
            )
            
            (490
            )Equity
                in net loss of investee
            
            
            (6
            )
            
            (1
            )
            
            (3
            )
            
            (4
            )Interest
                and other income, net
            
            
            82
            
            
            115
            
            
            194
            
            
            235Net
                loss before taxes
            
            
            (1,127
            )
            
            (169
            )
            
            (2,098
            )
            
            (259
            )Income
                tax provision
            
            
            —
            
            
            (3
            )
            
            —
            
            
            (7
            )Net
                loss
            
            $
            (1,127
            )
            $
            (172
            )
            $
            (2,098
            )
            $
            (266
            )Basic
                and diluted net loss per share
            
            $
            (0.07
            )
            $
            (0.01
            )
            $
            (0.13
            )
            $
            (0.02
            )Weighted
                average shares used in computing basic net loss per share
            
            
            15,708
            
            
            15,163
            
            
            15,753
            
            
            15,146Weighted
                average shares used in computing diluted net loss per share
            
            
            15,708
            
            
            15,163
            
            
            15,753
            
            
            15,146





See
      Notes
      to Consolidated Financial Statements.


4





**ALTIGEN
      COMMUNICATIONS, INC. AND SUBSIDIARY**


**CONDENSED
      CONSOLIDATED STATEMENTS OF CASH FLOWS**


**(UNAUDITED)**


**(In
      thousands)**




**Six
                  Months Ended**
                **March
                  31,****2008**
              
              **2007**CASH
                  FLOWS FROM OPERATING ACTIVITIES:Net
                  loss
              
              $
              (2,098
              )
              $
              (266
              )Adjustments
                  to reconcile net loss to net cash used in operating
                  activities:Depreciation
              
              
              124
              
              
              124Stock-based
                  compensation
              
              
              480
              
              
              256Equity
                  in net income of investee
              
              
              3
              
              
              3Changes
                  in operating assets and liabilities:Accounts
                  receivable
              
              
              (71
              )
              
              648Inventories,
                  net
              
              
              (439
              )
              
              (568
              )Prepaid
                  expenses and other current assets
              
              
              (130
              )
              
              (81
              )Accounts
                  payable
              
              
              490
              
              
              (162
              )Accrued
                  liabilities
              
              
              132
              
              
              (42
              )Deferred
                  revenue
              
              
              1,324
              
              
              (45
              )Long-term
                  deferred rent and other
              
              
              (36
              )
              
              (42
              )Net
                  cash used in operating activities
              
              
              (221
              )
              
              (175
              )CASH
                  FLOWS FROM INVESTING ACTIVITIES:Purchases
                  of short-term investments
              
              
              (22,718
              )
              
              (10,997
              )Proceeds
                  from sale of short-term investments
              
              
              26,106
              
              
              12,856Changes
                  in long-term deposits
              
              
              87
              
              
              —Purchases
                  of property and equipment
              
              
              (101
              )
              
              (33
              )Net
                  cash provided by investing activities
              
              
              3,374
              
              
              1,826CASH
                  FLOWS FROM FINANCING ACTIVITIES:Proceeds
                  from issuances of common stock, net of issuance costs
              
              
              156
              
              
              109Repurchase
                  of treasury stock
              
              
              (346
              )
              
              —Net
                  cash provided by (used in) financing activities
              
              
              (190
              )
              
              109NET
                  INCREASE IN CASH AND CASH EQUIVALENTS
              
              
              2,963
              
              
              1,760CASH
                  AND CASH EQUIVALENTS, BEGINNING OF YEAR
              
              
              6,111
              
              
              5,053CASH
                  AND CASH EQUIVALENTS, END OF YEAR
              
              $
              9,074
              
              $
              6,813


See
      Notes
      to 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 integrate
      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. 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, 2007, included
      in
      the Company’s 2007 Annual Report on Form 10-K filed with the SEC on December 27,
      2007. AltiGen’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 with an original maturity of three months
      or less from the date of purchase to be cash equivalents. Short-term investments
      are in highly liquid financial instruments with original maturities greater
      than
      three-months but less than one year and are classified as “available-for-sale”
investments. Investments are reported at their fair value, with unrealized
      gains
      and losses excluded from earnings and reported as a separate component of
      stockholders’ equity. As of March 31, 2008, our cash and cash equivalents
      consisted of commercial paper and cash deposited in checking and money market
      accounts.





**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 quarter ended March 31, 2008, we disposed of fully-reserved inventory with
      original cost at $411,000. We attribute this overall reduction in
      obsolete inventory to sales of inventory previously reserved as well as
      physically disposing of a portion of the reserved inventory. For the year ended September
      30, 2007, we recognized $96,000 of provision for excess and obsolete
      inventories. For the six months ended March 31, 2008, we recognized $1,000
      of
      provision for excess and obsolete inventories. The c omponents
      of inventories include (in thousands):





**March
                31,**
            
            **September
                30,****2008**
            
            **2007**Raw
                materials
            
            $
            603
            
            $
            675Work-in-progress
            
            
            161
            
            
            106Finished
                goods
            
            
            1,242
            
            
            786Total
            
            $
            2,006
            
            $
            1,567




6


**LONG-TERM
      INVESTMENTS**





As
      of
      March 31, 2008, we held an investment of common stock of a private Taiwanese
      telecommunication company valued at approximately $195,000 accounted for using
      the cost method. Our interest in the company is approximately 2%, which interest
      does not allow us to exercise significant influence.





In
      July
      2004, we purchased common stock of a private Korean telecommunications company
      for $79,000. As a result of this investment, we acquired approximately 23%
      of
      the voting power of the company. This gives us the right to nominate and elect
      one of the three members of the Company’s board of directors. We are accounting
      for this investment using the equity method and record our minority interest
      of
      their results in our results of operations. As of March 31, 2008, our investment
      in the Korean company had a remaining book value of approximately
      $14,000.





We
      perform periodic reviews of our investments for impairment. Our investments
      are
      considered impaired when a review of the issuer’s operations and other
      indicators of impairment indicate that the carrying value of the investment
      is
      not likely to be recoverable. Such indicators include, but are not limited
      to,
      limited capital resources, limited prospects of receiving additional financing,
      and limited prospects for liquidity of the related securities. No write-downs
      were recorded as of March 1, 2008.





**REVENUE
      RECOGNITION**





The
      Company recognizes revenue in accordance with Statement of Position (“SOP”)
      97-2, “Software Revenue Recognition.” Revenue consist of sales to end-users,
      including resellers, and to distributors. Revenue from sales to end-users
      including resellers are recognized upon shipment, when risk of loss has passed
      to the customer, collection of the receivable is reasonably assured, persuasive
      evidence of an arrangement exits, and the price is fixed and determinable.
      Sales
      to distributors are made under terms allowing certain rights of return and
      protection against subsequent price declines on the Company's products held
      by
      its distributors. Upon termination, any unsold products may be returned by
      the
      distributor for a full refund. These agreements may be canceled by either party
      based on a specified notice. As a result of the above provisions, 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. 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 evenly 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 unspecified upgrades/enhancements offered at no cost
      during Software Assurance arrangements historically have been and are expected
      to continue to be minimal and infrequent. All estimated costs of providing
      the
      services, including upgrades and enhancements are 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 of adoption, the Company has
      not
      restated the Company’s 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 stock price volatility. The
      Company estimates expected stock price volatility based on historical volatility
      rates since our initial public offering, 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
      underlying weighted-average assumptions used in the Black-Scholes model and
      the
      resulting estimates of fair value per share were as follows for options granted
      during the six months ended March 31, 2008 and 2007:




**Six
                  Months Ended March 31,**
              
              **Six
                  Months Ended March 31,****2008**
              
              **2007****Employee
                  Stock Option Plan**Expected
                  Life (in years)
              
              
              5
              
              
              5Risk-free
                  interest rate
              
              
              3.0
              %
              
              4.8
              %Volatility
              
              
              88
              %
              
              92
              %Dividend
                  yield
              
              
              0.0
              %
              
              0.0
              %**Employee
                  Purchase Plan**Expected
                  Life (in years)
              
              
              0.5
              
              
              0.5Risk-free
                  interest rate
              
              
              1.5
              %
              
              5.1
              %Volatility
              
              
              87
              %
              
              91
              %Dividend
                  yield
              
              
              0.0
              %
              
              0.0
              %


The
      following table presents stock-based compensation expense included in the
      accompanying consolidated statement of operations (in thousands):





**Three
                Months Ended**
              **March
                31,**
            
            **Six
                Months Ended**
              **March
                31,****2008**
            
            **2007**
            
            **2008**
            
            **2007**Cost
                of goods sold
            
            $
            6
            
            $
            4
            
            $
            9
            
            $
            11Research
                and development
            
            
            57
            
            
            36
            
            
            93
            
            
            89Selling,
                general and administrative
            
            
            188
            
            
            65
            
            
            378
            
            
            156Total
            
            $
            251
            
            $
            105
            
            $
            480
            
            $
            256





8


The
      following table summarizes the Company’s stock option plan as of October 1,
      2007, and changes during the six months ended March 31, 2008:




**Number
                  of Shares**
              
              **Weighted-**
                **average**
                **Exercise
                  Price**
              
              **Weighted-**
                **Average
                  Remaining**
                **Contractual
                  Life**
                **(in
                  years)**Outstanding
                  at October 1, 2007
              
              
              3,701,205
              
              $
              3.62Granted
              
              
              1,048,000
              
              
              1.30Exercised
              
              
              (72,674
              )
              
              0.63Forfeitures
                  and cancellations
              
              
              (110,246
              )
              
              3.83
 Outstanding
                  at March 31, 2008
              
              
              4,566,285
              
              $
              3.13
              
              
              5.76Vested
                  and expected to vest at March 31, 2008
              
              
              4,253,185
              
              $
              3.25
              
              
              5.50Exercisable
                  at March 31, 2008
              
              
              3,046,351
              
              $
              3.92
              
              
              4.00


At
      March
      31, 2008, the aggregate intrinsic value of outstanding stock options was $1.2
      million. At March 31, 2008, the total vested and expected to vest stock options
      represented 4.3 million shares, the weighted average exercise price was $3.25,
      the aggregate intrinsic value was $1.1 million, and the weighted average
      remaining contractual term was 5.5 years. At March 31, 2008, the total
      exercisable stock options represented approximately 3.0 million shares, the
      aggregate intrinsic value was $819,000, the weighted average exercise price
      was
      $3.92, and the weighted average remaining contractual term was 4.0
      years.





At
      March
      31, 2008, the Company has $858,000 in unamortized stock-based compensation
      related to our employee stock option plan. We estimate this expense will be
      amortized and recognized over the next 4 years.





Under
      the
      1999 Employee Stock Purchase Plan (the “1999 Purchase Plan”), we had reserved,
      as of September 30, 2007, 670,890 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). During
      the six months ended March 31, 2008, 95,830 shares were purchased by and
      distributed to employees at a price of $1.35 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. For the three
      and six months ended March 31, 2008, basic and diluted net loss per share
      numbers were identical as potential common shares resulting from the exercise
      of
      stock options were antidilutive and consequently excluded from the Company’s
      fully diluted share capital.





Basic
      and
      diluted loss per share for each of the three and six month periods ended March
      31, 2008 and 2007 were as follows (in thousands, except for per share data):





**Three
                Months Ended**
              **March
                31,**
            
            **Six
                Months Ended**
              **March
                31,****2008**
            
            **2007**
            
            **2008**
            
            **2007**Net
                loss
            
            $
            (1,127
            )
            $
            (172
            )
            $
            (2,098
            )
            $
            (266
            )Weighted
                average shares outstanding-basic loss per share
            
            
            15,708
            
            
            15,163
            
            
            15,753
            
            
            15,146Weighted
                average shares outstanding-
                diluted loss per share
            
            
            15,708
            
            
            15,163
            
            
            15,753
            
            
            15,146Basic
                loss per share
            
            $
            (0.07
            )
            $
            (0.01
            )
            $
            (0.13
            )
            $
            (0.02
            )Diluted
                loss per share
            
            $
            (0.07
            )
            $
            (0.01
            )
            $
            (0.13
            )
            $
            (0.02
            )





Options
      to purchase 4.5 million and 3.4 million shares of common stock were
      outstanding as of March 31, 2008 and 2007, respectively, and were excluded
      from
      the computation of diluted net loss per share for these periods because
      their effect would have been antidilutive.




9




**SEGMENT
      REPORTING**





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,****2008**
            
            **2007**
            
            **2008**
            
            **2007**Americas
            
            
            88
            %
            
            91
            %
            
            87
            %
            
            90
            %International
            
            
            12
            %
            
            9
            %
            
            13
            %
            
            10
            %Total
            
            
            100
            %
            
            100
            %
            
            100
            %
            
            100
            %




International
      is comprised of revenue primarily from China, the United Kingdom and Norway.
      Most significant long-lived assets are located in the United States. Our
      hardware tooling used to develop the IP710 and the IP705 phones as well as
      the
      tooling used to develop the face plate for the MAX1000 Voice over IP phone
      system are located in Taiwan.





Net
      revenue by customers that individually accounted for more than 10% of our
      revenue for the three and six months ended March 31, 2008 and 2007,
      respectively, were as follows :





**Three
                Months Ended**
              **March
                31,**
            
            **Six
                Months Ended**
              **March
                31,****2008**
            
            **2007**
            
            **2008**
            
            **2007**AltiSys
            
            
            15
            %
            
            14
            %
            
            16
            %
            
            14
            %Synnex
            
            
            34
            %
            
            54
            %
            
            35
            %
            
            51
            %Graybar
            
            
            15
            %
            
            13
            %
            
            14
            %
            
            15
            %Jenne
            
            
            11
            %
            
            —
            
            
            7
            %
            
            —Total
            
            
            75
            %
            
            81
            %
            
            72
            %
            
            80
            %





10


**2.
      WARRANTY**





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





Changes
      in our warranty liability for the three and six months ended March 31, 2008
      and
      2007, respectively, are as follows (in thousands):





**Three
                Months Ended**
              **March
                31,**
            
            **Six
                Months Ended**
              **March
                31,****2008**
            
            **2007**
            
            **2008**
            
            **2007**Beginning
                balance
            
            $
            145
            
            $
            267
            
            $
            148
            
            $
            263Provision
                for warranty liability
            
            
            40
            
            
            37
            
            
            80
            
            
            85Warranty
                cost including labor, components and scrap
            
            
            (40
            )
            
            (47
            )
            
            (83
            )
            
            (91
            )Ending
                balance
            
            $
            145
            
            $
            257
            
            $
            145
            
            $
            257





**3.
      COMMITMENTS AND CONTINGENCIES**





*Commitments*




We
      lease
      our facilities under various operating lease agreements expiring on various
      dates through February 2009. 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. The lease for its headquarters expires on February 21, 2009. Rent
      expense for all operating leases totaled approximately $170,000 and $338,000
      for
      the three and six months ended March 31, 2008, respectively as compared to
      $142,000 and $283,000 for the three and six months ended March 31, 2007,
      respectively. In June 2007, the Company’s Shanghai branch entered into a new
      lease agreement for a period of three years. The Company believes
      its current facilities are adequate to support its needs through the end of
      fiscal 2008. Additionally,
      the Company also leases certain equipment under capital lease arrangements.
      The
      minimum future lease payments under all noncancellable capital and operating
      leases as of March 31, 2008 are as follows (in thousands):




Fiscal
                  Years Ending September 30,
              
              **Capital**
                **Leases**
              
              **Operating**
                **Leases**Remainder
                  of 2008
              
              $
              22
              
              $
              3042009
              
              
              44
              
              
              4252010
              
              
              33
              
              
              3342011
              
              
              —
              
              
              16Total
                  contractual lease obligation
              
              $
              99
              
              $
              1,079Amount
                  representing interest
              
              $
              10Present
                  value of minimum lease payment
              
              $
              90Current
                  portion
              
              $
              38Long-term
                  portion
              
              
              52Total
                  capital lease commitments
              
              $
              90


*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.




11




**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. The repurchases will be made
      from time to time through November 14, 2008 at the Company’s discretion
      depending on 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. Under
      the
      currently active authority, the Company repurchased 213,515 shares in the six
      months ended March 31, 2008 for an aggregate cost of $346,000.







**5.
      SUBSEQUENT EVENT**





In
      April
      2008, we terminated our distribution agreement with Graybar. We believe the
      termination of our relationship with Graybar will not have a material impact
      on
      our business. As of March 31, 2008, the balances outstanding with Graybar were
      $170,000 in inventory and $414,000 in accounts receivable.





12


**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, 2007, including those set fourth 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 integrate with other technologies and provide
      integrated voice and data solutions. We believe this enables our customers
      to
      implement communication systems that have an increased return on investment
      versus past technology investments. We generated net revenue of $4.7 million
      and
      $9.0 million for the three and six months ended March 31, 2008, respectively,
      compared to net revenue of $4.1 million and $8.5 million for the three and
      six
      months ended March 31, 2007, respectively. As of March 31, 2008, we had an
      accumulated deficit of $54.2 million. Net cash used in operating activities
      was
      $221,000 for the six months ended March 31, 2008.





We
      derive
      our revenue from sales of our telephone systems. Product revenue is comprised
      of
      direct sales to end-users (including dealers) 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 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, 2008, were All Quality
      Services and Bestronics in San Jose, to insert the hardware components into
      the
      printed circuit board. We purchase fully-assembled chassis from Advantech
      Corporation, Analog phones from Fanstel Corporation and Internet protocol phones
      from BCM Communications, Inc. 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 that 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 them have no
      significant investment on their books for traditional phone systems. Also,
      we
      believe that small-to medium-sized businesses are looking for call center-type
      administration to increase the productivity and efficiency of their contacts
      with customers. Assuming that current market trends continue as a result of
      our
      enhanced products, we expect to see continued revenue growth for fiscal year
      2008. These trends include the growth in acceptance of our call center products,
      the growth in the marketplaces of Asia, Latin America, the Caribbean, and the
      status quo of the North American economy.




13




**CRITICAL
      ACCOUNTING POLICIES**





*Revenue
      Recognition.* Net
      sales
      consist primarily of revenue from direct sales to
      end-users, including resellers, and sales to distributors. We recognize
      r evenue
      pursuant to SEC Staff Accounting Bulletin ("SAB") No. 104, *Revenue
      Recognition* ,
      (“SAB
      No. 104”). Revenue from sales to end-users are recognized upon shipment, when
      risk of loss has passed to the customer, collection of the receivable is
      reasonably assured, persuasive evidence of an arrangement exists, and the 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 its distributors. Upon termination, any unsold products may be returned
      by
      the distributor for a full refund. These agreements may be canceled without
      cause by either party 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. Our total deferred
      revenue was $1.9 million and $486,000 as of March 31, 2008 and 2007,
      respectively. This increase was primarily attributable to an increase of
      $654,000 in software assurance revenue and an increase of approximately $689,000
      in distribution channels.





*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. 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
      evenly 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 unspecified upgrades/enhancements offered at no cost
      during Software Assurance arrangements historically have been and are expected
      to continue to be minimal and infrequent. All estimated costs of providing
      the
      services, including upgrades and enhancements are spread over the life of the
      Software Assurance term.





*Cash
      and Cash Equivalents* .
      Cash
      and cash equivalents include cash on hand, deposits with banks and highly liquid
      investments with a time to maturity of three months or less at the time of
      purchase.




*Short-Term
      Investment.* 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. We report our available-for-sale securities at their fair
      value. Further, we recognize unrealized gains and losses in our available-for
      sale securities as an increase or reduction in shareholders’ equity. We evaluate
      our available-for-sale securities for impairment quarterly.





*Inventory* .
      Inventory is stated at the lower of cost (first-in, first-out method) or market.
      Our inventory balance was $2.0 million and $1.9 million as of March 31, 2008
      and
      March 31, 2007, respectively. 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 which management
      believed would not be sold. The reserve was reduced by $1,000 in the six months
      ended March 31, 2008 as compared to an increase of $9,000 during the same period
      in the prior year. During
      the quarter ended March 31, 2008, we disposed of fully-reserved inventory with
      original cost at $411,000. We attribute this overall reduction in
      obsolete inventory to sales of inventory previously reserved as well as
      physically disposing of a portion of the reserved inventory. As of March 31,
      2008 and 2007, respectively, inventory allowance was $1.9 million and $2.3
      million.





*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 liability for product
      warranties was $145,000 and $257,000 as of March 31, 2008 and March 31, 2007,
      respectively. 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.




14




**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,****2008**
            
            **2007**
            
            **2008**
            
            **2007**Consolidated
                Statements of Operations Data:Net
                revenue:Hardware
            
            
            87.6
            %
            
            92.7
            %
            
            86.5
            %
            
            91.6
            %Software
            
            
            12.4
            
            
            7.3
            
            
            13.5
            
            
            8.4Total
                net revenue
            
            
            100.0
            
            
            100.0
            
            
            100.0
            
            
            100.0Cost
                of revenue:Hardware
            
            
            42.8
            
            
            45.3
            
            
            42.4
            
            
            45.3Software
            
            
            1.6
            
            
            0.7
            
            
            1.5
            
            
            0.7Total
                cost of revenue
            
            
            44.4
            
            
            46.0
            
            
            43.9
            
            
            46.0Gross
                profit
            
            
            55.6
            
            
            54.0
            
            
            56.1
            
            
            54.0Operating
                expenses:Research
                and development
            
            
            22.0
            
            
            19.9
            
            
            21.7
            
            
            19.3Sales
                and marketing
            
            
            39.1
            
            
            26.8
            
            
            40.2
            
            
            26.7General
                and administrative
            
            
            20.1
            
            
            14.2
            
            
            19.6
            
            
            13.8Total
                operating expenses
            
            
            81.2
            
            
            60.9
            
            
            81.5
            
            
            59.8Loss
                from operations
            
            
            (25.6
            )
            
            (6.9
            )
            
            (25.4
            )
            
            (5.8
            )Equity
                in net loss of investee
            
            
            (0.1
            )
            
            (
                0.0
            )
            
            (
                0.0
            )
            
            (
                0.0
            )Interest
                and other income, net
            
            
            1.7
            
            
            2.8
            
            
            2.2
            
            
            2.8Net
                loss before taxes
            
            
            (24.0
            )
            
            (4.1
            )
            
            (23.2
            )
            
            (3.0
            )Provision
                for income taxes
            
            
            (
                0.0
            )
            
            (0.1
            )
            
            (
                0.0
            )
            
            (0.1
            )Net
                loss
            
            
            (24.0
            )%
            
            (4.2
            )%
            
            (23.2
            )%
            
            (3.1
            )%





15


**Net
      Revenue**





Net
      sales
      consist primarily of revenue from direct sales to end-users, including
      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,****2008**
            
            **2007**
            
            **2008**
            
            **2007**Americas
            
            
            88
            %
            
            91
            %
            
            87
            %
            
            90
            %International
            
            
            12
            %
            
            9
            %
            
            13
            %
            
            10
            %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, 2008 and 2007,
      respectively, were as follows :





**Three
                Months Ended**
              **March
                31,**
            
            **Six
                Months Ended**
              **March
                31,****2008**
            
            **2007**
            
            **2008**
            
            **2007**AltiSys
            
            
            15
            %
            
            14
            %
            
            16
            %
            
            14
            %Synnex
            
            
            34
            %
            
            54
            %
            
            35
            %
            
            51
            %Graybar
            
            
            15
            %
            
            13
            %
            
            14
            %
            
            15
            %Jenne
            
            
            11
            %
            
            —
            
            
            7
            %
            
            —Total
            
            
            75
            %
            
            81
            %
            
            72
            %
            
            80
            %





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,****2008**
            
            **2007**
            
            **2008**
            
            **2007**Hardware
            
            
            88
            %
            
            93
            %
            
            86
            %
            
            92
            %Software
            
            
            12
            %
            
            7
            %
            
            14
            %
            
            8
            %Total
            
            
            100
            %
            
            100
            %
            
            100
            %
            
            100
            %





Net
      revenue increased 14% to $4.7 million for the three months ended March 31,
      2008
      as compared to $4.1 for the three months ended March 31, 2007. Revenue
      generated in the Americas segment accounted for $4.1 million, or 88%
      compared to $3.8 million, or 91% of our total revenue, for the three months
      ended March 31, 2008 and March 31, 2007, respectively. Revenue generated in
      the
      International segment accounted for $576,000, or 12% compared to $386,000,
      or 9%
      of our total revenue, for the three months ended March 31, 2008 and March 31,
      2007, respectively. The
      increase in net revenue in the Americas segment was primarily
      attributable to change in our product mix. Net revenue from sales of our smaller
      systems decreased approximately 14.9% while larger systems increased 109%.
      During the three months ended March 31, 2008, the number of systems shipped
      was
      0.78% lower than the corresponding period in the previous year but the average
      revenue per system was higher by approximately 7.11%, reflecting a higher number
      of extensions per system shipped. Additionally, during the three month ended
      March 31, 2008, we recognized $130,000 in software assurance revenue. 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. 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 evenly over the
      terms
      of the subscriptions.





Net
      revenue increased 5% to $9.0 million for the six months ended March 31, 2008
      as
      compared to $8.5 for the six months ended March 31, 2007. Revenue
      generated in the Americas segment accounted for $7.8 million, or 87%
      compared to $7.7 million, or 90% of our total revenue, for the six months ended
      March 31, 2008 and March 31, 2007, respectively. Revenue generated in the
      International segment accounted for $1.2 million, or 13% compared to $819,000,
      or 10% of our total revenue, for the six months ended March 31, 2008 and March
      31, 2007, respectively. The
      increase in net revenue in the Americas was primarily due to an increase of
      2.4%
      in the number of systems shipped compared to the corresponding period in the
      previous year.




16




**Cost
      of Revenue**





Cost
      of
      revenue for the three months ended March 31, 2008 increased $188,000, or 10%
      to
      $2.1 million from approximately $1.9 million for the three months ended March
      31, 2007. The increase was primarily caused by a shift in our product mix to
      larger sized systems with more extensions. Cost of revenue for the six months
      ended March 31, 2008 and March 31, 2007 was $3.9 million, respectively.





**Research
      and Development (“R&D”)**




Research
      and development expenses consist primarily of costs related to personnel and
      overhead expenses, consultant expenses and other costs associated with design,
      development, prototyping and testing of our products and enhancements of our
      converged telephone system software. Research and development expenses increased
      to $1.0 million, or 22% of net revenue, for the three months ended March 31,
      2008 from $825,000, or 20% of net revenue, for the same period in fiscal 2007.
      The expense increase in absolute dollars was primarily attributable to an
      increase in personnel-related expense of approximately $202,000 due to an
      increase in headcount; and an increase of $21,000 in non-cash stock-based
      compensation required by SFAS No. 123(R). Research and development expense
      increased to $1.9 million, or 22% of net revenue, for the six months ended
      March
      31, 2008 from $1.6 million, or 19% of net revenue, for the same period in fiscal
      2007. This increase in absolute dollars is attributable to an increase in
      personnel-related and overhead expenses of approximately $323,000. The
      increase in personnel-related expensed was the result of increased headcount
      of
      approximately 5%.




We
      believe that continued spending on research and development expenses will
      increase in the future periods over the long term to remain competitive. In
      the
      short term, we expect research and development expenses to remain consistent
      as
      management continues to monitor expenses and plans to keep them in line with
      expected revenue opportunities.





**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. Sales
      and marketing expenses increased to $1.8 million, or 39% of net revenue, for
      the
      three months ended March 31, 2008 from approximately $1.1 million, or 27% of
      net
      revenue, for the three months ended March 31, 2007. This increase in absolute
      dollars was primarily attributable to an increase of $342,000 in
      personnel-related expenses; $33,000 increase in travel related expenses; $51,000
      increase in service related expenses; $185,000 increase in partner conference
      expenses; increased advertising expenses of approximately $40,000; and $38,000
      increase in non-cash stock-based compensation expenses. The
      most
      significant factor contributing to the increase in personnel-related expenses
      was an increase in headcount. For
      the
      six months ended March 31, 2008, sales and marketing expenses increased to
      $3.6
      million or 40% of net revenue from approximately $2.3 million, or 27% of net
      revenue, for the same period in fiscal 2007. The expense increase in absolute
      dollars was the result of increased advertising expenses of approximately
      $104,000; increased partner conference expenses of approximately $165,000;
      $58,000 increase in travel related expenses; and an increase in
      personnel-related expenses of approximately $734,000 due to an increase in
      headcount of 13 employees. Other factors include an increase of $144,000 in
      service related expenses; $43,000 increase in non-cash stock-based compensation
      expenses; and $49,000 increases in consulting related expenses.





We
      anticipate sales and marketing expenses will increase in future periods over
      the
      long term due to increased staffing levels, particularly in sales, increased
      marketing activities and increased commission expense to the extent we achieve
      higher sales levels.





**General
      and Administrative (“G&A”)**





General
      and administrative expenses consist of salaries and related expenses for
      executive, finance and administrative personnel, facilities, allowance for
      doubtful accounts, legal, and other general corporate expenses. General and
      administrative expenses increased to $946,000, or 20% of net revenue, for the
      three months ended March 31, 2008 from $590,000, or 14% of net revenue, for
      the
      same period in the prior year. T he
      increase in absolute dollars in general and administrative was driven by an increase
      in personnel-related expenses of approximately $131,000; $24,000 increase in
      travel related expenses; $86,000 increase in non-cash stock based compensation
      expense required by SFAS No. 123(R); $34,000 increase in relocation expenses;
      and $48,000 increase in service and consulting related expenses. The increases
      in personnel-related, travel, non-cash stock based compensation and relocation
      expenses are directly tied to the hiring
      of
      our new president and chief operating officer. General
      and administrative expenses for the six months ended March 31, 2008 increased
      to
      $1.8 million, or 20% of net revenue, from $1.2 million, or 14% of net revenue
      for the six months ended March 31, 2007. This was mainly the result of a $60,000
      increase in service and consulting related expense; increased payroll related
      expenses of approximately $211,000; $19,000 increase in accounting fees; $43,000
      increase in relocation expenses; $41,000 increase in travel relates expenses;
      $23,000 banking fees; and approximately $179,000 increase in non-cash stock
      based compensation expense required by SFAS No. 123(R). Approximately $46,000
      of
      service and consulting related expenses were related to SOX
      Section 404 compliance testing. The increase in payroll related expenses are
      directly tied to the hiring
      of
      our new president and chief operating officer.




17




We
      expect
      general and administrative expenses to continue to increase due to the cost
      associated with compliance with Section 404 of the Sarbanes-Oxley Act during
      fiscal year 2008.





**Equity
      Investment in Common Stock of Private Company**





Equity
      investment in common stock of private company is primarily our allocated portion
      of the net income or losses of a private Korean telecommunications company
      that
      we acquired an ownership
      interest in
      July
      2004 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, 2008, the total equity loss with respect to
      this company was approximately $6,000 compared to net losses of $1,000 for
      the
      same period in fiscal 2007. For the six months ended March 31, 2008 and 2007,
      t he
      total equity loss with respect to this company was approximately $3,000 and
      $4,000 respectively.




**Interest
      Expense and Other Income, Net**





Net
      interest and other income decreased to $82,000 and $194,000 for the three and
      six months ended March 31, 2008, respectively, from $115,000 and $235,000 for
      the same periods in fiscal 2007. The
      change was directly related to lower interest rates. The
      weighted average interest rate earned by us on our cash, cash equivalents,
      and
      short-term investments decreased to 3.72% in the six months ended March 31,
      2008
      as compared to the 5.75% rate earned during the same period in fiscal 2007. We
      expect
      net interest and other income to remain relatively flat with little change
      in
      cash available to invest.




18




**Liquidity
      and Capital Resources**





Since
      inception, we have financed our operations primarily through the sale of equity
      securities. As of March 31, 2008, we held cash, cash equivalents and short-term
      investments totaling $9.5 million. As of March 31, 2008, $9.1 million of our
      total assets are classified as cash and cash equivalents compared with $6.8
      million as of March 31, 2007. Short-term investments were approximately $404,000
      and $3.0 million as of March 31, 2008 and 2007, respectively.





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):





**Six
                Months Ended**
              **March
                31,****2008**
            
            **2007**Cash
                and cash equivalents
            
            $
            9,074
            
            $
            6,813Short-term
                investments
            
            
            404
            
            
            3,010Total
                cash, cash equivalents and short-term investments
            
            $
            9,478
            
            $
            9,823




**Six
                Months Ended**
              **March
                31,****2008**
            
            **2007**Net
                cash used in operating activities
            
            $
            (221
            )
            $
            (175
            )Net
                cash provided by investing activities
            
            
            3,374
            
            
            1,826Net
                cash provided by (used in) financing activities
            
            
            (190
            )
            
            109Net
                increase in cash, cash equivalents, end of period
            
            $
            2,963
            
            $
            1,760





*Changes
      in Cash Flows*





During
      the six months ended March 31, 2008, our net cash used in operating
      activities was $221,000, which was approximately $46,000 higher than the cash
      used in operating activities during the same period in fiscal 2007. This was
      primarily attributable to our net loss of $2.1 million, an increase of $439,000
      in inventories, an increase of $490,000 in accounts payable, $1.3 million
      increase in deferred revenue, $131,000 increase in accrued liabilities and
      an
      increase of $127,000 in prepaid expenses. The cash impact of the loss for the
      six months ended March 31, 2008 was partially offset by non-cash adjustments
      of
      $125,000 in depreciation and amortization costs, and non-cash stock-based
      compensation expense of $480,000. The change in deferred revenue was primarily
      due to an increase of $588,000 in our software assurance sales as well as an
      increase of $676,000 in deferred channel due to more products being shipped
      to
      distribution channels than 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. Net cash used in operating
      activities of $175,000 in the six months ended March 31, 2007  was
      primarily due to a decrease of $648,000 in accounts receivable, a $162,000
      reduction in accounts payable, approximately $45,000 decrease in deferred
      revenue and a decrease of $256,000 in stock based compensation expense. These
      factors were partially offset by an increase in net inventories of $568,000,
      depreciation and amortization of approximately $124,000 and prepaid expenses
      of
      $81,000.





For
      the
      six months ended March 31, 2008, net cash provided by investing activities
      was
      $3.4 million as compared $1.8 million during the same period in fiscal 2007.
      This was directly related to purchases of short-term investments and proceeds
      from maturities of short-term investments.





Net
      cash
      used in financing activities for the six months ended March 31, 2008 was
      approximately $190,000 as compared to net cash provided by financing activities
      of $109,000 during the same period in fiscal 2007. This change was primarily
      related to the repurchase of treasury stock approved 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. The repurchases will be made from time to time through
      November 14, 2008 at our management’s discretion depending on 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. Under
      the
      currently active authority, we repurchased 213,515 shares in the six months
      ended March 31, 2008 for an aggregate cost of $346,000. Current cash balances
      and the proceeds from stock option exercises and purchases in the stock purchase
      plan have funded stock repurchases.




19




Net
      accounts receivable remained unchanged at $2.7 million at March 31, 2008 and
      at
      September 30, 2007.





We
      ended
      the first quarter of fiscal 2008 with a cash conversion cycle of 82 days as
      compared to 95 days for the second quarter of fiscal 2007. The cash conversion
      cycle is the duration between purchase of inventories and services and the
      collection of the cash from the sale of our products and services and is a
      metric on which we have focused as we continue to try to efficiently manage
      our
      assets. The cash conversion cycle results from the calculation of days of sales
      outstanding (DSO) added to days of supply in inventories (DOS), reduced by
      days
      of payable outstanding (DPO).





Inventories
      increased to $2.0 million at March 31, 2008 from $1.6 million at
      September 30, 2007 and our inventory turn rate decreased to 4.2 at March
      31, 2008 from 5.7 at September 30, 2007. The
      increased inventory level was primarily attributable to an increase in finished
      goods of approximately 58% due to the need to build up inventory for
      early shipments in early third quarter of fiscal 2008. We regularly provide
      forecasts to our contract manufacturers, and we order products from our contract
      manufacturers based on our projected sales levels well in advance of receiving
      actual orders from our customers. We seek to maintain sufficient levels of
      finished goods inventory to meet our forecasted product sales with limited
      levels of inventory to compensate for unanticipated shifts in sales volume
      and
      product mix. Our
      annualized inventory turn rate represents the number of times inventory is
      replenished during the year. Inventory management will continue to be an area
      of
      focus as we balance the need to maintain strategic inventory levels to help
      ensure competitive lead times with the risk of inventory obsolescence due to
      rapidly changing technology and customer requirements.





Accounts
      payable increased to $1.3 million at March 31, 2008 from $821,000 at
      September 30, 2007. This
      increase to accounts payable during this period was primarily attributable
      to an
      increase in the number of components purchased in the second quarter of fiscal
      2008. Approximately $270,000 of this increase was associated with the Internet
      protocol phones which we purchase from BCM Communications.





*Liquidity
      and Capital Resources*





As
      of
      March 31, 2008, our principal sources of liquidity included cash, cash
      equivalents and short-term investments of approximately $9.5 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 obtain the right to use complementary technologies.
      If we cannot raise needed 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,
      2008.
      We had total outstanding commitments on noncancelable capital and operating
      leases of $1.2 million as of March 31, 2008. Lease terms on our existing
      facility operating leases generally range from three to nine years. We believe
      that we have sufficient cash reserves to allow us to continue our current
      operations for more than a year.




20




The
      following table presents certain payments due by us under contractual
      obligations with minimum firm commitments as of March 31, 2008:




**Payment
                  Due by Period (in thousands)****Contractual
                  Obligations**
              
              **Total**
              
              **Payments
                  Due in Less**
                **Than
                  1 Year**
              
              **Payments
                  Due in**
                **1
                  - 3 Years**
              
              **Payments**
                **Due
                  in**
                **3
                  - 5 Years**
              
              **Payments
                  Due**
                **in
                  More**
                **Than
                  5 Years**Operating
                  leases obligation
              
              $
              1,079
              
              $
              304
              
              $
              775
              
              $
              —
              
              $
              —Capital
                  leases obligation
              
              
              99
              
              
              22
              
              
              77
              
              
              —
              
              
              —Total
                  contractual lease obligation
              
              $
              1,178
              
              $
              326
              
              $
              852
              
              $
              —
              
              $
              —
 **Effects
        of Recently Issued Accounting Pronouncements**





In
      July
      2006, the FASB issued FASB Interpretation No. (“FIN”) 48, *Accounting
      for Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109,
      “Accounting for Income Taxes* ,”
which
      seeks to reduce the diversity in practice associated with certain aspects of
      measurement and recognition in accounting for income taxes. In addition, FIN
      48
      provides guidance on derecognition, classification, interest penalties and
      accounting in interim periods, and requires expanded disclosure with respect
      to
      the uncertainty in income taxes. W e
      adopted the provisions of FIN 48 on October 1, 2007. There was no impact on
      our
      consolidated financial position, results of operations and cash flows as a
      result of adoption. We have no unrecognized tax benefit as of March 31, 2008,
      including no accrued amounts for interest and penalties.




21




**Item
      3. Quantitative and Qualitative Disclosures About Market
      Risk**





*Interest
      Rate Risk*





At
      March
      21, 2008, our investment portfolio consisted primarily of fixed income
      securities. 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,
      the
      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, 2008, 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 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. A
      hypothetical 10% favorable or unfavorable change in foreign currency exchange
      rates would not have a material impact on our results of
      operations.




**Item
      4. Controls and Procedures**





*Evaluation
      of Disclosure Controls and Procedures*





Our
      management carried out an evaluation, under the supervision and with the
      participation of our President and Chief Executive Officer and our Chief
      Financial Officer, of the effectiveness of our disclosure controls and
      procedures as of the end of our quarter ended March 31, 2008 pursuant to
      Exchange Act Rule 13a-15(e) and 15d-15(e). The term “disclosure controls
      and procedures,” as defined under the Exchange Act, 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, 2008, 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, 2008 that have materially affected,
      or are reasonably likely to materially affect, our internal controls over
      financial reporting.




22




**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
      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. This authorization was announced
      on November 14, 2007. Current cash balances and the proceeds from stock option
      exercises and employee stock purchase plan purchases have funded the stock
      repurchase program. Pursuant to the 2007 Board of Directors’ authorization, we
      repurchased 213,515 shares in the six months ended March 31, 2008, at an
      approximate cost of $346,000. This authorization expires on November 14,
      2008.





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**
            
            **Total Number of**
              **Shares**
              **Purchased**
              **as Part of 
                Publicly**
              **Announced**
              **Program**
            
            **Maximum**
              **Number of**
              **Shares that**
              **May Yet**
              **be Purchased**
              **Under**
              **the Program**November
                1, 2007 through November 30, 2007
            
            
            16,413
            
            $
            1.59
            
            
            16,413
            
            
            1,983,587December
                1, 2007 through December 31, 2007
            
            
            92,965
            
            
            1.60
            
            
            109,378
            
            
            1,890,622February
                1, 2008 through February 29, 2008
            
            
            80,218
            
            
            1.66
            
            
            189,596
            
            
            1,810,404March
                1, 2008 through March 31, 2008
            
            
            23,919
            
            
            1.61
            
            
            213,515
            
            
            1,786,485Total
            
            
            213,515
            
            $
            1.61
            
            
            213,515
            
            
            1,786,485




23


**Item
      6. Exhibits****.**




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




24





**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, 2008
            By:
            /s/
                Philip M. McDermottPhilip
                M. McDermott,Chief
                Financial Officer(Principal
                Financial and Accounting Officer)




25





**EXHIBIT
      INDEX**





**Exhibit**
              **Number**
            
            **Description**3.1
                (1)
            
            Amended
                and Restated Certificate of Incorporation.3.2
                (2)
            
            Second
                Amended and Restated Bylaws.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, file
                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, file
                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.




26