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, 2010


OR


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


FOR
THE TRANSITION PERIOD
FROM                      TO





Commission
File Number  000-27427








ALTIGEN
COMMUNICATIONS, INC.


(Exact
name of Registrant as specified in its charter)





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





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







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





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





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





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





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





The
number of shares of our common stock, par value $0.001 per share, outstanding as
of May 10, 2010 was: 16,433,397 shares.












ALTIGEN
COMMUNICATIONS, INC.


QUARTERLY
REPORT ON FORM 10-Q


FOR
THE QUARTERLY PERIOD ENDED MARCH 31, 2010


TABLE OF CONTENTS





PART
      I.  FINANCIAL INFORMATIONItem
      1.
                    Condensed
      Consolidated Financial Statements (Unaudited)
                    3Condensed
      Consolidated Balance Sheets as of March 31, 2010 and September 30,
      2009
                    3Condensed
      Consolidated Statements of Operations for the Three and Six Months Ended
      March 31, 2010 and 2009
                    4Condensed
      Consolidated Statements of Cash Flows for the Six Months Ended March 31,
      2010 and 2009
                    5Notes
      to Condensed Consolidated Financial Statements
                    6Item
      2.
                    Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                    15Item
      3.
                    Quantitative
      and Qualitative Disclosures about Market Risk
                    24Item
      4.
                    Controls
      and Procedures
                    24PART
      II.  OTHER INFORMATIONItem
      1.
                    Legal
      Proceedings
                    25Item
      1A
                    Risk Factors
                    25Item
      5.
                    Other
      Information
                    33Item
      6.
                    Exhibits
                    34SIGNATURE
                    35EXHIBIT INDEX
                    36


2


PART
I.  FINANCIAL INFORMATION





Item
      1.
            Condensed
      Consolidated Financial Statements





ALTIGEN
COMMUNICATIONS, INC. AND SUBSIDIARY


CONDENSED
CONSOLIDATED BALANCE SHEETS


(In
thousands, except share and per share amounts)





March 31,
                
                
                September 30,2010
                
                
                2009(Unaudited)
                
                
                
                (1)ASSETSCurrent
      assets:Cash
      and cash equivalents
                
                $
                7,505
                
                
                $
                7,397Accounts
      receivable, net of allowances of $20 and $35 at March 31, 2010
      and  September 30, 2009, respectively
                
                
                1,269
                
                
                
                1,545Inventories
                
                
                1,039
                
                
                
                1,266Prepaid
      expenses and other current assets
                
                
                320
                
                
                
                128Total
      current assets
                
                
                10,133
                
                
                
                10,336Property,
      plant and equipment, net
                
                
                475
                
                
                
                501Long-term
      investments
                
                
                202
                
                
                
                202Long-term
      deposit
                
                
                201
                
                
                
                292Total
      assets
                
                $
                11,011
                
                
                $
                11,331LIABILITIES
      AND STOCKHOLDERS' EQUITYCurrent
      liabilities:Accounts
      payable
                
                $
                1,242
                
                
                $
                1,165Accrued
      liabilities:Payroll
      and related benefits
                
                
                385
                
                
                
                672Warranty
                
                
                125
                
                
                
                122Marketing
                
                
                131
                
                
                
                111Accrued
      expenses
                
                
                425
                
                
                
                215Other
      accrued liabilities
                
                
                418
                
                
                
                484Total
      accrued liabilities
                
                
                1,484
                
                
                
                1,604Deferred
      revenue, short-term
                
                
                2,647
                
                
                
                2,573Total
      current liabilities
                
                
                5,373
                
                
                
                5,342Other
      long-term liabilities
                
                
                318
                
                
                
                232Commitments
      and contingencies (Note 3)Stockholders'
      equity:Convertible
      preferred stock, $0.001 par value; Authorized—5,000,000 shares;
      Outstanding—none at March 31, 2010 and September 30,
    2009
                
                
                —
                
                
                
                —Common
      stock, $0.001 par value; Authorized—50,000,000 shares;
      Outstanding—16,431,022 shares at March 31, 2010 and 16,188,857 shares at
      September 30, 2009
                
                
                18
                
                
                
                17Treasury
      stock at cost—1,318,830 shares at March 31, 2010 and September 30,
      2009
                
                
                (1,400
                )
                
                
                (1,400
                )Additional
      paid-in capital
                
                
                68,135
                
                
                
                67,716Accumulated
      other comprehensive income
                
                
                118
                
                
                
                165Accumulated
      deficit
                
                
                (61,551
                )
                
                
                (60,741
                )Total
      stockholders' equity
                
                
                5,320
                
                
                
                5,757Total
      liabilities and stockholders' equity
                
                $
                11,011
                
                
                $
                11,331





(1) The
information in this column was derived from the Company’s audited consolidated
financial statements as of and for the year ended September 30,
2009.




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


3





ALTIGEN
COMMUNICATIONS, INC. AND SUBSIDIARY


CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS


(In
thousands, except per share data)


(Unaudited)




Three Months Ended
                  March
      31,
              
              
              Six
      Months Ended
                  March
      31,2010
              
              
              2009
              
              
              2010
              
              
              2009Net
      revenue:Hardware
              
              $
              2,862
              
              
              $
              2,461
              
              
              $
              5,636
              
              
              $
              6,027Software
              
              
              689
              
              
              
              474
              
              
              
              1,269
              
              
              
              1,139Service
      support
              
              
              870
              
              
              
              642
              
              
              
              1,737
              
              
              
              1,271Total
      net revenue
              
              
              4,421
              
              
              
              3,577
              
              
              
              8,642
              
              
              
              8,437Cost
      of revenue:Hardware
              
              
              1,491
              
              
              
              1,466
              
              
              
              2,899
              
              
              
              3,360Software
              
              
              6
              
              
              
              4
              
              
              
              9
              
              
              
              8Service
      support
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —Total
      cost of revenue
              
              
              1,497
              
              
              
              1,470
              
              
              
              2,908
              
              
              
              3,368Gross
      profit
              
              
              2,924
              
              
              
              2,107
              
              
              
              5,734
              
              
              
              5,069Operating
      expenses:Research
      and development
              
              
              1,087
              
              
              
              1,243
              
              
              
              2,234
              
              
              
              2,468Sales
      and marketing
              
              
              1,291
              
              
              
              1,840
              
              
              
              2,670
              
              
              
              3,924General
      and administrative
              
              
              887
              
              
              
              811
              
              
              
              1,662
              
              
              
              1,782Total
      operating expenses
              
              
              3,265
              
              
              
              3,894
              
              
              
              6,566
              
              
              
              8,174Loss
      from operations
              
              
              (341
              )
              
              
              (1,787
              )
              
              
              (832
              )
              
              
              (3,105
              )Equity
      in net loss of investee
              
              
              —
              
              
              
              (3
              )
              
              
              —
              
              
              
              (6
              )Interest
      and other income, net
              
              
              1
              
              
              
              23
              
              
              
              23
              
              
              
              59Net
      loss before taxes
              
              
              (340
              )
              
              
              (1,767
              )
              
              
              (809
              )
              
              
              (3,052
              )Income
      taxes
              
              
              —
              
              
              
              —
              
              
              
              (1
              )
              
              
              16Net
      loss
              
              $
              (340
              )
              
              $
              (1,767
              )
              
              $
              (810
              )
              
              $
              (3,036
              )Basic
      and diluted net loss per share
              
              $
              (0.02
              )
              
              $
              (0.11
              )
              
              $
              (0.05
              )
              
              $
              (0.19
              )Weighted
      average shares used in computing basic and diluted net loss per
      share
              
              
              16,430
              
              
              
              15,862
              
              
              
              16,361
              
              
              
              15,842





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


4





ALTIGEN
COMMUNICATIONS, INC. AND SUBSIDIARY


CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS


(Unaudited)




Six Months Ended
                              March 31,2010
                            
                            
                            2009(In
      thousands)Cash
      flows from operating activities:Net
      loss
                            
                            $
                            (810
                            )
                            
                            $
                            (3,036
                            )Adjustments
      to reconcile net loss to net cash (used in) provided by operating
      activities:Depreciation
      and amortization
                            
                            
                            98
                            
                            
                            
                            110Stock-based
      compensation
                            
                            
                            370
                            
                            
                            
                            410Equity
      in net income of investee
                            
                            
                            —
                            
                            
                            
                            6Changes
      in operating assets and liabilities:Accounts
      receivable
                            
                            
                            276
                            
                            
                            
                            1,325Inventories
                            
                            
                            227
                            
                            
                            
                            (377
                            )Prepaid
      expenses and other current assets
                            
                            
                            (192
                            )
                            
                            
                            (106
                            )Accounts
      payable
                            
                            
                            77
                            
                            
                            
                            110Accrued
      liabilities
                            
                            
                            (120
                            )
                            
                            
                            (133
                            )Deferred
      revenue, short-term
                            
                            
                            74
                            
                            
                            
                            375Other
      long-term liabilities
                            
                            
                            86
                            
                            
                            
                            21Net
      cash provided by (used in) operating activities
                            
                            
                            86
                            
                            
                            
                            (1,295
                            )Cash
      flows from investing activities:Purchases
      of short-term investments
                            
                            
                            —
                            
                            
                            
                            (5,460
                            )Proceeds
      from sale of short-term investments
                            
                            
                            —
                            
                            
                            
                            3,338Changes
      in long-term deposits
                            
                            
                            91
                            
                            
                            
                            —Purchases
      of property and equipment
                            
                            
                            (73
                            )
                            
                            
                            (139
                            )Net
      cash provided by (used in) investing activities
                            
                            
                            18
                            
                            
                            
                            (2,261
                            )Cash
      flows from financing activities:Proceeds
      from issuances of common stock, net of issuance costs
                            
                            
                            51
                            
                            
                            
                            63Repurchase
      of treasury stock
                            
                            
                            —
                            
                            
                            
                            (19
                            )Net
      cash provided by financing activities
                            
                            
                            51
                            
                            
                            
                            44Effect
      of exchange rate changes on cash and cash equivalents
                            
                            
                            (47
                            )
                            
                            
                            —Net
      change in cash and cash equivalents during period
                            
                            
                            108
                            
                            
                            
                            (3,512
                            )Cash
      and cash equivalents, beginning of period
                            
                            
                            7,397
                            
                            
                            
                            9,467Cash
      and cash equivalents, end of period
                            
                            $
                            7,505
                            
                            
                            $
                            5,955





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




5




ALTIGEN
COMMUNICATIONS, INC. AND SUBSIDIARY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS





1.  SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES





BASIS
OF PRESENTATION





AltiGen
Communications, Inc. (“AltiGen,” “we” or the “Company’) is a leading provider of
100% Microsoft-based Voice over Internet Protocol (VoIP) business phone systems
and Unified Communications solutions. We design, deliver and support VoIP phone
systems and call center solutions that combine high reliability with integrated
IP communications applications.  As one of the first companies to
offer VoIP solutions, AltiGen has been deploying systems since 1996. We have
more than 10,000 customers worldwide with over 15,000 systems in use. Our
telephony solutions are primarily used by small- to medium-sized businesses,
companies with multiple locations, corporate branch offices, and call
centers.




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




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





These
financial statements should be read in conjunction with our audited consolidated
financial statements for the fiscal year ended September 30, 2009, included in
the Company’s 2009 Annual Report on Form 10-K filed with the SEC on December 28,
2009, as amended. The Company’s results of operations for any interim period are
not necessarily indicative of the results of operations for any other interim
period or for a full fiscal year.





CASH
AND CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS





The
Company’s policy is to invest in highly-rated securities with strong liquidity
and requires investments to be rated single-A or better. Our investment
portfolio consists entirely of investment grade institutional money market funds
and bank term deposits. We consider all highly liquid investments purchased with
an initial maturity of three months or less to be cash equivalents. Short-term
investments are highly liquid financial instruments with original maturities
greater than three months but less than one year and are classified as
“available-for-sale” investments. We classify our available-for-sale securities
as current assets and report them at their fair value. Further, we recognize
unrealized gains and losses related to these securities as an increase or
reduction to shareholders’ equity as a component of other comprehensive income
(loss). We evaluate our available-for-sale securities for impairment quarterly.
The Company did not hold any short-term investments at September 30, 2009 and
March 31, 2010.


6


INVENTORIES





Inventories
(which include costs associated with components assembled by third-party
assembly manufacturers, as well as internal labor and allocable overhead) are
stated at the lower of standard cost (which approximates actual cost on a
first-in, first-out basis) or market value. Provisions, when required, are made
to reduce excess and obsolete inventories to their estimated net realizable
values. We regularly monitor inventory quantities on hand and record a provision
for excess and obsolete inventories based primarily on our estimated forecast of
product demand and production requirements for the next six months. We record a
write-down for product and component inventories that have become obsolete or
are in excess of anticipated demand or net realizable value. Raw materials
inventory is considered obsolete and is fully reserved if it has not been used
in 365 days. The components of inventories include (in
thousands):





March 31,
                  
                  
                  September 30,2010
                  
                  
                  2009Raw
      materials
                  
                  $
                  385
                  
                  
                  $
                  450Work-in-progress
                  
                  
                  63
                  
                  
                  
                  29Finished
      goods
                  
                  
                  591
                  
                  
                  
                  787Total
                  
                  $
                  1,039
                  
                  
                  $
                  1,266





REVENUE
RECOGNITION





Revenue
consists of direct sales to end-users, resellers and distributors. Revenue from
sales to end-users and resellers is recognized upon shipment, when risk of loss
has passed to the customer, collection of the receivable is reasonably assured,
persuasive evidence of an arrangement exists, and the sales price is fixed and
determinable. Net revenue consists of hardware and software revenue reduced by
estimated sales returns and allowances. Sales to distributors are made under
terms allowing certain rights of return and protection against subsequent price
declines on the Company’s products held by its distributors. Upon termination of
such distribution agreements, any unsold products may be returned by the
distributor for a full refund. These agreements may be canceled by either party
without cause for convenience following a specified notice period. As a result
of these provisions, the Company defers recognition of distributor revenue until
such distributors resell our products to their customers. The amounts deferred
as a result of this policy are reflected as “deferred revenue” in the
accompanying consolidated balance sheets. The related cost of revenue is also
deferred and reported in the consolidated balance sheets as inventory. We do not
recognize revenue derived from sales to customers in Asia until both of the
following elements are satisfied: customer has taken ownership upon shipment and
AltiGen has received payment for the purchase.





SERVICE
SUPPORT PROGRAMS





Our
Software Assurance Program provides our customers with the latest updates, new
releases, and technical support for the applications they are licensed to use.
Our Premier Service Plan includes software assurance and extended hardware
warranty. These programs have an annual subscription and can range from one to
three years. Sales from our service support programs are recorded as deferred
revenue and recognized as service support revenue over the terms of their
subscriptions.





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





STOCK-BASED
COMPENSATION





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


7





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, 2010 and 2009:





Employee Stock Option Plans
                    Six Months Ended March 31,
                
                
                Employee Stock Purchase Plan
                    Six Months Ended March 31,2010
                
                
                2009
                
                
                2010
                
                
                2009Expected
      life (in years)
                
                
                6
                
                
                
                6
                
                
                
                0.5
                
                
                
                0.5Risk-free
      interest rate
                
                
                2.4
                %
                
                
                1.6
                %
                
                
                0.2
                %
                
                
                0.4
                %Volatility
                
                
                90
                %
                
                
                141
                %
                
                
                90
                %
                
                
                139
                %Expected
      dividend
                
                
                0.0
                %
                
                
                0.0
                %
                
                
                0.0
                %
                
                
                0.0
                %





The
following table summarizes stock-based compensation expense related to employee
and director stock options, employee stock purchases and stock awards for the
three and six months ended March 31, 2010 and 2009:





Three Months Ended
                    March 31,
                
                
                Six Months Ended
                    March 31,2010
                
                
                2009
                
                
                2010
                
                
                2009Cost
      of goods sold
                
                $
                2
                
                
                $
                2
                
                
                $
                10
                
                
                $
                7Research
      and development
                
                
                20
                
                
                
                27
                
                
                
                148
                
                
                
                92Sales
      and marketing
                
                
                14
                
                
                
                36
                
                
                
                123
                
                
                
                121General
      and administrative
                
                
                16
                
                
                
                59
                
                
                
                89
                
                
                
                190Total
                
                $
                52
                
                
                $
                124
                
                
                $
                370
                
                
                $
                410





The
following table summarizes the Company’s stock option plan as of October 1, 2009
and changes during the six months ended March 31, 2010:





Number of
                    Shares
                
                
                Weighted-
                    Average
                    Exercise Price
                
                
                Weighted
                    Average
                    Remaining
                    Contractual Life
                    (in years)Outstanding
      at October 1, 2009
                
                
                4,362,891
                
                
                $
                0.91Granted
                
                
                44,000
                
                
                
                0.90Exercised
                
                
                (5,156
                )
                
                
                0.68Forfeitures
      and cancellations
                
                
                (120,416
                )
                
                
                0.95Outstanding
      at March 31, 2010
                
                
                4,281,319
                
                
                $
                0.91
                
                
                
                7.65Vested
      and expected to vest at March 31, 2010
                
                
                3,388,855
                
                
                $
                0.92
                
                
                
                7.21Exercisable
      at March 31, 2010
                
                
                1,981,932
                
                
                $
                0.95
                
                
                
                5.71





On March
31, 2010, the aggregate intrinsic value of stock options outstanding was
$33,000. Total stock options vested and expected to vest at March 31, 2010 were
3.4 million shares with a weighted average exercise price of $0.92,
aggregate intrinsic value of $32,000, and a weighted average remaining
contractual term of 7.2 years. The total exercisable stock options as of March
31, 2010 were 1.9 million shares with an aggregate intrinsic value of
$32,000, weighted average exercise price of $0.95, and a weighted average
remaining contractual term of 5.7 years.





The
Company has unamortized stock-based compensation expense relating to options
outstanding of $789,000, which will be amortized to expense over a weighted
average period of 4 years.





On March
10, 2009, our 1999 Stock Plan and our 1999 Employee Stock Purchase Plan (the
“1999 Purchase Plan”) expired. These plans will, however, continue to govern the
securities previously granted under them. On April 21, 2009, our Board of
Directors approved a 2009 Equity Incentive Plan and a 2009 Employee Stock
Purchase Plan (the “2009 Purchase Plan”), which were both approved by our
stockholders on June 18, 2009.  The 2009 Purchase Plan allows eligible
employees to purchase shares of Company stock at a discount through payroll
deductions. The 2009 Purchase Plan consists of six-month offering periods
commencing on June 1st and
December 1st, each
year. Employees purchase shares in the purchase period at 85% of the market
value of the Company’s common stock at either the beginning of the offering
period or the end of the offering period, whichever price is
lower.


8





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





The
Company reserved 1.5 million shares of the Company’s common stock for future
issuance under the 2009 Purchase Plan. To date, 74,735 shares have been
purchased by and distributed to employees under the 2009 Purchase Plan at a
price of $0.62 per share, and during the six months ended March 31, 2010,74,735
shares were purchased by and distributed to employees under the 2009 Purchase
Plan at a price of $0.62 per share.




Issuance
of Common Stock as Bonuses





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





COMPUTATION
OF BASIC AND DILUTED NET LOSS PER SHARE





The
Company bases its basic net loss per share upon the weighted average number of
common stock outstanding during the period. Basic net loss per common stock is
computed by dividing the net loss by the weighted-average number of shares of
common stock outstanding during the period. Diluted earnings per share reflect
the potential dilution that could occur if securities or other contracts to
issue common stock were exercised or converted into common stock.





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





Three Months Ended
                    March 31,
                
                
                Six Months Ended
                    March 31,2010
                
                
                2009
                
                
                2010
                
                
                2009Net
      loss
                
                $
                (340
                )
                
                $
                (1,767
                )
                
                $
                (810
                )
                
                $
                (3,036
                )Divided
      by: weighted average shares outstanding—basic and diluted
                
                
                16,430
                
                
                
                15,862
                
                
                
                16,361
                
                
                
                15,842Basic
      and diluted net loss per share
                
                $
                (0.02
                )
                
                $
                (0.11
                )
                
                $
                (0.05
                )
                
                $
                (0.19
                )





Options
to purchase 4.3 million and 4.5 million shares of common stock were outstanding
as of March 31, 2010 and 2009, respectively, and were excluded from the
computation of diluted net earnings per share for these periods because their
effect would have been antidilutive.





COMPREHENSIVE
INCOME (LOSS)





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





As of
March 31, 2010, accumulated other comprehensive income consists of $118,000 of
accumulated foreign currency translation gains. The amounts comprising
unrealized gains and losses on marketable securities and the related changes as
of March 31, 2010 and 2009 were immaterial.


9




FAIR
VALUE MEASUREMENTS




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




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




The
Company did not record an adjustment to retained earnings as a result of the
adoption of this accounting standard, and the adoption did not have a material
effect on the Company’s results of operations. Fair value is defined as the
exchange price that would be received for an asset or paid to transfer a
liability (an exit price) in the principal or most advantageous market for the
asset or liability in an orderly transaction between market participants on the
measurement date. Valuation techniques used to measure fair value under this
standard must maximize the use of observable inputs and minimize the use of
unobservable inputs. The standard describes a fair value hierarchy based on
three levels of inputs, of which the first two are considered observable and the
last unobservable, that may be used to measure fair value which are the
following:




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


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


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




The
adoption of this standard with respect to our financial assets and liabilities
did not impact our consolidated results of operations and financial condition,
but requires additional disclosure for assets and liabilities measured at fair
value. The Company’s cash equivalents were held in money market funds (deemed to
be Level 1) in the amount of $4.6 million, both as of March 31, 2010 and
September 30, 2009.


10


SEGMENT
REPORTING





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





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


Three Months Ended
                    March 31,
                
                
                Six Months Ended
                    March 31,2010
                
                
                2009
                
                
                2010
                
                
                2009Americas
                
                
                87
                %
                
                
                86
                %
                
                
                85
                %
                
                
                86
                %International
                
                
                13
                %
                
                
                14
                %
                
                
                15
                %
                
                
                14
                %Total
                
                
                100
                %
                
                
                100
                %
                
                
                100
                %
                
                
                100
                %




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





Three Months Ended
                    March 31,
                
                
                Six Months Ended
                    March 31,2010
                
                
                2009
                
                
                2010
                
                
                2009Americas
                
                $
                (182
                )
                
                $
                (1,652
                )
                
                $
                (546
                )
                
                $
                (2,891
                )International
                
                $
                (158
                )
                
                $
                (115
                )
                
                $
                (264
                )
                
                $
                (145
                )Total
                
                $
                (340
                )
                
                $
                (1,767
                )
                
                $
                (810
                )
                
                $
                (3,036
                )





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





March 31,
                
                
                September 30,2010
                
                
                2009Americas
                
                $
                7,850
                
                
                $
                8,060International
                
                $
                3,161
                
                
                $
                3,271Total
                
                $
                11,011
                
                
                $
                11,331





CUSTOMERS





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




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


11


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




Three Months Ended
                    March 31,
                
                
                Six Months Ended
                    March 31,2010
                
                
                2009
                
                
                2010
                
                
                2009Synnex
                
                
                37
                %
                
                
                28
                %
                
                
                36
                %
                
                
                30
                %Altisys
      (1)
                
                
                —
                
                
                
                —
                
                
                
                10
                %
                
                
                —Fiserv
      (2)
                
                
                13
                %
                
                
                10
                %
                
                
                11
                %
                
                
                —Jenne
      (3)
                
                
                —
                
                
                
                14
                %
                
                
                —
                
                
                
                18
                %Total
                
                
                50
                %
                
                
                52
                %
                
                
                57
                %
                
                
                48
                %





(1)
            For
      the three months ended March 31, 2010 and 2009, revenue generated from
      Altisys was less than 10% of our total revenue. For the six months ended
      March 31, 2009, revenue generated from Altisys was less than 10% of our
      total revenue.


(2)
            For
      the six months ended March 31, 2009, revenue generated from Fiserv was
      less than 10% of our total revenue.


(3)
            In
      September 2009, we terminated our distribution agreement with Jenne. The
      termination of our relationship with Jenne did not have a material impact
      on our business.


12


2.
WARRANTY





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





Changes
in the reserves for our warranty liability for the three and six months ended
March 31, 2010 and 2009, respectively, are as follows (in
thousands):





Three Months Ended
                      March 31,
                  
                  
                  Six Months Ended
                      March 31,2010
                  
                  
                  2009
                  
                  
                  2010
                  
                  
                  2009Beginning
      balance
                  
                  $
                  111
                  
                  
                  $
                  128
                  
                  
                  $
                  122
                  
                  
                  $
                  137Provision
      for warranty liability
                  
                  
                  59
                  
                  
                  
                  25
                  
                  
                  
                  102
                  
                  
                  
                  58Warranty
      cost including labor, components and scrap
                  
                  
                  (45
                  )
                  
                  
                  (44
                  )
                  
                  
                  (99
                  )
                  
                  
                  (86
                  )Ending
      balance
                  
                  $
                  125
                  
                  
                  $
                  109
                  
                  
                  $
                  125
                  
                  
                  $
                  109




3.  COMMITMENTS
AND CONTINGENCIES





Commitments





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




In April
2009, the Company entered into a lease for a new corporate headquarters for a
period of five years with an option to extend for an additional five years. This
facility is leased through June 2014 and serves as our headquarters for
corporate administration, research and development, manufacturing, and sales and
marketing facility in San Jose, California. The terms of the lease include rent
escalations and a tenant allowance for certain leasehold
improvements.  Under the terms of the lease agreement, total rent
payment is approximately $1.4 million for a period of five years commencing on
June 12, 2009. Additionally, under the terms of the lease agreement, the Company
received up to $100,000 cash incentive as moving allowance. As of March 31,
2010, the Company recorded $100,000 of this allowance as part of deferred rent
liability to be amortized over the term of the lease. The Company reserved
$200,000 as collateral for an irrevocable and negotiable standby letter of
credit (the "Letter of Credit") as security for the facility lease. The $200,000
is restricted by the bank and recorded as part of the long-term deposit in our
consolidated balance sheet as of March 31, 2010. Under the terms of the
agreement, the Letter of Credit will expire in July 2014. We believe that the
new facility will be suitable, adequate and sufficient to meet the needs of the
Company through July 2014.





Rent
expense for all operating leases totaled approximately $190,000 and $379,000 for
the three and six months ended March 31, 2010, respectively, as compared to
$185,000 and $360,000 for the three and six months ended March 31, 2009,
respectively. We also lease certain equipment under capital lease arrangements,
which are reflected as property and equipment in our balance sheets as of March
31, 2010 and September 30, 2009. The minimum future lease payments under all
non-cancellable capital and operating leases as of  March 31,
2010 are shown in the following table (in thousands):





Capital
                    Leases
                
                
                Operating
                    LeasesFiscal
      Years Ending September 30,2010
                
                $
                11
                
                
                $
                3012011
                
                
                —
                
                
                
                3022012
                
                
                —
                
                
                
                3022013
                
                
                —
                
                
                
                3182014
                
                
                —
                
                
                
                248Total
      contractual lease obligation
                
                $
                11
                
                
                $
                1,471Amount
      representing interest
                
                $
                —Present
      value of minimum lease payment
                
                $
                11


13


Contingencies





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





The
Company has also agreed to indemnify its directors and executive officers for
costs associated with any fees, expenses, judgments, fines and settlement
amounts incurred by them in any action or proceeding to which any of them is, or
is threatened to be, made a party by reason of his or her service as a director
or officer, arising out of his or her services as the Company’s director or
officer.  Historically, the Company has not been required to make
payments under these obligations and the Company has recorded no liabilities for
these obligations in its condensed consolidated balance sheets.





The
Company typically warrants its hardware products for a period of one year
following shipment to end users in a manner consistent with general industry
standards that are reasonably applicable under normal use and circumstances.
Historically, the Company has experienced minimal warranty costs.  In
addition, the Company provides distributors protection from subsequent price
reductions.


14


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





FORWARD-LOOKING
INFORMATION





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





These
statements are based on current expectations and assumptions regarding future
events and business performance and involve known and unknown risks,
uncertainties and other factors that may cause industry trends or our actual
results, level of activity, performance or achievements to be materially
different from any future results, levels of activity, performance or
achievements expressed or implied by these statements. These factors include,
and you should also carefully review the cautionary statements contained in our
Annual Report on Form 10-K for the year ended September 30, 2009, as amended,
including those set forth in Item 1A “Risk Factors” of that report as well as in
Item IA “Risk Factors” of this report.





OVERVIEW





AltiGen
Communications, Inc. (“AltiGen,” “we” or the “Company”) is a leading provider of
100% Microsoft-based Voice over Internet Protocol (VoIP) business phone systems
and Unified Communications solutions. We design, deliver and support VoIP phone
systems and call center solutions that combine high reliability with integrated
IP communications applications.  As one of the first companies to
offer VoIP solutions, AltiGen has been deploying systems since 1996. We have
more than 10,000 customers worldwide with over 15,000 systems in use. Our
telephony solutions are primarily used by medium and enterprise sized
businesses, companies with multiple locations, corporate branch offices, and
call centers.





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





We
generated net revenue of $4.4 million and $8.6 million for the three and
six months ended March 31, 2010, respectively, compared to net revenue of $3.6
million and $8.4 million for the three and six months ended March 31, 2009,
respectively. As of March 31, 2010, we had an accumulated deficit of $61.6
million.  Net cash provided by operating activities was $85,000 for
the six months ended March 31, 2010, as compared to net cash used by operating
activities of $1.3 million for the six months ended March 31, 2009.





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


15





Our cost
of revenue consists of component and material costs, direct labor costs,
provisions for excess and obsolete inventory, warranty costs and overhead
related to the manufacturing of our products. Several factors that have affected
and will continue to affect our revenue growth are the state of the economy, the
market acceptance of our products, our ability to add new resellers and our
ability to design, develop, and release new products. We engage third-party
assemblers, which in fiscal year 2009 and the six month period ended March 31,
2010 were All Quality Services in Fremont, California and ISIS Surface Mounting,
Inc. in San Jose, California to insert the hardware components into the printed
circuit board. We purchase fully-assembled chassis from Advantech Corporation,
Internet protocol phones from BCM Communications, Inc., single board computers
for our MAX product from AAEON Electronics, Inc. and raw material components
from Avnet Electronics. We selected our manufacturing partners with the goals of
ensuring a reliable supply of high-quality finished products and lowering per
unit product costs as a result of manufacturing economies of scale. We cannot
assure you that we will maintain the volumes required to realize these economies
of scale or when or if such cost reductions will occur. The failure to obtain
such cost reductions could materially adversely affect our gross margins and
operating results.





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 customer and
geographical market segments and enter new customer and geographical market
segments. Additionally, we intend to continue selling our products to small- to
medium-sized businesses, enterprise businesses, multisite businesses, corporate
and branch offices and call centers. Also, we plan to continue to recruit
additional resellers and distributors to focus on selling phone systems to our
target customers. We believe that the adoption rate for our telecommunications
solution is much greater and faster with small- to medium-sized businesses
because many of these businesses have not yet made a significant investment for
a traditional phone system. Also, we believe that small- to medium-sized
businesses are more likely to be looking for call center-type administration to
increase the productivity and efficiency of their contacts with
customers.





CRITICAL
ACCOUNTING POLICIES





Revenue Recognition. Revenue
consists of direct sales to end-users, resellers and distributors. Revenue from
sales to end-users and resellers is recognized upon shipment, when risk of loss
has passed to the customer, collection of the receivable is reasonably assured,
persuasive evidence of an arrangement exists, and the sales price is fixed and
determinable. We provide for estimated sales returns and allowances and warrant
costs related to such sales at the time of shipment. Net revenue consists of
product revenue reduced by estimated sales returns and allowances. Sales to
distributors are made under terms allowing certain rights of return and
protection against subsequent price declines on our products held by the
distributors. Upon termination of such distribution agreements, any unsold
products may be returned by the distributor for a full refund. These agreements
may be canceled without cause for convenience following a specified notice
period. As a result of these provisions, we defer recognition of distributor
revenue until such distributors resell our products to their customers. The
amounts deferred as a result of this policy are reflected as “deferred revenue”
in the accompanying consolidated balance sheets. The related cost of revenue is
also deferred and reported in the consolidated balance sheets as inventory. We
do not recognize revenue derived from sales to customers in Asia until both of
the following elements are satisfied: customer has taken ownership upon shipment
and we have received payment for the purchase. Short-term deferred revenue was
approximately $2.6 million as of March 31, 2010 and September 30, 2009.
Long-term deferred revenue was approximately $176,000 and $154,000 as of March
31, 2010 and September 30, 2009, respectively.





Service Support
Programs.Our Software Assurance Program provides our
customers with the latest updates, new releases, and technical support for the
applications they are licensed to use. Our Premier Service Plan includes
software assurance and extended hardware warranty. These programs have an annual
subscription and can range from one to three years. Sales from our service
support programs are recorded as deferred revenue and recognized as revenue over
the terms of their subscriptions. Service support deferred revenue was
approximately $2.4 million and $2.2 million as of March 31, 2010 and September
30, 2009, respectively. Our service plan offering remains a growth opportunity
as we continue to add new service customers.





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


16


Cash and Cash
Equivalent.We consider all highly liquid investments
purchased with an initial maturity of three months or less to be cash
equivalents. Cash and cash equivalents are invested in various investment grade
institutional money market accounts, U.S. Agency securities and commercial
paper. The Company's investment policy requires investments to be rated single-A
or better. As of March 31, 2010, our investment portfolio consists entirely of
investment grade institutional money market funds and bank term deposits. We
also hold a total of $2.4 million in cash in Asia of which $2.2 million is held
in a bank term deposit account.




Inventory.Inventory
is stated at the lower of cost (first-in, first-out method) or market. Our
inventory balance for the six months ended March 31, 2010 was $1.0 million
compared to $1.2 million as of September 30, 2009. 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 obsolescence provision which would
negatively affect gross margins in the period when the write-downs were
recorded. In prior periods, we had established a reserve to write off excess
inventory that management believed would not be sold. During the six months
ended March 31, 2010, we disposed of fully-reserved inventory with a carrying
value of zero and an original cost at $33,000. The disposal of such inventory
had no material impact on our revenue, gross margins and net loss for the six
months ended March 31, 2010. Inventory allowance was $654,000 and $692,000
as of March 31, 2010 and September 30, 2009, respectively.





Warranty Cost.We
accrue for warranty costs based on estimated product return rates and the
expected material and labor costs to provide warranty services. If actual
products return rates, repair cost or replacement costs differ significantly
from our estimates, then our gross margin could be adversely affected. The
reserve for product warranties was $125,000 and $122,000 as of March 31, 2010
and September 30, 2009, respectively.





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


17


Results
of Operations





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





Three Months Ended
                        March 31,
                      
                      
                      Six Months Ended
                        March 31,2010
                      
                      
                      2009
                      
                      
                      2010
                      
                      
                      2009Consolidated
      Statements of Operations Data:Net
      revenue:Hardware
                      
                      
                      64.7
                      %
                      
                      
                      68.8
                      %
                      
                      
                      65.2
                      %
                      
                      
                      71.4
                      %Software
                      
                      
                      15.6
                      
                      
                      
                      13.3
                      
                      
                      
                      14.7
                      
                      
                      
                      13.5Service
      support
                      
                      
                      19.7
                      
                      
                      
                      17.9
                      
                      
                      
                      20.1
                      
                      
                      
                      15.1Total
      net revenue
                      
                      
                      100.0
                      
                      
                      
                      100.0
                      
                      
                      
                      100.0
                      
                      
                      
                      100.0Cost
      of revenue:Hardware
                      
                      
                      33.7
                      
                      
                      
                      41.0
                      
                      
                      
                      33.5
                      
                      
                      
                      39.8Software
                      
                      
                      0.1
                      
                      
                      
                      0.1
                      
                      
                      
                      0.1
                      
                      
                      
                      0.1Service
      support (1)
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      —Total
      cost of revenue
                      
                      
                      33.8
                      
                      
                      
                      41.1
                      
                      
                      
                      33.6
                      
                      
                      
                      39.9Gross
      profit
                      
                      
                      66.2
                      
                      
                      
                      58.9
                      
                      
                      
                      66.4
                      
                      
                      
                      60.1Operating
      expenses:Research
      and development
                      
                      
                      24.6
                      
                      
                      
                      34.7
                      
                      
                      
                      25.9
                      
                      
                      
                      29.3Sales
      and marketing
                      
                      
                      29.2
                      
                      
                      
                      51.4
                      
                      
                      
                      30.9
                      
                      
                      
                      46.5General
      and administrative
                      
                      
                      20.1
                      
                      
                      
                      22.7
                      
                      
                      
                      19.2
                      
                      
                      
                      21.1Total
      operating expenses
                      
                      
                      73.9
                      
                      
                      
                      108.8
                      
                      
                      
                      76.0
                      
                      
                      
                      96.9Loss
      from operations
                      
                      
                      (7.7
                      )
                      
                      
                      (49.9
                      )
                      
                      
                      (9.6
                      )
                      
                      
                      (36.8
                      )Equity
      in net loss of investee
                      
                      
                      —
                      
                      
                      
                      (0.1
                      )
                      
                      
                      —
                      
                      
                      
                      (0.1
                      )Interest
      and other income, net
                      
                      
                      —
                      
                      
                      
                      0.6
                      
                      
                      
                      0.3
                      
                      
                      
                      0.7Net
      loss before income taxes
                      
                      
                      (7.7
                      )
                      
                      
                      (49.4
                      )
                      
                      
                      (9.3
                      )
                      
                      
                      (36.2
                      )Income
      taxes
                      
                      
                      —
                      
                      
                      
                      (0.0
                      )
                      
                      
                      —
                      
                      
                      
                      0.2Net
      loss
                      
                      
                      (7.7
                      )
      %
                      
                      
                      (49.4
                      )
      %
                      
                      
                      (9.3
                      )
      %
                      
                      
                      (36.0
                      )
      %





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





Net
Revenue





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





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





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





Three Months Ended
                    March 31,
                
                
                Six Months Ended
                    March 31,2010
                
                
                2009
                
                
                2010
                
                
                2009Americas
                
                
                87
                %
                
                
                86
                %
                
                
                85
                %
                
                
                86
                %International
                
                
                13
                %
                
                
                14
                %
                
                
                15
                %
                
                
                14
                %Total
                
                
                100
                %
                
                
                100
                %
                
                
                100
                %
                
                
                100
                %


18


Net
revenue by customers that individually accounted for more than 10% of our
revenue for the three and six months ended March 31, 2010 and 2009,
respectively, were as follows:





Three Months Ended
                    March 31,
                
                
                Six Months Ended
                    March 31,2010
                
                
                2009
                
                
                2010
                
                
                2009Synnex
                
                
                37
                %
                
                
                28
                %
                
                
                36
                %
                
                
                30
                %Altisys
      (1)
                
                
                —
                
                
                
                —
                
                
                
                10
                %
                
                
                —Fiserv
      (2)
                
                
                13
                %
                
                
                10
                %
                
                
                11
                %
                
                
                —Jenne
      (3)
                
                
                —
                
                
                
                14
                %
                
                
                —
                
                
                
                18
                %Total
                
                
                50
                %
                
                
                52
                %
                
                
                57
                %
                
                
                48
                %





(1)
            For
      the three months ended March 31, 2010 and 2009, revenue generated from
      Altisys was less than 10% of our total revenue. For the six months ended
      March 31, 2009, revenue generated from Altisys was less than 10% of our
      total revenue.


(2)
            For
      the six months ended March 31, 2009, revenue generated from Fiserv was
      less than 10% of our total revenue.


(3)
            In
      September 2009, we terminated our distribution agreement with Jenne. The
      termination of our relationship with Jenne did not have a material impact
      on our business.





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





Three
      Months Ended
                
                
                Six
      Months EndedMarch 31,
                
                
                March 31,2010
                
                
                2009
                
                
                2010
                
                
                2009Hardware
                
                
                65
                %
                
                
                69
                %
                
                
                65
                %
                
                
                71
                %Software
                
                
                15
                %
                
                
                13
                %
                
                
                15
                %
                
                
                14
                %Service
      Support Plans
                
                
                20
                %
                
                
                18
                %
                
                
                20
                %
                
                
                15
                %Total
                
                
                100
                %
                
                
                100
                %
                
                
                100
                %
                
                
                100
                %





Net
revenue for the three months ended March 31, 2010 was $4.4 million as compared
to $3.6 million for the three months ended March 31, 2009. Revenue generated in
the Americas segment accounted for $3.8 million, or 87% of our total net
revenue, as compared to $3.1 million, or 86% of our total net revenue, for the
three months ended March 31, 2010 and 2009, respectively. Revenue generated in
the International segment accounted for $568,000, or 13% of our total net
revenue, as compared to $489,000, or 14% of our total net revenue, for the three
months ended March 31, 2010 and 2009, respectively. In the Americas segment,
during the three months ended March 31, 2010 and 2009, we generated
approximately $957,000 and $664,000, respectively, in non-system related
revenue. Non-system related revenue is primarily comprised of revenue generated
from our service support plans. In the Americas segment, the increase in net
revenue excluding non-system related revenue was approximately 25%. This
increase in net revenue in the Americas segment was primarily attributable to
change in our product mix. The number of systems shipped was approximately 1%
lower than the corresponding period in the previous year. However, the average
revenue per system was higher by approximately 25% because sales of our smaller
systems, with lower unit pricing, decreased by approximately 34% while sales of
our larger systems, with higher unit pricing, increased by approximately 53%.
Sales in all markets continued to be affected by the global economic recession.
We will continue to focus our sales efforts on larger enterprise customers. To
the extent we are successful in penetrating larger enterprise customer, we
believe that that sales of our product will increase and this will allow us to
take market share from our competitors.





Net
revenue for the six months ended March 31, 2010 was $8.6 million as compared to
$8.4 million for the six months ended March 31, 2009. Revenue generated in the
Americas segment accounted for $7.3 million, or 85% of our total net revenue, as
compared to $7.2 million, or 86% of our total net revenue, for the six months
ended March 31, 2010 and March 31, 2009, respectively. Revenue generated in the
International segment accounted for $1.3 million, or 15% of our total net
revenue, as compared to $1.2 million, or 14% of our total net revenue, for the
six months ended March 31, 2010 and 2009, respectively.





Cost
of Revenue





Our cost
of product revenue consists primarily of component and material costs, direct
labor costs, provisions for excess and obsolete inventory, warranty costs and
overhead related to the manufacturing of our products. The majority of these
costs vary with the unit volumes of product sold.


19


Cost of
revenue was $1.5 million for the three months ended March 31, 2010 and 2009. For
the six months ended March 31, 2010, cost of revenue decreased to $2.9 million,
compared to $3.4 million for the same period of the previous fiscal year. This
decrease was primarily caused by a shift in our product mix in the period. Cost
of goods sold for the six months ending March 31, 2010, decreased to 33% of net
revenue, compared to 40% of net revenue for the six months ending March 31, 2009
as a result of an increase of our non-system related revenue.




Research
and Development Expenses
 
 Research
and development expenses consist primarily of costs related to personnel and
overhead expenses, consultant expenses and other costs associated with the
design, development, prototyping and testing of our products and enhancements of
our converged telephone system software. For the second quarter of fiscal year
2010, research and development expenses were $1.1 million, or 25% of net
revenue, compared to $1.2 million, or 35% of net revenue, for the second quarter
of fiscal year 2009. The decrease in absolute dollars was primarily attributable
to $81,000 of reduced personnel-related expenses. Research and development
expenses decreased to $2.2 million, or 26% of net revenue, for the six months
ended March 31, 2010 from $2.5 million, or 29% of net revenue, for the same
period in fiscal year 2009. This $234,000 expense reduction for the six month
period ended March 31, 2010 as compared to the same period of the prior year is
primarily attributable to $118,000 of reduced personnel-related expenses, with
reductions of $89,000 in consulting related services. The
decrease in both the three and six months ended March 31, 2010 compared to the
same periods of the prior year is attributable to the Company’s ongoing efforts
to reduce operating expenses, including our April 2009 salary reduction program
described below.
 
 Notwithstanding the reductions to
research and development expenses described above, we intend to continue to make
investments in our research and development and we believe that focused
investments in research and development are critical to the future growth and
our ability to enhance our competitive position in the marketplace. We believe
that our ability to develop and meet enterprise customer requirements is
essential to our success. Accordingly, we have assembled a team of engineers
with expertise in various fields, including voice and IP communications, unified
communications network design, data networking and software engineering. Our
principal research and development activities are conducted in San Jose,
California and our subsidiary in Shanghai, China. Management continues to focus
on cost control until business conditions improve. If business conditions
deteriorate or the rate of improvement does not meet our expectations,we may implement additional
cost-cutting actions.
 
 Sales
and Marketing Expenses
 
 Sales and marketing
expenses consist primarily of salaries, commissions and related expenses for
personnel engaged in marketing, sales and customer support functions, as well as
trade shows, advertising, and promotional expenses. For the second quarter of
fiscal year 2010, sales and marketing expenses were $1.3 million, or 29% of
net revenue, compared to $1.8 million, or 51% of net revenue, for the second
quarter of fiscal year 2009. The decrease was primarily driven by $218,000 of
reduced personnel-related expenses, a reduction
of $77,000 in advertising and partner conference expenses, reduced consulting
expenses of $53,000 and reduced travel related expenses of $104,000. Sales and
marketing expenses decreased to $2.7 million, or 31% of net revenue, for the six
months ended March 31, 2010 from $3.9 million, or 46% of net revenue, for the
same period in fiscal year 2009. This decrease was attributable to $567,000 in
personnel-related and overhead expenses, a decrease of $179,000 in service
related expenses, a decrease of $197,000 in travel related expenses, with a
decrease of $192,000 in advertising and partner conference expenses.The
most significant factor in the decrease in both the three and six months ended
March 31, 2010 compared to the same periods of the prior year is attributable to
the Company’songoing
efforts to reduce operating expenses, including our April 2009 salary reduction
program described below.




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




General
and Administrative Expenses




General
and administrative expenses consist of salaries and related expenses for
executive, finance and administrative personnel, facilities, allowance for
doubtful accounts, legal and other general corporate expenses. For the second
quarter of fiscal year 2010, general and administrative expenses were $887,000
or 20% of revenue, compared to $811,000 or 23% of revenue for the second quarter
of fiscal year 2009. The increase in absolute dollars in general and
administrative was attributable to $100,000 increase in legal expenses
associated with corporate governance matters, partially offset by a $41,000
decrease in personnel-related expenses. For the six months ended March 31, 2010
and 2009, general and administrative expenses were $1.7 million and $1.8
million, respectively. As a percentage of net revenue, general and
administrative expenses decreased to 19% for the six months ended March 31, 2010
from 21% for the same period in the previous fiscal year. The $100,000 expense
reduction for the six month period ended March 31, 2010 as compared to the same
period of the prior year is primarily attributable to $126,000 decrease in
non-cash stock-based compensation expenses, partially offset by an increase of
$25,000 in service related expenses. In April 2009, in an effort to reduce
ongoing operating expenses and to conform our business to our objectives and
opportunities, we implemented a mandatory salary reduction for all of our
employees, including our executive officers.  These salary reductions
ranged between 5% and 15%, depending on several factors, including, but not
limited to, participation in commission plans and the original base
salary.  The salaries of all of our executive officers were reduced by
15%.


20




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




Equity
Investment in Common Stock of Private Company





In July
2004, we purchased common stock of a private Korean telecommunications company
for approximately $79,000. As a result of this investment, we acquired
approximately 23% of the voting power of the company. This gives us the right to
nominate and elect one of the three members of the investee’s current board of
directors. We are accounting for this investment using the equity method and
record our minority interest in our results of operations. The Korean company is
also a reseller for AltiGen. For the six months end March 31, 2010 and 2009,
product sales revenue from this company was approximately $4,000 and $0,
respectively. Our accounts receivable from this company was $0 and $18,000 as of
March 31, 2010 and 2009, respectively.





Interest
Expense and Other Income, Net





Interest
expense primarily consists of interest incurred on our capital lease commitments
and other income primarily consists of interest earned on cash, cash equivalents
and short-term investments. Net interest and other income decreased to $1,000
and $23,000 for the three and six months ended March 31, 2010, respectively,
from $23,000 and $59,000 for the same periods in fiscal year 2009. The decrease
in interest and other income, net for the three and six month periods ended
March 31, 2010 as compared with the same periods of the prior year, was a
combination of lower invested balances, reduced cash balances and reduced rates
of interest available for cash and investments in financial assets in fiscal
year 2010. In the longer term, we may generate less interest income if our total
invested balance decreases and these decreases are not offset by rising interest
rates or increased cash generated from operations or other sources.





Liquidity
and Capital Resources





We have
historically financed our operations primarily through the sale of equity
securities. Cash and equivalents as of March 31, 2010 were $7.5 million, an
increase of $108,000 compared to the balance of $7.4 million as of September 30,
2009. The Company’s principle source of liquidity consists of cash equivalents
held in liquid money market funds.





The
following table shows the major components of our condensed consolidated
statements of cash flows for the six months ended March 31, 2010 and 2009 (in
thousands):





Six Months Ended
                    March 31,2010
                
                
                2009Cash
      and equivalents, beginning of period
                
                $
                7,397
                
                
                $
                9,467Cash
      provided by (used in) operating activities
                
                
                86
                
                
                
                (1,295
                )Cash
      provided by (used in)  investing activities
                
                
                18
                
                
                
                (2,261
                )Cash
      provided by financing activities
                
                
                51
                
                
                
                44Effect
      of exchange rate changes on cash and cash equivalents
                
                
                (47
                )
                
                
                —Cash
      and equivalents, end of period
                
                $
                7,505
                
                
                $
                5,955





During
the six months ended March 31, 2010, our net cash provided by operating
activities was $86,000, as compared to net cash used in operating activities of
$1.3 million during the same period in fiscal year 2009. This was primarily
attributable to our net loss of $810,000, a decrease of $276,000 in accounts
receivable, a decrease of $227,000 in net inventories, a decrease of $121,000 in
accrued liabilities and an increase of $160,000 in deferred revenue and
long-term liabilities. The cash impact of the loss for the six months ended
March 31, 2010 was partially offset by a non-cash expense of $370,000 in
stock-based compensation expense and $98,000 in depreciation and amortization
costs. Generally, as sales levels fall, we expect accounts receivable and
accounts payable, and to a lesser extent inventories, to decrease. Inventories
react more slowly because we outsource much of our production, and reduced
demand takes time to be reflected back through our supply chain. Further, there
will be routine fluctuations in these accounts from period to period that may be
significant in amount. The decrease in accounts receivable was primarily due to
lower shipments and good collections during the second quarter of fiscal year
2010. The increase in deferred revenue for the six months ended March 31, 2010
was primarily the result of continued growth of our recurring revenue programs.
These plans include both the Software Assurance Program, which provides our
customers with new software releases and support for an annual fee, and the
Premier Service Plan, which includes software assurance and extended
hardware.


21




Net
accounts receivable decreased 18% from $1.5 million at September 30, 2009 to
$1.2 million at March 31, 2010. Quarterly accounts receivable day of sales
outstanding (DSO) decreased from 29 days as of September 30, 2009 to 26 days as
of March 31, 2010. The net accounts receivable and DSO decrease was primarily
due to lower shipments and good collections during the second quarter of fiscal
year 2010.





Net
inventories decreased 18% from $1.2 million at September 30, 2009 to
$1.0 million at March 31, 2010. The decrease in net inventories during this
period was the result of routine period to period fluctuations. Our annualized
inventory turn rate, which represents the number of times inventory is
replenished during the year, increased from 5.4 turns as of September 30, 2009
to 5.8 turns as of March 31, 2010. Inventory management will continue to be an
area of focus as we balance the need to maintain strategic inventory levels to
help ensure competitive lead times with the risk of inventory obsolescence due
to rapidly changing technology and customer requirements.





We ended
the second quarter of fiscal year 2010 with a cash conversion cycle of 14 days,
as compared to 66 days for the first quarter of fiscal year 2010. The cash
conversion cycle is the duration between purchase of inventories and services
and the collection of the cash from the sale of our products and services and is
a metric on which we have focused as we continue to try to efficiently manage
our assets. The cash conversion cycle results from the calculation of (a) the
days of sales outstanding added to (b) the days of supply in inventories and
reduced by (c) the days of payable outstanding.  The decrease in our
cash conversion cycle was primarily due to good collections during the second
quarter of fiscal year 2010.





For the
six months ended March 31, 2010, net cash provided by investing activities was
$18,000, as compared to net cash used in investing activities of $2.3 million
during the same period in fiscal year 2009. For the six months ended March 31,
2010, the Company spent approximately $73,000 on purchases of property and
equipment compared to $139,000 for the six month period ended March 31, 2009.
Additionally, for the six month period ended March 31, 2010, we reclassified our
Shanghai facilities-related deposit of $92,000 from long-term deposit to
short-term deposit.





Net cash
provided by financing activities for the six months ended March 31, 2010 was
approximately $51,000, as compared to $44,000 during the same period in fiscal
year 2009. For the second quarter of fiscal year 2010, proceeds from issuance of
common stock under employee stock plans represented approximately $50,000 as
compared to $63,000 for the same period in fiscal year 2009. Additionally,
during the second quarter of fiscal year 2009, repurchase of our treasury stock
was approximately $19,000.





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





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





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





We did
not have any material commitments for capital expenditures as of March 31, 2010.
We had total outstanding commitments on noncancelable capital and operating
leases of $1.5 million as of March 31, 2010. Lease terms on our existing
facility operating leases generally range from three to nine years. We believe
that we have sufficient cash reserves to allow us to continue our current
operations for more than a year.


22




Contractual
Obligations




The
following table presents certain payments due by us under contractual
obligations with minimum firm commitments as of March 31, 2010:




Payments Due by PeriodContractual Obligations
              
              Total
              
              
              Payments
                  Due in Less
                  Than 1 Year
              
              
              Payments
                  Due in
                  1 - 3 Years
              
              
              Payments
                  Due in
                  3 - 5 Years
              
              
              Payments
                  Due in More
                  Than 5 Years(In
      thousands)Operating
      leases obligation
              
              $
              1,471
              
              
              $
              301
              
              
              $
              922
              
              
              $
              248
              
              
              $
              —Capital
      leases obligation
              
              
              11
              
              
              
              11
              
              
              
              —
              
              
              
              —
              
              
              
              —Total
      contractual lease obligation
              
              $
              1,482
              
              
              $
              312
              
              
              $
              922
              
              
              $
              248
              
              
              $
              —





Effects
of Recently Issued Accounting Pronouncements





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





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




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




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





In June
2009, the Company adopted FASB ASC 855-10, Subsequent Events – Overall(“ASC 855-10”). ASC 855-10 establishes general standards of accounting
for and disclosure of events that occur after the balance sheet date but before
financial statements are issued or are available to be issued. It required
the disclosure of the date through which an entity has evaluated subsequent
events and the basis for that date – that is, whether that date represents the
date the financial statements were issued or were available to be
issued. This disclosure should alert all users of financial statements that
an entity has not evaluated subsequent events after that date in the set of
financial statements being presented. In February 2010, the FASB issued ASU
2010-09, Amendments to Certain
Recognition and Disclosure Requirements(“ASU 2010-09”). ASU 2010-09
amended the guidance on subsequent events to remove the requirement for SEC
filers to disclose the date through which an entity has evaluated subsequent
events. Adoption of ASC 855-10, as amended, did not have a material impact on
the Company’s results of operations, financial position or
liquidity.


23


Item
3. Quantitative and Qualitative Disclosures About Market Risk




Market
Interest Rate Risk





At March
31, 2010, our investment portfolio consisted primarily of cash and cash
equivalents of $7.5 million. These securities are subject to interest rate risk
and will decline in value if market interest rates increase. Our interest income
and expense is most sensitive to fluctuations in the general level of U.S.
interest rates. As such, changes in U.S. interest rates affect the interest
earned on our cash, cash equivalents and short-term investments, and the fair
value of those investments. Due to the short duration and conservative nature of
these instruments, we do not believe that we have a material exposure to
interest rate risk. For example, if market interest rates were to increase
immediately and uniformly by 10% from levels as of March 31, 2010, the decline
in the fair value of the portfolio would not have a material effect on our
results of operations over the next fiscal year.




Foreign
Currency Exchange Risk




We
transact a portion of our business in non-U.S. currencies, primarily the Chinese
Yuan (Renminbi). We bill a majority of our customers in U.S.
dollars.  Although the fluctuation of currency exchange rates may
impact our customers, and thus indirectly impact us, we do not attempt to hedge
this indirect and speculative risk.  We monitor our foreign currency
exposure; however, as of March 31, 2010, we believe our foreign currency
exposure is not material enough to warrant foreign currency hedging. In the
short term, we do not foresee foreign exchange currency fluctuations to pose a
material market risk to us. In future periods over the long term, we anticipate
we will be exposed to fluctuations in foreign currency exchange rates on
accounts receivable from sales in these foreign currencies and the net monetary
assets and liabilities of the related foreign subsidiary located in Shanghai,
China. A hypothetical 10% favorable or unfavorable change in foreign currency
exchange rates would not have a material impact on our results of
operations.





Item
4. Controls and Procedures





Evaluation
of Disclosure Controls and Procedures




We
maintain disclosure controls and procedures that are designed to ensure that
information required to be disclosed in our reports filed under the Securities
Exchange Act of 1934, as amended (the “Exchange Act”) is recorded, processed,
summarized and reported within the time periods specified in the Securities and
Exchange Commission’s rules and forms and that such information is accumulated
and communicated to our management, including our Chief Executive Officer and
Chief Financial Officer, as appropriate, to allow for timely decisions regarding
required disclosure.  In designing and evaluating the disclosure
controls and procedures, management recognizes that any controls and procedures,
no matter how well designed and operated, can provide only reasonable assurance
of achieving the desired control objectives, and management is required to apply
its judgment in evaluating the cost-benefit relationship of possible controls
and procedures.




Under the
supervision and with the participation of our management, including our Chief
Executive Officer and Chief Financial Officer, we recently implemented
additional disclosure controls and procedures and carried out an evaluation of
the effectiveness of the design and operation of our disclosure controls and
procedures (as such term is defined in Rule 13a-15(e)) as of March 31,
2010.  Based on the foregoing, our Chief Executive Officer and Chief
Financial Officer concluded that our disclosure controls and procedures were
effective as of March 31, 2010.




Changes in Internal Control Over
Financial Reporting





There
have not been any changes in the Company’s internal control over financial
reporting during the quarter ended March 31, 2010 that have materially affected,
or are reasonably likely to materially affect the Company’s internal control
over financial reporting.





We
believe that our present internal control program has been effective at a
reasonable assurance level to ensure that our financial reporting has not been
materially misstated.  Nonetheless, we will continue to review, and
where necessary, enhance our internal control design and documentation, ongoing
risk assessment, and management review as part of our internal control
program.


24


PART
II. OTHER INFORMATION





Item
1.  Legal Proceedings





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




Item
1A.  Risk Factors




CERTAIN
FACTORS AFFECTING BUSINESS, OPERATING RESULTS, AND FINANCIAL
CONDITION





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




Risks
Related to Ownership of our Common Stock





Our
common stock no longer trades on the NASDAQ Capital Market





In March
2010, we voluntarily delisted our common stock from the NASDAQ Capital Market
and moved our common stock listing to the OTCQX over-the-counter
market.  As a result, investors may find it more difficult to dispose
of or obtain accurate quotations as to the market value of our common stock, and
the ability of our stockholders to sell our securities in the secondary market
may be materially limited.





Our
stock price may be volatile.





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





·
            variations
      in our operating results;


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


·
            the
      gain or loss of significant
customers;


·
            recruitment
      or departure of key personnel;


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


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


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


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





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





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





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


25




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





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





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





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





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


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


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


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


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


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





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





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





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




Risks
Related to Our Business




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




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


26




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





We have
had a history of operating losses since our inception and, as of March 31, 2010,
we had an accumulated deficit of $61.6 million.  We may incur
operating losses in the future, and these losses could be substantial and impact
our ability to attain profitability.  We do not expect to
significantly increase expenditures for product development, general and
administrative expenses, and sales and marketing expenses; however, if we cannot
maintain current revenue or revenue growth, we will not achieve or sustain
profitability or positive operating cash flows.  Even if we achieve
profitability and positive operating cash flows, we may not be able to sustain
or increase profitability or positive operating cash flows on a quarterly or
annual basis.




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




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




·
            our ability to respond
      effectively to competitive pricing
  pressures;


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


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


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


·
            our success in supporting our
      products and systems;


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


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


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


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


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


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





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





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





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




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





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


27


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





We expect
our competitors to continue to improve the performance of their current products
and introduce new products or new technologies.  If our competitors
successfully introduce new products or enhance their existing products, our
sales or market acceptance of our products and services could be reduced, price
competition could be increased or our products could become
obsolete.  To remain competitive, therefore, we must continue to
invest significant resources in research and development, sales and marketing
and customer support.  We may not have sufficient resources to make
these investments or to make the technological advances necessary to be
competitive, which in turn will cause our business to suffer.




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





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




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





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




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





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





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


28




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





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




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





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




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





Sales
through our distributors, Altisys Communications, Inc., Synnex Corporation
and Fiserv Solutions, Inc. accounted for 57% of our net revenue during the six
months ended March 31, 2010. Our business and operating results will suffer if
any one of these distributors does not continue distributing our products, fails
to distribute the volume of our products that it currently distributes or fails
to expand our customer base.  We also need to establish and maintain
relationships with additional distributors and original equipment manufacturers.
In September 2009, we terminated our distribution agreement with Jenne
Distributors, Inc. We believe the termination of our relationship with Jenne
Distributors, Inc. will not have a material impact on our business because we
anticipate that revenue from other distributors will offset a portion of the
lost revenue.





We may
not be able to establish, or successfully manage, relationships with additional
distribution partners.  In addition, our agreements with distributors
typically provide for termination by either party upon written notice to the
other party.  For example, our agreement with Synnex provides for
termination, with or without cause, by either party upon 30 days' written notice
to the other party, or upon insolvency or bankruptcy.  Generally,
these agreements are non-exclusive and distributors sell products that compete
with ours.  If we fail to establish or maintain relationships with
distributors and original equipment manufacturers, our ability to increase or
maintain our sales and our customer base will be substantially
harmed.




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





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




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





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


29




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





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




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





We may
begin to outsource a substantial amount of our product assembly and test
functions.  This outsourcing strategy involves certain risks,
including the potential lack of adequate capacity and reduced control over
delivery schedules, manufacturing yield, quality and costs.  In the
event that any significant subcontractors were to become unable or unwilling to
continue to manufacture or test our products in the required volumes, we would
have to identify and qualify acceptable replacements.  Finding
replacements could take time and we cannot be sure that additional sources would
be available to us on a timely basis.  Any delay or increase in costs
in the assembly and testing of products by third-party subcontractors could
seriously harm our business, financial condition and results of
operations.




Our
expansion in international markets has been slow and steady.  However,
our plan is to accelerate this growth rate and will involve new risks that our
previous domestic operations have not prepared us to address; our failure to
address these risks could harm our business, financial condition and results of
operations.





For the
second quarter of fiscal year 2010, approximately 13% of our net revenue came
from customers outside of the Americas.  We intend to expand our
international sales and marketing efforts.  Our efforts are subject to
a variety of risks associated with conducting business internationally, any of
which could seriously harm our business, financial condition and results of
operations.  These risks include:





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


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


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


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




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





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





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


30




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





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




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





We may
become parties to litigation in the normal course of our
business.  Litigation in general, and intellectual property and
securities litigation in particular, can be expensive and disruptive to normal
business operations.  Moreover, the results of complex litigation are
difficult to predict.  We were previously a defendant in a patent
infringement suit brought by Vertical Networks.  On October 4,
2007, the parties entered into a stipulation dismissing the lawsuit in its
entirety without prejudice.  Consequently, Vertical Networks may
reassert these or related claims in one or more separate
proceedings.





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




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





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





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




Risks
Related to the Industry




Integrated,
multifunction telecommunications systems may not achieve widespread
acceptance.





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


31




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





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




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





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




32




Item
5. Other Information





On
February 23, 2010, the Board of Directors of the Company unanimously approved a
plan to voluntarily delist the Company’s common stock from the NASDAQ Capital
Market and to move its common stock listing to the OTCQX over-the-counter
market. In connection therewith, the Company notified the NASDAQ Capital
Market on March 5, 2010 of its intention to delist and filed a Form 25 with the
SEC on March 15, 2010, which became effective ten (10) days following its
filing.





Following
delisting from the NASDAQ Capital Market, the Company’s common stock is quoted
on the OTCQX over-the-counter market, a centralized electronic quotation service
for over-the-counter securities, operated by Pink OTC Markets, Inc. The Company
intends to continue to comply with OTCQX alternate reporting standards,
including annual audited financial statements and unaudited quarterly financial
statements beginning on or after July 1, 2010. The Company expects that its
common stock will continue to trade on OTCQX so long as market makers
demonstrate an interest in trading in the common stock and the Company maintains
compliance with applicable rules and regulations.


33


Item
6. Exhibits.





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


34





SIGNATURE





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




ALTIGEN
      COMMUNICATIONS, INC.Date:
      May 12, 2010
                  By:
                  /s/
      Philip M. McDermottPhilip
      M. McDermottChief
      Financial
Officer


35




EXHIBIT
INDEX





Exhibit
              Number
            
            Description3.1
      (1)
            
            Amended
      and Restated Certificate of Incorporation.3.2
      (2)
            
            Second
      Amended and Restated Bylaws.3.3(3)
            
            Certificate
      of Designation of Rights, Preferences and Privileges of Series A
      Participating Preferred Stock of AltiGen Communications,
    Inc.4.1(4)
            
            Preferred
      Stock Rights Agreement, dated as of April 21, 2009, between AltiGen
      Communications, Inc. and Computershare Trust Company, N.A., including the
      Certificate of Designation, the form of Rights Certificate and the Summary
      of Rights attached thereto as Exhibits A, B and C,
      respectively.4.2(1)
            
            Specimen
      common stock certificates.4.3(1)
            
            Third
      Amended and Restated Rights Agreement dated May 7, 1999 by and among
      AltiGen Communications, Inc. and the Investors and Founder named
      therein.31.1
            
            Certification
      of Principal Executive Officer, filed herewith.31.2
            
            Certification
      of Principal Financial Officer, filed herewith.32.1
            
            Certification
      of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted
      Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed
      herewith.32.2
            
            Certification
      of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted
      Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed
      herewith.


___________________________________________





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


36