Edgar Filing: ALTIGEN COMMUNICATIONS INC

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

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FORM 10-Q

/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITY EXCHANGE
ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 2001

/ / 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

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ALTIGEN COMMUNICATIONS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

Delaware 94-3204299
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)

47427 Fremont Boulevard
Fremont, CA 94538
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(address of principal executive offices) (zip code)

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (510) 252-9712
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: None
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: Common Stock

(TITLE OF CLASS)

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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
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AS OF FEBRUARY 8, 2002, 14,194,292 shARES OF THE REGISTRANT'S COMMON
STOCK WERE OUTSTANDING.

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Table of Contents

Page
PART I FINANCIAL INFORMATION

Item 1. Unaudited Condensed Consolidated Financial Statements:

Unaudited Condensed Consolidated Balance Sheets as of
December 31, 2001 and September 30, 2001 3

Unaudited Condensed Consolidated Statements of Operations for
the Three Months Ended December 31, 2001 and 2000 4

Unaudited Condensed Consolidated Statements of Cash Flows for
the Three Months Ended December 31, 2001 and 2000 5

Notes to Unaudited Condensed Consolidated Financial Statements 6

Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 11

Item 3. Quantitative and Qualitative Disclosures about Market Risk 22

PART II OTHER INFORMATION

Item 1. Legal Proceedings 23

Item 2. Changes in Securities and Use of Proceeds 23

Item 3. Defaults Upon Senior Securities 23

Item 4. Submission of Matters to a Vote of Security Holders 23

Item 5. Other Information 23

Item 6. Exhibits and Reports on From 8-K 23

SIGNATURES

PART I. FINANCIAL INFORMATION
Item 1. Unaudited Condensed Consolidated Financial Statements.

ALTIGEN COMMUNICATIONS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS

December 31, September 30,
2001 2001
------------------------- -------------------------
(unaudited) (see Note 1)

ASSETS
Current assets:
Cash and cash equivalents..................................... $ 4,199,796 $ 11,899,754
Short-term investments........................................ 10,873,366 5,628,319
Accounts receivable, net of allowances of $441,680
and $403,423, respectively................................ 1,229,201 1,274,315
Inventories .................................................. 2,258,206 2,543,316
Prepaid expenses and other current assets..................... 516,129 269,442
--------------- ---------------
Total current assets................................. 19,076,698 21,615,146
--------------- ---------------
Property and equipment:

Leasehold improvements........................................ 297,922 297,922
Furniture and equipment....................................... 1,669,926 1,647,391
Computer software............................................. 913,253 913,253
--------------- ---------------
2,881,101 2,858,566
Less: Accumulated depreciation and amortization............... (1,900,893) (1,733,357)
--------------- ---------------
Net property and equipment................................ 980,208 1,125,209
--------------- ---------------
Other non-current assets:

Promissory note to officer / stockholder ..................... 364,057 722,745
Long-term investments......................................... 397,826 397,826
--------------- ---------------
Total other non-current assets....................... 761,883 1,120,571
--------------- ---------------
$ 20,818,789 $ 23,860,926
============== ==============

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.............................................. $ 530,421 $ 467,542
Accrued liabilities:
Payroll and related benefits.............................. 269,552 278,340
Warranty.................................................. 446,955 523,245
Marketing................................................. 411,237 409,165
Other..................................................... 511,516 573,724
Deferred revenue.............................................. 512,837 798,857
--------------- ---------------
Total current liabilities............................ 2,682,518 3,050,873
--------------- ---------------
Contingencies (Note 4)
Stockholders' equity:
Common stock, $0.001 par value; Authorized -
50,000,000 shares; Outstanding - 13,874,884 shares
at December 31, 2001 and 13,772,488 shares at September
30, 2001.................................................. 13,875 13,772
Treasury stock at cost - 802,155 shares at December 31, (105,009)
2001 and 114,900 shares at September 30, 2001............. (755,278)
Additional paid-in capital.................................... 61,666,076 61,593,451
Deferred stock compensation................................... (362,225) (454,983)
Accumulated deficit........................................... (42,426,177) (40,237,178)
--------------- ---------------
Total stockholders' equity........................... 18,136,271 20,810,053
--------------- ---------------
$ 20,818,789 $ 23,860,926
=============== ===============

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

ALTIGEN COMMUNICATIONS, INC. AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

Three Months Ended December 31,
---------------------------------------
2001 2000
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Revenues, net.................................................... $ 1,769,777 $ 2,384,510
Cost of revenues................................................. 902,524 1,191,747
------------------ ------------------

Gross profit..................................................... 867,253 1,192,763
------------------ ------------------
Operating expenses:
Research and development...................................... 1,046,090 1,158,088
Sales and marketing........................................... 1,444,967 2,031,176
General and administrative.................................... 570,804 773,901
Amortization of deferred stock compensation (Note 5) ........ 92,758 170,166
------------------ ------------------
Total operating expenses................................... 3,154,619 4,133,331
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Loss from operations............................................. (2,287,366) (2,940,568)
Interest and other income, net................................... 98,367 478,924
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Net loss ........................................................ $ (2,188,999) $ (2,461,644)
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Basic and diluted net loss per share.......................... $ (0.16) $ (0.18)
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Shares used in computing basic and diluted net loss per share. 13,462,555 13,555,854
------------------ ------------------

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

ALTIGEN COMMUNICATIONS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

Three Months Ended December 31,
---------------------------------------
2001 2000
------------------ ------------------

CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss..................................................... $ (2,188,999) $ (2,461,644)
Adjustments to reconcile net loss to net cash used in operating
activities................................................
Depreciation and amortization............................ 167,536 137,701
Amortization of deferred stock compensation............... 92,758 170,166
Provision for accounts receivable allowance............... 38,653 9,852
Provision for excess and obsolete inventories............. -- 260,000
Changes in operating assets and liabilities
Accounts receivable....................................... 6,461 193,866
Inventories............................................... 285,110 (1,642,060)
Prepaid expenses and other current assets................. (246,687) (170,674)
Accounts payable.......................................... 62,879 (22,375)
Accrued liabilities....................................... (145,214) (294,522)
Deferred revenue.......................................... (286,020) (64,574)
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Net cash used in operating activities.................. (2,213,523) (3,884,264)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of short-term investments....................... (5,245,047) --
Proceeds from sale of short-term investments.............. -- 1,445,736
Purchases of property and equipment....................... (22,535) (80,255)
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Net cash used in (provided by) investing activities .. (5,267,582) 1,365,481
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CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuances of common stock................... 72,728 149,588
Purchase of treasury stock ............................... (650,269) --
Repayment of promissory note to officer/stockholder ...... 358,688 --
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Net cash used in (provided by) financing activities ... (218,853) 149,588
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NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS............. (7,699,958) (2,369,195)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD................... 11,899,754 15,141,380
-------------- --------------
CASH AND CASH EQUIVALENTS, END OF PERIOD......................... $ 4,199,796 12,772,185
============== ==============

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

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BASIS OF PRESENTATION

AltiGen Communications, Inc. ("AltiGen" or the "Company") designs, manufactures
and markets integrated, multifunction telecommunications systems that allow
businesses to use data networks, such as the Internet, and the traditional
telephone network interchangeably and seamlessly to carry voice and data
communications.

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 ("SEC"). These
unaudited condensed consolidated financial statements reflect the operations of
the Company and its wholly-owned subsidiary. All significant intercompany
transactions and balances have been eliminated. In our opinion, these unaudited
condensed consolidated financial statements include all adjustments necessary
(which are of a normal and recurring nature) for a fair presentation of the
Company's financial position, results of operations and cash flows for the
periods presented.

The condensed consolidated balance sheet as of September 30, 2001 has been
derived from the audited consolidated financial statements as of that date.

These financial statements should be read in conjunction with our audited
consolidated financial statements for the fiscal year ended September 30, 2001,
included in the Company's 2001 Annual Report on Form 10-K. Our 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 considers all highly liquid investments with an original maturity of
three months or less from the date of purchase to be cash equivalents.
Short-term investments are in highly liquid financial instruments with original
maturities greater than three months but less than one year and are classified
as "available-for-sale" investments. As of December 31, 2001, the Company's cash
and cash equivalents consisted of commercial paper and cash deposited in
checking and money market accounts. For the first quarter of fiscal years 2002
and 2001, the Company did not make any cash payments for interest or income
taxes.

INVENTORIES

Inventories (which include costs associated with components assembled by third
party assembly manufacturers, as well as internal labor and overhead) are stated
at the lower of cost (first-in, first-out) or market. Provisions, when required,
are made to reduce excess and obsolete inventories to their estimated net
realizable values. The components of inventories include:

December 31, September 30,
2001 2001
------------ -------------

Raw materials............................. $ 518,765 $ 585,131
Work-in-progress.......................... 162,317 88,711
Finished goods............................ 1,577,124 1,869,474
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$ 2,258,206 $ 2,543,316
============ =============

REVENUE RECOGNITION

Revenues consist of sales to end-users, including resellers, and to
distributors. Revenues from sales to end-users are recognized upon shipment. The
Company provides for estimated sales returns and allowances and warranty costs
related to such sales at the time of shipment. Net revenues consist of product
revenues 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, any unsold products may be returned by the
distributor for a full refund. These agreements may be canceled by either party
based on a specified notice. As a result of the above provisions, the Company
defers recognition of revenues and the proportionate costs of revenues derived
from sales to distributors until such distributors resell the Company's products
to their customers. The amounts deferred as a result of this policy are
reflected as "deferred revenue" in the accompanying consolidated balance sheets.

Software components are generally not sold separately from the Company's
hardware components. Accordingly, the Company allocates revenues between the
hardware and software components of its products based on management's best
estimate of their relative fair market values. The Company then accounts for the
recognition of software revenues in accordance with Statement of Position
("SOP") 97-2, "Software Revenue Recognition". Software revenues consist of
license revenues that are recognized upon the delivery of application products.
The Company provides limited post-contract customer support ("PCS"), consisting
primarily of technically support and "bug" fixes. In accordance with SOP 97-2,
revenue earned on software arrangements involving multiple elements is allocated
to each element based upon the relative fair values of the elements. Although
the Company provides PCS, the revenue allocated to this element is recognized
together with the initial licensing fee on delivery of the software because: (1)
the PCS fee is included with the initial licensing fee; (2) the PCS included
with the initial license fee is for one year or less; (3) the estimated cost of
providing PCS during the arrangement is insignificant; and (4) unspecified
upgrades/enhancements offered for minimal or no cost during PCS arrangements
historically have been and are expected to continue to be minimal and
infrequent. All estimated costs of providing the services, including
upgrades/enhancements are accrued for at the time of delivery.

In December 1999, the Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial
Statements." SAB 101 provides guidance on applying generally accepted accounting
principles to revenue recognition in financial statements. The Company evaluated
the effect of the adoption of SAB No. 101 and has determined that the Company's
current revenue recognition policies comply with SAB No. 101. Accordingly, there
was no impact on the Company's financial statements from adopting SAB No. 101.

BASIC AND DILUTED NET LOSS PER SHARE

Historical net loss per share has been calculated under SFAS No. 128, "Earnings
per Share." SFAS No. 128 requires companies to compute earnings per share under
two methods (basic and diluted). Basic net loss per share is calculated by
dividing net loss by the weighted average shares of common stock outstanding
during the period. Basic and diluted net loss per share numbers are the same ,
as potential common shares resulting from the exercise of stock options are
antidilutive. The Company evaluated the requirements of the SEC Staff Accounting
Bulletin No. 98 ("SAB No. 98"), and concluded that there are no nominal
issuances of common stock or potential common stock which would be required to
be shown as outstanding for all periods presented herein as outlined in SAB No.
98.

COMPREHENSIVE INCOME

SFAS No. 130, "Reporting Comprehensive Income" establishes standards for
reporting and presentation of comprehensive income. SFAS No. 130, which was
adopted by the Company in the first quarter of fiscal year 1998, requires
companies to report a new measurement of income or loss. Comprehensive loss for
the Company consists of net loss plus the effect of foreign currency translation
adjustments and other unrealized gains and losses, which are not material for
each of the three years ended September 30, 2001. Accordingly, comprehensive
loss closely approximates actual net loss. " The Company's other comprehensive
income is immaterial for all periods presented.

SEGMENT REPORTING

In June 1997, the FASB also issued SFAS No. 131, "Disclosures About Segments of
an Enterprise and Related Information." SFAS No. 131 was adopted by the Company
beginning on October 1, 1997. This statement establishes standards for
disclosures about operating segments, products and services, geographic areas
and major customers. The Company is organized and operates as one operating
segment. The Company operates primarily in one geographic area, the United
States.

Net revenue by geographic region based on customer location for the three month
periods ended December 31, 2001 and 2000 were as follows:

Three Months Ended
December 31,
-----------------------------------
2001 2000
===================================

Net Revenue
United States..................... 96% 98%
International .................... 4% 2%
--------------- --------------
100% 100%
=============== ==============

Net revenue by certain customers individually that account for more than 10% of
revenue for the three month periods ended December 31, 2001 and 2000 were as
follows:

Three Months Ended
December 31,
-----------------------------------
2001 2000
===================================

Customer A 27% 26%
Customer B 38% 26%
Customer C 22% 17%
Customer D --% 12%
All others 13% 19%
--------------- --------------
100% 100%
=============== ==============

Nearly all long-lived assets are located in the United States for all periods
presented.

Note 2. RECENT ACCOUNTING PRONOUNCEMENTS

In June 1999, the FASB issued SFAS No. 137, "Accounting for Derivative Financial
Instruments and Hedging Activities - Deferral of the Effective Date of FASB
Statement No. 133," which amends SFAS No. 133 to be effective for all fiscal
years beginning after June 15, 2000. In June 2000, SFAS No. 133 was amended by
SFAS No. 138, "Accounting for Certain Derivative Financial Instruments and
Certain Hedging Activities", which amended or modified certain issues discussed
in SFAS No. 133. SFAS No. 138 is also effective for all fiscal years beginning
after June 15, 2000. SFAS No. 133 and SFAS No. 138 establish accounting and
reporting standards requiring that every derivative instrument be recorded in
the balance sheet as either as an asset or liability measured as its fair value.
The statements also require that changes in the derivative's fair value be
recognized currently in the earnings unless specific hedge accounting criteria
are met. There was no impact on the Company's financial statements as the
Company does not currently hold any derivative instruments and does not engage
in hedging activities.

In July 2001, FASB issued SFAS No.'s 141 and 142, "Business Combinations" and
"Goodwill and Other Intangibles". FASB 141 requires all business combinations
initiated after June 30, 2001 to be accounted for using the purchase method.
Under FASB 142, goodwill is no longer subject to amortization over its estimated
useful life. Rather, goodwill is subject to at least an annual assessment for
impairment applying a fair-value based test. Additionally, an acquired
intangible asset should be separately recognized if the benefit of the
intangible asset is obtained through contractual or other legal rights, or if
the intangible asset can be sold, transferred, licensed, rented, or exchanged,
regardless of the acquirer's intent to do so. The Company does not believe that
the adoption of these statements will have a material impact on its financial
position or results of operations.

In April 2001, the Emerging Issues Task Force ("EITF") reached a consensus on
Issue No. 00-25, "Vendor Income Statement Characterization of Consideration Paid
to a Reseller of the Vendor's Products". This issue concluded that certain
consumer and trade sales promotion expenses are presumed to be a reduction of
the selling price of the vendor's products and therefore, should be
characterized as a reduction of revenue when recognized in the vendor's income
statement. The provisions of this pronouncement are required to be applied
starting with fiscal years beginning after December 15, 2001. The Company will
adopt this pronouncement in the first quarter of fiscal 2003. The Company does
not believe that the adoption of this statement will have a material impact on
its financial position or results of operations.

In August 2001, the FASB issued SFAS No. 144 "Accounting for the Impairment or
Disposal of Long-Lived Assets". SFAS 144 establishes one accounting model to be
used for long-lived assets to be disposed of by sale, and broadens the
presentation of discontinued operations to include more disposal operations.
SFAS 144 supersedes both SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed of", and the
accounting and the reporting provisions of APB Opinion No. 30. SFAS 144 is
effective for fiscal years beginning after December 15, 2001. The Company does
not expect the adoption of SFAS No. 144 will have a material impact on its
financial position or results of operations.

Note 3. PROMISSORY NOTE TO OFFICER / STOCKHOLDER:

On August 31, 2000, the Company granted a $1 million loan to its Chief Executive
Officer and significant stockholder. The original promissory note had a one-year
term with an interest rate of 6.88%. The principal for the promissory note was
fully secured by a perfected security interest in the borrower's primary
residence. The interest for the promissory note was fully secured by the
borrower's assets. During fiscal 2001, the Company received approximately
$277,000 of payment against the note.

On September 17, 2001, the Company entered into a new note for the then unpaid
principal amount of $800,000. The new note requires two principal payment of
$400,000, due on September 30, 2001 and 2002, plus interest of 6.125% due
monthly. The note and related interest is full recourse and is secured by an
interest in the borrower's personal assets. During the three month period ended
December 31, 2001, approximately $359,000 was paid against the note. Such note
is not secured by an interest in the borrowers primary residence.

Note 4. CONTINGENCIES

We have settled intellectual property litigation with Sonoma Systems, Inc.
("SSI"), formerly NetPhone, Inc. In April 2001, the NetPhone/SSI litigation
ended with a Compromise Settlement and Release of all claims and defenses
associated with the litigation, in addition to a Patent and Cross-License
Agreement between the parties.

Note 5. DEFERRED STOCK COMPENSATION

The amortization of deferred stock compensation relates to the following items
in the accompanying unaudited condensed consolidated statements of operations:

Three Months Ended
December 31,

------------- -------------
2001 2000
============= =============

Research and development ................. $ 36,026 $ 71,614
Sales and marketing ...................... 28,654 54,352
General and administrative ............... 28,078 44,200
------------- -------------
$ 92,758 $ 170,166
============= =============

Note 6. STOCK REPURCHASE PROGRAMS

On April 24, 2001, the Company's Board of Directors authorized a stock
repurchase program to buy back up to $1.0 million of the Company's outstanding
common stock in the open market. During the quarter ended December 31, 2001, the
Company repurchased $650,269 of its outstanding common stock under this
repurchase program.

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

FORWARD-LOOKING INFORMATION

Certain statements in this Form 10-Q contain "forward-looking" information (as
defined in Section 27A of the Securities Act of 1933, as amended and Section 21E
of the Securities Exchange Act of 1934, as amended) that involve risks and
uncertainties which may cause actual results to differ materially from those
predicted in the forward-looking statements. Forward-looking statements can be
identified by their use of such verbs as "expects," "anticipates," and
"believes" or similar verbs or conjugations of such verbs. If any of our
assumptions on which the statements are based prove incorrect or should
unanticipated circumstances arise, our actual results could materially differ
from those anticipated by such forward-looking statements. The differences could
be caused by a number of factors or combination of factors, including, but not
limited to, the "Certain Factors Affecting Business, Operating Results and
Financial Conditions " described herein and the Risk Factors described in our
Securities and Exchange Commission filings, including the Registration Statement
on Form S-1, as amended (Registration No. 333-79509), effective October 4, 1999.

OVERVIEW

We are a leading provider of integrated, multi-function telecommunications
systems. We were incorporated in May 1994 and began operations in July 1994.
From inception through July 1996, we were a development-stage company and had no
revenues. During this period, our operating activities consisted primarily of
developing our initial product, recruiting personnel, raising capital and
building our corporate infrastructure. We first recognized revenues from product
sales of our Quantum board and AltiWare software in July 1996. We generated net
revenues of $1.8 million and $2.4 million for the three months ended December
31, 2001 and 2000, respectively. As of December 31, 2001, we had an accumulated
deficit of $42.4 million.

We derive our revenues from sales of our AltiServ system, which includes Quantum
boards, Triton boards and AltiWare software. Software sales were $207,000 and
$505,000 for the three months ended December 31, 2001 and 2000, respectively. We
generally do not sell software separately from our hardware products. Product
revenues consist of sales to end users (including dealers) and to distributors.
Revenues from product sales to end users are recognized upon shipment. We defer
recognition of sales to distributors until they resell our products to their
customers. Under our distribution contracts, a distributor has the right in
certain circumstances to return products the distributor determines are
overstocked, so long as they provide an offsetting purchase order for products
in an amount equal to or greater than the dollar value of the returned products.
In addition, we provide distributors protection from subsequent price
reductions.

Our cost of revenues consists of component and material costs, direct labor
costs, provisions for excess and obsolete inventory, warranty costs and overhead
related to manufacturing our products. Software sales typically carry a higher
gross margin than hardware sales.

We have experienced operating losses and negative cash flows from operations in
each quarterly and annual period since our inception and we currently expect to
continue to incur losses for the foreseeable future. We have not recognized any
future tax benefits of our cumulative net operating losses due to uncertainty as
to future realizability.

Results of Operations

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

Three Months Ended
December 31,
-----------------------------------
2001 2000
===================================
(unaudited)

Revenues,net ............................................................. 100.0% 100.0%
Cost of revenues ......................................................... 51.0 49.9
-------------- ---------------
Gross profit ............................................................. 49.0 50.1
Operating expenses :
Research and development ............................................ 59.1 48.6
Sales and marketing ................................................. 81.6 85.2
General and administrative .......................................... 32.3 32.5
Amortization of deferred stock compensation ......................... 5.2 7.1
-------------- ---------------
Total operating expenses ....................................... 178.2 173.4
-------------- ---------------
Loss from operations ..................................................... (129.2) (123.3)
Interest and other income, net ........................................... 5.6 20.1
-------------- ---------------
Net loss ................................................................. (123.6)% (103.2)%
-------------- ---------------

Revenues, net. Revenues consist of sales to end users (including dealers) and to
distributors. Net revenues were $1.8 million for the first quarter of fiscal
2002, a decrease of 26% from $2.4 million for the same period of fiscal 2001.
The decrease in revenues was a result of decreased or delayed capital spending
by existing and prospective customers and the recent slowdown of the U.S.
economy. Sales through our main distributors, AltiSys, Synnex, Ingram Micro, and
Tech Data (now terminated) accounted for approximately 27.4%, 38.1%, 22.0%, and
0.0%, respectively, of our revenues for the first quarter of fiscal 2002 as
compared to 26.4%, 25.8%, 17.4%, and 11.5%, respectively, of our revenues for
the same period of fiscal 2001.

Cost of revenues. Cost of revenues was $903,000 for the first quarter of fiscal
2002, a decrease of 24% from approximately $1.2 million for the same period of
fiscal 2001. Cost of revenues consists primarily of component and material
costs, direct labor costs, provisions for excess and obsolete inventory,
warranty costs and overhead related to manufacturing our products. Cost of
revenues as a percentage of net revenues increased from 49.9% for the first
quarter of fiscal 2001 to 51.0% for the same period of fiscal 2002. This
increase was primarily due to unabsorbed overhead resulting from a decline in
the Company's manufacturing volume during the quarter ended December 31, 2001 as
compared to the quarter ended December 31, 2000. Further declines in demand,
although not currently anticipated, would result in reduced sales, increased
operating losses and additional inventory provisions.

Gross profit. Gross profit decreased to $867,000 for the first quarter of fiscal
2002 from $1.2 million for the same period of fiscal 2001. As a percentage of
revenue, gross profit decreased from 50.1% for the first quarter of fiscal 2001
to 49.0% for the same period of fiscal 2002. The decrease in gross profit as a
percentage of net revenues was primarily due to the previously mentioned
unabsorbed overhead resulting from a decline in the Company's manufacturing
volume during the quarter ended December 31, 2001 as well as the decline in
revenues.

Research and development expenses. Research and development expenses decreased
to $1.0 million for the first quarter of fiscal 2002 from $1.2 million for the
same period of fiscal 2001. Research and development expenses consist
principally of salaries and related personnel expenses, consultant fees and
prototype expenses related to the design, development and testing of our
products and enhancement of our converged telephone system software. The
decrease was primarily due to a reduction in service fees, equipment and
consultant expenses.

Sales and marketing expenses. Sales and marketing expenses decreased to $1.4
million for the first quarter of fiscal 2002 from $2.0 million for the same
period of fiscal 2001. Sales and marketing expenses consist of salaries,
commissions and related expenses for personnel engaged in sales and marketing
functions, trade show expenses, promotional and marketing programs and related
expenses. This decrease was due to a reduction in promotional and advertising
expenses, commission and decreased spending on travel expenses during the stated
periods.

General and administrative expenses. General and administrative expenses
decreased to $571,000 for the first quarter of fiscal 2002 from $774,000 for the
same period of fiscal 2001. The decrease was primarily due to reduction in legal
fees as a result of the settlement of litigation with Sonoma Systems, Inc. and
the Company's desire to conserve capital during the current economic downturn.

Deferred stock compensation expense. Deferred stock compensation expense was
$93,000 for the first quarter of fiscal 2002 as compared to $170,000 for the
same period of fiscal 2001. Deferred stock compensation expense reflects the
amortization of stock compensation charges resulting from granting stock options
at exercise prices below the deemed fair value of our common stock on the dates
the options were granted. The Company amortizes these amounts using the
straight-line method over the vesting period of the related stock options. The
Company expects to amortize approximately $278,000 of the remaining balance of
this deferred stock compensation in fiscal year 2002 and $84,000 in fiscal year
2003.

Interest and other income, net. Net interest and other income decreased to
$98,000 for the first quarter of fiscal 2002 from $479,000 for the same period
of fiscal 2001. The Company invested the proceeds from our initial public
offering in October 1999 in highly liquid, short-term and long-term investments.
The decrease was due to decreases in invested principal and declines in interest
rates.

Liquidity and Capital Resources

Since inception, we have financed our operations primarily through the sale of
equity securities. As of December 31, 2001, we had cash and short-term
investments totaling $15.1 million consisting of cash and cash equivalents of
$4.2 million and $10.9 million of highly liquid short-term investments.

Net cash used in our operating activities was $2.2 million and $3.9 million for
the three months ended December 31, 2001 and 2000, respectively. Net cash used
in operating activities primarily reflected the impact of the net loss for each
of the periods.

Net cash used in investing activities was $5.3 million for the three months
ended December 31, 2001, which was primarily a result of purchases of short-term
investments. Cash provided by investing activities for the three months ended
December 31, 2000 was $1.4 million, which was primarily a result of redemption
of short and long-term investments.

Net cash used in financing activities was $219,000 for the three months ended
December 31, 2001, consisting primarily of proceeds from the exercise of stock
options and investments in our employee stock purchase plan, payment of
stockholder's promissory note and repurchase of Company's common stock. Cash
provided by financing activities was $150,000 for the three months ended
December 31, 2000, consisting primarily of proceeds from the exercise of stock
options and investment in our employee stock purchase plan.

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
product enhancements, 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
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.

Additionally, There may be other financial alternatives, such as but not limited
to, private placements, strategic partnerships, mergers, and the issuance of
equity or debt securities, which may be explored.

In January 2002, we restructured our organization and reduced overall headcount
by 6%.

Based on our current revenue projections, and recent cost savings, we believe
that our cash reserves and working capital will be adequate to fund our
operations during the next twelve months. Our management intends to invest our
cash in excess of current operating requirements in short-term, interest-bearing
investment-grade securities. Additional financing may not be available to us on
favorable terms or not at all. We may also require additional capital to acquire
or invest in complementary businesses or products, or obtain the right to use
complimentary technologies. If we can not raise funds, if needed, on acceptable
terms, we may not be able to develop or enhance our products, take advantage of
future opportunities, or to respond to competitive pressures or unanticipated
requirements, which could seriously harm our business. Even if additional
financial is available, we may be required to obtain the consent of our
stockholders, which 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 the Company.

CERTAIN FACTORS AFFECTING BUSINESS, OPERATING RESULTS, AND FINANCIAL CONDITION

RISKS RELATED TO ALTIGEN

WE HAVE A HISTORY OF LOSSES AND EXPECT TO INCUR FUTURE LOSSES, WHICH MAY PREVENT
US FROM BECOMING PROFITABLE.

We have experienced operating losses since our inception. As of December 31,
2001, we had an accumulated deficit of $42.4 million. We expect to incur
operating losses for the foreseeable future, and these losses may be
substantial. Further, we expect our operating cash flows to be negative for the
foreseeable future. Because we expect continued expenditures for product
development and general and administrative expenses, and sales and marketing
expenses, we will need to increase revenues significantly to achieve
profitability and positive operating cash flows. Even if we do 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.

WE HAVE A LIMITED OPERATING HISTORY, WHICH MAKES IT DIFFICULT TO EVALUATE OUR
BUSINESS AND OUR FUTURE PROSPECTS.

We shipped our first products in July 1996. As a result of our limited operating
history, we have limited financial data that you can use to evaluate our
business. You must consider our prospects in light of the risks, expenses and
challenges we might encounter because we are at an early stage of development

in a new and rapidly evolving market. To address these risks and achieve
profitability and increased sales levels, we must:

o establish and increase market acceptance of our technology, products and
systems;

o expand 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;

o introduce products and systems incorporating our technology and
enhancements to our product applications on a timely basis;

o respond effectively to competitive pressures; and

o successfully market and support our products and systems.

We may not successfully meet any of these challenges, and our failure to do so
will seriously harm our business and results of operations. In addition, because
of our limited operating history, we have limited insight into trends that may
emerge and harm our business.

OUR OPERATING RESULTS VARY, MAKING FUTURE OPERATING RESULTS DIFFICULT TO
PREDICT.

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

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

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

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

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

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

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

Our budgets and commitments that we have made for the future 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 depend primarily 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 COMPETE
ADEQUATELY.

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

We face competition from companies providing traditional private telephone
systems. Our principal competitors that produce traditional private telephone
systems are Avaya Communications, NEC and Nortel Networks. We also compete
against providers of multifunction telecommunications systems, including 3Com
Corporation, Artisoft, Inc., Cisco System, Inc. and Shoreline Teleworks, Inc.,
as well as any number of future competitors. Many of our competitors are
substantially larger than we are and have significantly greater name
recognition, financial, sales and marketing, technical, customer support,
manufacturing and other resources. These competitors may also 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 devote greater
resources to the development, promotion and sale of their products. These
competitors may enter our existing or future markets with solutions that may be
less expensive, provide higher performance or additional features or be
introduced earlier than our solutions. 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, this could reduce the sales or market acceptance of our products and
services, increase price competition or make our products obsolete. To be
competitive, 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.

LOSING ANY OF OUR KEY DISTRIBUTORS WOULD HARM OUR BUSINESS. WE ALSO NEED TO
ESTABLISH AND MAINTAIN RELATIONSHIPS WITH ADDITIONAL DISTRIBUTORS AND ORIGINAL
EQUIPMENT MANUFACTURERS.

Sales through our three key distributors, Altisys, Synnex, and Ingram Micro
accounted for 87.5% of our net revenues in the first quarter of fiscal 2002. Our
business and operating results will suffer if either of these distributors does
not continue distributing our products, fails to distribute the volume of our
products that it currently distributes or fails to expand our customer base. We
also need to establish and maintain relationships with additional distributors
and original equipment manufacturers. We may not be able to establish, or
successfully manage, relationships with additional distribution partners. In
addition, our agreements with distributors typically provide for termination by
either party upon written notice to the other party. For example, our agreement
with Synnex provides for termination, with or without cause, by either party
upon 30 days' written notice to the other party, or upon insolvency or
bankruptcy. Generally, these agreements are non-exclusive and distributors sell
products that compete with ours. If we fail to establish or maintain
relationships with distributors and original equipment manufacturers, our
ability to increase or maintain our sales and our customer base will be
substantially harmed.

WE SELL OUR PRODUCTS THROUGH DEALERS AND DISTRIBUTORS, WHICH LIMITS OUR ABILITY
TO CONTROL THE TIMING OF OUR SALES, AND THIS MAKES IT MORE DIFFICULT TO PREDICT
OUR REVENUES.

We do not recognize revenue from the sale of our products to our distributors
until these products are sold to either dealers or end users. We have little
control over the timing of product sales to dealers and end users. Our lack of
control over the revenue which we recognize from our distributors' sales to

dealers and end users limits our ability to predict revenue for any given
period. Our budgets and commitments that we have made for the future 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 SOLE-SOURCED COMPONENTS AND THIRD-PARTY TECHNOLOGY AND PRODUCTS; IF
THESE COMPONENTS ARE NOT AVAILABLE, OUR BUSINESS MAY SUFFER.

We purchase technology from third parties that is incorporated into our
products, including virtually all of our hardware products. We order
sole-sourced components using purchase orders and do not have supply contracts
for them. One sole-sourced component, a Zarlink Corporation 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 solutions. This could entail qualifying an alternative source or
redesigning our products based on different components. Our inability to obtain
these sole-sourced components, especially the Zarlink Corporation chip, could
significantly delay shipment of our products, which could have a negative effect
on our business, financial condition and results of operations.

WE RELY ON DEALERS TO PROMOTE, SELL, INSTALL AND SUPPORT OUR PRODUCTS, AND THEIR
FAILURE TO DO SO MAY SUBSTANTIALLY REDUCE OUR SALES AND THUS SERIOUSLY HARM OUR
BUSINESS.

We rely on dealers who can provide high quality sales and support services. As
with our distributors, we compete with other telecommunications systems
providers for our dealers' business, as our dealers generally market competing
products. If a dealer 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 dealer or the failure of
dealers to provide adequate customer service could cause our business to suffer.
If we do not properly train our dealers 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 REVENUES.

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.
For example, a small number of our boards failed and were returned. We have
replaced these boards and made certain design changes. We cannot be sure that
the problem has been fully addressed and that similar or different problems may
not occur in existing or new boards in the future. In addition, 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 revenues, uncollectable 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.

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 are not
currently party to any material litigation.

More generally, litigation related to these types of claims may require us to
acquire licenses under third-party patents which may not be available on
acceptable terms, if at all. We believe that an increasing portion of our
revenues in the future will come from sales of software applications for our
hardware products. The software market has traditionally 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.

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 filed 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 to our technology. In addition,
others may independently develop substantially equivalent proprietary
information not covered by 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 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.

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 in which we sell or plan to
sell them. We have also obtained or are trying to obtain the certifications that
we believe are required to sell our products in these countries. However, we
cannot 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 those products in that country. This 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.

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. Therefore, to be
competitive, we will 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.

IF WE DO NOT MANAGE OUR GROWTH EFFECTIVELY, OUR BUSINESS WILL SUFFER.

We may not be successful in managing any future growth. We have expanded our
operations rapidly since our inception. In order to manage this expansion and to
grow in the future, we will need to expand or enhance our management,
manufacturing, research and development and sales and marketing capabilities. We
may not be able to hire the management, staff or other personnel required to do
so.

We may not be able to install adequate control systems in an efficient and
timely manner, and our current or planned operational systems, procedures and
controls may not be adequate to support our future operations. Difficulties in
installing and implementing new systems, procedures and controls may
significantly burden our management and our internal resources. Delays in the
implementation of new systems or operational disruptions when we transition to
new systems would impair our ability to accurately forecast sales demand, manage
our product inventory and record and report financial and management information
on a timely and accurate basis.

Lead times for materials and components used in the assembly of our products
vary significantly, and depend on factors such as the supplier, contract terms
and demand for a component at a given time. If orders do not match forecasts, we
may have excess or inadequate inventory of certain materials and components,
which may seriously harm our business, financial condition and results of
operations.

OUR PLANNED EXPANSION IN INTERNATIONAL MARKETS 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.

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:

o 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;

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

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

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

WE NEED ADDITIONAL 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 revenues.
Competition for highly trained personnel is intense, especially in the San
Francisco Bay Area where most of our operations are located. We cannot be
certain that we will be successful in our recruitment and retention efforts. If
we fail to attract or retain qualified personnel or suffer from delays in hiring
required personnel, our business, financial condition and results of operations
may be seriously harmed.

OUR FACILITY IS VULNERABLE TO DAMAGE FROM EARTHQUAKES AND OTHER NATURAL
DISASTERS; ANY SUCH DAMAGE COULD SERIOUSLY OR COMPLETELY IMPAIR OUR BUSINESS.

We perform final assembly, software installation and testing of our products at
our facility in Fremont, California. Our facility is located on or near known
earthquake fault zones and is vulnerable to damage from fire, floods,
earthquakes, power loss, telecommunications failures and similar events. If such
a disaster 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.

WE RELY ON A CONTINUOUS POWER SUPPLY TO CONDUCT OPERATIONS, AND CALIFORNIA'S
CURRENT ENERGY CRISIS COULD DISRUPT OUR BUSINESS AND INCREASE OUR EXPENSES.

California is in the California is in the midst of an energy crisis that could
disrupt our operations and increase our expenses. In the event of an acute power
shortage that is, when power reserves for California fall below 1.5%, California
has on some occasions implemented, and may in the future continue to implement,
rolling blackouts throughout California. We currently have only limited backup
generators for emergency alternate sources of power in the event of blackout. If
blackouts interrupt our power supply, we would be temporarily unable to continue
operations at our facility. Any such interruption in our ability to continue
operations at our facility could delay shipments of our products to customers,
and could result in lost revenue, which could harm our business and results of
operations.

OUR STRATEGY TO OUTSOURCE ASSEMBLY AND TEST FUNCTIONS IN THE FUTURE COULD DELAY
DELIVERY OF PRODUCTS, DECREASE QUALITY OR INCREASE COSTS.

Based on volume or customer requirements, we may begin outsourcing some assembly
and test functions. In addition, we may determine that we need to establish
assembly and test operations overseas to better serve our international
customers. Establishing overseas assembly and test operations may be more
difficult or take longer than we anticipate. 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 subcontractor 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.

IF WE ARE UNABLE TO COMPLY WITH NASDAQ'S CONTINUED LISTING REQUIREMENTS, OUR
COMMON STOCK COULD BE DELISTED FROM THE NASDAQ NATIONAL MARKET.

Our common stock trades on Nasdaq National Market, which has certain compliance
requirements for continued listing of common stock. If the minimum closing bid
price per share is less than $1.00 for a period of 30 consecutive business days,
our shares may be delisted following a 90 days notice period during which the
minimum closing bid price must be $1.00 or above per share for a period of 10
consecutive business days, if we do not file an appeal. During fiscal year 2001
and thereafter, the minimum bid price for our common stock closed, at times,
below $1.00 per share.

The result of delisting from the Nasdaq National Market would be a reduction in
the liquidity of any investment in our common stock and a material adverse
effect on the price of our common stock. Delisting would reduce the ability of
holders of our common stock to purchase or sell shares as quickly and as
inexpensively as they could have done in the past. This lack of liquidity would
make it more difficult for us to raise capital in the future. Although we are
working to comply with all continued listing requirements of Nasdaq, there can
be no assurance that we will be able to satisfy such requirements. On September
27, 2001, the Nasdaq temporarily suspended the $1.00 minimum closing bid price
requirement. The suspension will last until January 2, 2002.

RISKS RELATED TO THE INDUSTRY

INTEGRATED, MULTIFUNCTION TELECOMMUNICATIONS SYSTEMS MAY NOT ACHIEVE WIDESPREAD
ACCEPTANCE, AND OUR FIXED COSTS IN THE SHORT RUN COULD CAUSE OUR OPERATING
RESULTS AND BUSINESS TO SUFFER.

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 may also 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 may also experience these problems if the networks do not have
sufficient capacity to carry all of these communications at the same time. We
incur many fixed costs in anticipation of a certain level of revenues. If
businesses defer purchasing or decide not to purchase integrated, multifunction
telecommunications systems and the market for our products does not grow or
grows substantially more slowly than we anticipate, our operating results will
suffer and our business will be harmed because we will be unable to reduce fixed
costs in the short term to offset the reduced revenues.

FUTURE REGULATION OR LEGISLATION COULD HARM OUR BUSINESS OR INCREASE OUR COST OF
DOING BUSINESS.

In April 1998, the Federal Communications Commission 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, however,
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. 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.

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 may also 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.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Market Risk. Our interest income is sensitive to changes in the general level of
U.S. interest rates, particularly since the majority of our investments are in
cash equivalents and short-term instruments. Due to the short-term nature of our
cash equivalents and investments, we have concluded that there is no material
market risk exposure. Therefore, no quantitative tabular disclosures are
required.

PART II

Item1. Legal Proceedings

Item 2. Changes in Securities and Use of Proceeds

For the three months ended December 31, 2001, we issued 510 shares of common
stock pursuant to the exercise of stock options at exercise prices of 0.23. All
of the stock options were granted under our 1994 Stock Option Plan prior to our
initial public offering. For the same period, 97,070 shares were purchased and
distributed to employees at an average price of $0.75 per share related to
Employee Stock Purchase Plan. All of these stocks were granted under our 1999
Employee Stock Purchase Plan. Our issuance of shares of our common stock upon
the exercise of these options was exempt from registrant pursuant to rule 701
promulgated under the Securities Act of 1933, as amended.

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

None

Item 6. Exhibits and Report on Form 8-K

(a) Exhibits:

Number Description
------ -----------

10.26** OEM Agreement between AltiSys Communications and AltiGen
Communications, Inc., dated January 18, 1999.

10.27** Distribution Agreement between Synnex Information Technologies,
Inc. and AltiGen Communications, Inc., dated December 22, 1999.

** A request for confidential treatment for portions of this agreement has been
submitted to the Commission. Omitted portions have been filed separately with
the Commission.

(b) Report on Form 8-K:

None

Item 3. and Item 5. not applicable

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of
1934, the Registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized, in the city of Fremont, State of
California, on the 13th day of February, 2002.

ALTIGEN COMMUNICATIONS, INC.

By: /s/ Phillip M. Mcdermott
------------------------
Philip M. McDermott,
Chief Financial Officer
(Principal Financial and Accounting Officer)