Edgar Filing: ALTIGEN COMMUNICATIONS INC

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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 SECURITY EXCHANGE
ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002

/ / 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
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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 AUGUST 12, 2002, 13,479,711 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 3

Unaudited Condensed Consolidated Balance Sheets as of
June 30, 2002 and September 30, 2001 3

Unaudited Condensed Consolidated Statements of Operations for
the Three and Nine Months Ended June 30, 2002 and 2001 4

Unaudited Condensed Consolidated Statements of Cash Flows for
the Nine Months Ended June 30, 2002 and 2001 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 23

PART II OTHER INFORMATION

Item 1. Legal Proceedings 24

Item 2. Changes in Securities and Use of Proceeds 24

Item 4. Submission of Matters to a Vote of Security Holders 24

Item 6. Exhibits and Reports on Form 8-K 24

SIGNATURES 25

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

ALTIGEN COMMUNICATIONS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)

June 30, September 30,
2002 2001
------------------------- --------------------------
(see Note 1)

ASSETS
Current assets:
Cash and cash equivalents..................................... $ 4,213,448 $ 11,899,754
Short-term investments........................................ 8,797,497 5,628,319
Accounts receivable, net of allowances of $283,805
and $403,423 at June 30, 2002 and September 30, 2001,
respectively.............................................. 1,441,961 1,274,315
Inventories .................................................. 1,589,241 2,543,316
Prepaid expenses and other current assets..................... 345,289 269,442
Promissory note from officer / stockholder (Note 3) .......... 350,012 722,745
--------------- ---------------
Total current assets................................. 16,737,448 22,337,891
--------------- ---------------
Property and equipment:

Leasehold improvements........................................ 297,922 297,922
Furniture and equipment....................................... 1,733,372 1,647,391
Computer software............................................. 913,253 913,253
--------------- ---------------
2,944,547 2,858,566
Less: Accumulated depreciation and amortization............... (2,191,916) (1,733,357)
--------------- ---------------
Net property and equipment................................ 752,631 1,125,209
--------------- ---------------
Long-term investment............................................. 397,826 397,826
--------------- ---------------
$ 17,887,905 $ 23,860,926
=============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.............................................. $ 696,130 $ 467,542
Accrued liabilities:
Payroll and related benefits.............................. 305,303 278,340
Warranty.................................................. 538,795 523,245
Marketing................................................. 538,724 409,165
Other..................................................... 524,270 573,724
Deferred revenue.............................................. 614,603 798,857
--------------- ---------------
Total current liabilities............................ 3,217,825 3,050,873
--------------- ---------------
Contingencies
Stockholders' equity:
Common stock, $0.001 par value; Authorized -
50,000,000 shares; Outstanding - 14,543,606 shares at
June 30, 2002 and 13,772,488 shares at September
30, 2001.................................................. 14,544 13,772
Treasury stock at cost - 1,063,895 shares at June 30,
2002 and 114,900 shares at September 30, 2001............. (1,014,499) (105,009)
Additional paid-in capital.................................... 61,801,895 61,593,451
Deferred stock compensation................................... (176,709) (454,983)
Accumulated other comprehensive gain.......................... 4,649 --
Accumulated deficit........................................... (45,959,800) (40,237,178)
--------------- ---------------
Total stockholders' equity........................... 14,670,080 20,810,053
--------------- ---------------
$ 17,887,905 $ 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 June 30, Nine Months Ended June 30,
---------------------------------- ---------------------------------
2002 2001 2002 2001
--------------- --------------- --------------- ---------------

Revenues, net.................................... $ 2,764,539 $ 2,695,850 $ 6,735,986 $ 7,990,570
Cost of revenues................................. 1,205,849 2,672,082 3,206,764 5,567,056
--------------- --------------- --------------- ---------------
Gross profit..................................... 1,558,690 23,768 3,529,222 2,423,514
--------------- --------------- --------------- ---------------
Operating expenses:
Research and development...................... 1,038,686 1,386,322 3,090,234 3,753,327
Sales and marketing........................... 1,490,926 3,082,496 4,490,348 7,628,770
General and administrative.................... 547,338 665,924 1,622,211 2,169,188
Deferred stock compensation (Note 4) ........ 92,757 133,209 278,274 655,939
--------------- --------------- --------------- ---------------
Total operating expenses................... 3,169,707 5,267,951 9,481,067 14,207,224
--------------- --------------- --------------- ---------------
Loss from operations............................. (1,611,017) (5,244,183) (5,951,845) (11,783,710)
Interest and other income, net................... 61,138 243,535 229,223 1,105,023
--------------- --------------- --------------- ---------------
Net loss ........................................ $ (1,549,879) $ (5,000,648) $ (5,722,622) $ (10,678,687)
=============== =============== =============== ===============
Basic and diluted net loss per share.......... $ (0.12) $ (0.36) $ (0.43) $ (0.78)
=============== =============== =============== ===============
Shares used in computing basic
and diluted net loss per share......... 13,390,331 13,722,266 13,334,865 13,630,423
=============== =============== =============== ===============

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)

Nine Months Ended June 30,
--------------------------------------
2002 2001
------------------- -----------------

CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss..................................................... $ (5,722,622) $ (10,678,687)
Adjustments to reconcile net loss to net cash used in
operating activities.......................................:
Depreciation and amortization............................ 458,559 454,825
Amortization of deferred stock compensation............... 278,274 655,939
Provision for accounts receivable allowance............... (115,973) 77,685
Provision for excess and obsolete inventories............. -- 2,149,000
Changes in operating assets and liabilities
Accounts receivable....................................... (51,673) 187,596
Inventories............................................... 954,074 (1,473,465)
Prepaid expenses and other current assets................. (75,847) (400,826)
Accounts payable.......................................... 228,588 (393,216)
Accrued liabilities....................................... 122,618 (620,249)
Deferred revenue.......................................... (184,254) (208,959)
------------- -------------
Net cash used in operating activities.................. (4,108,256) (10,250,357)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of short-term investments.................. (26,366,939) (19,940,354)
Proceeds from sale and maturities of short-term investments 23,197,762 27,423,841
Purchases of property and equipment.................. (85,981) (777,313)
------------ ------------
Net cash (used in) provided by investing activities (3,255,158) 6,706,174
------------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuances of common stock.............. 209,216 315,946
Purchase of treasury stock .......................... (909,490) (7,500)
Collection of promissory note from officer/stockholder 372,733 --
Unrealized gain on short term investments ........... 4,649 --
-------------- --------------
Net cash (used in) provided by financing activities (322,892) 308,446
--------------- --------------
NET DECREASE IN CASH AND CASH EQUIVALENTS........................ (7,686,306) (3,235,737)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD................... 11,899,754 15,141,380
-------------- --------------
CASH AND CASH EQUIVALENTS, END OF PERIOD......................... $ 4,213,448 $ 11,905,643
============== ==============

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.
Certain amounts from the prior period have been reclassified to conform to the
current period presentation. Such reclassifications have no effect on net income
as previously reported.

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 primarily consist of high-grade debt securities with
original maturities greater than three months but less than one year and are
classified as "available-for-sale" investments. As of June 30, 2002, the
Company's cash and cash equivalents consisted of commercial paper and cash
deposited in checking and money market accounts. For the third 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 allocable overhead)
are stated at the lower of cost (first-in, first-out) or market. Provisions,
when required, are made to write down excess and obsolete inventories to their
estimated net realizable values. The components of inventories include:

June 30, September 30,
2002 2001
------------ -------------

Raw materials............................. $ 253,873 $ 585,131
Work-in-progress.......................... 247,698 88,711
Finished goods............................ 1,087,670 1,869,474
------------ -------------
$ 1,589,241 $ 2,543,316
============ =============
LONG-TERM INVESTMENT

The Company has an approximately $380,000 equity investment in a private China
based telecommunications company. AltiGen's interest in the company is
approximately 2% and AltiGen does not have the ability to exercise significant
influence. Accordingly, this investment is carried at cost. If this investment
declined in fair value on an other than temporary basis, the Company would
record an adjustment to the carrying value. To date, no such impairment has been
recognized.

Revenue Recognition

Revenues consist of sales to end-users, including resellers, and to
distributors. Revenues from sales to end-users are recognized upon shipment,
when risk of loss has passed to the customer, collection of the receivable is
reasonably assured, persuasive evidence of an arrangement exists, and the price
is fixed and determinable. 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. The Company 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.

BASIC AND DILUTED NET LOSS PER SHARE

Historical net loss per share has been calculated under Statement of Financial
Accounting Standards ("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. Options to
purchase 3,536,886 shares of common stock were outstanding at June 30, 2002.

COMPREHENSIVE INCOME

SFAS No. 130, "Reporting Comprehensive Income" establishes standards for
reporting and presentation of comprehensive income. Comprehensive loss for the
Company consists of net loss plus the effect of foreign currency translation
adjustments and other unrealized gains and losses.

Three Months Ended Nine Months Ended
June 30, June 30,
---------------------------------- ---------------------------------------
2002 2001 2002 2001
----------------- ---------------- ------------------- -------------------

Net loss ($ 1,549,879) ($ 5,000,648) ($ 5,722,622) ($ 10,678,687)
Other comprehensive income-
Change in net unrealized gain
on investments 4,649 -- 4,649 --
----------------- ---------------- ------------------- -------------------
($ 1,545,230) ($ 5,000,648) ($ 5,717,973) ($ 10,678,687)
================= ================ =================== ===================

SEGMENT REPORTING

The Company is organized and operates as one operating segment. The Company
operates primarily in one geographic area, North America.

Net revenue by geographic region based on customer location for the three month
and nine month periods ended June 30, 2002 and 2001 were as follows:

Net Revenue
North America........................ 94% 97% 95% 99%
International ....................... 6% 3% 5% 1%
----------------- ---------------- ------------------- -------------------
100% 100% 100% 100%
================= ================ =================== ===================

Net revenue by certain customers individually that account for more than 10% of
revenue for the three month and nine month periods ended June 30, 2002 and 2001
were as follows:

Customer A 28% 55% 30% 41%
Customer B 20% 22% 27% 27%
Customer C 28% 20% 26% 21%
Others 24% 3% 17% 11%
----------------- ---------------- ------------------- -------------------
100% 100% 100% 100%
================= ================ =================== ===================

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

Note 2. RECENT ACCOUNTING PRONOUNCEMENTS

In July 2001, FASB issued SFAS No.'s 141 and 142, "Business Combinations" and
"Goodwill and Other Intangibles". SFAS No. 141 require all business combinations
initiated after June 30, 2001 to be accounted for using the purchase method.
Under SFAS No. 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 will follow SFAS No.
141 for any future business acquisitions. The Company adopted SFAS No. 142 on
October 1, 2001 and this adoption did not have a material impact on its
consolidated financial position or results of operations.

In October 2001, the FASB issued SFAS No. 144 "Accounting for the Impairment or
Disposal of Long-Lived Assets". SFAS No. 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 No. 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 Accounting Principles Board ("APB")
Opinion No. 30, "Reporting the Results of Operations - Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and Unfrequently
Occurring Events and Transactions". SFAS No. 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 consolidated financial position
or results of operations.

In June 2002, the FASB issued SFAS 146, "Accounting for Costs Associated with
Exit or Disposal Activities", which addresses accounting for restructuring and
similar costs. SFAS 146 supersedes previous accounting guidance, principally
Emerging Issues Task Force Issue No. 94-3. The Company will adopt the provisions
of SFAS 146 for restructuring activities initiated after December 31, 2002. SFAS
146 requires that the liability for costs associated with an exit or disposal
activity be recognized when the liability is incurred. Under Issue 94-3, a
liability for an exit cost was recognized at the date of the Company's
commitment to an exit plan. SFAS 146 also establishes that the liability should
initially be measured and recorded at fair value. Accordingly, SFAS 146 may
affect the timing of recognizing future restructuring costs as well as the
amounts recognized.

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 in exchange for a secured promissory note
with a one-year term, bearing interest at 6.88%. 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, replacing the
previous note, for the then unpaid principal amount of $800,000. The new note
requires two principal payments of $400,000 each, due on September 30, 2001 and
2002, respectively, with interest of 6.125% per annum due monthly. The note and
related interest is full recourse and is secured by a security interest in the
borrower's personal assets. During the nine month period ended June 30, 2002,
approximately $373,000 was paid against the note.

Note 4. DEFERRED STOCK COMPENSATION

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

Research and development.......... $ 36,026 $ 53,360 $ 108,078 $ 276,308
Sales and marketing............... 28,654 48,895 85,962 213,409
General and administrative........ 28,077 30,954 84,234 166,222
----------------- ---------------- ------------------- -------------------
$ 92,757 $ 133,209 $ 278,274 $ 655,939
================= ================ =================== ===================

Note 5. 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. As of June 30, 2002, all $1.0 million had been
used to repurchase 1,063,895 shares of the Company's common stock.

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.

OVERVIEW

We are a leading provider of integrated, multi-function telecommunications
systems. We began operations in July 1994 and we first recognized revenues from
product sales of our Quantum board and AltiWare software in July 1996. We
generated net revenues of $2.8 million and $6.7 million for the third quarter
and the first nine months of fiscal 2002, respectively, compared to net revenues
of $2.7 million and $8.0 million for the third quarter and the first nine months
of fiscal 2001. As of June 30, 2002, we had an accumulated deficit of $46.0
million.

We derive our revenues from sales of our AltiServ system, which includes Quantum
boards, Triton boards and AltiWare software. We generally do not sell software
separately from our hardware products. Software sales were $680,000 and $1.2
million for the third quarter and the first nine months of fiscal 2002,
respectively, compared to software sales of $376,000 and $1.4 million for the
same periods of fiscal 2001, respectively. 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 and negative cash flows 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 Nine Months Ended
June 30, June 30,
------------------------------------ -----------------------------------
2002 2001 2002 2001
------------------------------------ -----------------------------------
(unaudited) (unaudited)

Revenues, net......................... 100.0% 100.0% 100.0% 100.0%
Cost of revenues...................... 43.6 99.1 47.6 69.7
------------------ ----------------- ------------------ ----------------
Gross margin.......................... 56.4 0.9 52.4 30.3
Operating expenses :
Research and development......... 37.6 51.4 45.9 47.0
Sales and marketing ............. 53.9 114.4 66.7 95.5
General and administrative....... 19.8 24.7 24.1 27.1
Deferred stock compensation...... 3.4 4.9 4.1 8.2
------------------ ----------------- ------------------ ----------------
Total operating expenses ... 114.7 195.4 140.8 177.8
------------------ ----------------- ------------------ ----------------
Loss from operations ................. (58.3) (194.5) (88.4) (147.5)
Interest and other income, net ....... 2.2 9.0 3.4 13.8
------------------ ----------------- ------------------ ----------------
Net loss ............................. (56.1)% (185.5)% (85.0)% (133.7)%
================== ================= ================== ================

Revenues, net. Revenues consist of sales to end users (including dealers) and to
distributors. Net revenues increased 3% from $2.7 million for the third quarter
of fiscal 2001 to $2.8 million for the third quarter of fiscal 2002. Net
revenues decreased 16% from $8.0 million for the first nine months of fiscal
2001 to $6.7 million for the first nine months of fiscal 2002 as a result of
decreased or delayed capital spending by existing and prospective customers and
the slowdown of U.S. economy. Sales through our main distributors, AltiSys,
Synnex, and Ingram Micro, accounted for approximately 19.6%, 27.8%, and 28.4%,
respectively, of our revenues for the third quarter of fiscal 2002 as compared
to 21.7%, 54.5%, and 20.4%, respectively, of our revenues for the same period of
fiscal 2001. Approximately 12% of our revenues for the quarter ended June 30,
2002 were derived from a promotional program in which we sold upgrades of the
latest software release to our installed base. The increase in software revenues
also contributed to the higher gross margin for the quarter ended June 30, 2002.

Cost of revenues. Cost of revenues were $1.2 million and $3.2 million for the
third quarter and the first nine months of fiscal 2002, respectively, decreases
of 55% and 42% from $2.7 million and $5.6 million for the same periods 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 decreased from 99.1% and 69.7% for the third quarter
and the first nine months of fiscal 2001, respectively, to 43.6% and 47.6% for
the same periods of fiscal 2002. The year-over-year decreases were primarily due
to the fact that our inventory balance as of June 30, 2002 did not require
additional write down for excess and obsolete inventory. Management continues to
monitor our inventory levels in line with forecasted future shipment.

Gross margin. Gross profit increased to $1.6 million and $3.5 million for the
third quarter and the first nine months of fiscal 2002, respectively, from
$24,000 and $2.4 million for the same periods of fiscal

2001. As a percentage of revenue, gross margin increased to 56.4% and 52.4% for
the third quarter and the first nine months of fiscal 2002, respectively, from
0.9% and 30.3% for the same periods of fiscal 2001. The increase in gross profit
as a percentage of net revenues was primarily due to the previously mentioned
write down for excess and obsolete inventory.

Research and development expenses. Research and development expenses decreased
to $1.0 million and $3.1 million for the third quarter and the first nine months
of fiscal 2002, respectively, from $1.4 million and $3.8 million for the same
periods 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 year-over-year decreases were
primarily due to a reduction in consulting fees, equipment and recruiting
expenses.

Sales and marketing expenses. Sales and marketing expenses decreased to $1.5
million and $4.5 million for the third quarter and the first nine months of
fiscal 2002, respectively, from $3.1 million and $7.6 million for the same
periods of fiscal 2001, respectively. 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. The year-over-year decreases were primarily due to
significantly lower sales forces expenses in the first nine months of fiscal
2002 resulting from headcount reduction and cutback in the promotional and
advertising activities.

General and administrative expenses. General and administrative expenses
decreased to $547,000 and $1.6 million for the third quarter and the first nine
months of fiscal 2002, respectively, from $666,000 and $2.2 million for the same
periods of fiscal 2001. The year-over-year decreases were primarily due to
reduction in legal fees as a result of the settlement of litigation with Sonoma
Systems, Inc.

Deferred stock compensation expense. Deferred stock compensation expense was
$93,000 and $278,000 for the third quarter and the first nine months of fiscal
2002, respectively, as compared to $133,000 and $656,000 for the same period of
fiscal 2001, respectively. 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 $93,000 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
$61,000 and $229,000 for the third quarter and the first nine months of fiscal
2002, respectively, from $244,000 and $1.1 million for the same period of fiscal
2001, respectively. The Company invested the proceeds from our initial public
offering in October 1999 in highly liquid, short-term investments. The decreases
were due to reductions 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 June 30, 2002, we had cash and short-term investments
totaling $13.0 million consisting of cash and cash equivalents of $4.2 million
and $8.8 million of highly liquid short-term investments.

Net cash used in our operating activities was $4.1 million and $10.3 million for
the nine months ended June 30, 2002 and 2001, respectively. Net cash used in
operating activities primarily reflected the impact of the net loss for each of
the periods reported.

Net cash used in investing activities was $3.3 million for the nine months ended
June 30, 2002, which was primarily a result of purchases of short-term
investments. Net cash provided by investing activities

for the nine months ended June 30, 2001 was $6.7 million, which was primarily a
result of redemption of short-term investments.

Net cash used in financing activities was $323,000 for the nine months ended
June 30, 2002, consisting primarily of funds used in the repurchase of our
common stock. Cash provided by financing activities was $308,000 for the nine
months ended June 30, 2001, consisting primarily of proceeds from issuances of
common stock under our employee stock options and stock purchase plans.

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% to reduce our ongoing cash expenditures. Based on our current revenue
projections, and recent cost savings, we believe that our cash reserves and
working capital will be adequate to finance our operations for 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, if required, may not be available on acceptable terms, or
at all. We may also require additional capital to acquire or invest in
complementary businesses or products, or obtain the right to use complementary
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
financing 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 AltiGen.

AltiGen's common stock was transferred to the Nasdaq SmallCap Market at the
opening of business on June 12th, 2002. Pursuant to a letter received from the
Nasdaq staff on June 10, 2002, we must now demonstrate compliance with a
requirement involving a minimum bid price of $1.00 per share by August 26, 2002.
Staff will provide written notification that compliance is achieved once our
common stock closes at $1.00 per share or more for a minimum of 10 consecutive
trading days. If compliance with this rule cannot be demonstrated by August 26,
2002, Staff will determine whether AltiGen meets the initial listing criteria
for this market under Marketplace Rule 4310(c)(2)(A). If it meets the initial
listing criteria, Staff will notify us that it has been granted an additional
180 calendar day grace period to demonstrate compliance. Otherwise, Staff will
provide written notification that our securities will be delisted. At that time,
we may appeal the Staff's determination to delist our securities to a Listing
Qualifications Panel.

The result of delisting from the Nasdaq SmallCap 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 the Nasdaq SmallCap
Market, there can be no assurance that we will be able to satisfy such
requirements.
14

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 June 30, 2002,
we had an accumulated deficit of $46.0 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 sales and
marketing activities, 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.

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

THE CURRENT ECONOMIC DOWNTURN MAY CONTINUE TO ADVERSELY AFFECT OUR REVENUES,
GROSS MARGINS AND EXPENSES.

Our quarterly revenue and operating results have and may continue to fluctuate
due to the effects of general economic conditions in the United States and
globally, and, in particular, market conditions in the telecommunications
industry. In recent quarters, our operating results have been adversely affected
as a result of the economic slowdown and reduced capital spending, particularly
in the United States. The downturn has also contributed to the decline in
revenue during the first three quarters of 2002 compared to the same period in
2001. We have experienced gross margin declines, reflecting the effect of
competitive pressures as well as write-downs for inventories as a result of the
downturn. We are uncertain about the extent, severity, and length of the
economic downturn. If the economic conditions in the United States and globally
do not improve, or if we experience a worsening in the global economic slowdown,
we may continue to experience material negative effects on our business,
operating results, and financial condition.

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.
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 75.8% of our net revenues in the third 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 are 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 TI DSP chip, is particularly important
to our business because it is included in virtually all of our Triton family
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 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.

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, 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.

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
operation.

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. In
spite of the economy downturn, competition for highly trained personnel can be
intense, especially in the San Francisco Bay Area where most of our operations
are located. Volatility or lack of positive performance in our stock price may
also adversely affect our ability to retain key employees, all of whom have been
granted stock options. 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 recently experienced 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 was 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.

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 June 30, 2002, we issued 299,463 shares of common
stock pursuant to the exercise of stock options at exercise price 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, 49,851 shares were purchased and
distributed to employees at a price of $0.51 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 Reports on Form 8-K

(a) Exhibits:

Number Exhibit Description

99.1 Certification of Chief Executive Officer and Chief Financial
Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002

(b) Reports on Form 8-K:

We filed a report on Form 8-K with the Securities and Exchange Commission
on June 26, 2002 announcing a change in the Company's independent public
accountants for the fiscal year ended September 30, 2002, from Arthur
Andersen LLP to Deloitte & Touche LLP. An amended 8-K/A was filed on July
10, 2002.

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 14th day of August, 2002.

ALTIGEN COMMUNICATIONS, INC.

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