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 MARCH 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 94538
Fremont, CA ---------------------------------
---------------------------------------- (zip code)
(address of principal executive offices)

Registrant's telephone number, including area code: (510) 252-9712
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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 MAY 11, 2001, 13,768,532 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
March 31, 2001 and September 30, 2000 3

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

Unaudited Condensed Consolidated Statements of Cash Flows for
the Six Months Ended March 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 10

Item 3. Quantitative and Qualitative Disclosures about Market Risk 21

PART II OTHER INFORMATION

Item 1. Legal Proceedings 22

Item 2. Changes in Securities and Use of Proceeds 22

Item 3. Defaults Upon Senior Securities 22

Item 4. Submission of Matters to a Vote of Security Holders 22

Item 5. Other Information 22

Item 6. Exhibits and Reports on Form 8-K 22

SIGNATURES

PART I. FINANCIAL INFORMATION

Item 1. Unaudited Condensed Consolidated Financial Statements.

ALTIGEN COMMUNICATIONS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS

March 31, September 30,
2001 2000
----------- ------------
(unaudited) (see Note 1)

ASSETS
Current assets:
Cash and cash equivalents.................................... $ 14,313,624 $ 15,141,380
Short-term investments....................................... 8,336,826 14,082,129
Accounts receivable, net of allowances of $300,953 and
$423,296, respectively................................... 1,634,646 2,041,395
Inventories, net............................................. 5,331,213 4,268,152
Prepaid expenses and other current assets.................... 556,253 358,094
Promissory note to officer / stockholder..................... 1,000,000 1,000,000
------------ ------------
Total current assets................................ 31,172,562 36,891,150
------------ ------------
Property and equipment:
Leasehold improvement........................................ 297,922 --
Furniture and equipment...................................... 1,574,452 1,313,004
Computer software............................................ 751,040 632,638
------------ ------------
2,623,414 1,945,642
Less: Accumulated depreciation............................... (1,380,220) (1,097,003)
------------ ------------
Net property and equipment............................... 1,243,194 848,639
------------ ------------
Long-term investments........................................... 397,826 905,626
------------ ------------
$ 32,813,582 $ 38,645,415
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable............................................. $ 886,735 $ 1,105,295
Accrued liabilities:
Payroll and related benefits............................. 286,598 521,420
Warranty................................................. 652,814 719,889
Marketing................................................ 312,279 275,683
Other.................................................... 653,900 921,208
Deferred revenue............................................. 524,263 610,018
------------ ------------
Total current liabilities........................... 3,316,589 4,153,513
------------ ------------
Commitments and contingencies (Note 2)
Stockholders' equity:
Common stock, $.001 par value; Authorized - 50,000,000
Shares; Outstanding - 13,627,454 shares at March
31, 2001 and 13,507,162 shares at September 30, 2000..... 13,627 13,507
Additional paid-in capital................................... 61,480,099 61,368,011
Deferred stock compensation.................................. (771,052) (1,341,974)
Accumulated deficit.......................................... (31,225,681) (25,547,642)
------------ ------------
Total stockholders' equity.......................... 29,496,993 34,491,902
------------ ------------
$ 32,813,582 $ 38,645,415
============ ============

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

ALTIGEN COMMUNICATIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)

Three Months Ended March 31, Six Months Ended March 31,
---------------------------- --------------------------
2001 2000 2001 2000
------------ ----------- ----------- -----------

Revenues, net...................................... $ 2,910,209 $ 3,169,636 $ 5,294,719 $ 5,654,633
Cost of revenues................................... 1,703,228 1,424,787 2,894,975 2,585,437
------------ ----------- ----------- -----------
Gross profit....................................... 1,206,981 1,744,849 2,399,744 3,069,196
------------ ----------- ----------- -----------
Operating expenses:
Research and development.......................... 1,208,914 975,808 2,367,002 1,797,040
Sales and marketing............................... 2,515,100 2,634,913 4,546,276 4,307,092
General and administrative........................ 729,363 911,698 1,503,264 1,625,205
Deferred stock compensation (Note 3)............. 352,564 243,240 522,730 486,480
------------ ----------- ----------- -----------
Total operating expenses........................ 4,805,941 4,765,659 8,939,272 8,215,817
------------ ----------- ----------- -----------
Loss from operations............................... (3,598,960) (3,020,810) (6,539,528) (5,146,621)
Interest and other income, net..................... 382,565 545,994 861,489 1,018,422
------------ ----------- ----------- -----------
Net loss........................................... $(3,216,395) $(2,474,816) $(5,678,039) $(4,128,199)
------------ ----------- ----------- -----------
Basic and diluted net loss per share.............. $ (0.24) $ (0.18) $ (0.42) $ (0.32)
------------ ----------- ----------- -----------
Shares used in computing basic
and diluted net loss per share.................. 13,613,785 13,430,353 13,584,501 13,086,614
------------ ----------- ----------- -----------

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

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

Six Months Ended March 31,
---------------------------
2001 2000
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CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss........................................................................ $ (5,678,039) $ (4,128,199)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation.................................................................. 283,217 230,515
Amortization of deferred stock compensation................................... 522,730 486,480
Provision for accounts receivable allowance................................... 26,406 144,480
Provision for excess and obsolete inventories................................. 670,000 50,000
Changes in operating assets and liabilities:
Accounts receivable........................................................... 380,343 (766,609)
Inventories................................................................... (1,733,061) (29,708)
Prepaid expenses and other current assets..................................... (198,159) (270,602)
Accounts payable.............................................................. (218,560) (822,475)
Accrued liabilities........................................................... (532,609) 688,119
Deferred revenue.............................................................. (85,755) (49,496)
------------ ------------
Net cash used in operating activities....................................... (6,563,487) (4,467,495)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of investments...................................................... (15,190,738) (26,638,062)
Net proceeds from sale of investments......................................... 21,443,841 3,600,000
Purchases of property and equipment........................................... (677,772) (323,836)
------------ ------------
Net cash provided by (used in) investing activities......................... 5,575,331 (23,361,898)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuances of common stock......................................... 160,400 37,392,967
Issuance costs related to initial public offering of common stock............... -- (2,661,194)
------------ ------------
Net cash provided by financing activities..................................... 160,400 34,731,773
------------ ------------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS.............................. (827,756) 6,902,380
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD.................................... 15,141,380 5,934,070
------------ ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD.......................................... $ 14,313,624 $ 12,836,450
============ ============

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, 2000 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, 2000,
included in the Company's 2000 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.

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 including
$670,000 recorded during the six month period ended March 31, 2001, are made to
reduce excess and obsolete inventories to their estimated net realizable values.
The components of inventories include:

March 31, September 30,
------------ ------------
2001 2000
------------ ------------

Raw materials.................... $ 3,287,435 $ 1,315,988
Work-in-progress................. 366,537 1,414,121
Finished goods................... 1,677,241 1,538,043
------------ ------------
$ 5,331,213 $ 4,268,152
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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 March 31, 2001, the Company's cash and cash equivalents consisted of
commercial paper and cash deposited in checking and money market accounts. For
the second quarter of fiscal years 2001 and 2000, the Company did not make any
cash payments for interest or income taxes.

REVENUE RECOGNITION

Revenues consist of sales of hardware, software and peripheral components to end
users, including dealers, 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 the 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
unaudited condensed 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 technical 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 related to 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 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. Under current SEC guidance, we will be required to adopt
SAB 101 in the fourth quarter of our fiscal 2001. Management has evaluated the
effect of the adoption of SAB 101 and has determined that the Company's current
revenue recognition policies comply with SAB 101.

BASIC AND DILUTED NET LOSS PER SHARE

Basic and diluted 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. No separate diluted loss per share information
has been presented in the accompanying unaudited condensed consolidated
statements of operations since potential common shares from the conversion of
dilutive stock options are antidilutive. The Company

evaluated the requirements of the 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

In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No.
130, "Reporting Comprehensive Income," which 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. "Comprehensive Income (Loss)" is to include as other
comprehensive income, foreign currency translation gains and losses and other
unrealized gains and losses that have historically been excluded from net income
(loss) and reflected instead in equity. 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
and six month periods ended March 31, 2001 and 2000 were as follows:

Three Months Ended Six Months Ended
March 31, March 31,
-------- -------- -------- --------
2001 2000 2001 2000
======== ======== ======== ========

Net Revenue
United States ............................... 100% 94% 99% 95%
International ............................... - 6% 1% 5%
-------- -------- -------- --------
100% 100% 100% 100%
======== ======== ======== ========

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

Three Months Ended Six Months Ended
March 31, March 31,
------- -------- ------ -------
2001 2000 2001 2000
======= ======== ====== =======

Customer A 38% 14% 33% --
Customer B 28% 14% 27% 15%
Customer C 22% 16% 20% 16%
Customer D -- 21% -- 25%
Customer E -- 11% -- --
Others 12% 24% 20% 44%
------- -------- ------ -------
100% 100% 100% 100%
======= ======== ====== =======

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

ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities,"which requires companies to record
derivative financial instruments on the balance sheet as assets or liabilities,
measured at fair value. Gains or losses resulting from changes in the values of
those derivatives would be accounted for depending on the use of the derivative
and whether it qualifies for hedging accounting. The key criterion for hedge
accounting is that the hedging relationship must be highly effective in
achieving offsetting changes in fair value or cash flows. In June 1999, the FASB
issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging
Activities - Deferral of the Effective Date of FASB Statement No. 133," which
amend SFAS No. 133 to be effective for all fiscal quarters of all fiscal years
beginning after June 15, 2000 (or October 1, 2000 for AltiGen). Management does
not believe this statement will have a material impact on the financial
position or results of operations as the Company does not currently hold any
derivative instruments and does not engage in hedging activities.

Note 2. COMMITMENTS AND CONTINGENCIES

The Company has settled its litigation with Sonoma Systems, Inc. ("SSI"),
formerly NetPhone, Inc. ("NetPhone"). On June 30, 1999, the Company had filed a
complaint for declaratory judgment against NetPhone seeking a judgement that the
Company does not infringe any valid claims of U.S. Patent No. 5,875,234 patent
("the `234 patent"), a patent allegedly owned by NetPhone. NetPhone answered the
complaint on July 13, 1999 and asserted a counterclaim, alleging infringement
and seeking injunctive relief against what NetPhone refers to as the Quantum
Device. On August 11, 1999, the Company received NetPhone's motion for
preliminary injunction. On February 11, 2000, the district court issued an order
denying NetPhone's motion for preliminary injunction, finding that "AltiGen has
raised substantial questions as to whether the `234 patent will survive attacks
on its validity at trial." NetPhone was subsequently acquired by Sonoma Systems,
Inc. and SSI was added as a party to the lawsuit.

On February 6, 2001, SSI and the Company entered into a Patent Cross-License
Agreement pursuant to which the Company and SSI will have the right to use
certain intellectual property rights of the other in their respective
businesses. The terms of the Cross-License Agreement are confidential. This
agreement finally settles all outstanding disputes between the parties,
including the lawsuit that was pending in the U.S. District Court for the
Northern District of California.

Note 3. 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 Six Months Ended
March 31, March 31,
---------- --------- --------- ---------
2001 2000 2001 2000
========== ========= ========= =========

Research and development ........................ $ 151,334 $ 105,806 $ 222,948 $ 211,612
Sales and marketing ............................. 110,162 88,190 164,514 176,380
General and administrative ...................... 91,068 49,244 135,268 98,488
---------- --------- --------- ---------
$ 352,564 $ 243,240 $ 522,730 $ 486,480
========== ========= ========= =========

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 $2.9 million and $5.3 million for the second quarter and the first
six months of fiscal 2001, respectively, compared to net revenues of $3.2
million and $5.7 million for the second quarter and the first six months of
fiscal 2000. As of March 31, 2001, we had an accumulated deficit of $31.2
million.

We derive our revenues from sales of our AltiServ system, which includes Quantum
boards, Triton boards and AltiWare software. Software sales were $531,000 and
$1.0 million for the second quarter and the first six months of fiscal 2001,
respectively, compared to software sales of $304,000 and $587,000 for the second
quarter and the first six months of fiscal 2000, respectively. We generally do
not sell software separately from our hardware products. We believe software
sales will comprise a greater portion of our net revenues in the future.
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 Six Months Ended
March 31, March 31,
------------------------- -------------------------
2001 2000 2001 2000
========================= =========================
(unaudited) (unaudited)

Revenues,net............................ 100.0% 100.0% 100.0% 100.0%
Cost of revenues ....................... 58.5 45.0 54.7 45.7
-------- -------- -------- --------
Gross profit............................ 41.5 55.0 45.3 54.3
Operating expenses :
Research and development ............... 41.5 30.8 44.7 31.8
Sales and marketing .................... 86.4 83.0 85.8 76.2
General and administrative ............. 25.1 28.8 28.4 28.7
Deferred stock compensation............. 12.1 7.7 9.9 8.6
-------- -------- -------- --------
Total operating expenses................ 165.1 150.3 168.8 145.3
-------- -------- -------- --------
Loss from operations ................... (123.6) (95.3) (123.5) (91.0)
Interest and other income, net ......... 13.1 17.2 16.3 18.0
-------- -------- -------- --------
Net loss................................ (110.5)% (78.1)% (107.2)% (73.0)%
======== ======== ======== ========

Revenues, net. Revenues consist of sales to end users (including dealers) and
to distributors. Net revenues were $2.9 million and $5.3 million for the second
quarter and the first six months of fiscal 2001, a decrease of 8% and 6% from
net revenues of $3.2 million and $5.7 million for the same periods of fiscal
2000, respectively. 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
28.2%, 38.2%, 21.7%, and 4.0%, respectively, of our revenues for the second
quarter of fiscal 2001 compared to 14.5%, 14.2%, 16.1%, and 20.8%,
respectively, of our revenues for the same period of fiscal 2000.

Cost of revenues. Cost of revenues were $1.7 million and $2.9 million for the
second quarter and the first six months of fiscal 2001, an increase of 20% and
12% from cost of revenues of $1.4 million and $2.6 million for the same periods
of fiscal 2000, respectively. 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 45.0% and 45.7%
for the second quarter and the first six months of fiscal 2000, respectively, to
58.5% and 54.7% for the same periods of fiscal 2000, respectively. This increase
was primarily due to an increase in provision for excess and obsolete inventory
as a result of our higher inventory balance as of March 31, 2001 reflecting the
slowdown in telecom capital spending and the general downturn in the U.S.
economy. Management continues to closely monitor the company's inventory levels.
Further declines in demand, although not currently anticipated, would result in
reduced sales, increased operating losses and reductions in inventory valuation.

Gross profit. Gross profit decreased to $1.2 million and $2.4 million for the
second quarter and the first six months of fiscal 2001, respectively, from $1.4
million and $3.1 million for the same periods of fiscal 2000, respectively. As
a percentage of revenue, gross profit decreased from 55.0% and 54.3% for the

second quarter and the first six months of fiscal 2000, respectively, to 41.5%
and 45.3% for the same periods of fiscal 2001, respectively. The decrease in
gross profit as a percentage of net revenues was primarily due to an increase in
provision for excess and obsolete inventory as well as the decrease in revenues.

Research and development expenses. Research and development expenses increased
to $1.2 million and $2.4 million for the second quarter and the first six months
of fiscal 2001, respectively, from $976,000 and $1.8 million for the same
periods of fiscal 2000, respectively. The increase was primarily due to hiring
of additional engineers, and increased resources dedicated to release of new
products. Additionally, the Company expanded research and development
facilities in China, resulting in increased depreciation and spending on design
and development of new products. We currently intend to increase research and
development expenses in absolute dollars in the foreseeable future to allow us
to develop new products, features, and expand into new markets in Asia Pacific.

Sales and marketing expenses. Sales and marketing expenses remained relatively
flat at $2.5 million and $4.5 million for the second quarter and the first six
months of fiscal 2001, respectively, from $2.6 million and $4.3 million for the
same periods of fiscal 2000, respectively. Sales and marketing expenses consist
of compensation, commissions and related cost for personnel engaged in sales and
marketing functions, trade show expenses, promotional and marketing programs and
related expenses. The reduction in expenditures for the second quarter of fiscal
2001 was the result of management's desire to conserve capital during the
current economic downturn. In the near term, sales and marketing expenses are
expected to be maintained at the same level as in the previous quarter. Long
term, it may be necessary to increase sales and marketing expenses to introduce
our new products and continue to pursue new channels and markets and to promote
customer and end user awareness of the features and benefits of our products.

General and administrative expenses. General and administrative expenses
decreased to $729,000 and $1.5 million for the second quarter and the first six
months of fiscal 2001 from $912,000 and $1.6 million for the same period of
fiscal 2000, respectively. The decrease was primarily due to reduction in legal
fees as a result of the settlement of litigation with Sonoma Systems, Inc. and
management's desire to conserve capital during the current economic downturn. In
the near term, general and administrative expenses are expected to be maintained
at the same level as in the previous quarter. Long term, it may be necessary to
increase general and administrative expenses while we continue to build our
infrastructure to support the growth of our business.

Deferred stock compensation expense. Deferred stock compensation expense was
$353,000 and $523,000 for the second quarter and the first six months of fiscal
2001, respectively, as compared to $243,000 and $486,000 for the same period of
fiscal 2000, 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. We are amortizing these amounts using the straight-
line method over the vesting period of the related stock options. We expect to
amortize approximately $279,000 of the remaining balance of this deferred stock
compensation in fiscal year 2001, $401,000 in fiscal year 2002, and $91,000 in
fiscal year 2003 and doing so will increase our loss (or reduce any profits that
we may have).

Interest and other income, net. Net interest and other income decreased to
$383,000 and $861,000 for the second quarter and the first six months of fiscal
2001, respectively, from $546,000 and $1.0 million for the same period of fiscal
2000, respectively. 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 interest rates.

Liquidity and Capital Resources

Since inception, we have financed our operations primarily through the sale of
equity securities. We

have raised an aggregate of $24.7 million, net of offering expenses, through the
sale of preferred stock. On October 8, 1999, AltiGen received cash proceeds, net
of underwriters' discounts and commissions, and expenses previously paid of $1.5
million, totaling approximately $33.3 million upon the closing of its initial
public offering. As of March 31, 2001, we had cash and cash equivalents of $14.3
million, which consist of cash deposited in checking and money market accounts
with original maturities of less than three months and $8.3 million of short-
term investments.

Net cash used in our operating activities was $6.6 million and $4.5 million for
the six months ended March 31, 2001 and 2000, respectively. Net cash used in
operating activities primarily reflected the impact of the net loss for each of
the periods, as well as working capital required to fund our growth in
operations.

Net cash provided by investing activities was $5.6 million for the six months
ended March 31, 2001, which was primarily a result of redemption of short-term
investments. Cash used in investing activities for the six months ended March
31, 2000 was $23.4 million, which was primarily a result of purchases of short
and long-term investments.

Net cash provided by financing activities was $160,000 for the six months ended
March 2001, consisting primarily of proceeds from the exercise of stock options
and investments in our employee stock purchase plan. Cash provided by financing
activities was $34.7 million for the six months ended March 31, 2000, which was
primarily due to $33.3 million in net proceeds from the initial public offering
of 3,737,500 shares of common stock on October 9, 1999.

We currently believe that existing cash and cash equivalents balances and short-
term investments, will provide us with sufficient funds to finance our
operations for at least the next 12 months. Our management intends to invest our
cash in excess of current operating requirements in short-term, interest-bearing
investment-grade securities. Subsequently, we may need to raise additional
funds, and additional financing may not be available on favorable terms, if 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 respond to competitive pressures or unanticipated
requirements, which could seriously harm our business, financial condition, and
results of operations. If additional funds are raised through the issuance of
equity securities, the net tangible book value per share may decrease, the
percentage ownership of then current stockholders may be diluted, and such
equity securities may have rights, preferences or privileges senior to those of
the holders of our common stock.

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 March 31, 2001,
we had an accumulated deficit of $31.2 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 increased expenditures for product development and general and
administrative expenses, and substantial increases in 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:

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

. 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;

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

. respond effectively to competitive pressures; and

. 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:

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

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

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

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

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

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

Our 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 Lucent Technologies and Nortel Networks. We also compete against
providers of multifunction telecommunications systems, including Picasso
Communications, Inc. and Artisoft, Inc. We potentially face competition from
companies such as Shoreline Teleworks, Inc., NBX Corporation, acquired by 3Com
Corporation, Selsius Systems, acquired by Cisco Systems, Inc., as well as any
number of future competitors. Many of our competitors are substantially larger
than we are and have significantly greater name recognition, financial, 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. A description of
our principal competitors and the competitive nature of our market are discussed
in greater detail in "Business--Competition."

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 four key distributors, Altisys, Synnex, Ingram Micro, and Tech
Data accounted for 92.0% of our net revenues in the second quarter of fiscal
2001. 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. In the second quarter of fiscal 2001, we cancelled our
agreement with Tech Data and Avnet/Hallmark.

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 Mitel 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 Mitel 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, 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.

Generally, litigation, which can be costly and time consuming, may be necessary
to determine the scope and validity of others' proprietary rights, or to enforce
any patent issued to us, in either case, in judicial or administrative
proceedings. For example, we have settled a litigation with Sonoma Systems, Inc.
("SSI"), formerly NetPhone, Inc. On June 30, 1999, the Company had filed a
complaint for declaratory judgment against NetPhone seeking a judgement that the
Company does not infringe any valid claims of U.S. Patent No. 5,875,234 patent
("the `234 patent"), a patent allegedly owned by NetPhone. NetPhone answered the
complaint on July 13, 1999 and asserted a counterclaim, alleging infringement
and seeking injunctive relief against what NetPhone refers to as the Quantum
Device. On August 11, 1999, the Company received NetPhone's motion for
preliminary injunction. On February 11, 2000, the district court issued an order
denying NetPhone's motion for preliminary injunction, finding that "AltiGen has
raised substantial questions as to whether the `234 patent will survive attacks
on its validity at trial." NetPhone was subsequently acquired by Sonoma Systems,
Inc. and SSI was added as a party to the lawsuit.

agreement finally settles all outstanding disputes between the parties,
including the lawsuit that was pending in the U.S. District Court for the
Northern District of California.

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:

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

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

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

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

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.

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. Our manufacturing and assembly
operations are discussed in greater detail in "Business--Manufacturing and
Assembly."

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 March 31, 2001, we issued 44,917 shares of common
stock pursuant to the exercise of stock options at exercise prices ranging from
$0.17 to $0.83. All of the stock options were granted under our 1994 Stock
Option Plan prior to our initial public offering. 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.

At the Company's annual meeting of stockholders on February 9, the stockholders
approved the following items:

1. The election of the following individuals as directors of the Company:
Wen-Huang (Simon) Chang and Richard Black.

2. The appointment of Arthur Andersen LLP as the independent public
accountants of the Company for the fiscal year ending September 30,
2001.

Item 6. Exhibits and Report on Form 8-K

(a) Exhibits:

None

(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 14th day of May, 2001.

ALTIGEN COMMUNICATIONS, INC.

Dated: May 14, 2001 By: /s/ Philip M. McDermott
-------------------------

Philip M. McDermott,
Chief Financial Officer
(Principal Financial and Accounting Officer)