UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM 10-K





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




For
the fiscal year ended December 31, 2007




OR




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




For
the transition period from
                       
to
                       .




Commission
File Number: 000-31121





AVISTAR
COMMUNICATIONS CORPORATION


(Exact
name of registrant as specified in its charter)




Delaware
            
            88-0463156(State
      or other jurisdiction of
              incorporation
      or organization)
            
            (I.R.S.
      Employer
              Identification
      Number)1875
      South Grant Street, 10th
      Floor, San Mateo California
            
            94402(Address
      of Principal Executive Offices)
            
            (Zip
      Code)


Registrant’s
telephone number, including area code: (650) 610-2900




Securities
registered pursuant to Section 12(b) of the Act:




Title of each class
            
            
            Name of each exchange on which registeredCommon
      Stock, $0.001 par value
            The
      NASDAQ Stock Market LLC(NASDAQ
      Capital Market)




Securities
registered pursuant to Section 12(g) of the Act:


None





Indicate
by check mark if the registrant is a well known seasoned issuer, as defined in
Rule 405 of the Securities Act. Yes o  No x




Indicate
by check mark if the registrant is not required to file the reports pursuant to
Section 13 or 15(d) of the Act. Yes o  No x




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




Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of the registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. o




Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a small reporting company. See
definitions of “large accelerated filer,” “accelerated filer” and “small
reporting company” in Rule 12b-2 of the Exchange Act.




Large
accelerated filer o                                                                                  Accelerated
filer o




Non-accelerated
filer o (Do
not check if a smaller reporting
company)          Smaller
reporting company x




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




Aggregate
market value of the voting and non-voting common equity held by non-affiliates
computed by reference to the price at which the common equity was last sold on
June 30, 2007 was $12,944,624. Shares of Common Stock held by each
executive officer and director and by each person who owns 10% or more of the
outstanding Common Stock have been excluded in that such persons may be deemed
to be affiliates. This determination of affiliate status is not necessarily a
conclusive determination for other purposes.




As of
March 12, 2008, the registrant had outstanding 34,499,557  shares
of Common Stock.


DOCUMENTS
INCORPORATED BY REFERENCE




The
Registrant incorporates by reference into Part III of this Annual Report on
Form 10-K specific portions of its Proxy Statement for its 2008 Annual
Meeting of Stockholders.
















AVISTAR
COMMUNICATIONS CORPORATION




ANNUAL
REPORT ON FORM 10-K




YEAR
ENDED DECEMBER 31, 2007




TABLE
OF CONTENTS


PagePART IItem 1. Business
              
              
              3Item 1a. Risk Factors
              
              
              18Item 1b. Unresolved Staff
      Comments
              
              
              29Item 2. Properties
              
              
              29Item 3. Legal
    Proceedings
              
              
              29Item 4. Submission of Matters to a Vote
      of Security Holders
              
              
              29PART IIItem 5. Market for Registrant’s Common Equity,
      Related Stockholder Matters and Issuer Purchases of Equity
      Securities
              
              
              30Item 6. Selected Financial Data
              
              
              32Item 7. Management’s Discussion and Analysis
      of Financial Condition and Results of Operations
              
              
              34Item 7a. Quantitative and Qualitative Disclosures
      About Market Risk
              
              
              45Item 8. Financial Statements and Supplementary
      Data
              
              
              45Item 9. Changes in and
      Disagreements with Accountants on Accounting and Financial
      Disclosure
              
              
              45Item 9a. Controls and
    Procedures
              
              
              46Item 9b. Other Information
              
              
              46PART IIIItem 10. Directors, Executive Officers and Corporate
      Governance
              
              
              47Item 11. Executive
Compensation
              
              
              47Item 12. Security Ownership of Certain Beneficial
      Owners and Management and Related Stockholder
                Matters
              
              
              47Item 13. Certain Relationships and Related
      Transactions and Director Independence
              
              
              48Item 14. Principal Accountant Fees and
      Services
              
              
              48PART IVItem 15. Exhibits, Financial Statement
      Schedules
              
              
              49Signatures
              
              
              52Index to Financial Statements
              
              
              F-1
  2


Forward
      Looking Statements




This
Annual Report on Form 10-K, the exhibits hereto and the information
incorporated by reference herein contain “forward looking statements” within the
meaning of Section 27A of the Securities Act of 1933, as amended (the
“Securities Act”) and Section 21E of the Securities Exchange Act of 1934,
as amended (the “Exchange Act”), and such forward looking statements involve
risks and uncertainties. When used in this Annual Report, the words “expects,”
“anticipates,” “believes,” “plans,” “intends” and “estimates” and similar
expressions are intended to identify forward looking statements. These forward
looking statements include predictions, among others, regarding our future
revenues and profits, income from settlement and patent licensing, customer
concentration, customer buying patterns, research and development expenses,
sales and marketing expenses, general and administrative expenses, litigation
and legal fees, income tax provision and effective tax rate, realization of
deferred tax assets, liquidity and sufficiency of existing cash, cash
equivalents, and investments for near-term requirements, sufficiency of leased
facilities, purchase commitments, product development and transitions, expansion
and licensing of our patent portfolio, competition and competing technologies,
and financial condition and results of operations as a result of recent
accounting pronouncements. Such statements are subject to risks and
uncertainties that could cause actual results to differ materially from those
projected. These risks and uncertainties include those discussed below and those
discussed in “Item 1a. Risk Factors” as well as others incorporated by reference
herein. Avistar Communications Corporation (the “Company,” “we,” or “us”)
undertakes no obligation to publicly release any revisions to these forward
looking statements to reflect events or circumstances after the date this Annual
Report is filed with the Securities and Exchange Commission or to reflect the
occurrence of unanticipated events.




Item
1a. Risk Factors




Item 1. Business




We were
founded as a Nevada limited partnership in 1993. We filed our articles of
incorporation in Nevada in December 1997 under the name Avistar Systems
Corporation. We reincorporated in Delaware in March 2000 and changed our
name to Avistar Communications Corporation in April 2000. The operating
assets and liabilities of the business were then contributed to our wholly owned
subsidiary, Avistar Systems Corporation, a Delaware corporation. In
July 2001, our Board of Directors and the Board of Directors of Avistar
Systems approved the merger of Avistar Systems with and into Avistar
Communications Corporation (Avistar). The merger was completed in
July 2001.




Our
principal executive offices are located at 1875 South Grant Street, 10th Floor,
San Mateo California, 94402. Our telephone number is (650) 525-3300. Our
trademarks include Avistar and the Avistar logo, AvistarVOS, Shareboard, vBrief
and The Enterprise Video Company. This Annual Report on Form 10-K also
includes our and other organizations’ product names, trade names and trademarks.
Our corporate website is www.avistar.com.




Our
Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current
Reports on Form 8-K, and amendments to reports filed pursuant to
Sections 13(a) and 15(d) of the Securities Exchange Act of 1934,
as amended, are available free of charge on our website when such reports are
available on the U.S. Securities and Exchange Commission (SEC) website
(see “Company—Investor Relations—SEC Information”). The public may read and copy
any materials filed by us with the SEC at the SEC’s Public Reference
Room at 450 Fifth Street, NW, Washington, DC 20549. The public may
obtain information on the operation of the Public Reference Room by calling
the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains
reports, proxy and information statements and other information regarding
issuers that file electronically with the SEC at http://www.sec.gov. The
contents of these websites are not incorporated into this filing.




Overview




Avistar
creates technology that provides the missing critical element in unified
communications: bringing people in organizations face-to-face, through enhanced
communications for true collaboration anytime, anyplace. Our latest product,
Avistar C3, draws on over a decade of market experience to deliver a
single-click desktop videoconferencing and collaboration experience that moves
business communications into a new era. Available as a stand-alone solution, or
integrated with existing unified communications software from other vendors,
Avistar C3 users gain an instant messaging-style ability to initiate video
communications across and outside the enterprise. Patented bandwidth management
enables thousands of users to access desktop videoconferencing, Voice over IP
(VoIP) and streaming media without requiring substantial new network investment
or impairing network performance.  By integrating Avistar C3 tightly
into the way they







3


work,
our customers can use our solutions to help reduce costs and improve
productivity and communications within their enterprise and between enterprises
and, to enhance their relationships with customers, suppliers and partners.
Using Avistar C3 software and leveraging video, telephony and Internet
networking standards, Avistar solutions are designed to be scalable, reliable,
cost effective, easy to use, and capable of evolving with communications
networks as bandwidth increases and as new standards and protocols emerge. We
currently sell our system directly and indirectly to the small and medium sized
business, or SMB and globally distributed organizations, or Enterprise, markets
comprising the Global 5000. Our objective is to establish our technology as the
standard for networked visual unified communications and collaboration through
direct sales, indirect channel sales/partnerships and the licensing of our
technology to others. We also seek to license our broad portfolio of patents
covering, among other areas, video and rich media collaboration technologies,
networked real-time text and non-text communications and desktop workstation
echo cancellation.




We have
three go-to-market strategies. Product and Technology Sales involves direct and
channel sales of video and unified communications and collaboration solutions
and associated support services to the Global 5000. Partner and Technology
Licensing involves co-marketing, sales and development, embedding, integration
and interoperability to enterprises, and  IP Licensing involves the
prosecution, maintenance, support and licensing of the intellectual property
that we have developed, some of which is used in our products.




Since
inception, we have recognized the innovative value of our research and
development efforts, and have invested in securing protection for these
innovations through domestic and foreign patent applications and issuance. As of
December 31, 2007, we held 80 U.S. and foreign patents, which we look to
license to others in the collaboration technology marketplace.




In
September 2007, we announced an intensive set of corporate initiatives aimed at
increasing our product sales, expanding our customer deployments and support,
improving our corporate efficiency and increasing our development
capacity.  The components of this initiative include:




·
            
            Centering
      our sales, marketing and operations activities, and associated management
      functions in our New York City
offices;




·
            
            Introducing
      a new go-to-market strategy and delivery model for hosting desktop video
      services, a fully managed, turnkey, desktop video solution that provides
      comprehensive video communications and data-sharing capabilities without
      the need for companies to install and maintain onsite video
      infrastructure;




·
            
            Supplementing
      our position in the financial services vertical by expanding our market
      focus to additional verticals with complex business problems, where our
      collaboration products can help global organizations speed business
      processes, save costs and reduce their carbon
  footprints;




·
            
            Engaging
      the market with a new, dynamic application integration and network risk
      management product set with video as the primary, empowering
      technology;




·
            
            Implementing
      aggressive cost control measures including a reduction in our employees
      from an average of 88 in  2007 to approximately 55 in the three
      months ended March 31, 2008; and




·
            
            Pursuing
      multiple distribution, services and technology
  partners.




These and
other changes in our business are aimed at reducing our structural costs,
increasing our organizational and partner-driven capacity, and leveraging our
reputation for innovation and intellectual property leadership, to grow and
expand our business.  However, these organizational changes and
initiatives involve transitional costs and expenses and result in uncertainty in
terms of their implementation and their impact on our business.  As
with any significant organizational change, our initiatives will take time to
implement and the results of these initiatives will not be apparent in the near
term.




Industry
      Background




Globalization,
supported by the near ubiquity of communications networks such as the Internet,
has allowed companies to lower costs, reach new markets, change business
processes (e.g., eBusiness) and distribute and outsource operations. It also has
meant increased competition, a faster business pace and less differentiation.
These factors, coupled with the difficulty and cost of travel, increased risks
due to socio-political uncertainties and pandemic concerns and the desire
to





4


reduce carbon
emissions and environmental impact, are causing businesses to look for new tools
that will help them increase productivity, reduce budgetary expenses, take
advantage of revenue opportunities, and minimize business continuity risks.
Enterprises of all sizes stand to benefit from new and advanced communication
and collaboration tools that enable their employees, partners, suppliers and
customers to collaborate more effectively and form tighter relationships within
and across buildings and over disparate geographies and time zones.
Communications tools that speed decision-making, build trust-based
relationships, especially across cultures, and are software-presence-aware are
becoming even more critical in today’s increasingly complex business
environment.




The
emergence of the Internet has accelerated the adoption of network-based
collaboration applications including email, instant messaging, and web
conferencing. The increasing availability and affordability of bandwidth on
communication networks is further driving businesses to utilize new
communication tools, such as voice and video over IP, and are enabling users to
connect from more places, including home offices and WiFi hot spots such as
airports, and hotels. This is enabling more distributed, mobile and global
operations while maintaining communications.




Limitations
      of Current Means of Communication and
  Collaboration




As
technology advances become more affordable and modes of communication expand,
enterprises are seeking widely deployable and cost effective technology to
replicate, at the desktop, the impact of visual communication and collaboration
that occurs in a face-to-face meeting. Individuals generally prefer face-to-face
encounters to less personal forms of communication because they can see one
another and benefit from the non-verbal cues that speed communication and deepen
understanding. This is particularly true for more complex interactions such as
negotiations, sales, product development, project and crises management and
decision making across geography/functions/cultures. However, in today’s
globalized, fast-paced business environment, face-to-face interactions are often
forgone due to the difficulty and time required for travel, and the need to act
quickly. These time and distance challenges become increasingly difficult to
deal with as the number of potential participants increase. Beyond traditional
teleconferencing, attempts to conduct virtual meetings as an alternative to
face-to-face meetings have generally been limited to conference room-based video
conferencing and web-based data teleconferences.




To
address the growing need for collaboration across distance and time,
organizations have resorted to using a patchwork of discrete technologies,
including video conferencing and teleconferencing, fax, email, instant
messaging, Internet audio and video delivery and data sharing applications. Many
of these technologies have been widely adopted, and collectively indicate the
need for collaboration tools including visual unified communications solutions.
However, these discrete technologies are not good substitutes by themselves for
face-to-face meetings and presentations because they do not provide an
integrated communications solution that fosters team interaction and delivers
critical, time-sensitive information quickly and reliably. By providing
face-to-face collaboration in an integrated communications solution, video can
speed problem resolution and motivate action, trust and understanding.
Additionally, users want to leverage knowledge and expertise by being able to
create and publish video content from their desktop, either spontaneously, as
with email or voicemail, or in a more formal manner for broader distribution
through the Internet or corporate data network.




Although
IP communications technologies are already in use at many enterprises,
businesses and other organizations require increasingly comprehensive,
integrated and scalable visual unified communication capabilities. For example,
video conferencing is often limited to scheduled point-to-point communication
from designated rooms or through the use of “roll-about” products, where call
set-up procedures, lack of networking, bandwidth requirements and room
availability greatly constrain functionality, spontaneity, usability,
reliability and efficiency. Most individuals do not have immediate access to
these video technologies, and the reservation and set-up time make them unlikely
to be used on a spontaneous basis. Few of these video solutions are deployed
widely to individuals to support them where and how they normally work—at their
desks, integrated into the business applications they use. Usage and adoption of
these systems is thus often limited.




Elements
      of a Complete Communications and Collaboration
    Solution


To become
a critical tool in the enterprise, a communications solution must first and
foremost provide application functionality that boosts worker productivity. It
also has to be “self service” and provide high quality at scale, high
reliability, low total cost of ownership, and be available to people where and
when they do most of their work, which typically means at their desks, but
increasingly means from home or while traveling. It must also effectively
utilize existing and evolving network infrastructure. We believe a complete
communications and collaboration solution must provide the
following:




5




Applications and Functionality
  ·
              support
      or integrate into the applications people use, in the way they use them,
      to deliver real-time and non-real-time self service personal for
      collaboration and visual
communication;
  ·
              do
      so in an intuitive, “easy” manner in order to foster expanding
      usage;
  Quality
  ·
              approximate
      the video and audio quality of television for natural and easy
      interaction;
  ·
              make
      interactions as realistic as possible by minimizing visual artifacts when
      transmitting and receiving video calls such as latency, jitter,
      freeze-frame, stutter and small frame
size;
  ·
              seamlessly
      integrate all forms of audio, video and data
    communications;
  Scalability
  ·
              like
      the Internet and public telephone networks, the communications solution
      must be designed for size independence and should scale cost-effectively
      to support a very large numbers of
users;
  Reliability
  ·
              operate
      dependably and reliably to avoid user frustration, while minimizing
      support costs;
  ·
              provide
      visual unified communications with the ease of use, speed, quality,
      functionality, flexibility and global access of the telephone, while
      easily supporting more complex applications and
  situations;
  Adaptability
  ·
              offer
      an upgradeable architecture that can evolve as bandwidth availability,
      protocols, standards and compression technologies
  change;
  ·
              include
      powerful software to manage an integrated suite of collaborative
      applications, relying on networked
  infrastructure;
  ·
              leverage
      current and future business investments in local and wide area networks,
      Internet protocol and standards-based
  infrastructures;
  ·
              reduce
      reliance on hardware components through a shift to software-based
      integrated communications
functionality;
 Affordability
  ·
              operate
      and scale cost effectively;
  ·
              utilize
      standard, low cost and widely available hardware components, such as
      “web-cams”;
  ·
              be
      cost-effective compared to other pervasive forms of enterprise
      communication, such as email; and
  ·
              deliver
      cost savings through innovations in support, network and resource
      management.




The
      Avistar Solution




Avistar
delivers a suite of video, audio and collaboration solutions which are designed
to support users in the office, via the conference room or on-the-go. It is
through an intelligent coupling of various forms of communication and
collaboration







6


into
daily work processes that we believe the benefits described above can be
realized. To fulfill this, we deliver a communication and collaboration platform
known as Avistar C3. C3 provides a comprehensive and integrated suite of video,
audio and collaboration applications that include on-demand access to
interactive video calling and conferencing, content creation and publishing,
broadcast origination and video distribution, and video-on-demand, as well as
data sharing, presence-based directory services and network management. Our C3
architecture is open and flexible in order to embrace continued technological
innovation and standardization. It is designed to use existing and emerging
communication and video standards such as session initiation protocol, or SIP.
It also provides customers choice and flexibility in designing and implementing
network topologies to best deliver high-quality video, audio and collaboration
applications to desktops, conference rooms and individuals
on-the-go.




We have
built a complete collaboration solution that is delivering business-quality
video, audio and collaboration solutions to thousands of desktops across
hundreds of locations. Each of our applications can be used, integrated and
managed in conjunction with one another. Our platform also joins users in a
high-quality video network to improve their ability to solve complex problems,
connect to co-workers, customers and suppliers, manage large projects and
quickly act together on opportunities. Our system does this cost effectively and
reliably, and is designed to be able to serve the wide range of businesses from
a single office operation to global corporations with branch offices and/or
geographically dispersed operations.




Interactive video calling.Our system allows users to participate in spontaneous interactive video
collaborations from their desktops. Users can simultaneously see multiple
participants in windows on their workstations or an external monitor.
Additionally, our system provides full duplex audio, which allows multiple users
to speak and hear each other clearly at the same time. The desktop window can be
divided into four quadrants, to permit up to three other video sources. These
sources can include other participants in real-time, broadcast content or
recorded video. The participants can include individual users or conference-room
groups located at multiple sites and/or various enterprises, all without
requiring advance reservations or conferencing services. Each participant has
the full ability to utilize all the call functions of the system, such as adding
or removing participants, focusing the view on one participant, putting anyone
or the entire call on hold, and transferring the call. Advanced telephony
features such as Caller ID, Do Not Disturb, leave Message and multiline calling
are also provided. The system supports the communications needs of users by
allowing them to add a third or fourth participant into a call spontaneously for
a quick conference, and then revert back to a two or three party call. This
ability helps speed decision-making and leverages the knowledge of experts. As
an example, a sales trader can be on a video call with a client portfolio
manager and spontaneously add a research analyst to the call for added insight
on a particular security, then drop the analyst and add a trader to review
execution strategy, instantaneously with a series of mouse clicks.




Interactive broadcasts and
presentations.Interactive broadcasts allow moderated presentations to an
audience of viewers, who have the ability to send questions to the presenters.
Moderators can dynamically control who’s presenting, bring audience members into
the broadcast, select what views are broadcast, and monitor questions. Sales
meetings, training seminars, analyst reports, management presentations and live
news broadcasts can be delivered real-time to every user’s workstation and
streamed to browser-based users. For example, a customer employed its Avistar
video network to maximize the reach and impact of an educational seminar. The
customer broadcasted the seminar to an estimated 300 desktops and meeting rooms,
with more than 2,000 employees and clients watching in the United States and
Europe. As another example, one customer has shifted its international sales
meetings to broadcasts and recorded presentations on its Avistar system, thereby
saving travel time and costs, while expanding the broadcast to a wider audience.
Additionally, video feeds from broadcast TV channels or other video sources can
be distributed to users through the Avistar system.




Video-on-demand.Users
anywhere on the Avistar network can easily retrieve stored videos. For example,
a corporation has used our system to record its sales training seminars.
Salespeople who are unable to attend these face-to-face presentations are now
able to watch the seminars by retrieving and playing the stored videos on their
desktops when it is convenient for them. Another customer uses our system to
record and broadcast their daily morning meetings so colleagues in other time
zones around the world can be updated on the issues of the day when they report
to work. The ability to both archive and retrieve stored content can facilitate
the establishment of a visual “institutional memory” and support training
efforts.




Integrated collaboration & data
sharing.In addition to viewing the four quadrants of our video window,
multiple users can simultaneously create and annotate a shared document using
text or drawing tools color-coded specifically for each


7
 user.
All participants can access the contents of any shared window and save the
marked changes for later reference. Our system can also be utilized in
conjunction with other application-sharing programs that utilize data networks
or the Internet, including popular web-based data collaboration solutions. As
one example, while participating in an interactive video call, users can access
Microsoft NetMeeting’s application sharing capabilities through a button on our
tool bar, and jointly view and edit a document. Multiple design engineers, for
example, can share a technical drawing in order to resolve an issue with a
defective part.




Our system has the following key features necessary to make integrated video
collaboration effective:




·
            Easy to use
      interface.Our applications
      combine the rich interaction of a face-to-face meeting with a self-service
      interface that’s intuitive and easy to
use.




·
            Click-to-connect
      simplicity.To initiate calls or add another user to a call already
      underway, a user simply clicks on either a “direct connect” button or a
      name in the directory. Standard telephone-like features such as hold,
      hang-up, forward, “leave message” or “begin another call” are all
      completed with the click of a mouse, or keyboard shortcuts. Additionally,
      anyone on an Avistar network can initiate a video call to the desktop of
      colleagues, customers, suppliers and others on other Avistar networks. If
      the person being called is logged-in but unavailable, users can leave a
      personalized call back message that allows the person to automatically
      return the video call without having to look up the address. A portion of
      this functionality is protected under certain patents held by
      Avistar.




·
            “Find Me, Follow
      Me.”Avistar video calling is built on directories and
      presence-based features referred to as “Find Me, Follow Me.” Using this
      feature, our system is able to determine the presence and location of any
      user on an Avistar network at any time. To call any user in the Avistar
      network, it is not necessary to know their number or current location. As
      long as the Avistar user is logged into his or her Avistar application,
      the Find Me, Follow Me application automatically registers where that user
      is logged in, regardless of site or geography, and routes all calls to the
      user’s location. Using this Find Me, Follow Me technology, Avistar’s
      system makes video calling a one-click process and enables what we call
      “Video Instant Messaging.” A portion of this functionality is protected
      under certain patents held by
Avistar.




·
            Comprehensive
      directory.  The presence-based Avistar network directory is a
      comprehensive list of Avistar numbers that can be called with a click. All
      users currently logged into an enterprise’s Avistar network will be shown,
      providing immediate ‘presence’ information as to availability. The global
      directory can be tailored to include only a subset of a more specific
      business’ community of users. In addition, a private directory feature
      allows users to create their own directory and reach frequently called
      parties with a one-click “direct connect” tool. Both global and private
      directories can also include other non-Avistar sites that use
      standards-based video conferencing systems. Through the Avistar Community
      Exchange and Avistar C3 Proxy products, presence information can be shared
      across participating enterprises. The result is one-click, presence-based,
      cross-enterprise calling network which helps form a community of users. A
      portion of this functionality is protected under certain patents held by
      Avistar.




·
            Consistency across
      locations.The Avistar user interface is consistent across desktops
      and conference rooms. Thus, a user who is familiar with the functionality
      at the desktop requires no additional training or set-up to utilize an
      Avistar system in a conference room setting. This allows conference room
      systems to be “self-service,” thereby avoiding the support logistics and
      expense of traditional room-based
systems.




·
            Seamless integration of system
      applications.All of our
      applications are seamlessly integrated with one user interface. As a user
      adds an additional video source during an on going video call—such as an
      additional live participant, a one-way broadcast or a stored video
      clip—there is virtually no delay in launching another application or
      downloading data. In addition, each application is synchronized with the
      others so that all participants in a video call see and hear the same
      content simultaneously. Thus, recorded or broadcast video can be added to
      a live session and shown to all participants. The entire session can also
      be recorded. Our system enables common network and application management,
      so the same directory can be used for two-way calls, one-way broadcasts
      and data sharing in the same session. Usage can be determined with our
      integrated call-reporting tool that provides summary data for analysis and
      cost management. A portion of this functionality is protected under
      certain patents held by Avistar.







8





·
            Network Bandwidth
      Management.Our network
      architecture provides system administrators with the ability to flexibly
      and proactively manage each of the various components of the network.
      Within our system, the most costly and complex equipment and software
      applications are shared as networked resources. This arrangement allows
      for redundancy and dynamic allocation of these resources to users who need
      them, and ensures that users experience the best video quality possible at
      the highest reliability and lowest cost of use. Servers and switches can
      be maintained, installed and repaired centrally, and many network support
      functions can be performed remotely over the data network, assisted by
      System Central, thereby limiting the disruption of service to an
      individual user. Similarly, additional desktops and meeting rooms can be
      easily and inexpensively added to the Avistar network, with those new
      users concurrently added to the Avistar directory. Additionally, our
      software makes call routing decisions to minimize communications costs and
      control bandwidth utilization. A portion of this functionality is
      protected under certain patents held by
Avistar.




We
believe our solution includes the following benefits to our
customers:




·
            Speed business processes.We provide a fully integrated Internet protocol-based video
      collaboration solution that seamlessly allows individuals to make video
      calls, view broadcasts and create, store and access video content or other
      forms of data from the desktop making visual communications widely and
      easily available which can speed business processes by enhancing
      collaboration and communication.




·
            Increased availability of
      knowledge within the enterprise.At many businesses, individuals
      who possess valuable knowledge often cannot effectively distribute their
      knowledge to the rest of the organization. Our system enables these
      businesses to access these individuals and disseminate their knowledge
      more efficiently and effectively by offering them the ability to call,
      broadcast or record from their desktops, and offering other users the
      ability to receive this information real-time, or access video recordings
      at a convenient time and location. The ability to spontaneously add
      additional participants to a call encourages personal communications
      between individuals who otherwise might not enjoy this access. In
      addition, our system gives every desktop the ability to create and publish
      valuable visual content, which can be distributed inside and outside the
      organization to support employee and customer needs
    worldwide.




·
            Improved productivity and
      revenue generation.Our system helps companies increase the
      productivity of their employees and accelerate time critical
      decision-making. By creating a network of Avistar users, our customers can
      have face-to-face meetings within the enterprise and with customers and
      partners, without the costs and time delays of travel. Negotiations,
      crises management, sales, advisory services, decision-making and other
      persuasive communications are more effective when done face-to-face. Our
      solution allows interactions to happen in real-time, speeding up the
      manner in which business is done, freeing up time for employees, enhancing
      business-to-business communications, and potentially increasing revenue
      generation.




·
            Enhanced customer and partner
      relationships.Our system helps companies to be more responsive to
      and develop stronger business relationships with their customers, partners
      and suppliers. An Avistar call is generally as easy and reliable as a
      telephone call or “instant message”, while being more personal. One of our
      customers has provided Avistar networks to their clients and business
      partners, including offshore outsource partners, in order to facilitate
      interactions and improve
relationships.




·
            Opportunity to leverage
      existing and future communication infrastructures.We provide an
      open architecture that uses existing standards and is designed to take
      advantage of emerging standards. Our system integrates into our customers’
      existing network communications infrastructure, and supports the protocols
      a company may choose to use for video broadcasts, data sharing and the
      transport of information. However, video quality varies depending on the
      protocol selected. Our system utilizes existing data networks for
      transporting video, and is designed to support real time digital
      networking and video transmission. We have designed our system to continue
      to work with Internet protocol-based technologies as standards evolve and
      quality of service improves. We expect this flexibility, together with
      simplified software and hardware at the desktop, to allow companies to
      make effective use of their existing local area and wide area networks, as
      well as their next generation
networks.




·
            Better communication to face
      new business challenges such as globalization, business continuity
      planning, and distributed locations.Within global corporations,
      professionals collaborate daily with customers, partners
    and







9





associates
      who are often located in different offices and/or different time zones.
      This has increasingly become the case as firms, due to economic and
      security concerns, have restricted travel, begun decentralizing their
      personnel across a more distributed set of locations, taking advantage of
      lower costs of real estate and increased business resiliency through
      distributed operations, and shifted more operations to outsourcing
      providers. In this context, critical information must be delivered on a
      timely basis and without confusion, as smoothly as if colleagues were
      working together in person. Avistar’s video product suite enables
      companies that are reducing travel and/or distributing their operations to
      easily and quickly connect small, remote offices as well as at-home
      workers to the central organization and still benefit from face-to-face
      interaction. Based on our experience in helping existing customers choose
      their optimal configurations, we are able to advise new customers on
      setups and configurations that will be most effective for a large central
      office, a small branch office, an outsourcing provider, or other remote
      locations.




System
      Architecture and Technology




Our
visual unified communications solutions are based on our 10th major release of
our open architecture, which enables users to communicate using various
networking protocols and transport media, including IP networks and the
Internet. We developed our architecture to address the necessary elements of a
complete video-enabled collaboration solution.




We
believe that the following technical factors will transform and consolidate the
existing video collaboration applications marketplace, creating a strong need
for a software platform that will support this consolidation and
evolution:




·
            improved
      compression technologies;




·
            widespread
      proliferation of broadband infrastructure and virtual private networks, or
      VPNs (with enhanced tools to optimize bandwidth for video transmission
      (QOS; quality of service));




·
            developing
      availability of converged audio, video and data
  networks;




·
            improved
      computer processing speeds; and




·
            adoption
      of critical digital video and multimedia
  standards.




Our C3
platform supports this consolidation and evolution by integrating industry
standards for audio, video and data transport, but separating them from
application functionality and system management. This allows our software
application platform to manage the interoperation and transcoding of various
standards to seamlessly integrate video, audio and data into complex
applications, and not be limited by the functionality built into one particular,
application-specific standard. It also allows the system to accommodate new and
evolving standards with minimal disruption. Current industry and widely accepted
proprietary standards supported include H.263, H.264, H.320, H.323, SIP, NTSC,
PAL, MPEG, Microsoft Windows Media Video and Real Networks RealMedia. Our system
uses TCP/IP, the standard Internet protocol, for providing video and audio
calls, scheduling and starting broadcast presentations, and managing the
creation of materials. In addition, we use TCP/IP for overall systems and
network management throughout our C3 software platform. This approach allows us
to deliver connectivity throughout an enterprise and allows us to leverage
existing Internet infrastructure. For delivery of high-quality video streams in
the local area network, including wireless, we primarily utilize video over IP
technology but offer a choice of IP or traditional circuit switched
technologies, including the ability to mix and match network types. Thus,
Avistar customers can successfully deploy desktop video across the enterprise,
even if portions of their network, in older buildings for example, aren’t
capable of supporting real-time video on their data networks. We use our
gateways to translate between the various network technologies used in our
system. These gateways are managed and controlled by our systems software with
TCP/IP-based protocols.




Each
Avistar endpoint functions as a node on the network, like personal computers,
printers or file servers on a local area network. Just as color printers and
file servers are often shared network resources on the local area network, the
more costly equipment in an Avistar system, such as servers, media servers,
switches, and gateways, are centralized and made available to multiple users.
Network nodes and resources, like those of a data network, are managed through
centralized, Internet protocol-based applications and administration tools, such
as web-based reports of video call activity.




We
believe our video software platform positions us to lead the transformation
described above. Further, we provide a suite of collaboration applications that
seamlessly operate with the AvistarVOS system allowing users to access
this







10





functionality
in an easy and intuitive manner. We expect to make this platform more accessible
to developers and to allow integration with other applications and network
hardware.




Because
of the intelligent integration of various video network components, all Avistar
products are controlled by the Avistar C3 platform, our architecture has the
following key features:




·
            Network management:Avistar C3 utilizes open protocols for call set-up, call control
      and directory services. It also complies with standards and interfaces and
      connects with video networks through shared Avistar gateways, which are
      further connected via private or public telephony or TCP/IP networks.
      Servers communicate through our signaling system for video protocol, SSV,
      which is based on TCP/IP, the standard Internet protocol. Through this
      signaling system, servers exchange configuration information and allocate
      call resources during call set-up, and exchange network status
      information. The signaling system selects the optimal route for all video
      calls, helping to minimize call costs and performance demands on wide area
      network resources. Most videoconferencing equipment using industry
      standard compression technologies also can communicate with an Avistar
      network.




·
            Transport standard
      independence:Our system selects the appropriate transport
      standards for transmitting information over networks to help deliver the
      highest quality video possible and full duplex audio in the most efficient
      manner. For example, the Avistar C3 software automatically exchanges
      information among servers and switches to determine the best network route
      for video calls. For the transport of video over a local area network, our
      system uses either data networks with our IP endpoints, or existing spare
      Ethernet wires for our legacy product to deliver standards-compliant high
      quality signals. This allows customers to choose the transport type to
      best fit their network capabilities in the local area. In a wide area
      network, we use industry video compression standards across a customer’s
      private IP network, or VPN’s, or the Internet, or the public telephony
      network. Recent product releases have enhanced our ability to support
      mobile and home workers who may have lower bandwidth connections. For the
      transmission of recorded content on corporate data networks or via the
      Internet, our system uses standard digital storage formats and transport
      technologies.




·
            Expandable to thousands of
      usersBecause shared resources, such as servers, are attached
      to the Avistar switch and are managed through the data network, new users
      and new capabilities can be added without replacing existing
      infrastructure, but rather, by simply adding video software and a
      web-camera at each desktop. Just as local area network switches and public
      telephony networks can be linked together without the use of routers,
      Avistar switches can be similarly linked without the use of video network
      gateways. As a result, customers can easily add capacity as their needs
      grow.




System
      Products and Applications




Our
system-level products and applications consist of shared resources and a network
of desktop, laptop and conference room endpoints which connect to each other and
to shared resources.




Infrastructure,
      Server and Software Products




·
            Avistar C3 Server.All
      systems require Avistar C3 Server software. It enables the seamless
      integration of video applications, audio support, collaboration services,
      comprehensive network and bandwidth management and administration. The
      Avistar C3 software supports a highly-distributed topology, and multiple
      instances may be deployed.




·
            Avistar Directory
      Software.Our directories allow a user to place a video call by
      simply clicking on a name in the presence-based Avistar network directory.
      Our system will route the call to the correct location over the local area
      network or the wide area as appropriate. The user doesn’t need to know
      phone numbers or IP addresses. The user can also look up addresses in
      private and global address books, utilize browser style type-in boxes, and
      access speed-dial ‘direct connect buttons’. This server-based directory
      integrates with LDAP directories, simplifies administration, and allows
      users to get started quickly, without having to manually enter many video
      phone numbers into their desktop
directory.




·
            Shareboard
      Software.Our Shareboard application allows users to collaborate on
      graphics, data or text during a video call. By clicking on the “share”
      button, users are linked to the Shareboard data sharing application. Users
      can







11





share
      any application window or image with all conference participants, see all
      users’ color-keyed pointers and text and paintbrush annotations, and save
      or print shared images from any desktop or conference
  room.




·
            Avistar Call Reporting
      System.With our web-based call reporting system, our
      customers can track all calls logged by our servers. Reports show call
      details, device usage and calls by user, all viewable from any Web
      browser. Reports can be customized and stored for future or specialized
      analysis.




Desktop
      and Conference Room Endpoint
Products




Client
personal computers run the Avistar C3 Client software applications, including
Avistar Conference, the primary user interface to server-based video
applications. Endpoints access video services managed by the Avistar C3 Server
software through the Avistar C3 Client software and Client Access Licenses.
Software-only endpoints have higher processing power requirements on the client
PC than endpoints with hardware assist. The Avistar C3 software detects what, if
any, additional hardware is attached and can work in any of three modes. Thus,
in the office, a user may have an IP hardware accelerator to minimize processor
loading, while on the road or at home, they may use the software-only mode to
simplify the equipment required.




Desktop Endpoints.The
standard Avistar two-way desktop system consists of the following
components:




·
            Avistar
      C3 client software, which includes video and audio
  codecs;




·
            Web
      camera—required for software-only operation;
or,




·
            A
      high quality camera with built-in directional microphone for hardware
      assisted endpoints.




Avistar Room Systems.We deliver complete video
systems for a range of room sizes and layouts. We believe that one key advantage
of our system is that the interface used in a conference room system is
consistent with the interface used on individual desktops, allowing for all
forms of video-enabled communications: interactive video calling, content
creation and publishing, broadcasting and video-on-demand. Therefore, desktop
users are familiar with the controls used in Avistar room systems and do not
need additional training to operate the room system, nor do they need a
technician to set-up and connect conference room calls (as is common with
traditional room systems). In addition, since rooms are simply additional nodes
on the network, they can be less expensive than self-contained, traditional room
systems.




Patent
      Licensing




We derive
a significant portion of our annual revenues by licensing our broad portfolio of
patents covering, among other areas, video and rich media collaboration
technologies, networked real-time text and non-text communications and desktop
workstation echo cancellation. This broad suite of patents enables much of the
functionality of our Avistar C3 platform. Licenses to third parties may cover
part of or all of our patent portfolio. End-to-end rich media collaborative
application companies which have taken licenses to our patents include firms
such as Polycom, Inc., Tandberg ASA, Sony Corporation and Sony Computer
Entertainment Inc.(SCEI), Emblaze-VCON Ltd., and Radvision. Examples of the
many patented innovations in our portfolio include: the handling of
decentralized video call endpoints, unshielded twisted pair video conferencing,
with data conferencing and desktop workstation echo cancellation. We maintain
and support an active program to protect and grow our intellectual property,
primarily through the filing of patent applications and the defense of issued
patents against infringement. As of December 31, 2007, we had 80 U.S. and
international patents covering various aspects of our technology, with
expiration dates ranging from 2013 to 2018, and have over 25 pending patent
applications. In addition, we attempt to protect our trade secrets and other
proprietary information through agreements with licensees, proprietary
information agreements with employees and consultants, and other security
measures. We also rely on trademarks and trade secret laws to protect our
intellectual property.




Segment
      Information




We
operate through two segments:




·
            Our
      products division engages in the design, development, manufacture, sale
      and marketing of networked video communications
  products.







12





·
            Our
      intellectual property division engages in the development, prosecution,
      maintenance, support and licensing of the intellectual property and
      technology used in our video communications
  system.




Financial
information regarding these segments is provided in Note 11 to our consolidated
financial statements included in this Annual Report on Form 10-K. Financial
information relating to revenues and other operating income, net loss, operating
expenses and total assets for the three years ended December 31, 2007, can
be found in Item 6 “Selected Financial Data” and also in our Consolidated
Financial Statements attached hereto.




Customers




Video
      Communications Products




As of
December 31, 2007, we have licensed and recognized revenue with respect to
over 18,000 end-users at over 400 customer sites in approximately 151 cities in
over 40 countries. Because many of our customers operate on a decentralized
basis, decisions to purchase our systems are often made independently by
individual business units. As such, a single company may represent several
separate accounts, and multiple customer sites may relate to the same
company.




For the
year ended December 31, 2007, Radvision Ltd., Deutsche Bank AG and its
affiliates, and UBS Warburg LLC and its affiliates accounted for 33%, 24% and
18% of our total revenues, respectively. For the year ended December 31,
2006, Sony Corporation, Deutsche Bank AG and its affiliates, and UBS Warburg LLC
and its affiliates accounted for 38%, 25% and 20% of our total revenues,
respectively. For the year ended December 31, 2005, UBS Warburg LLC and its
affiliates accounted for 45% of our total revenue and Deutsche Bank AG and its
affiliates accounted for 39% of our total revenue. The level of sales to any
customer may vary from quarter to quarter, and we expect that significant
customer concentration will continue for the foreseeable future. The loss of, or
a decrease in the level of sales to, or a change in the ordering pattern of, any
one of these customers could have a material adverse impact on our financial
condition or results of operations.




International
revenue, which consists of sales to customers with operations principally in
Western Europe and Asia comprised 72%, 75% and 63% of total revenue for 2007,
2006 and 2005, respectively. For 2007, 2006 and 2005, revenues to customers in
the United Kingdom accounted for 12%, 12% and 23% of total revenue,
respectively.




Licensing
      Activities




We
derived 42%, or $5.0 million and 39%, or $5.2 million, of our annual revenues in
2007 and 2006, respectively, by licensing our broad portfolio of patents to
third parties covering video and rich media collaboration technologies,
networked real-time text and non-text communications and desktop workstation
echo cancellation. Our license revenue in 2007 was primarily generated by
Radvision Ltd. and Sony Corporation and its subsidiaries, including SCEI.
Radvision agreed to make an up-front license payment of $4.0 million in the
three months ended June 30, 2007.  License revenue in 2006 was
primarily due to a license to Sony Corporation and its subsidiaries. Sony
Corporation agreed to make an up-front license payment of $5.0 million and
future royalty payments, which was recognized by us as licensing revenue in the
three months ended September 30, 2006. No license revenue was recorded in
2005.




Sales
and Marketing




Sales.We have a direct sales force
in the United States and Europe consisting of sales managers located in New York
and London. Sales managers have direct responsibility for selling and account
management of our technology at customer sites.




Indirect Sales.Through our partnership
organization, we have established a set of relationships with strategic partners
and value added resellers, in order to establish and expand an indirect channel
of sales for our products.




Marketing.Our marketing efforts are
directed towards Global 5000 companies with targeted solutions for the SMB and
Enterprise markets, focused on the specific collaboration needs of each. We also
work with our existing customers to demonstrate how our solutions can further
satisfy their needs, thereby growing our footprint within our installed base. We
emphasize initiatives to develop market awareness of our solutions and services,
as well as increase usage of our installed systems.







13





We also
use marketing programs to build recognition of our corporate brand, foster
partnerships, and promote our technology in regards to licensing
opportunities.




Installation,
      Maintenance, Training and Support
Services




We
provide a wide variety of services for installation, design and adoption of our
video communications products. This may include the analysis of workflows in
order to identify patterns of collaboration between workgroups, so that the best
configuration of networked resources can be designed and implemented for the
enterprise. We generally install our systems for new customers. In an increasing
number of cases, our customers’ information technology group or services partner
install follow-on orders. In the future, we expect our customers or their
services partners will increasingly perform the installation
process.




The
installation that we offer to our customers as a separately-priced service
relates to the physical set up and configuration of desktop and infrastructure
components of our solution. To accomplish this activity, our staff frequently
interfaces with the customer’s internal information technology, or IT, staff and
external suppliers, in order to provide for connectivity to the customer’s local
and wide area networks, and for the physical placement (arranging for rack space
and appropriate environmental conditions) and connections between the various
components purchased. The effective operation of software and hardware is
checked by our staff during this installation process. Although the “work time”
of this activity at a single location may be only one or two days, the
coordination necessary for accommodating the equipment and establishing
connectivity frequently creates cycle times of between two and six weeks from
product shipment to installation at the customer’s site.




Our
maintenance services ensure that customers benefit from the latest networked
video technology through software upgrades and expedited repair and replacement
services. Our customer support center provides voice and video call assistance
to Avistar users and administrators throughout the world. On-site support is
also available from each of our major regional offices for a separate fee. In
addition, training for users is available on-site or at an Avistar facility, and
for system administrators at an Avistar facility, on a for-fee
basis.




Backlog




We had no
backlog of product orders at December 31, 2007. Backlog is not necessarily
indicative of past or future operating results.




Research
      and Development




We
believe that strong system development capabilities are essential to our
strategy. Our research and development efforts focus on enhancing our core
technology, developing additional applications, addressing emerging
technologies, standards and protocols, and engaging in patent generation
activities. Our system development team consists of engineers and software
developers with experience in video and data networking, voice communications,
video and data compression, email, collaboration and Internet technologies. We
believe that our diverse technical expertise contributes to the highly
integrated functionality of our system. We devote a significant amount of our
resources to research and development as this is core to our business strategy
and ongoing success.  Our research and development expense for the
years ended December 31, 2007 and 2006 was $7.7 million and  $5.8
million, respectively.




Manufacturing




We use
contract manufacturers to produce and/or purchase components, and to perform
some material assembly. Our operations staff develops manufacturing strategies
and qualifies and audits manufacturing processes and suppliers. We work with our
contract manufacturers to reduce manufacturing costs and to resolve quality
control issues, as we perform the final assembly and testing of our products. We
believe our manufacturing strategy enables us to utilize the capabilities of our
contract manufacturers, while allowing us to focus on rapid system development
and deployment, software architecture and development of video communication
applications. We use third party, commercially available camera components,
microphones, speakers and monitors for desktop and room systems, as well as
third party compression and decompression components for our
gateways.







14


Intellectual Property and Proprietary Rights




Our
ability to compete, and to continue to provide technological innovation depends
substantially upon internally developed technology. We rely on a combination of
patent, copyright, trademark and trade secret laws, as well as licensing,
non-disclosure and other agreements with our consultants, suppliers, customers
and employees, to protect our technology. We believe that other factors such as
the technological and creative skills of our personnel, new system developments,
frequent system and feature enhancements and reliable system support and
maintenance are also essential to maintaining our leadership position in
technology.




We have
pursued registration of our key trademarks and service marks in the United
States, the United Kingdom and certain other European countries, and intend to
pursue additional registrations in additional countries where we plan to
establish a significant business presence. We own several United States,
Canadian and United Kingdom trademarks, including Avistar and the Avistar logo,
AvistarVOS, Shareboard, vBrief and The Enterprise Video Company.




We held
29 United States patents and 51 non-United States patents as of
December 31, 2007. The patents that have been issued expire at varying
dates between 2013 and 2018. In addition, numerous patent applications are
pending in the United States and several other jurisdictions. Specifically,
these patent applications, some of which relate to and claim priority from an
application originally filed in 1993, include both method and apparatus claims.
These patents and pending patent applications disclose and/or claim aspects of
our analog or digital desktop video conferencing technology, video and
multimedia storage technology for messaging and publishing, directory services,
and public wide area networking access, switching and architecture. A portion of
these technologies is currently utilized in our system. To date, we have focused
on expanding our patent portfolio, expediting patent issuance and licensing of
our patents to reinforce the adoption of our technology.




On
February 25, 2008 we announced that Microsoft Corporation had filed requests for
re-examination of 24 of our 29 U.S. patents.  Subsequently, Microsoft
also filed requests for re-examination of the remaining 5 U.S.
patents.  The United States Patent and Trademark Office (USPTO) has
approximately two months to decide whether to grant the requests and engage in a
formal re-examination. Patent re-examination, if undertaken by the USPTO, could
take between six months and two years.  We believe that our U.S.
patents are valid and we intend to defend our patents through any re-examination
process.  However, the re-examination of patents by the USPTO is a
lengthy, time consuming and expensive process in which the ultimate outcome is
uncertain.




Our
intellectual property division seeks to license its broad portfolio of patents
covering, among other areas, video and rich media collaboration technologies,
networked real-time text and non-text communications and desktop workstation
echo cancellation. The broad suite of patents enables much of the functionality
of our Avistar C3 application platform. Licenses to third parties may cover part
or all of our patent portfolio. Examples of the many patented innovations in our
portfolio include: the handling of decentralized video call endpoints,
unshielded twisted pair video conferencing with data conferencing and desktop
workstation echo cancellation.




We
generally enter into confidentiality, license and nondisclosure agreements with
our employees, consultants, prospective customers, licensees, and partners that
seek to limit the use and distribution of our proprietary materials and prohibit
reverse-engineering of our proprietary technologies. In addition, we control
access to and distribution of our software, documentation and other proprietary
information. Several of our license agreements with our customers require us to
place our software source code into escrow. In these cases, these agreements
provide that these customers may be entitled to retain copies of the software,
and have a limited non-exclusive right to use and/or reproduce, maintain,
update, enhance and produce derivative works of the software source code under
the terms of the agreements if we fail to cure a contractual breach by us on a
timely basis, or if we become the subject of a bankruptcy or similar
proceeding.




We
maintain a strong working relationship with vendors whom we identify as key
suppliers, and assign preferred provider status to these vendors under
agreements that secure ordering and extended warranty rights for us. Pacific
Corporation, is a single source supplier for a key component for one of our
products and Equator Technologies Inc., is our only current source of a
component used in our IP gateway product.







15


Competition




The
market for video collaboration products and solutions is highly competitive. As
a result of advances in technology, increases in communications capability and
reductions in communications costs in the past several years, the market is now
characterized by many competitors, rapidly changing technology, evolving user
needs, developing industry standards and protocols and the frequent introduction
of new products and services. Within the market for video collaboration products
and solutions, we compete primarily with Polycom, Inc., Tandberg ASA,
Radvision, Ltd., and Emblaze-VCON Ltd.




With
increasing interest in the power of video collaboration, unified communications
and the establishment of communities of users, we face increasing competition
from alternative communications solutions that employ new technologies or new
combinations of technologies from companies such as Cisco Systems, Inc.,
Avaya, Inc., Nortel Networks Corporation, Microsoft Corporation, and IBM
Corporation that enable web-based or network-based video and unified
communications with low-cost digital camera systems.




We
believe that the principal factors affecting competition in our markets
include:




·
            product
      features, functionality and
scalability;




·
            product
      quality and performance;




·
            product
      reliability and ease of use;




·
            use
      of open standards;




·
            quality
      of service and support;




·
            company
      reputation, size and financial
stability;




·
            price
      and overall cost of ownership;




·
            integration
      with other desktop collaboration products;
and




·
            document
      sharing, including internet-based
collaboration.




Currently,
our principal competitors are companies that provide products and services in
specific areas where we offer our integrated system, such as:




·
            room-based
      point-to-point and multi-point video communications
    products;




·
            desktop
      video communications products;




·
            broadcast
      video products;




·
            video
      retrieval and viewing products;




·
            desktop
      content creation products; and




·
            web-based
      data collaboration products.




While a
number of companies have marketed applications that enable users to use
individual features similar to our solutions, we do not believe that any single
competitor currently offers as comprehensive a set of functionality as our
solution provides. We believe these companies in many cases can also represent
complementary opportunities to extend the reach of our solutions by potentially
expanding the market for video and unified communications and
collaboration.




We expect
competition to increase significantly in the future from existing providers of
specialized video and unified communications products, VOIP solution providers
and other companies as they enter our existing or future markets, possibly
including major telephone companies or communications equipment providers. These
companies may develop similar or substitute solutions, which may be less costly
or provide better performance or functionality than our systems. A number of our
existing and potential competitors have longer operating histories,
significantly greater financial, marketing, service, support, technical and
other resources, significantly greater name recognition and a larger installed
base of customers than we do. In addition, many of our current or potential
competitors have well-established relationships with our current
and







16


potential
customers, and have extensive knowledge of our industry. It is possible that new
competitors or alliances among competitors may emerge and acquire significant
market share. To be successful, we must continue to respond promptly and
effectively to the challenges of developing customer requirements, technological
change and competitors’ innovations. Accordingly, we cannot predict what our
relative competitive position will be as the market evolves for video
collaboration and unified communications products and services.




Employees




As of
December 31, 2007, we had 74 employees, including personnel dedicated to
research and development, customer service, including installation and support
services, sales and marketing, and finance and administration. Our future
performance depends in significant part upon the continued service of our key
technical, sales and marketing, and senior management personnel, most of whom
are not obligated to remain with us by an employment agreement. The loss of the
services of one or more of our key employees could harm our
business.




Executive
      Officers




Our
officers and their ages as of December 31, 2007 were as
follows:




Name
            
            
            
            
            Age
            
            
            PositionGerald
      J. Burnett
            
            65
            
            Chairman
      of the Board and Chief Executive Officer*William
      L. Campbell
            
            59
            
            Vice
      Chairman and Director of Strategic Development*Robert
      J. Habig
            
            53
            
            Chief
      Financial OfficerJ.
      Chris Lauwers
            
            47
            
            Chief
      Technology and Product OfficerSimon
      B. Moss
            
            42
            
            President,
      Products Division*Anton
      F. Rodde
            
            65
            
            President,
      Intellectual Property DivisionGary
      Stager
            
            55
            
            Vice
      President, EngineeringDarren
      Innes
            
            42
            
            General
      Manager and Global Head of Sales







*Dr. Burnett resigned as our
Chief Executive Officer and Mr. Moss was appointed as our Chief Executive
Officer effective January 1, 2008.  William Campbell resigned as
Director of Strategic Development on January 1, 2008.




Gerald J. Burnett is one of
our founders and has been Chairman of our Board of Directors since March 2000,
and our Chief Executive Officer from March 2000 until December 2007. He
served as Chief Executive Officer of Avistar Systems from 1998 until 2000. Dr.
Burnett resigned as our Chief Executive Officer effective January 1, 2008. From
1993 to 1997, he was a director of Avistar Systems or a principal of its
predecessor limited partnership. He is a member of the Corporation (Board of
Trustees) of the Massachusetts Institute of Technology. Dr. Burnett holds a
B.S. and an M.S. from the Massachusetts Institute of Technology in electrical
engineering and computer science, and a Ph.D. from Princeton University in
computer science and communications.




William L. Campbellis one of our founders
and has been a member of our Board of Directors since March 2000.  Mr.
Campbell served as our Director of Strategic Development from September 2007 to
December 31, 2007.  Mr. Campbell served as our Chief Operating Officer
from July 2005 to September 2007 and served as our Executive Vice President from
March 2000 until September 2007. He was our Corporate Secretary from June
2001 until September 2007. He was our Chief Executive Officer of our
Intellectual Products Division beginning in 1997 to September 2007. In
July 2005 he received the title of Chief Operating Officer which he held
until September 2007. Mr. Campbell holds a B.S. in general engineering from
the U.S. Military Academy and an M.S. in management from the Sloan School of the
Massachusetts Institute of Technology.




Robert J. Habig has been our
Chief Financial Officer since May 2001. He had previously served as Chief
Financial Officer at think3 Corporation, a private computer-aided design
software company from 1999 to 2001, as Chief Financial Officer at CrossWorlds
Software, Inc., an enterprise software company from 1998 to 1999, as
Executive Vice President at First Data Corporation, a financial transactions
processing company, from 1997 to 1998, as a business unit Chief Financial
Officer at AlliedSignal Corporation, an automotive, aerospace and chemical
manufacturing company from 1994 to 1997, and







17





held
a number of positions with PepsiCo from 1979 to 1994. Mr. Habig holds a
B.A. in economics and business from Lafayette College and an M.B.A. from the
Simon Graduate School of Business at the University of Rochester.




J. Chris Lauwershas been our Chief
Technology and Product Officer since August 2005. He served as Chief Technology
Officer from March 2001 to August 2005. He was our Vice President of Engineering
from 1996 to 2001 and Director of Engineering from 1994 to 1996. He previously
served as Principal Software Architect at Vicor Inc., a private e-business
product solutions and engineering consulting company, from 1990 to 1994, and as
a research associate at Olivetti Research Center from 1987 to 1990.
Dr. Lauwers holds a B.S. in electrical engineering from the Katholieke
Universiteit Leuven of Belgium. Dr. Lauwers also holds an M.S. and a Ph.D.
in electrical engineering and computer science from Stanford
University.




Simon B. Moss joined Avistar
in July 2007 as President of our Products Division and became Chief Executive
Officer on January 1, 2008.  He previously served as Chief Executive
Officer of Mantas, Inc. a behavior detection software company, from April 2002
to 2006, where he led its successful acquisition by Oracle/I-flex. He was a
Partner at PricewaterhouseCoopers LLC from 2000 to 2002, President of FNX from
1999 to 2000, Director of Financial Markets at IBM Corporation and co-founder
of IBM's risk management practice in London, from 1994 to 1999 and held
various positions at Chase Manhattan Bank prior to 1994.




Anton F. Roddehas been the President
of the Intellectual Properties Division, Inc., since December 2003.
Prior to joining Avistar, he served as President and CEO of Western Data
Systems, an ERP software company, from 1991 to 2002, as Group Vice President at
Manugistics from 2002 to 2003, the company which acquired Western Data Systems,
as President and General Manager of several subsidiaries of Teknekron
Corporation, a technology incubator, from 1984 to 1991, as founder and President
of Control Automation, a robotics company, from 1980 to 1984, and held a variety
of technical and management positions at AT&T from 1970 to 1980.
Dr. Rodde holds a B.S. in physics from Benedictine University and an M.S.
and Ph.D. in physics from the Illinois Institute of Technology.




Gary Stagerjoined Avistar in
December 2006 as Vice President of Engineering. From 2004 to 2006,
Mr. Stager was Senior Vice President of Engineering and Operations for
Exavio, Inc., where he was responsible for the design, manufacture and
support of Exavio’s networked storage products for digital media production and
HPC applications. From 2001 to 2003, he served as VP of Engineering at Omneon
Video Networks. Mr. Stager holds degrees in Electrical Engineering and
Liberal Arts from the University of Florida.




Darren Innesjoined Avistar in
November 2007 as General Manager and Global Head of Sales. Prior to joining
Avistar, Mr. Innes served as Global Head of Sales and General Manager EMEA at
Mantas Inc. from April 2002 to November 2007 and as Financial Services Practice
Manager at Izodia, a business to business e-commerce software company prior to
2002.Item




Item 1a.RiskFactors   Factors
      Affecting Future Operating Results
  We
have incurred substantial losses in the past and may not be profitable in the
future.
  We
incurred net losses of $2.9 million for 2007, $8.1 million for 2006 and $5.2
million for 2005. As of December 31, 2007, our accumulated deficit was
$105.7 million. Our revenue and income from settlement and patent licensing may
not increase, or even remain at its current level. In addition, our operating
expenses, which have been reduced recently, may increase as we continue to
develop our business and pursue licensing opportunities. As a result, to become
profitable, we will need to increase our revenue and income from settlement and
patent licensing by increasing sales to existing customers and by attracting
additional new customers and licensees. If our expenses increase more rapidly
than our revenue, we may not become or remain profitable. Due to the volatility
of our product and licensing revenue and our income from settlement and patent
licensing activities, we may not be able to achieve, sustain or increase
profitability on a quarterly or annual basis. If we fail to achieve or to
maintain profitability or to sustain or grow our profits within the time frame
expected by investors, the market price of our common stock may be adversely
impacted.
 18
 Our
expected future working capital needs may require
that we seek additional debt or equity funding which, if not available on
acceptable terms, could cause our business to suffer.
  As of December 31,
2007, our accumulated deficit was $105.7 million. Our revenue and income from
settlement and patent licensing may not increase, or even remain at its current
level. In addition, our operating expenses may increase as we continue to
develop our business and pursue licensingopportunities. As a result, we
may need to arrange for the availability of additional funding in order to meet
our future business requirements. If we are unable to obtain additional funding
when needed on acceptable terms, we may not be able to develop or enhance our
products, take advantage of future opportunities, respond to competitive
pressures or unanticipated requirements, or finance our efforts to protect and
enforce our intellectual property rights, which could seriously harm our
business, financial condition, results of operations and ability to continue
operations.  We have in the past and may in the future reduce our
expenditures on research and development and significantly reduce our employee
headcount in order to better align our expenditures with our available
resources.  Any such reductions may adversely affect our ability to
maintain or grow our business.
  We
are in the process of implementing changes in our organizational structure,
sales, marketing and distribution strategy, licensing
efforts and strategic direction, which, if unsuccessful, could adversely affect
our business and results of operations.
 
 In
July 2007, Simon Moss was appointed as President of the products division of our
company.  In September 2007, William Campbell resigned from the
position of Chief Operating Officer and in November 2007 we announced that
Gerald Burnett was resigning from his position as our Chief Executive Officer
effective January 1, 2008 and would be replaced in that position by Simon
Moss.  In addition John Carlson, Vice President of Marketing resigned
effective October 2007 and Robert Garrigan, Vice President of Sales resigned
effective in November 2007 and was replaced by Darren Innes who joined the
company as General Manager and Global Head of Sales on November 1,
2007.  In September 2007, we announced an intensive set of corporate
initiatives aimed at increasing our product sales, expanding our customer
deployments and support, improving our corporate efficiency and increasing our
development capacity.  The components of this initiative
included:
 
 ·
              Centering
      our sales, marketing and operations activities, and associated management
      functions in our New York City
offices;
  ·
              Introducing
      a new go-to-market strategy and delivery model for hosting desktop video
      services, a fully managed, turnkey, desktop video solution that provides
      comprehensive video communications and data-sharing capabilities without
      the need for companies to install and maintain on-site video
      infrastructure;
  ·
              Supplementing
      our position in the financial services vertical by expanding our market
      focus to additional verticals with complex business problems, where our
      collaboration products can help global organizations speed business
      processes, save costs and reduce their carbon
  footprints;
  ·
              Implementing
      aggressive cost control measures including a reduction in our employees
      from an average of 88 in  2007 to approximately 55 in the three
      months ended March 31, 2008; and
  ·
              Pursuing
      multiple distribution, services and technology licensing
      partners.
  These
and other changes in our business are aimed at reducing our structural costs,
increasing our organizational and partner-driven capacity, leveraging our
reputation for innovation and intellectual property leadership, and growing and
expanding our business.  However, these organizational changes and
initiatives involve transitional costs and expenses and result in uncertainty in
terms of their implementation and their impact on our business.  As
with any significant organizational change, our initiatives will take time to
implement, and the results of these initiatives may not be apparent in the near
term.  If our initiatives are unsuccessful in achieving our stated
objectives, our business could be harmed and our results of operations and
financial condition could be adversely affected .
  We
may not satisfy the criteria for continued listing on The NASDAQ Capital Market
and our securities could be subject to delisting, which could materially and
adversely affect the price and liquidity of our stock, our business and our
financial condition.
   19
  On
November 16, 2007, we received a deficiency letter from The NASDAQ Stock Market
indicating that we do not comply with Marketplace Rule 4310(c)(3), which
requires that we have a minimum of $2,500,000 in stockholders’ equity or
$35,000,000 in market value of listed securities or $500,000 of net income from
continuing operations for the most recently completed fiscal year or two of the
three most recently completed fiscal years.  The NASDAQ staff noted
that the market value of our listed securities had been below the minimum
$35,000,000 for the previous 10 consecutive trading days.  On March
20, 2008, we received notification from the NASDAQ Hearings Panel that we had
regained compliance with the continued listing standards of The NASDAQ Stock
Market, but will be subject to an additional compliance monitoring period
through June 1, 2008.  In its determination, the Panel noted that if
at any time before June 1, 2008, the market value of our securities falls below
the required minimum of $35 million for 30 consecutive trading days, the Panel
will promptly conduct a hearing with respect to such failure and our securities
would be subject to immediate delisting. Failure to comply with any other
continued listing requirement would be subject to standard notice, hearing and
restoration periods.
 
 There
can be no assurance that we will remain in compliance with The NASDAQ’s
continued listing standards during the NASDAQ’s special compliance monitoring
period or thereafter.  If we are unable to continue to list our common
stock for trading on The NASDAQ Capital Market, there may be an adverse impact
on the market price and liquidity of our common stock, and our stock may be
subject to the “penny stock rules” contained in Section 15(g) of the
Securities Exchange Act of 1934, as amended, and the rules promulgated
thereunder. Delisting of our common stock from The NASDAQ Capital Market could
also have a materially adverse effect on our business, including, among other
things: our ability to raise additional financing to fund our operations; our
ability to attract and retain customers; and our ability to attract and retain
personnel, including management personnel. In addition, institutional investors
may no longer be able to retain their interests in and/or make further
investments in our common stock because of their internal rules and
protocols.
 
 Our
common stock has been and will likely continue to be subject to substantial
price and volume fluctuations due to a number of factors, many of which will be
beyond our control, which may prevent our stockholders from reselling our common
stock at a profit.
  The
trading price of our common stock has in the past been and could in the future
be subject to significant fluctuations in response to:
  ·
              general
      trends in the equities market, and/or trends in the technology
      sector;
  ·
              quarterly
      variations in our results of
operations;
  ·
              announcements
      regarding our product developments;
  ·
              the
      size and timing of agreements to license our patent
    portfolio;
  ·
              developments
      in the examination of our patent applications and the potential
      re-examination of our issued patents by the U.S. Patent and Trademark
      Office;
  ·
              announcements
      of technological innovations or new products by us, our customers or
      competitors;
  ·
              announcements
      of competitive product introductions by our
  competitors;
  ·
              changes
      in the status of our listing on The NASDAQ Capital
  Market;
  ·
              sales,
      or the perception in the market of possible sales, of a large number of
      shares of our common stock by our directors, officers, employees or
      principal stockholders; and
  ·
              developments
      or disputes concerning patents or proprietary rights, or other
      events.
  If
our revenue and results of operations are below the expectations of public
market securities analysts or investors, then significant fluctuations in the
market price of our common stock could occur. In addition, the securities
markets have, from time to time, experienced significant price and volume
fluctuations, which have particularly affected the market prices for high
technology companies, and which often are unrelated and disproportionate to the
operating performance of particular
   20
  companies.
These broad market fluctuations, as well as general economic, political and
market conditions, may negatively affect the market price of our common
stock.
  Provisions
of our certificate of incorporation, our bylaws and Delaware law may make it
difficult for a third party to acquire us, despite the possible benefits to our
stockholders.
  Our
certificate of incorporation, our bylaws, and Delaware law contain provisions
that may inhibit changes in our control that are not approved by our Board of
Directors. For example, the Board of Directors has the authority to issue up to
10,000,000 shares of preferred stock and to determine the terms of this
preferred stock, without any further vote or action on the part of the
stockholders.
  These
provisions may have the effect of delaying, deferring or preventing a change in
the control of Avistar despite possible benefits to our stockholders, may
discourage bids at a premium over the market price of our common stock, and may
adversely affect the market price of our common stock and the voting and other
rights of our stockholders.
  Our principal stockholders can
exercise a controlling influence over our business affairs and they may make
business decisions with which you disagree that will affect the value of your
investment.
  Our
executive officers, directors and entities affiliated with them, in the
aggregate, beneficially owned approximately 60% of our common stock as of
December 31, 2007. If they were to act together, these stockholders would
be able to exercise control over most matters requiring approval by our
stockholders, including the election of directors and approval of significant
corporate transactions. These actions may be taken even if they are opposed by
other investors. This concentration of ownership may also have the effect of
delaying or preventing a change in control of Avistar, which could cause the
market price of our common stock to decline.
  Our
market is in the early stages of development, and our system may not be widely
accepted.
  Our
ability to achieve profitability depends in part on the widespread adoption of
networked video communications systems and the sale and adoption of our video
system in particular either as a separate solution or as a technology integrated
into a unified communications platform. If the market for our system and
technology fails to grow or grows more slowly than we anticipate, we may not be
able to increase revenue or achieve profitability. The market for our system is
relatively new and evolving. We have to devote substantial resources to
educating prospective customers about the uses and benefits of our system. Our
efforts to educate potential customers may not result in our system achieving
broad market acceptance. In addition, businesses that have invested or may
invest substantial resources in other video products may be reluctant or slow to
adopt our system. Consequently, the conversion from traditional methods of
communication to the extensive use of networked video and unified communications
may not occur as rapidly as we wish.
  Our
lengthy sales cycle to acquire new customers or large follow-on orders may cause
our operating results to vary significantly and make it more difficult to
forecast our revenue.
  We
have generally experienced a product sales cycle of four to nine months for new
customers or large follow-on orders from existing customers.   This
sales cycle is due to the time needed to educate customers about the uses and
benefits of our system, and the time needed to process the investment decisions
that our prospective customers must make when they decide to buy our system.
Many of our prospective customers have neither budgeted expenses for networked
video communications systems, nor for personnel specifically dedicated to the
procurement, installation or support of these systems. As a result, our
customers spend a substantial amount of time before purchasing our system in
performing internal reviews and obtaining capital expenditure approvals.
Economic conditions over the last several years have contributed to additional
deliberation and an associated delay in the sales cycle.
  Our
lengthy sales cycle is one of the factors that has caused, and may continue to
cause our operating results to vary significantly from quarter-to-quarter and
year-to-year in the future. This makes it difficult for us to forecast revenue,
and could cause volatility in the market price of our common stock. A lost or
delayed order could result in lower than expected revenue in a particular
quarter or year. There is also a tendency in the technology industry to close
business deals at the end of a quarter, thereby increasing the likelihood that a
possible material deal would not be concluded in a current quarter, but slip
into a subsequent reporting period. This kind of delay may result in a given
quarter’s performance being below shareholder expectations.
   21
  Since
a majority of our product revenue has come from follow-on orders to existing
customers, our financial performance could be harmed if we fail to obtain
follow-on orders in the future.
  Our
customers typically place limited initial orders for our networked video
communications system, as they seek to evaluate its utilization and resultant
value. Our strategy is to pursue additional and larger follow-on orders after
these initial orders. Excluding licensing revenue, product revenue generated
from follow-on orders accounted for approximately 94% of our revenue in 2007,
95% in 2006 and 99% in 2005. Our future financial performance depends on
successful initial installations of our system, and successful generation of
follow-on orders as the Avistar network expands within a customer’s
organization. If our system does not meet the needs and expectations of
customers, we may not be able to generate follow-on orders.
  Because
we depend on a few customers for a majority of our product revenue, services
revenue, and income from settlement and patent licensing, the loss of one or
more of them could cause a significant decrease in our operating
results.
  We
have historically derived the majority of our revenue from a limited number of
customers, particularly Deutsche Bank AG and their affiliates and UBS Warburg
LLC and their affiliates. In 2007, these customers and Radvision Ltd. accounted
for 75% of our total revenue. In 2006, these customers and Sony Corporation and
its subsidiaries, including SCEI accounted for 83% of our total revenue.
Deutsche Bank AG and their affiliates and UBS Warburg LLC and their affiliates
accounted for 84% of our revenue for 2005. No other customers individually
contributed greater than 10% of our total revenue for 2007, 2006 or 2005. As of
December 31, 2007, three customers represented 38%, 30% and 10% of gross
accounts receivable. As of December 31, 2006, three customers represented
44%, 20% and 20% of gross accounts receivable. As of December 31, 2005,
three customers represented 48%, 32% and 17% of gross accounts
receivable.
  The
loss of a major customer or the reduction, delay or cancellation of orders from
one or more of our significant customers could cause our revenue to decline and
our losses to increase.  For example, income from settlement and patent
licensing activities from Tandberg, which was $12.0 million in the first quarter
of 2007, was a one-time payment, as was the $4.0 payment for a patent license
from Radvision Ltd in the second quarter of 2007. We expect to complete the
amortization of the Polycom proceeds in 2009. If we are unable to license our
patent portfolio to additional parties on terms equal to or better than our
agreements with Polycom, Tandberg, Sony and Radvision, our licensing revenue and
our income from settlement and patent licensing will decline, which could cause
our losses to increase. We currently depend on a limited number of customers
with lengthy budgeting cycles and unpredictable buying patterns, and as a
result, our revenue from quarter-to-quarter or year-to-year may be volatile.
Adverse changes in our revenue or operating results as a result of these
budgeting cycles or any other reduction in capital expenditures by our large
customers could substantially reduce the trading price of our common
stock.
  We
may not be able to modify and improve our products in a timely and cost
effective manner to respond to technological change and customer
demands.
  Future
hardware and software platforms embodying new technologies and the emergence of
new industry standards and customer requirements could render our system
non-competitive or even obsolete.  Additionally, communication and
collaboration products and technologies are moving towards integrated platforms
characterized as unified communications. The market for our system is
characterized by:
  ·
              rapid
      technological change;
  ·
              the
      emergence of new competitors;
  ·
              significant
      development costs;
  ·
              changes
      in the requirements of our customers and their communities of
      users;
  ·
              integration
      of joint solutions in collaboration
platforms;
  ·
              evolving
      industry standards; and
  ·
              transition
      to Internet protocol connectivity for video at the desktop, with
      increasing availability of bandwidth and quality of
    service.
 
 22
  Our system is
designed to work with a variety of hardware and software configurations, and be
integrated with commoditized components (example: “web cams”) of data networking
infrastructures used by our customers. The majority of these customer networks
rely on Microsoft Windows servers. However, our software may not operate
correctly on other hardware and software platforms or with other programming
languages, database environments and systems that our customers use. Also, we
must constantly modify and improve our system to keep pace with changes made to
our customers’ platforms, data networking infrastructures, and their evolving
ability to integrate video with other applications. This may result in
uncertainty relating to the timing and nature of our new release announcements,
introductions or modifications, which in turn may cause confusion in the market,
with a potentially harmful effect on our business. If we fail to promptly
modify, integrate, or improve our system in response to evolving industry
standards or customers’ demands, our system could become less competitive, which
would harm our financial condition and reputation.
  Difficulties
or delays in installing our products could harm our revenue and
margins.
  We
generally recognize initial product and installation revenue upon the
installation of our system in those cases where we are responsible for
installation, which often entails working with sophisticated software and
computing and communications systems. If we experience difficulties with
installation or do not meet deadlines due to delays caused by our customers or
ourselves, we could be required to devote more customer support, technical and
other resources to a particular installation. If we encounter delays in
installing our products for new or existing customers, or installation requires
significant amounts of our professional services support, our revenue
recognition could be delayed, our costs could increase and our margins could
suffer.
  Competition
could reduce our market share and decrease our revenue.
  The
market in which we operate is highly competitive. In addition, because our
industry is relatively new and is characterized by rapid technological change,
evolving user needs, developing industry standards and protocols and the
introduction of new products and services, it is difficult for us to predict
whether or when new competing technologies or new competitors will enter our
market. Currently, our competition comes from many other kinds of companies,
including communication equipment, integrated solution, broadcast video and
stand-alone “point solution” providers. Within the video-enabled network
communications market, we compete primarily against Polycom, Tandberg ASA, Sony
Corporation, Apple Inc., Radvision and Emblaze-VCON Ltd.  Many of these
companies, including Polycom, Tandberg, Sony, Radvision and Emblaze-VCON have
acquired rights to use our patented technology through licensing agreements with
us, which, in some cases, include rights to use future patents filed by
us.  With increasing interest in the power of video collaboration and the
establishment of communities of users, we believe we face increasing competition
from alternative video communications solutions that employ new technologies or
new combinations of technologies from companies such as Cisco
Systems, Inc., Avaya, Inc., Microsoft Corporation and Nortel Networks
Corporation that enable web-based or network-based video communications with
low-cost digital camera systems.
  We
expect competition to increase in the future from existing competitors,
partnerships of competitors, and from new market entrants with products that may
be less expensive than ours, or that may provide better performance or
additional features not currently provided by our products. Many of our current
and potential competitors have substantially greater financial, technical,
manufacturing, marketing, distribution and other resources, greater name
recognition and market presence, longer operating histories, lower cost
structures and larger customer bases than we do. As a result, they may be able
to adapt more quickly to new or emerging technologies and changes in customer
requirements.
  We
may be required to reduce prices or increase spending in response to competition
in order to retain or attract customers, pursue new market opportunities or
invest in additional research and development efforts. As a result, our revenue,
margins and market share may be harmed. We cannot assure you that we will be
able to compete successfully against current and future competitors and
partnerships of our competitors, or that competitive pressures faced by us will
not harm our business, financial condition and results of
operations.
  General
economic conditions may impact our revenues and harm our business in the future,
as they have in the past.
  The
international economic slowdown and the downturn in the investment banking
industry that began in 2000 negatively affected our business, and a reoccurrence
of a difficult economic environment may do so in the future. During the previous
economic downturn, the investment banking industry suffered a sharp decline,
which caused many of our existing   23
 and
potential customers to cancel or delay orders for our products. The U.S. economy
may slow, and our customers and potential customers may delay ordering our
products, and we could fall short of our revenue expectations for 2008 and
beyond. Slower growth among our customers, tightening of customers’ operating
budgets, retrenchment in the capital markets and other general economic factors
all have had, and could in the future have, a materially adverse effect on our
revenue, capital resources, financial condition and results of
operations.
  Future
revenues and income from settlement and licensing activities are difficult to
predict for several reasons, including our lengthy and costly licensing cycle.
Our failure to predict revenues and income accurately may cause us to miss
analysts’ estimates and result in our stock price declining.
  Because
our licensing cycle is a lengthy process, the accurate prediction of future
revenues and income from settlement and patent licensing from new licensees is
difficult. The process of persuading companies to adopt our technologies, or
convincing them that their products infringe upon our intellectual property
rights, can be lengthy. There is also a tendency in the technology industry to
close business deals at the end of a quarter, thereby increasing the likelihood
that a possible material deal would not be concluded in a current quarter, but
slip into a subsequent reporting period. This kind of delay may result in a
given quarter’s performance being below analyst or shareholder expectations. The
proceeds of our intellectual property licensing and enforcement efforts tend to
be sporadic and difficult to predict. Recognition of those proceeds as revenue
or income from settlement and licensing activities depends on the terms of the
license agreement involved, and the circumstances surrounding the agreement. As
a result, our licensing and enforcement efforts are expected to result in
significant volatility in our quarterly and annual financial condition and
results of operations, which may result in us missing investor expectations,
which may cause our stock price to decline.
  Our
U.S. Patents are the subject of a re-examination request filed with the U.S.
Patent and Trademark Office by Microsoft Corporation, which could adversely
affect our business and results of operations.
  On
February 25, 2008 we announced that Microsoft Corporation had filed requests for
re-examination of 24 of our 29 U.S. patents.  Subsequently, Microsoft
also filed requests for re-examination of the remaining 5 U.S.
patents.  Some of the re-examination requests were initially rejected
by the USPTO on procedural grounds. If all procedural flaws are corrected, the
USPTO has approximately two months to decide whether to grant the requests and
engage in a formal re-examination. Patent re-examination, if undertaken by the
USPTO, could take between six months and two years.  In addition, we
have elected to withdraw and re-submit for examination seven about-to-issue
patent applications. This will give the USPTO the opportunity to evaluate
Microsoft’s re-examination documents in the context of these applications as
well.  We believe that our U.S. patents are valid and we intend to
defend our patents through any re-examination process.  However, the
re-examination of patents by the USPTO is a lengthy, time consuming and
expensive process in which the ultimate outcome is
uncertain.   If the USPTO elects to re-examine some or all of our
U.S. patents, we will be required to spend substantial time and resources
defending our patents, including the fees and expenses of our legal
advisors.  The re-examination of some or all of our U.S. patents, if
granted by the USPTO, may adversely impact our licensing negotiations in
process, our financial condition, and results of operations and may require us
to seek additional financing to fund our operations and defense of our
patents.  We may also enter into contingency arrangements with
investors, legal counsel or other advisors that would give such parties a
significant portion of any future licensing and settlement amounts we derive
from our patent portfolio.  If the USPTO elects to re-examine our U.S.
patents and determines that some or all of such patents should not be affirmed,
our business, financial condition and future licensing prospects may be
materially and adversely affected.
  Infringement
of our proprietary rights could affect our competitive position, harm our
reputation or cost us money.
  We
regard our system as open but proprietary. In an effort to protect our
proprietary rights, we rely primarily on a combination of patent, copyright,
trademark and trade secret laws, as well as licensing, non-disclosure and other
agreements with our consultants, suppliers, customers and employees. However,
these laws and agreements provide only limited protection of our proprietary
rights. In addition, we may not have signed agreements in every case, and the
contractual provisions that are in place and the protection they produce may not
provide us with adequate protection in all circumstances. Although we hold
patents and have filed patent applications covering some of the inventions
embodied in our systems, our means of protecting our proprietary rights may not
be adequate. It may be possible for a third party to copy or otherwise obtain
and use our technology without authorization and without our detection. In the
event that we believe a third party is infringing
our intellectual property rights, an infringement claim brought by us could,
regardless of the outcome, result in   24
 substantial
cost to us, divert our management’s attention and resources, be time consuming
to prosecute and result in unpredictable damage awards. A third party may also
develop similar technology independently, without infringing upon our patents
and copyrights. In addition, the laws of some countries in which we sell our
system may not protect our software and intellectual property rights to the same
extent as the laws of the United States or other countries where we hold
patents. As we move to more of a software based system, unauthorized copying,
use or reverse engineering of our system could harm our business, financial
condition or results of operations.
 
 Others
may bring infringement claims against us or challenge the legitimacy of our
patents, which could be time-consuming and expensive to defend.
  In
recent years, there has been significant litigation in the United States
involving patents and other intellectual property rights, and we have been a
party to such litigation. We have been party to such litigation in the past and
may be again in the future. The prosecution and defense of such lawsuits would
require us to expend significant financial and managerial resources, and
therefore may have a material negative impact on our financial position and
results of operations. The duration and ultimate outcome of these proceedings
are uncertain. We may be a party to additional litigation in the future to
protect our intellectual property, or as a result of an alleged infringement of
the intellectual property of others. These claims and any resulting lawsuit
could subject us to significant liability for damages and invalidation of our
proprietary rights. In addition, the validity of our patents has been challenged
in the past and may be challenged in the future through re-examination requests
or other means. These lawsuits or challenges of our patents legitimacy in the US
or foreign patent offices, regardless of their success, would likely be
time-consuming and expensive to resolve and would divert management’s time and
attention. Any potential intellectual property litigation also could force us to
do one or more of the following:
  ·
              stop
      selling, incorporating or using products or services that use the
      challenged intellectual property;
  ·
              obtain
      from the owner of the infringed intellectual property a license to the
      relevant intellectual property, which may require us to license our
      intellectual property to such owner, or may not be available on reasonable
      terms or at all; and
  ·
              redesign
      those products or services that use technology that is the subject of an
      infringement claim.
  If
we are forced to take any of the foregoing actions, we may be unable to
manufacture, use, sell, import and export our products, which would reduce our
revenues.
  Our
inability to protect the intellectual property created by us would cause our
business to suffer.
  We
rely on a combination of license, development and nondisclosure agreements,
trademark, trade secret and copyright law, and contractual provisions to protect
our other, non-patentable intellectual property rights. If we fail to protect
these intellectual property rights, our licensees, potential licensees and
others may seek to use our technology without the payment of
license fees and royalties, which could weaken our competitive position, reduce
our operating results and increase the likelihood of costly litigation. The
growth of our business depends in part on the applicability of our intellectual
property to the products of third parties, and our ability to enforce
intellectual property rights against them. In addition, effective trade secret
protection may be unavailable or limited in certain foreign countries. Although
we intend to protect our rights vigorously, if we fail to do so, our business
will suffer.
  If
our customers do not perceive our system or services to be effective or of high
quality, our brand and name recognition would suffer.
  We
believe that establishing and maintaining brand and name recognition is critical
for attracting and expanding our targeted customer base. We also believe that
the importance of reputation and name recognition will increase as competition
in our market increases. Promotion and enhancement of our name will depend on
the success of our marketing efforts, and on our ability to continue to provide
high quality systems and services, neither of which can be assured. If our
customers do not perceive our system or services to be effective or of high
quality, our brand and name recognition will suffer, which would harm our
business.
   25
 Our system could have defects for which we could be
held liable for, and which could result in lost revenue, increased costs, and
loss of our credibility or delay in the further acceptance of our system in the
market.
  Our
system may contain errors or defects, especially when new products are
introduced or when new versions are released. Despite internal system testing,
we have in the past discovered software errors in some of the versions of our
system after their introduction. Errors in new systems or versions could be
found after commencement of commercial shipments, and this could result in
additional development costs, diversion of technical and other resources from
our other development efforts or the loss of credibility with current or future
customers. Any of these events could result in a loss of revenue or a delay in
market acceptance of our system, and could harm our reputation.
  In
addition, we have warranted to some of our customers that our software is free
of viruses. If a virus infects a customer’s computer software, the customer
could assert claims against us, which, regardless of their merits, could be
costly to defend and could require us to pay damages and potentially harm our
reputation.
  Our
license agreements with our customers typically contain provisions designed to
limit our exposure to potential product liability and certain contract claims.
Our license agreements also typically limit a customer’s entire remedy to either
a refund of the price paid or modification of our system to satisfy our
warranty. However, these provisions vary as to their terms and may not be
effective under the laws of some jurisdictions. Although we maintain product
liability (“errors and omissions”) insurance coverage, we cannot assure you that
such coverage will be adequate. A product liability, warranty or other claim
could harm our business, financial condition and/or results of operations.
Performance interruptions at a customer’s site could negatively affect the
demand for our system or give rise to claims against us.
  The
third party software we license with our system may also contain errors or
defects for which we do not maintain insurance. Typically, our license
agreements transfer any warranty from the third party to our customers to the
extent permitted. Product liability, warranty or other claims brought against us
with respect to such warranties could, regardless of their merits, harm our
business, financial condition or results of operations.
  Although
we are quickly moving to a software-centric product offering and reducing our
dependencies on specialized hardware, the loss of any of our outside contract
manufacturers or third party equipment suppliers that produce key components of
our system could significantly disrupt our manufacturing and new product
development process.
  We
depend on outside manufacturers to produce components of our systems, such as
cameras, microphones, gateway, speakers and monitors that we install at desktops
and in conference rooms. One supplier, Pacific Corporation, is a single source
supplier for a key component for one of our products. Another supplier, Equator
Technologies Inc., is our only current source of a component used in our IP
gateway product. In addition, during 2006, we began using an offshore contract
resource in China for product development work and may use offshore resources in
the future. Our reliance on these third parties involves a number of risks,
including:
  ·
              the
      possible unavailability of critical services and components on a timely
      basis, on commercially reasonable terms or at
  all;
  ·
              if
      the components necessary for our system were to become unavailable, the
      need to qualify new or alternative components for our use or reconfigure
      our system and manufacturing process could be lengthy and expensive for
      those products impacted;
  ·
              the
      likelihood that, if particular components or human resources were not
      available, we would suffer an interruption in the manufacture and shipment
      of our systems until these components or alternatives become
      available;
  ·
              reduced
      control by us over the quality and cost of our system and over our ability
      to respond to unanticipated changes and increases in customer orders, and
      conversely, price changes from suppliers if committed volumes are not
      met;
  ·
              the
      possible unavailability of, or interruption in, access to some
      technologies due to infringement claims, production/supply issues or other
      hindrances; and
  ·
              the
      possible misappropriation of our source code through reverse engineering
      or other means by contract developers or other
  parties.
   26
  We
do not have long-term supply contracts with most of our manufacturers and
suppliers. If these manufacturers or suppliers cease to provide us with the
assistance or the components necessary for the operation of our business, we may
not be able to identify alternate sources in a timely fashion. Any transition to
alternate manufacturers or suppliers would likely result in operational problems
and increased expenses, and could cause delays in the shipment of or otherwise
limit our ability to provide some of our products. We cannot assure you that we
would be able to enter into agreements with new manufacturers or suppliers on
commercially reasonable terms, or at all. Any disruption in product flow may
limit our revenue, delay our product development, seriously harm our competitive
position and/or result in additional costs or cancellation of orders by our
customers.
 If
we are unable to expand our direct sales force and/or add distribution channels,
our business will suffer.
  To
increase our revenue, we must increase the size and/or the productivity of our
direct sales force and add indirect distribution channels, such as systems
integrators, product partners and/or value-added resellers, and/or effect sales
through our customers. If we are unable to maintain or increase our direct sales
force or add indirect distribution channels due to our own cost constraints,
limited availability of qualified personnel or other reasons, our future revenue
growth may be limited and our future operating results may suffer. We cannot
assure you that we will be successful in attracting, integrating, motivating and
retaining sales personnel. Furthermore, it can take several months before a new
hire becomes a productive member of our sales force. The loss of existing
salespeople, or the failure of new salespeople and/or indirect sales partners to
develop the necessary skills in a timely manner, could impact our revenue
growth.
  We
may not be able to retain our existing key personnel, or hire and retain the
additional personnel that we need to sustain and grow our business.
  We
depend on the continued services of our executive officers and other key
personnel. We do not have long-term employment agreements with our executive
officers or other key personnel and we do not carry any “key man” life
insurance. The loss of the services of any of our executive officers or key
personnel could harm our business, financial condition and results of
operations.
  Our
products and technologies are complex, and to successfully implement our
business strategy and manage our business, an in-depth understanding of video
communication and collaboration technologies and their potential uses is
required. We need to attract and retain highly skilled technical and managerial
personnel for whom there is intense competition. If we are unable to attract and
retain qualified technical and managerial personnel due to our own cost
constraints, limited availability of qualified personnel or other reasons, our
results of operations could suffer and we may never achieve profitability. The
failure of new personnel to develop the necessary skills in a timely manner
could harm our business.
  Our
plans call for growth in our business, and our inability to achieve or manage
growth could harm our business.
  Failure
to achieve or effectively manage growth will harm our business, financial
condition and operating results. Furthermore, in order to remain competitive or
to expand our business, we may find it necessary or desirable in the future to
acquire other businesses, products or technologies. If we identify an
appropriate acquisition candidate, we may not be able to negotiate the terms of
the acquisition successfully, to finance the acquisition or to integrate the
acquired businesses, products or technologies into our existing business and
operations. In addition, completing a potential acquisition and integrating an
acquired business may strain our resources and require significant management
time.
  Our
international operations expose us to potential tariffs and other trade
barriers, unexpected changes in foreign regulatory requirements and laws and
economic and political instability, as well as other risks that could adversely
affect our results of operations.
  International
revenue, which consists of sales to customers with operations principally in
Western Europe and Asia, comprised 72% of total revenue for 2007, 75% for 2006
and 63% for 2005. Some of the risks we may encounter in conducting international
business activities include the following:
  ·
              tariffs
      and other trade barriers;
  ·
              unexpected
      changes in foreign regulatory requirements and
  laws;
   27
  ·
              economic
      and political instability;
  ·
              increased
      risk of infringement claims;
  ·
              protection
      of our intellectual property;
  ·
              restrictions
      on the repatriation of funds;
  ·
              potentially
      adverse tax consequences;
  ·
              timing,
      cost and potential difficulty of adapting our system to the local language
      standards in those foreign countries that do not use the English
      language;
  ·
              fluctuations
      in foreign currencies; and
  ·
              limitations
      in communications infrastructures in some foreign
    countries.
  Some of our products
are subject to various federal, state and international laws governing
substances and materials in products, including those restricting the presence
of certain substances in electronics products. We could incur substantial costs,
including fines and sanctions, or our products could be enjoined from entering
certain jurisdictions, if we were to violate environmental laws or if our
products become non-compliant with environmental laws. We also face increasing
complexity in our product design and procurement operations as we adjust to new
and future requirements relating to the materials composition of our products,
including the restrictions on lead and certain other substances that apply to
specified electronics products sold in the European Union as of July 1,
2006 (Restriction of Hazardous Substances Directive). The ultimate costs under
environmental laws and the timing of these costs are difficult to predict.
Similar legislation has been or may be enacted in other regions, including in
the United States, the cumulative impact of which could be
significant.
  International
political instability may increase our cost of doing business and disrupt our
business.
  Increased international political instability,
evidenced by the threat or occurrence of terrorist attacks, enhanced national
security measures and/or sustained military action may halt or hinder our
ability to do business, may increase our costs and may adversely affect our
stock price. This increased instability has had and may have negative effects on
financial markets in the future, including significant price and volume
fluctuations in securities markets. If this international political instability
continues or escalates, our business and results of operations could be harmed,
and the market price of our common stock could decline.
  If
our share price is volatile, we may be the target of securities litigation,
which is costly and time-consuming to defend.
  In the past, following periods of market volatility
in the price of a company’s securities, security holders have often instituted
class action litigation. Many technology companies have been subject to this
type of litigation. Our share price has, in the past, experienced price
volatility, and may continue to do so in the future. If the market value of our
common stock experiences adverse fluctuations and we become involved in this
type of litigation, regardless of the merits or outcome, we could incur
substantial legal costs and our management’s attention could be diverted,
causing our business, financial condition and operating results to suffer.
  Changes
in stock option accounting rules enacted have and will continue to adversely
impact our reported operating results prepared in accordance with generally
accepted accounting principles, which may in turn adversely impact our stock
price and our ability to attract and retain employees.
  On
January 1, 2006, we adopted SFAS No. 123R, which requires employee stock options
and rights to purchase shares under stock participation plans to be accounted
for under the fair value method, and eliminates the ability to account for these
instruments under the intrinsic value method prescribed by Accounting Principles
Board Opinion No. 25, and allowed under the original provisions of SFAS No. 123.
SFAS No. 123R requires the use of an option pricing model for estimating fair
value, which is amortized to expense over the service periods.  We
expect to continue to grant stock options to employees. The adoption of SFAS No.
123R had, and is expected to continue to have, a material impact on our results
of operations.
  The pro
forma impact of the adoption of SFAS No. 123 on our historical financial
statements is included in the notes to the consolidated financial statements
presented elsewhere in this Annual Report on Form 10-K.
   28
 Item
      1b.  Unresolved StaffComment


None.




Item 2.  Properties




Our
corporate headquarters and intellectual property division are located in San
Mateo, California, where we occupy approximately 29,000 square feet under a
lease that expires in March 2012. We believe that our current leased facilities,
together with facilities that are available to us or are being negotiated, will
be sufficient to meet our needs for the next twelve months. In addition, we
lease a combined total of approximately 11,000 square feet of office space in
New York, New York, and London, England to support the operations of our
products division.




Item 3.  Legal
      Proceedings




On
May 11, 2005, Collaboration Properties Inc., our wholly-owned patent
prosecution and licensing subsidiary, which was subsequently merged into Avistar
on October 1, 2007, commenced a patent infringement lawsuit against Tandberg ASA
and Tandberg, Inc., alleging that numerous Tandberg videoconferencing
products infringe three patents held by us. The suit was filed in the United
States District Court for the Northern District of California. The three patents
involved were U.S. Patent Nos. 5,867,654; 5,896,500; and 6,212,547. Both of
the Tandberg entities answered the complaint on July 15, 2005, at which
time they asserted that they did not infringe the patents and that the patents
were invalid and unenforceable.




On
January 30, 2006, Tandberg Telecom AS, a wholly-owned subsidiary of
Tandberg ASA, filed a patent infringement lawsuit against us in the United
States District Court for the Eastern District of Texas. The suit alleged that
our videoconferencing products infringe one patent purchased by Tandberg Telecom
AS. The patent involved is U.S. Patent No. 6,621,515, which claims a method
and system for routing video calls. We responded to the complaint on
March 23, 2006, at which time we asserted that we did not infringe the
patent, that the patent was invalid, and that the claim was without
merit.




On
February 15, 2007, we entered into a patent license agreement with Tandberg
ASA, Tandberg AS and Tandberg, Inc. Under this agreement, we agreed to
dismiss our infringement suit against Tandberg, Tandberg agreed to dismiss its
infringement suit against us, and the companies agreed to cross-license each
other’s patent portfolios. The agreement resulted in a payment to us from
Tandberg in the amount of $12.0 million, of which $4.3 million was used by us to
pay contingent legal fees we incurred in connection with the
litigation.




We
sometimes encounter other claims in the normal course of business that are not
expected to have a material effect on our business.  However, dispute
resolution is inherently unpredictable, and the costs and other effects of
pending or future claims, litigation, legal and administrative cases and
proceedings, and changes in any such matters, and developments or assertions by
or against us relating to intellectual property rights and intellectual property
licenses, could have a material adverse effect on our business, financial
condition and operating results.




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




None.







29





PART II




Item 5.  Market for Registrant’s Common
      Equity, Related Stockholder Matters and Issuer Purchases of
      EquitySecurities




Our
common stock has traded on the NASDAQ National Market from August 17, 2000
until October 29, 2002 and has traded on the NASDAQ Capital Market since
October 30, 2002 under the symbol “AVSR.”  Prior to
August 17, 2000, there was no public market for our common stock. The
following table sets forth for the period indicated the high and low closing
sale prices for our common stock, as reported by the NASDAQ Capital
Market.




Year Ended
              December 31, 2007
            
            
            Year Ended
              December 31, 2006High
            
            
            Low
            
            
            High
            
            
            LowFirst
      Quarter
            
            $
            1.91
            
            
            $
            1.32
            
            
            $
            1.79
            
            
            $
            1.22Second
      Quarter
            
            $
            1.75
            
            
            $
            1.28
            
            
            $
            1.76
            
            
            $
            1.25Third
      Quarter
            
            $
            1.44
            
            
            $
            1.10
            
            
            $
            1.81
            
            
            $
            1.33Fourth
      Quarter
            
            $
            1.27
            
            
            $
            0.31
            
            
            $
            2.52
            
            
            $
            1.44







On
December 31, 2007, the last reported sale price of our common stock on the
NASDAQ Capital Market was $0.36 per share. According to the records of our
transfer agent, as of December 31, 2007 there were 70 holders of record of
our common stock and we believe there are a substantially greater number of
beneficial holders.




Dividend
      Policy




We have
never paid cash dividends on our common stock, and we do not anticipate paying
cash dividends in the foreseeable future.




Equity
      Compensation Plan Information




The
information required by this Item is included under Item 12 of Part III of
this Annual Report on Form 10-K.







30





Stock
      Performance Graph




This
performance graph shall not be deemed “filed” for purposes of Section 18 of
the Securities Exchange Act of 1934, as amended or otherwise subject to the
liabilities under that Section, and shall not be deemed to be incorporated by
reference into any filing of Avistar under the Securities Act of 1933, as
amended or the Exchange Act. Set forth below is a line graph comparing the
percentage change in the cumulative return to the holders of our common stock
with the cumulative return of The NASDAQ Composite U.S. Index and a group of
industry peers within the communications software infrastructure and video
communications industries for the period commencing December 31, 2002 and
ending on December 31, 2007. Returns for the indices are weighted based on
market capitalization at the beginning of each fiscal year. Data for The NASDAQ
Composite Index and the Peer Group assumes reinvestment of
dividends.









Total
Return Analysis




12/31/2002
            
            12/31/2003
            12/31/2004
            12/31/2005
            12/31/2006
            12/31/2007Avistar
      Communications Corp.
            
            $
            100.00
            
            
            $
            660.87
            
            $578.26
            $669.61
            $786.96
            $156.52Peer
      Group
            
            $
            100.00
            
            
            $
            175.91
            
            $196.01
            $167.21
            $304.29
            $390.14NASDAQ
      Composite
            
            $
            100.00
            
            
            $
            150.01
            
            $162.89
            $165.13
            $180.85
            $198.60




Source:
CTA Integrated Communications www.ctaintegrated.com (303) 665-4200. Data from
Reuters BRIDGE Data Networks




(1)The
      above graph sets forth the cumulative total return to our stockholders
      during the period from December 31, 2002 to December 31, 2007. The
      graph assumes the investment on December 31, 2002 of $100 in our
      common stock, The NASDAQ Composite Index, and an Industry Peer Group.
      Stockholder returns over the indicated period should not be considered
      indicative of future stockholder
returns.




(2)The
      Industry Peer Group consists of WebEx Communications, Inc.,
      RealNetworks Inc., Packeteer, Inc., and Radvision Ltd. WebEx
      Communications, Inc. was acquired in May 2007 by Cisco Systems, Inc. and
      is included in the Industry Peer Group until acquired. Although the
      companies included in the industry peer group were selected because of
      similar industry characteristics, they are not entirely representative of
      our business.







31





Item 6.SelectedFinancial
  Data




The
selected consolidated financial data below should be read in conjunction with
“Management’s Discussion and Analysis of Financial Condition and Results of
Operations” in Item 7 hereof and our consolidated financial statements and notes
thereto. The selected statements of operations data for the years ended
December 31, 2007, 2006 and 2005 and the selected balance sheet data as of
December 31, 2007 and 2006 are derived from, and are qualified by reference
to, the audited financial statements included elsewhere in this Annual Report on
Form 10-K. The selected statement of operations data for the year ended
December 31, 2004 and 2003 and the selected balance sheet data as of
December 31, 2005, 2004 and 2003 is derived from our financial statements
not included in the Annual Report on Form 10-K. The historical results
presented below are not necessarily indicative of future results.




Year Ended December 31,2007
            
            
            2006
            
            
            2005
            
            
            2004
            
            
            2003(In thousands, except per share data)
              Restated(1)Statements
      of Operations DataRevenue:Product
            
            $
            3,462
            
            
            $
            4,528
            
            
            $
            3,403
            
            
            $
            3,121
            
            
            $
            2,817Licensing
            
            
            5,016
            
            
            
            5,155
            
            
            
            —
            
            
            
            —
            
            
            
            —Services,
      maintenance and support
            
            
            3,477
            
            
            
            3,542
            
            
            
            3,508
            
            
            
            3,200
            
            
            
            3,775Total
      revenue
            
            
            11,955
            
            
            
            13,225
            
            
            
            6,911
            
            
            
            6,321
            
            
            
            6,592Costs
      and expenses:Cost
      of product revenues*
            
            
            2,684
            
            
            
            3,185
            
            
            
            1,892
            
            
            
            1,435
            
            
            
            1,425Cost
      of services, maintenance and support revenues*
            
            
            2,243
            
            
            
            1,820
            
            
            
            2,220
            
            
            
            1,937
            
            
            
            2,119Income
      from settlement and patent licensing
            
            
            (16,226
            )
            
            
            (4,226
            )
            
            
            (4,226
            )
            
            
            (575
            )
            
            
            —Research
      and development*
            
            
            7,670
            
            
            
            5,753
            
            
            
            3,544
            
            
            
            2,588
            
            
            
            2,432Sales
      and marketing*
            
            
            6,192
            
            
            
            5,488
            
            
            
            3,379
            
            
            
            2,456
            
            
            
            3,702General
      and administrative*
            
            
            12,465
            
            
            
            9,682
            
            
            
            5,697
            
            
            
            6,956
            
            
            
            6,038Total
      costs and expenses
            
            
            15,028
            
            
            
            21,702
            
            
            
            12,506
            
            
            
            14,797
            
            
            
            15,716Loss
      from operations
            
            
            (3,073
            )
            
            
            (8,477
            )
            
            
            (5,595
            )
            
            
            (8,476
            )
            
            
            (9,124
            )Other
      income (expenses):Interest
      income
            
            
            346
            
            
            
            299
            
            
            
            537
            
            
            
            118
            
            
            
            44Other
      (expense) income, net
            
            
            (188
            )
            
            
            (2
            )
            
            
            (94
            )
            
            
            15
            
            
            
            481Total
      other income, net
            
            
            158
            
            
            
            297
            
            
            
            443
            
            
            
            133
            
            
            
            525Loss
      before provision for (recovery from) income taxes
            
            
            (2,915
            )
            
            
            (8,180
            )
            
            
            (5,152
            )
            
            
            (8,343
            )
            
            
            (8,599
            )Provision
      for (recovery from) income taxes
            
            
            23
            
            
            
            (31
            )
            
            
            22
            
            
            
            363
            
            
            
            20Net
      loss
            
            $
            (2,938
            )
            
            $
            (8,149
            )
            
            $
            (5,174
            )
            
            $
            (8,706
            )
            
            $
            (8,619
            )Net
      loss per share—basic and diluted
            
            $
            (0.09
            )
            
            $
            (0.24
            )
            
            $
            (0.15
            )
            
            $
            (0.27
            )
            
            $
            (0.33
            )Weighted
      average shares used in calculating basic and diluted net loss per
      share
            
            
            34,290
            
            
            
            33,928
            
            
            
            33,600
            
            
            
            32,610
            
            
            
            26,368*Including
      stock-based compensation of:Cost
      of product, services, maintenance and support revenues
            
            $
            188
            
            
            $
            155
            
            
            $
            —
            
            
            $
            —
            
            
            $
            15Research
      and development
            
            
            879
            
            
            
            618
            
            
            
            —
            
            
            
            —
            
            
            
            12Sales
      and marketing
            
            
            614
            
            
            
            497
            
            
            
            —
            
            
            
            —
            
            
            
            104General
      and administrative
            
            
            1,008
            
            
            
            764
            
            
            
            100
            
            
            
            24
            
            
            
            4







As of December 31,2007
            
            
            2006
            
            
            2005
            
            
            2004
            
            
            2003(In thousands)
              Restated(1)Balance
      Sheet DataCash
      and cash equivalents
            
            $
            4,077
            
            
            $
            7,854
            
            
            $
            8,216
            
            
            $
            21,656
            
            
            $
            4,438Short-term
      investments
            
            
            799
            
            
            
            —
            
            
            
            2,995
            
            
            
            —
            
            
            
            1,000Working
      capital (deficit)
            
            
            (7,182
            )
            
            
            (2,575
            )
            
            
            6,306
            
            
            
            16,367
            
            
            
            4,848Total
      assets
            
            
            10,577
            
            
            
            14,699
            
            
            
            20,358
            
            
            
            30,408
            
            
            
            8,228Stockholders’
      equity (deficit)
            
            
            (9,826
            )
            
            
            (9,949
            )
            
            
            (4,158
            )
            
            
            514
            
            
            
            5,491








32








(1)
Change in Accounting Treatment




In
September 2005, we received a comment letter from the SEC relating to our
2004 Form 10-K, which included questions regarding our accounting for the
November 2004 settlement and patent cross-license agreement with
Polycom, Inc. The settlement and patent cross-license agreement resulted in
a $27.5 million one-time payment by Polycom, Inc. to us, and a payment by
us to our own litigation counsel of $6.4 million in contingent legal fees. Our
Form 10-K for the fiscal year ended December 31, 2004 and
Form 10-Q for the three, six and nine months ended March 31, 2005,
June 30, 2005 and September 30, 2005, respectively, reported the one
time payment by Polycom, Inc. as revenue, recognized ratably over a
five-year period, net of contingent legal fees. As a result of the SEC’s inquiry
as to whether the Polycom, Inc. transaction should be characterized as
revenue and after discussions with the SEC, we concluded that a reclassification
of license revenues from revenue to a component of operating expenses, reflected
as “Income from settlement and patent licensing”, was necessary for previously
filed financial reports. The reclassification of the proceeds and expenses from
the Polycom, Inc. settlement and patent cross-license agreement had no
effect on reported net loss, loss per share, stockholders’ equity (deficit) or
net cash flows from operating, investing or financing activities, but did have
the effect of overstating revenues and operating expenses for previously issued
interim and annual consolidated financial statements, as of and for the quarters
and year-to-date periods ended December 31, 2004, March 31, 2005,
June 30, 2005 and September 30, 2005. In addition, the balance sheet
as of December 31, 2004 was amended to reflect the gross effect of the
$27.5 million payment by Polycom, Inc. to us, and the payment of $6.4
million of contingent legal fees by us, which was previously reported on a net
basis as deferred revenue. Significant concentrations, revenue recognition,
segment reporting footnotes and the unaudited interim results have been modified
to reclassify the Polycom, Inc. proceeds from revenue to “Income from
settlement and patent licensing,” to be consistent with the presentation of the
net proceeds from the Polycom, Inc. settlement and patent cross-license
agreement in the 2007, 2006 and 2005 Statements of Operations. The presentation
within operations is supported by a determination that the Polycom, Inc.
licensing transaction is central to the activities that constitute our ongoing
major or central operations, but that the settlement may also contain a gain
element related to the settlement, which is not considered revenue under the
Financial Accounting Standards Board (FASB) Concepts Statement No. 6, Elements of Financial Statements(CON 6). We did not have sufficient historical evidence to support a
reasonable determination of value for the purpose of segregating the transaction
into revenue related to the patent licensing and an operating or non-operating
gain upon settlement of litigation, resulting in the determination that the
entire transaction is more appropriately classified as “Income from settlement
and patent licensing” within operations, as opposed to revenue.







33





Item 7. Management’s Discussion and
      Analysis of Financial Condition and Results of
      Operations




The
following discussion should be read in conjunction with the Consolidated
Financial Statements and Notes thereto included elsewhere in this Annual Report
on Form 10-K. Certain statements in this “Management’s Discussion and
Analysis of Financial Condition and Results of Operations” are forward looking
statements. These statements relate to future events or our future financial
performance and involve known and unknown risks, uncertainties and other factors
that may cause our or our industry’s actual results, levels of activity,
performance or achievements to be materially different from any future results,
levels of activity, performance or achievements expressed or implied by the
forward looking statements. These risks and other factors include those listed
under “Risk Factors” elsewhere in this Annual Report on Form 10-k. In some
cases, you can identify forward looking statements by terminology such as “may”,
“will”, “should”, “expects”, “intends”, “plans”, “anticipates”, “believes”,
“estimates”, “predicts”, “potential”, “continue” or the negative of these terms,
or other comparable terminology. These statements are only predictions. Actual
events or results may differ materially. In evaluating these statements, you
should specifically consider various factors, including the risks outlined under
“Risk Factors.” These factors may cause our actual results to differ materially
from any forward-looking statement.   Although we believe that the
expectations reflected in the forward-looking statements are reasonable, we
cannot guarantee future results, levels of activity, performance or
achievements.




Although
we believe that the expectations reflected in the forward looking statements are
reasonable, we cannot guarantee future results, levels of activity, performance
or achievements. We are under no duty to update any of the forward-looking
statements after the date of this Annual Report on Form 10-K to conform our
prior statements to actual results.




Overview




Avistar
creates technology that provides the missing critical element in unified
communications: bringing people in organizations face-to-face, through enhanced
communications for true collaboration anytime, anyplace. Our latest product,
Avistar C3, draws on over a decade of market experience to deliver a
single-click desktop videoconferencing and collaboration experience that moves
business communications into a new era. Available as a stand-alone solution, or
integrated with existing unified communications software from other vendors,
Avistar C3 users gain an instant messaging-style ability to initiate video
communications across and outside the enterprise. Patented bandwidth management
enables thousands of users to access desktop videoconferencing, Voice over IP,
or VoIP, and streaming media without requiring substantial new network
investment or impairing network performance.  By integrating Avistar
C3 tightly into the way they work, our customers can use our solutions to help
reduce costs and improve productivity and communications within the enterprise
and between enterprises, and to enhance relationships with customers, suppliers
and partners. Using Avistar C3 software and leveraging video, telephony and
Internet networking standards, Avistar solutions are designed to be scalable,
reliable, cost effective, easy to use, and capable of evolving with
communications networks as bandwidth increases and as new standards and
protocols emerge. We currently sell our system directly and indirectly to the
SMB and Enterprise markets comprising the Global 5000. Our objective is to
establish our technology as the standard for networked visual unified
communications and collaboration through direct sales, indirect channel
sales/partnerships and the licensing of our technology to others. We also seek
to license our broad portfolio of patents covering, among other areas, video and
rich media collaboration technologies, networked real-time text and non-text
communications and desktop workstation echo cancellation.




We
operate on a 52-week fiscal year ending December 31. We operate in two
segments. Our products division engages in the design, development, manufacture,
sale and marketing of networked video communications products and associated
support services. Our intellectual property division engages in the prosecution,
maintenance, support and licensing of the intellectual property and technology
that we have developed, some of which is used in our
products.




Since
inception, we have recognized the innovative value of our research and
development efforts, and have invested in securing protection for these
innovations through domestic and foreign patent applications and issuance. As of
December 31, 2007, we held 80 U.S. and foreign patents, which we look to
license to others in the collaboration technology marketplace.




In
September 2007, we announced an intensive set of corporate initiatives aimed at
increasing our product sales, expanding our customer deployments and support,
improving our corporate efficiency and increasing our development
capacity.  The first components of this initiative
included:





34







·
            Implementing
      changes in our management team and centering our sales and marketing
      activities, and associated management functions in our New York City
      office;




·
            Introducing
      a new go-to-market strategy and delivery model for hosting desktop video
      services, a fully managed, turnkey, desktop video solution that provides
      comprehensive video communications and data-sharing capabilities without
      the need for companies to install and maintain on-site video
      infrastructure;




·
            Supplementing
      our position in the financial services vertical by expanding our market
      focus to additional verticals with complex business problems, where our
      collaboration products can help global organizations speed business
      processes, save costs and reduce their carbon
  footprints;




·
            Implementing
      aggressive cost control measures including a reduction in our employees
      from an average of 88 in  2007 to approximately 55 in the three
      months ended March 31, 2008; and




·
            Pursuing
      multiple distribution, services and technology
  partners.




These and
other changes in our business are aimed at reducing our structural costs,
increasing our organizational and partner-driven capacity, leveraging our
reputation for innovation and intellectual property leadership, and growing and
expanding our business.  However, these organizational changes and
initiatives involve transitional costs and expenses and result in uncertainty in
terms of their implementation and their impact on our business and there can be
no assurance that these initiatives will achieve our intended
objectives.




On
February 25, 2008 we announced that Microsoft Corporation had filed requests for
re-examination of 24 of our 29 U.S. patents. Subsequently, Microsoft also filed
requests for re-examination of the remaining 5 U.S. patents.  The
USPTO has approximately two months to decide whether to grant the requests and
engage in a formal re-examination. Patent re-examination, if undertaken by the
USPTO, could take between six months and two years.  We believe that
our U.S. patents are valid and we intend to defend our patents through any
re-examination process.  However, the re-examination of patents by the
USPTO is a lengthy, time consuming and expensive process in which the ultimate
outcome is uncertain.   If the USPTO elects to re-examine some or
all of our U.S. patents, we will be required to spend substantial time and
resources defending our patents, including the fees and expenses of our legal
advisors.  Accordingly, we do not expect to recognize significant new
licensing revenue or income from settlement and licensing activities during the
re-examination process.  The re-examination of some or all of our U.S.
patents, if granted by the USPTO, may adversely impact our licensing
negotiations in process, our financial condition, and results of operations and
may require us to seek additional financing to fund our operations and defense
of our patents.




Critical
      Accounting Policies




The
preparation of our Consolidated Financial Statements in accordance with
accounting principles generally accepted in the United States requires us to
make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. We base our estimates on historical experience and assumptions
that we believe to be reasonable under the circumstances, the results of which
form the basis for making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources. Actual results may
differ from these estimates.




We
believe the following critical accounting policies, among others, affect our
more significant judgments and estimates used in the preparation of our
Consolidated Financial Statements:




·
            Revenue
      recognition;




·
            Income
      from settlement and patent
licensing;




·
            Stock
      based compensation;




·
            Valuation
      of accounts receivable; and




·
            Valuation
      of inventories.




Revenue
Recognition







35





We derive
product revenue from the sale and licensing of our video-enabled networked
communications system, consisting of a suite of Avistar-designed software and
hardware products, including third party components. We also derive revenue from
fees for installation, maintenance, support, training services and software
development. In addition, we derive revenue from the licensing of our
intellectual property portfolio. Product revenue as a percentage of total
revenue was 29%, 34% and 49% for 2007, 2006 and 2005, respectively.




We
recognize product and services revenue in accordance with Statement of Position
(SOP)  97-2, Software
Revenue Recognition(SOP 97-2), as amended by SOP 98-9,
Modification of SOP 97-2, Software Revenue Recognition, With
Respect to Certain Transactions(SOP 98-9). We derive product
revenue from the sale and licensing of a set of desktop (endpoint) products
(hardware and software) and infrastructure products (hardware and software) that
combine to form an Avistar video-enabled collaboration solution. Services
revenue includes revenue from installation services, post-contract customer
support, training, out of pocket expenses, freight and software development. The
installation services that we offer to customers relate to the physical set-up
and configuration of desktop and infrastructure components of our solution. The
fair value of all product, installation services, post-contract customer support
and training offered to customers is determined based on the price charged when
such products or services are sold separately.




Arrangements
that include multiple product and service elements may include software and
hardware products, as well as installation services, post-contract customer
support and training. Pursuant to SOP 97-2, we recognize revenue when all
of the following criteria are met: (i) persuasive evidence of an
arrangement exists, (ii) delivery has occurred, (iii) the fee is fixed
or determinable, and (iv) collectibility is probable. We apply these
criteria as discussed below:




·
            Persuasive evidence of an
      arrangement exists. We require a written contract, signed by both
      the customer and us, or a purchase order from those customers that have
      previously negotiated a standard end-user license arrangement or volume
      purchase agreement with us prior to recognizing revenue on an
      arrangement.




·
            Delivery has occurred.
      We deliver software and hardware to our customers physically. Our standard
      delivery terms are FOB shipping
point.




·
            The fee is fixed or
      determinable. Our determination that an arrangement fee is fixed or
      determinable depends principally on the arrangement’s payment terms. Our
      standard terms generally require payment within 30 to 90 days of the date
      of invoice. Where these terms apply, we regard the fee as fixed or
      determinable, and we recognize revenue upon delivery (assuming other
      revenue recognition criteria are met). If the payment terms do not meet
      this standard, but rather involve “extended payment terms,” we may not
      consider the fee to be fixed or determinable and would then recognize
      revenue when customer installments are due and
  payable.




·
            Collectibility is
      probable. To recognize revenue, we must judge collectibility of the
      arrangement fees, which we do on a customer-by-customer basis pursuant to
      our credit review policy. We typically sell to customers with which we
      have had a history of successful collections. For new customers, we
      evaluate the customer’s financial position and ability to pay. If we
      determine that collectibility is not probable based upon our credit review
      process or the customer’s payment history, we recognize revenue when cash
      is collected.




If there
are any undelivered elements, we defer revenue for those elements, as long as
Vendor Specific Objective Evidence (VSOE) exists for the undelivered elements.
Additionally, when we provide installation services, the product and
installation revenue is recognized upon completion of the installation process
and receipt of customer confirmation, subject to the satisfaction of the revenue
recognition criteria described above. We believe that the fee associated with
the delivered product elements does not meet the collectibility criteria if the
installation services have not been completed. Customer confirmation is obtained
and documented by means of a standard form indicating the installation services
were provided and the hardware and software components were installed. When the
customer or a third party provides installation services, the product revenue is
recognized upon shipment, subject to satisfaction of the revenue recognition
criteria described above.




Payment
for product is due upon shipment, subject to specific payment terms. Payment for
installation and professional services is due upon providing the services,
subject to specific payment terms. Reimbursements received for out of pocket
expenses and shipping costs incurred during installation and support services
have not been significant to date. These expenses are recognized as revenue in
accordance with Emerging Issues Task Force (EITF) Issue No. 01-14, Income Statement Characterization of
Reimbursements Received for “Out of Pocket” Expenses
Incurred.







36





The price
charged for maintenance and/or support is defined in the product sale contract,
and is based on a fixed price for both hardware and software components as
stipulated in the customer agreement. Customers have the option to renew the
maintenance and/or support services in subsequent periods at the same or similar
rate as paid in the initial year subject to contractual adjustments for
inflation in some cases. Revenue from maintenance and support is recognized
pro-rata over the maintenance and/or support term, which is typically one year
in length. Payments for services made in advance of the provision of services
are recorded as deferred revenue and customer deposits in the accompanying
balance sheets. Training services are offered independently of the purchase of
product. The value of these training services is determined based on the price
charged when such services are sold separately. Training revenue is recognized
upon performance of the service.




We
recognize service revenue from software development contracts in accordance with
SOP 81-1, Accounting for
Performance of Construction-Type and Certain Production-Type Contracts.
Revenue related to contracts for software development is recognized using the
percentage of completion method, when all of the following conditions are met: a
contract exists with the customer at a fixed price, we have fulfilled all of our
material contractual obligations to the customer for each deliverable of the
contract, verification of completion of the deliverable has been received, and
collection of the receivable is probable. Amounts billed to customers in excess
of revenues recognized to date are deferred and recorded as deferred revenue and
customer deposits in the accompanying balance sheets. Assumptions used for
recording revenue and earnings are adjusted in the period of change to reflect
revisions in contract value and estimated costs to complete the contract. Any
anticipated losses on contracts in progress are charged to earnings when
identified.




We also
recognize revenue from the licensing of our intellectual property portfolio,
according to SOP 97-2, based on the terms of the royalty, partnership and
cross-licensing agreements involved. In the event that a license to our
intellectual property is granted after the commencement of litigation between us
and the licensee, the proceeds of such transaction are recognized as licensing
revenue by us only if sufficient historical evidence exists for the
determination of fair value of the licensed patents to support the segregation
of the proceeds between a gain on litigation settlement and patent license
revenues, consistent with FASB CON 6. As of December 31, 2007, these criteria
for recognizing license revenue following the commencement of litigation have
not been met, and proceeds received after commencement of litigation have
therefore been recorded in “income from settlement and patent licensing” in our
statement of operations.




In June
2007, we entered into a Patent License Agreement with Radvision Ltd.  Under
the license agreement, we granted Radvision and its subsidiaries a license in
the field of videoconferencing to all of our patents, patent applications and
patents issuing therefrom with a filing date on or before May 15, 2007. 
Also under the license agreement, Radvision granted to us a license in the field
of videoconferencing to all of Radvision’s patents, patent applications and
patents issuing there from with a filing date on or before May 15, 2007. 
The license agreement includes mutual releases of the parties from claims of
past infringement of the licensed patents.  As partial consideration for
the licenses and releases granted under the agreement, Radvision made a one-time
license payment to us of $4.0 million, which was recognized as licensing revenue
in the three months ended June 30, 2007.




To date,
a significant portion of our revenue has resulted from sales to a limited number
of customers, particularly Deutsche Bank AG and their affiliates and UBS Warburg
LLC and their affiliates. In 2007, these customers and Radvision Ltd. accounted
for $9.0 million, or 75% of our total revenue. In 2006, these customers and Sony
Corporation and its subsidiaries, including SCEI accounted for $10.9 million, or
83% of our total revenue. Deutsche Bank AG and their affiliates and UBS Warburg
LLC and their affiliates accounted for $5.8 million, or 84% of our revenue for
2005. No other customers individually contributed greater than 10% of our total
revenue for 2007 and 2006 or 2005. As of December 31, 2007, three customers
represented 38%, 30% and 10% of gross accounts receivable. We anticipate that
our revenue, and therefore, our operating results for any given period, will
continue to depend to a significant extent on a limited number of customers. As
a result, the loss of or a reduction in sales to any one of these customers
would have a significant adverse impact on our operations and financial
performance.




International
revenue, which consists of sales to customers with operations principally in
Western Europe and Asia, comprised 72% of total revenue for 2007, 75% for 2006
and 63% for 2005.




Income
from Settlement and Patent Licensing




We
recognize the proceeds from settlement and patent licensing agreements based on
the terms involved. When litigation has been filed prior to a settlement and
patent licensing agreement, and insufficient historical evidence exists for
the







37


determination
of fair value of the patents licensed to support the segregation of the proceeds
between a gain on litigation settlement and patent license revenues, we report
all proceeds in “income from settlement and patent licensing” within operating
costs and expenses. The gain portion of the proceeds, when sufficient historical
evidence exists to segregate the proceeds, would be reported in other income
according to Statement of Financial Accounting Standards (SFAS) No. 5,
Accounting for
Contingencies . To date, all proceeds from settlement and patent
licensing agreements entered into following the commencement of litigation have
been reported as income from settlement and patent licensing. When a patent
license agreement is entered into prior to the commencement of litigation, we
report the proceeds of such transaction as licensing revenue in the period in
which such proceeds are received, subject to the revenue recognition criteria
described above.




On
February 15, 2007, we entered into a Patent License Agreement with Tandberg ASA,
Tandberg Telecom AS and Tandberg, Inc.  Under this agreement, we dismissed
our infringement suit against Tandberg, Tandberg dismissed its infringement suit
against us, and we cross-licensed each other’s patent portfolios.  The
agreement resulted in a payment of $12.0 million to us from Tandberg. We recognized the
gross proceeds of $12.0 million from the patent license agreement as income from
settlement and patent licensing within operations in the three months ended
March 31, 2007.  To recognize the proceeds as revenue, we would have
required sufficient history of transactions to allow us to isolate the aspect of
the settlement attributable to the gain associated with the process of
litigation, separate from commercial compensation for the use of our
intellectual property.  Sufficient evidence was not available to allow this
distinction.   The Patent License Agreement with Tandberg includes a
ten year capture period, extending from the date of the agreement, during which
patents filed with a priority date within the capture period would be licensed
in addition to existing patents on the agreement date.  However, such
additional patents would be licensed under the agreement solely for purposes of
the manufacture, sale, license or other transfer of existing products of
Tandberg and products that are closely related enhancements of such products
based primarily and substantially on the existing products.  We reviewed
the existing products of Tandberg and considered the likelihood that future
patent filings by us would relate to or otherwise affect existing Tandberg
products and closely related enhancements thereto.  We concluded that the
filing for such additional patents was unlikely, and therefore concluded that
the ten year capture period was not material from an accounting perspective
related to recognition.




Stock
      Based Compensation




We
account for stock based compensation to employees according to the SFAS
No. 123 (R), Share-Based
Payment (SFAS No. 123R), which is a very complex accounting
standard, the application of which requires significant judgment and the use of
estimates, particularly surrounding Black-Scholes-Merton assumptions such as
stock price volatility and expected option terms, as well as expected option
forfeiture rates. There is little experience or guidance with respect to
developing these assumptions and models. SFAS No. 123R requires the recognition
of the fair value of stock compensation in net income (loss). Refer to Note 2 —
Stock-Based Compensation in the Notes to our Consolidated Financial Statements
included elsewhere in this Annual Report of Form 10-K for more
information.




Valuation
      of Accounts Receivable




Estimates
are used in determining our allowance for doubtful accounts and are based on our
historical collection experience, historical write-offs, current trends, and the
credit quality of our customer base and the characteristics of our accounts
receivable by aging category. If the allowance for doubtful accounts were to be
understated, our operating income could be significantly reduced. The impact of
any such change or deviation may be increased by our reliance on a relatively
small number of customers for a large portion of our total revenue. As of
December 31, 2007, three customers represented 38%, 30% and 10% of our
gross accounts receivable balance. As of December 31, 2006, three customers
represented 44%, 20% and 20% of our gross accounts receivable
balance.




Valuation
      of Inventories




We record
a provision for obsolete or excess inventory for systems and components that are
no longer manufactured, or are at risk of being replaced with new versions of
our product. In determining the allowance for obsolete or excess inventory, we
look at our forecasted demand versus quantities on hand and commitments. Any
significant unanticipated changes in demand or technological developments could
have a significant impact on the value of our inventory and commitments and our
reported results. If actual market conditions are less favorable than those
projected, additional inventory write-downs, provision for purchase commitments
and charges against earnings may be required, which would negatively affect our
operating results for such period.







38


Results of Operations




The
following table sets forth data expressed as a percentage of total revenue for
the periods indicated.




Percentage of Total RevenueYear Ended December 31,2007
            
            2006
            
            2005Revenue:Product
            
            
            29
            %
            
            
            34
            %
            
            
            49
            %Licensing
            
            
            42
            
            
            
            39
            
            
            
            —Services,
      maintenance and support
            
            
            29
            
            
            
            27
            
            
            
            51Total
      revenue
            
            
            100
            
            
            
            100
            
            
            
            100Costs
      and expenses:Cost
      of product revenues
            
            
            22
            
            
            
            24
            
            
            
            28Cost
      of services, maintenance and support revenues
            
            
            19
            
            
            
            14
            
            
            
            32Income
      from settlement and patent licensing
            
            
            (136
            )
            
            
            (32
            )
            
            
            (61
            )Research
      and development
            
            
            64
            
            
            
            44
            
            
            
            51Sales
      and marketing
            
            
            52
            
            
            
            41
            
            
            
            49General
      and administrative
            
            
            104
            
            
            
            73
            
            
            
            82Total
      costs and expenses
            
            
            125
            
            
            
            164
            
            
            
            181Loss
      from operations
            
            
            (25
            )
            
            
            (64
            )
            
            
            (81
            )Other
      income (expense):Interest
      income
            
            
            3
            
            
            
            2
            
            
            
            8Other
      (expense) income, net
            
            
            (2
            )
            
            
            —
            
            
            
            (2
            )Total
      other income, net
            
            
            1
            
            
            
            2
            
            
            
            6Loss
      before provision for (recovery from) income taxes
            
            
            (24
            )
            
            
            (62
            )
            
            
            (75
            )Provision
      for (recovery from) income taxes
            
            
            —
            
            
            
            —
            
            
            
            —Net
      loss
            
            
            (24
            )%
            
            
            (62
            )%
            
            
            (75
            )%








39





COMPARISON
      OF 2007 AND 2006




Revenue




Total
revenue decreased by 10% in 2007 to $12.0 million from $13.2 million for 2006.
The decrease in total revenue in 2007 relative to 2006 was primarily due to
decreased product sales.  Product revenue decreased by $1.1 million,
or 24%, to $3.5 million in 2007 from $4.5 million in 2006, due primarily to
reduced sales to our existing customer base. Licensing revenues decreased by
$139,000, or 3% to $5.0 million from $5.2 million in 2006.  Services,
maintenance and support revenue totaled $3.5 million in 2007 and 2006. In 2007,
three customers accounted for 75% of our revenue as compared to 2006 when three
customers accounted for 83% of our revenue. The level of sales to any customer
may vary from quarter to quarter and year to year. We anticipate that our
revenue will continue to depend on a limited number of major customers for the
foreseeable future; although the companies considered to be major customers and
the percentage of revenue represented by each major customer may vary from
period to period. The loss of any one of those customers would have a material
adverse impact on our financial condition and operating results.




Cost
      of Revenue




Total
cost of revenue decreased by $78,000, or 2%, in 2007 to $4.9 million from $5.0
million for 2006. The decrease in total cost of revenue in 2007 relative to 2006
was due to declines in product sales, offset by an increase in personnel salary
and benefits. We expect cost of revenue to vary in the future based on the
future mix of product revenues between hardware and software and the mix of
services revenues.




Income
      from Settlement and Patent
Licensing




Income
from settlement and patent licensing increased by  284% in 2007 to
$16.2 million from $4.2 million for 2006, reflecting a $12.0 million settlement
and patent licensing agreement with Tandberg in the three months ended March 31,
2007 and the $4.2 million recognition of the full year amortization of
income in 2007 and 2006 associated with the Polycom, Inc. settlement
and patent cross-license agreement.




Operating
      Expenses




Research and
development.Research and development
expenses increased by 33% in 2007 to $7.7 million from $5.8 million in 2006. The
increase in research and development expenses in 2007 relative to 2006 was due
to the hiring of new employees focused on new product development projects in
2007, the use of external labor to augment our internal development
capabilities, and an increase in stock-based compensation of $261,000. Research
and development projects associated with customer funded development are
expensed to cost of sales in the period in which they are incurred. Research and
development expenses in 2008 are expected to decrease due to a reduction of
engineering employees at the end of the year located at our headquarters in
San Mateo, California, offset by the use of third party development
organizations located primarily in China.




Sales and
marketing.Sales
and marketing expenses increased by 13% in 2007 to $6.2 million from $5.5
million in 2006. The increase in sales and marketing expenses in 2007 relative
to 2006 was due to the hiring of additional sales and marketing personnel and an
increase in stock-based compensation of $117,000.




General and
administrative.General and administrative
expenses increased by 29% in 2007 to $12.5 million from $9.7 million in 2006.
The increase in general and administrative expenses in 2007 relative to 2006 was
due primarily to the contingent legal fees associated with the litigation with
Tandberg of $4.3 million. The litigation concluded in a patent license agreement
on February 15, 2007, resulting in a decrease in 2007 of $3.5 million in
ongoing litigation expenses due to the cessation of the litigation against
Tandberg.  This decrease was offset by an increase in 2007 of $1.1
million of patent prosecution fees due to increased activity related to patent
applications on file with the USPTO. There was also an increase in 2007 of $0.3
million in salaries and recruiting fees associated with the hiring of Simon
Moss, President Products Division, and an increase of $244,000 in stock-based
compensation. General and administrative expenses in 2008 are expected to
decrease due to decreased litigation activity.




Interest income.Interest income increased by
$47,000, or 16%, in 2007 to $346,000 from $299,000 in 2006. The increase in
interest income in 2007 relative to 2006 was due primarily to the effect of
increased interest income from higher average cash and cash equivalents and
short-term investment balances in 2007, offset by lower interest rates earned on
those balances in 2007 compared to 2006.







40







Other expense, net.Other expense, net increased
by $186,000 in 2007 to an expense of $188,000 from an expense of $2,000 in 2006.
The increase in other expense, net in 2007 relative to 2006 was due to interest
expense on higher average outstanding balances on our line of credit during
2007, as compared to 2006.




Provision for (recovery from) income
taxes.Provision for (recovery from) income taxes increased to a $23,000
expense in 2007 due to foreign tax expense, from a recovery of $31,000 in 2006,
which was partially due to the recovery of $53,000 in 2006 of tax overpayments
made in 2004.




COMPARISON
      OF 2006 AND 2005




Revenue




Total
revenue increased by 91% in 2006 to $13.2 million from $6.9 million for 2005.
The increase in total revenue in 2006 relative to 2005 was primarily due to the
licensing revenue of $5.2 million from Sony Corporation and SCEI and others,
compared to no license revenue in 2005. The proceeds of our intellectual
property licensing efforts tend to be sporadic and difficult to predict, which
is expected to continue to contribute to the volatility of our financial
condition and operating results. Product revenue increased by $1.1 million, or
33%, to $4.5 million in 2006 from $3.4 million in 2005, due primarily to
additional sales to our existing customer base. Services, maintenance and
support revenue totaled $3.5 million in 2006 and 2005. In 2006, three customers
accounted for 83% of our revenue, as compared to 2005 when two customers
accounted for 84% of our revenue. The level of sales to any customer may vary
from quarter to quarter and year to year. We anticipate that our revenue will
continue to depend on a limited number of major customers for the foreseeable
future, although the companies considered to be major customers and the
percentage of revenue represented by each major customer may vary from period to
period. The loss of any one of those customers would have a material adverse
impact on our financial condition and operating results.




Cost
      of Revenue




Total
cost of revenue increased by 22% in 2006 to $5.0 million from $4.1 million for
2005. The increase in total cost of revenue in 2006 relative to 2005 was
attributable to increased personnel utilized to support our maintenance and
services offerings, and additional product costs related to increased product
sales. We expect cost of revenue to vary in the future based on the mix of
product revenues between hardware and software and the mix of services
revenues.




Income
      from Settlement and Patent
Licensing




Income
from settlement and patent licensing was $4.2 million in 2006 and 2005,
reflecting a full year of amortization of income associated with the
Polycom, Inc. settlement and patent cross-license agreement.




Operating
      Expenses




Research and
development.Research and development
expenses increased by 62% in 2006 to $5.8 million from $3.5 million in 2005. The
increase in research and development expenses in 2006 relative to 2005 was due
to the hiring of new employees focused on new product development projects in
2006, the use of external labor to augment our internal development
capabilities, and stock-based compensation of $618,000. There was no stock-based
compensation recorded in 2005. Research and development projects associated with
customer funded development are expensed to cost of sales in the period in which
they are incurred.




Sales and marketing.Sales and marketing expenses
increased by 62% in 2006 to $5.5 million from $3.4 million in 2005. The increase
in sales and marketing expenses in 2006 relative to 2005 was due to the hiring
of additional sales and marketing personnel and stock-based compensation of
$497,000. There was no stock-based compensation recorded in 2005.




General and
administrative.General and administrative
expenses increased by 70% in 2006 to $9.7 million from $5.7 million in 2005. The
increase in general and administrative expenses in 2006 relative to 2005 was due
primarily to an increase in legal fees associated with the litigation with
Tandberg, which concluded in a patent license agreement on February 15,
2007, and stock-based compensation of $764,000 compared to $100,000 in
2005.







41





Other income, net.Other income, net
decreased by 33% in 2006 to $297,000 from $443,000 in 2005. The decrease in
other income, net in 2006 relative to 2005 was due primarily to the effect of
reduced interest payments on lower levels of deposited cash, cash equivalents,
and short and long term investments in 2006, offset by higher short-term
interest rates.




Provision for (recovery from) income
taxes.Provision for (recovery from) income taxes reflected a $31,000
recovery in 2006, as compared to an expense of $22,000 in 2005 due to the
recovery of $53,000 in 2006 for tax overpayments made in 2004, offset by foreign
tax expenses of $22,000 in 2006.




Liquidity
      and Capital Resources




We have
funded our operations since inception primarily from product, services and
licensing revenue, the net proceeds of $31.3 million from our August 2000
initial public offering of common stock, lines of credit with related parties
and financial institutions, the proceeds of approximately $5.7 million and $3.6
million from the private sale of our common stock in October 2003 and
March 2004, respectively, the gross proceeds of $39.5 million from the
settlement and patent cross-license agreements signed with Polycom, Inc. in
2004 and Tandberg ASA, Tandberg AS and Tandberg, Inc. in February
2007.




We had
cash, cash equivalents and short term investments of $4.9 million as of
December 31, 2007 and cash, cash equivalents and short and long-term
investments of $7.9 million as of December 31, 2006. For 2007, we had a net
decrease in cash, cash equivalents and short term investments of $3.0 million
resulting primarily from a net loss from operations of $2.9 million, a $5.5
million decrease in deferred income from settlement and patent licensing and
other, purchases of property and equipment of $1.0 million and a $812,000
decrease in accrued and other liabilities, partially offset by a decrease of
$1.3 million in deferred settlement and patent licensing costs, a $2.1 million
draw on our line of credit, and $3.2 million in non-cash stock-based
compensation and depreciation.




We had
cash and cash equivalents of $4.1 million as of December 31, 2007 and $7.9
million as of December 31, 2006. For 2007, we had a net cash outflow of
$3.8 million resulting primarily from net cash outflows from operations of $4.5
million, net cash outflows from investing activities of $1.8 million and net
cash inflows from financing activities of $2.5 million. The net cash outflows
from operations were primarily due to a net loss of $2.9 million, a decrease in
deferred income from settlement and patent licensing and other of $5.5 million,
and a decrease in accrued liabilities and other of $812,000, partially offset by
non-cash expenses of $3.2 million of stock-based compensation and depreciation
and  a decrease in deferred settlement and patenting licensing costs
of $1.3 million. The net cash outflows from investing were due to the purchase
of $1.0 million of property and equipment and the purchase of $799,000 in
short-term investments. The net cash inflows from financing activities were due
to $2.1 million drawn on our line of credit, and $372,000 from the net issuance
of common stock through our employee stock purchase plan and stock option
plans.




We had
cash and cash equivalents of $7.9 million as of December 31, 2006 and $8.2
million as of December 31, 2005. For 2006, we had a net cash outflow of
$362,000 resulting primarily from net cash outflows from operations of $7.3
million, net cash inflows from investing activities of $3.7 million and net cash
inflows from financing activities of $3.3 million. The net cash outflows from
operations were primarily due to a net loss of $8.1 million, a decrease in
deferred income from settlement and patent licensing and other of $5.5 million,
partially offset by non-cash expenses of $2.4 million associated with the
expensing of stock-based compensation and depreciation, a decrease in deferred
settlement and patenting licensing costs of $1.3 million, an increase in
deferred services revenue and customer deposits of $1.3 million, and an increase
in account payable, accrued liabilities and other of $1.3 million. The net cash
inflows from investing were due to $4.0 million in short and long-term
investments that matured in 2006, offset by the purchase of $290,000 of property
and equipment. The net cash inflows from financing activities were due to $3.0
million drawn on our line of credit, and $312,000 from the issuance of common
stock through our employee stock purchase plan and stock option
plans.




For 2005,
we had a net cash outflow of $13.4 million resulting primarily from net cash
outflows from operations of $9.5 million and net cash outflows from investing
activities of $4.4 million. The net cash outflows from operations were primarily
due to a net loss of $5.2 million, a decrease in deferred income from settlement
and patent licensing of $5.4 million and an increase in accounts receivable of
$641,000, partially offset by a decrease in deferred costs from settlement and
patenting licensing of $1.3 million and non cash expenses of $472,000. The net
cash outflows from investing were due to $4.0 million in purchases of short and
long-term investments and the purchase of $392,000 of property and equipment.
The net cash inflows from financing activities were due to $414,000 in proceeds
from the issuance of common stock.







42





Expenditures
for property and equipment in 2007 were approximately $979,000. At
December 31, 2007, we did not have any material commitments for future
capital expenditures. We anticipate spending approximately $0.5 million in
capital expenditures during the next 12 months.




The
following table summarizes our known contractual obligations and commitments as
of December 31, 2007 (in thousands) for the periods presented.




Payments due by periodTotal
              
              
              Less than 1
                Year
              
              
              1
      – 3
                Years
              
              
              3
      – 5
                Years
              
              
              More than
                5 YearsContractual
      ObligationsOperating
      Lease Obligations
              
              $
              6,226
              
              
              $
              1,250
              
              
              $
              2,138
              
              
              $
              1,520
              
              
              $
              1,318Purchase
      Obligations
              
              
              755
              
              
              
              505
              
              
              
              250
              
              
              
              —
              
              
              
              —Total
              
              $
              6,981
              
              
              $
              1,755
              
              
              $
              2,388
              
              
              $
              1,520
              
              
              $
              1,318




On
November 12, 2004, we entered into a settlement and patent cross-license
agreement with Polycom, Inc. Under this agreement, we agreed to dismiss,
with prejudice, our infringement suit against Polycom, Inc. and both
companies agreed to cross-license each other’s patent portfolios. The agreement
resulted in a payment, net of legal fees, to us from Polycom, Inc. in the
amount of $21.1 million.




In
July 2006, we entered into a Patent License Agreement with Sony Corporation
and SCEI. Under the license agreement, we granted Sony Corporation and its
subsidiaries, including SCEI a license to all of our patents with a filing date
on or before January 1, 2006 for a specific field of use relating to video
conferencing. As consideration for the licenses granted under the agreement,
Sony Corporation and SCEI agreed to make an upfront license payment of
$5.0 million and agreed to make future royalty payments relating to the
sale, in certain countries, of certain SCEI products.




In
February 2007, we entered into a patent license agreement with Tandberg ASA,
Tandberg AS and Tandberg, Inc. Under this agreement we agreed to dismiss,
with prejudice, our infringement suit against Tandberg and both companies agreed
to cross-license each other’s patent portfolios. The agreement resulted in a
payment to us from Tandberg in the amount of $12.0 million, $4.3 million of
which was used by us to pay contingent legal fees associated with the Tandberg
litigation.




In
June 2007, we entered into a Patent License Agreement with Radvision Ltd.
Under the license agreement, we granted a license to all of our patents and
certain patent applications for a specific field of use relating to video
conferencing. As consideration for the licenses granted under the agreement,
Radvision Ltd. agreed to make an upfront license payment to us of
$4.0 million.




On
December 23, 2006, we entered into a Revolving Credit and Promissory Note
and a Security Agreement with a financial institution to borrow up to $10.0
million under a revolving line of credit. The agreement includes a first
priority security interest in all of our assets. Gerald Burnett, our Chairman
and Chief Executive Officer, provided a collateralized guarantee to the
financial institution, assuring payment of our obligations under the agreement
and as a consequence, there are no restrictive covenants, allowing us greater
access to the full amount of the facility. The line of credit requires monthly
interest-only payments based on LIBOR plus 0.75%, or 6.0% at December 31,
2007 or Prime Rate minus 2.0%, or 5.3% at December 31, 2007. On
December 28, 2006, we borrowed $3.0 million under the revolving line of
credit. In December 2007, we borrowed an additional $2.1 million. The Revolving
Credit and Promissory Note was renewed without significant modification in
December 2007. It expires on December 23, 2008, and is subject to annual
renewal. The outstanding balance of $5.1 million on December 31, 2007 was paid
in full in January 2008.




On
January 4, 2008, we issued $7,000,000 of 4.5% Convertible Subordinated Secured
Notes, which are due in 2010 (Notes). The Notes were sold pursuant to a
Convertible Note Purchase Agreement to Baldwin Enterprises, Inc., a subsidiary
of Leucadia National Corporation, directors Gerald Burnett, R. Stephen
Heinrichs, William Campbell, and Craig Heimark, officers Simon Moss and Darren
Innes, and WS Investment Company. Our obligations under the Notes are secured by
the grant of a security interest in substantially all  our tangible
and intangible assets pursuant to a Security Agreement among the us and the
purchasers. The Notes have a two year term, will be due on January 4, 2010 and
are convertible prior to maturity.  Interest on the Notes will accrue
at the rate of 4.5% per annum and will be payable semi-annually in arrears
on







43


June 4
and December 4 of each year, commencing on June 4, 2008.  From the one
year anniversary of the issuance of the Notes until maturity, the holders of the
Notes will be entitled to convert the Notes into shares of common stock at an
initial conversion price per share of $0.70.




We
currently believe that existing cash and cash equivalent balances will provide
us with sufficient funds to finance our operations for the next 12 months. We
intend to continue to invest in the development of new products and enhancements
to our existing products. Our future liquidity and capital requirements will
depend upon numerous factors, including without limitation, general economic
conditions and conditions in the financial services industry in particular, the
level and timing of product, services and licensing revenue, the costs and
timing of our product development efforts and the success of these development
efforts, the costs and timing of our sales and marketing activities, the extent
to which our existing and new products gain market acceptance, competing
technological and market developments, the costs and proceeds involved in
maintaining and enforcing patent claims and other intellectual property rights,
all of which may impact our ability to achieve and maintain profitability. From
time to time, we may be required to raise additional funds through public or
private financing, strategic relationships or other arrangements. There can be
no assurance that such funding, if needed, will be available on terms attractive
to us, or at all. Furthermore, any additional debt or equity financing
arrangements may be dilutive to stockholders, and debt financing, if available,
may involve restrictive covenants. Strategic arrangements, if necessary to raise
additional funds, may require us to relinquish our rights to certain of our
technologies or products. Our failure to raise capital when needed could have a
material adverse effect on our business, operating results and financial
condition.




Recent
      Accounting Pronouncements


In
June 2006, the FASB reached a consensus on Emerging Issues Task Force
(“EITF”) Issue No. 06-3, How
Taxes Collected from Customers and Remitted to Governmental Authorities Should
Be Presented in the Income Statement (That Is, Gross versus Net Presentation)(“EITF 06-03”). EITF 06-3 indicates that the income statement
presentation on either a gross basis or a net basis of the taxes within the
scope of the issue is an accounting policy decision that should be disclosed.
EITF 06-3 is effective for interim and annual periods beginning after
December 15, 2006. The adoption of EITF 06-3 did not change our policy of
presenting taxes within the scope of EITF 06-3 on a net basis and had no impact
on our consolidated financial statements.


In
September 2006, the FASB issued FASB Statement No. 157, Fair Value Measurements
(SFAS No. 157). The standard provides guidance for using fair value to
measure assets and liabilities and responds to investors’ requests for expanded
information about the extent to which companies measure assets and liabilities
at fair value, the information used to measure fair value, and the effect of
fair value measurements on earnings. The standard applies whenever other
standards require or permit assets or liabilities to be measured at fair value.
The standard does not expand the use of fair value in any new circumstances.
SFAS No. 157 must be adopted prospectively as of the beginning of the year
it is initially applied. SFAS 157 is effective for financial statements
issued for fiscal years beginning after November 15, 2007, and interim
periods within those fiscal years. We are evaluating the impact this standard
will have on our financial position and results of operations.




In
February 2007, the FASB issued Statement No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities, including an amendment of FASB Statement
No. 115 (SFAS No. 159) , The standard allows an entity the
irrevocable option to elect fair value for the initial and subsequent
measurement for certain financial assets and liabilities under an
instrument-by-instrument election. Subsequent measurements for the financial
assets and liabilities an entity elects to fair value will be recognized in
earnings. SFAS No. 159 also establishes additional disclosure requirements. SFAS
No. 159 is effective for fiscal years beginning after November 15,
2007.  We are evaluating the impact this standard will have on our
financial position and results of operations.




In
December 2007, the FASB issued SFAS No. 141(Revised), Business Combinations, or
SFAS No. 141(R), which replaces SFAS No. 141, Business Combinations, and
requires an acquirer to recognize the assets acquired, the liabilities assumed,
and any noncontrolling interest in the acquiree at the acquisition date,
measured at their fair values as of that date, with limited exceptions. This
statement also requires the acquirer in a business combination achieved in
stages to recognize the identifiable assets and liabilities, as well as the
noncontrolling interest in the acquiree, at the full amounts of their fair
values. SFAS No. 141(R) makes various other amendments to authoritative
literature intended to provide additional guidance or to confirm the guidance in
that literature to that provided in this statement. This statement applies
prospectively to business combinations for which the acquisition date is on or
after the beginning of the first annual reporting period beginning on or after
December 15, 2008.  We expect to adopt this statement on January 1,
2009.  SFAS No. 141(R)’s impact on accounting for business
combinations is dependent upon acquisition activity on or after its effective
date.




In
December 2007, FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial
Statements, which amends Accounting Research Bulletin No. 51, Consolidated Financial
Statements, to improve the relevance, comparability, and transparency of
the financial information that a reporting entity provides in its consolidated
financial statements. SFAS No. 160 establishes accounting and reporting
standards that require the ownership interests in subsidiaries not held by
the







44


parent
to be clearly identified, labeled and presented in the consolidated statement of
financial position within equity, but separate from the parent’s equity. This
statement also requires the amount of consolidated net income attributable to
the parent and to the noncontrolling interest to be clearly identified and
presented on the face of the consolidated statement of income. Changes in a
parent’s ownership interest while the parent retains its controlling financial
interest must be accounted for consistently, and when a subsidiary is
de-consolidated, any retained non-controlling equity investment in the former
subsidiary must be initially measured at fair value. The gain or loss on the
de-consolidation of the subsidiary is measured using the fair value of any
non-controlling equity investment. The statement also requires entities to
provide sufficient disclosures that clearly identify and distinguish between the
interests of the parent and the interests of the non-controlling owners. This
statement applies prospectively to all entities that prepare consolidated
financial statements and applies prospectively for fiscal years, and interim
periods within those fiscal years, beginning on or after December 15, 2008. We
are currently evaluating the effect, if any, of this statement on our financial
condition and results of operations.




Item 7a. Quantitative and Qualitative
      Disclosures About Market
Risk




We
develop products primarily in the United States, and sell those products
primarily in North America, Europe and Asia. International revenue, which
consists of sales to customers with operations principally in Western Europe and
Asia, comprised 72%, 75% and 63% of total revenue for the years ended 2007, 2006
and 2005, respectively. As a result, our financial condition could be affected
by factors such as changes in foreign currency exchange rates or weak economic
conditions in foreign markets. As all of our sales are currently made in United
States dollars, a strengthening of the United States dollar could make our
products less competitive in foreign markets. We do not use derivative financial
instruments for speculative or trading purposes, nor do we engage in any foreign
currency hedging transactions.




Our
interest income is sensitive to changes in the general level of United States
interest rates, particularly since the majority of our cash equivalents are
invested in money market funds or securities.




Cash and Cash Equivalents and
Short and Long-Term Investments




Cash
equivalents consist primarily of securities and money market funds acquired with
remaining maturity periods of three months or less, and are stated at cost, plus
accrued interest that approximates market value. We would not expect our
operating results or cash flow to be significantly impacted by the effect of
sudden changes in market interest rates given the nature of our short-term
investments.




The
following table provides information about our investment portfolio. For
investment securities, the table presents cash, cash equivalents and short-term
investments and related weighted average interest rates by category at
December 31, 2007.




Amounts
            
            Weighted Average
              Interest Rate(in thousands)DescriptionCash,
      cash equivalents and short-term investments:Cash
            
            $
            740
            
            
            
            —Cash
      equivalent money market funds
            
            
            47
            
            
            
            4.79
            %Cash
      equivalent commercial paper (average 27 remaining days to
      maturity)
            
            
            3,290
            
            
            
            4.25
            %Total
      cash and cash equivalents
            
            
            4,077Short-term
      investments
            
            
            799
            
            
            
            5.16
            %Total
      cash, cash equivalents and short-term investments at December 31,
      2007
            
            $
            4,876







Item 8. FinancialStatements and Supplementary
      Data




Our
consolidated financial statements and Report of Independent Registered Public
Accounting Firm appears on pages F-1 through F-27 of this
Report.




Item 9.Changes in and Disagreements
      with Accountants on Accounting and Financial
    Disclosure





None


45




Item 9a. Controls and
      Procedures




Evaluation
of disclosure controls and procedures




Our
management evaluated, with the participation of our Chief Executive Officer and
Chief Financial Officer, the effectiveness of our disclosure controls and
procedures as of the end of the period covered by this Annual Report on
Form 10-K. Based on this evaluation, our Chief Executive Officer and Chief
Financial Officer have concluded at a reasonable assurance level that our
disclosure controls and procedures (as defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934 (the Exchange Act)) are
effective to provide reasonable assurance that information required to be
disclosed by us in reports that we file or submit under the Exchange Act
(i) is accumulated and communicated to our management, including our Chief
Executive Officer and Chief Financial Officer, as appropriate to allow timely
decisions regarding required disclosure, and (ii) is recorded, processed,
summarized and reported within the time periods specified in Securities and
Exchange Commission rules and forms.




Management’s Report on Internal
Control Over Financial Reporting




Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting, as such term is defined in Exchange Act
Rule 13a-15(f). Under the supervision and with the participation of our
management, including our Chief Executive Officer and Chief Financial Officer,
we conducted an evaluation of the effectiveness of our internal control over
financial reporting as of December 31, 2007 based on the criteria set forth
in Internal Control -
Integrated Frameworkissued by the Committee of Sponsoring Organizations
of the Treadway Commission. Based on our evaluation under the criteria set forth
in Internal Control —
Integrated Framework, our management concluded that our internal control
over financial reporting was effective as of December 31, 2007.




Changes
in Internal Control Over Financial Reporting




There was
no change in our internal control over financial reporting that occurred during
the quarter ended December 31, 2007 that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.




Inherent
Limitations on Effectiveness of Controls




In
designing and evaluating the disclosure controls and procedures, management
recognizes that any controls and procedures, no matter how well designed and
operated, can provide only reasonable assurance of achieving the desired control
objectives. In addition, the design of disclosure controls and procedures must
reflect the fact that there are resource constraints and that management is
required to apply its judgment in evaluating the benefits of possible controls
and procedures relative to their costs.




Attestation
Report of Registered Public Accounting Firm Not Required




This annual report does not include an attestation report of our registered
public accounting firm regarding internal control over financial reporting.
Management's report was not subject to attestation by our registered public
accounting firm pursuant to temporary rules of the Securities and Exchange
Commission that permit us to provide only management's report in this annual
report.




Item 9b. Other
      Information




None







46





PART III




Item 10.Directors, Executive Officers and Corporate Governance




The
information required by this item is incorporated by reference to the sections
captioned “Election of Directors” and “Section 16(a) Beneficial
Ownership Reporting Compliance” contained in our Proxy Statement related to the
2008 Annual Meeting of Stockholders, to be filed with the Securities and
Exchange Commission within 120 days of December 31, 2007, pursuant to
General Instruction G(3) of Form 10-K (the “Proxy Statement”). Certain
information required by this item concerning executive officers is set forth in
Part I of this Report in “Business—Executive Officers,” and certain other
information required by this item is incorporated by reference from the sections
captioned “Principal Stockholders” contained in our Proxy
Statement.




We have
adopted a code of ethics that applies to our principal executive officers and
all members of our finance department, including the principal financial officer
and principal accounting officer. This code of ethics, which also applies to
employees generally, is posted on our Internet website. The Internet address for
our website is http://www.avistar.com, and the code of ethics may be found as
follows:




1.From
      our main Web page, first click on
“Company.”




2.Next,
      click on “Investor Relations.”




3.Next,
      click on “Avistar’s Business Conduct and Ethics
  Policy.”




We intend
to satisfy the disclosure requirement under Item 5.05 of Form 8-K regarding
an amendment to, or waiver from, a provision of this code of ethics by posting
such information on our website, at the address and location specified
above.




Item 11.  Executive
      Compensation




The
information required by this item is incorporated by reference to the section
captioned “Executive Compensation and Other Matters” contained in our Proxy
Statement.




Item
      12.Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters




The
information required by this item is incorporated by reference to the sections
captioned “Principal Stockholders”, “Executive Compensation and Other Matters”
and “Certain Transactions” contained in our Proxy Statement.




Equity
Compensation Plan Information




The
following table provides information as of December 31, 2007 with respect
to the shares of our Common Stock that may be issued under our existing equity
compensation plans.




A
            
            B
            
            CPlan Category
            
            Number of securities
              to be issued upon
              exercise of outstanding
              options
            
            Weighted-average
              exercise price of
              outstanding options
            
            Number of securities
              remaining available for
              future issuance under
              equity compensation
              plans (excluding
              securities reflected in
              Column A)Equity
      compensation plans approved by security holders
            
            
            10,565,092
            (1)
            
            $
            2.28
            
            
            
            2,635,424
            (2)Equity
      compensation plans not approved by security holders
            
            
            —
            
            
            
            —
            
            
            
            —Total
            
            
            10,565,092
            
            
            $
            2.28
            
            
            
            2,635,424







(1)This
      number reflects the number of shares to be issued upon exercise of
      outstanding options under our 2000 Director Option Plan (“Director Plan”),
      the 1997 Stock Option Plan (the “1997 Plan”) and the 2000 Stock Option
      Plan (the “2000 Option Plan”). This number excludes purchase rights
      accruing under the Employee Stock Purchase Plan (“Purchase Plan”). The
      Purchase Plan authorizes the granting of stock purchase rights to eligible
      employees during six month offering
periods.







47





Shares
      are purchased through employee payroll deductions at purchase prices equal
      to 85% of the lesser of the fair market value of our Common Stock at
      either the first day of each offering period or the date of
      purchase.




(2)Includes
      996,976 shares available for issuance under the 2000 Option Plan, 336,480
      shares available for issuance under the Director Plan and 1,301,968 shares
      available for issuance under the Purchase Plan. No securities are
      available for future issuance under the 1997 Plan. The 2000 Option Plan
      provides for an annual increase in the number of shares of Common Stock
      reserved for issuance thereunder on the first day of our fiscal year in an
      amount equal to the lesser of (x) 1,200,000 shares, (y) 4% of
      the outstanding shares of the Company’s common Stock as of the last day of
      the prior fiscal year or (z) such lesser amount as determined by the
      Board. The Director Plan currently provides for an annual increase to the
      number of shares reserved thereunder on the first day of the Company’s
      fiscal year equal to the lesser of (x) 175,000 shares, (y) 1% of
      the outstanding shares of our Common Stock on such date or (z) such
      amount as determined by the Board. The Purchase Plan provides for an
      annual increase in the number of shares of Common Stock reserved
      thereunder on the first day of our fiscal year in an amount equal to the
      lesser of (x) 900,000 shares, (y) 3% of our outstanding shares
      on the last day of the prior fiscal year or (z) such amount as
      determined by the Board. Under the terms of the Plans, on January 1,
      2007, 1,200,000 and 175,000 shares were added to the 2000 Option Plan and
      the Director Plan, respectively. No shares were added to the Purchase Plan
      on January 1, 2007.




Item
      13.Certain
      Relationships and Related Transactions and Director
      Independence




The
information required by this item is incorporated by reference to the sections
captioned “Proposal One—Election of Directors,” “Compensation Committee
Interlocks and Insider Participation” and “Certain Transactions” contained in
our Proxy Statement.




Item 14.Principal
      Accountant Fees and
Services




The
information required by this section is incorporated by reference from the
information in the section entitled “Ratification of Appointment of Independent
Accountants” in our Proxy Statement.







48


PART IV
  Item 15. Exhibits, Financial Statement
      Schedules
  (a)(1) Financial
Statements
  The
following financial statements are incorporated by reference in Item 8 of this
Annual Report:
  PageReport
      of Independent Registered Public Accounting Firm
                
                
                F-2Consolidated
      Balance Sheets as of December 31, 2007 and 2006
                
                
                F-3Consolidated
      Statements of Operations for the years ended December 31, 2007, 2006
      and 2005
                
                
                F-4Consolidated
      Statements of Stockholders’ Equity (Deficit) for the years ended
      December 31, 2007, 2006 and 2005
                
                
                F-5Consolidated
      Statements of Cash Flows for the years ended December 31, 2007, 2006
      and 2005
                
                
                F-6Notes
      to the Consolidated Financial Statements
                
                
                F-7
 
  (a)(2) Financial Statement
Schedules
  Schedule
      II—Valuation and Qualifying Accounts (see
  page S-1)
  Schedules
not listed above have been omitted because the information required to be set
forth therein is not applicable or is shown in the financial statements or notes
thereto.
  (a)(3) Exhibits
  3.2
                
                Restated
      Certificate of Incorporation(Filed as an
      exhibit to the Company’s Registration Statement on Form S-1 (File No.
      333-39008) as declared effective by the Securities and Exchange Commission
      on August 16, 2000.)3.3
                
                Bylaws
      of Avistar Communications Corporation(Filed
      as an exhibit to the Registrant’s Annual
      Report on Form 10-K for the year ended December 31, 2004 filed with the
      Securities and Exchange Commission on March 28,
    2005.)4.1
                
                Specimen
      Certificate evidencing shares of Common Stock(Filed asan
      exhibit to the Company’s Registration Statement on Form S-1 (File No.
      333-39008) as declared effective by the Securities and Exchange Commission
      on August 16, 2000.)10.1
                
                1997
      Stock Option Plan, as amended*(Filed as an
      exhibit to the Company’s Registration Statement on Form S-1 (File No. 333-39008)
      as declared effective by the Securities and Exchange Commission on August
      16, 2000.)10.1.1
                
                1997
      Stock Option Plan Form of Stock Option Agreement*(Filed as an exhibit to the Company’s
      Registration Statement on Form S-1
      (File No. 333-39008) as declared effective by the Securities and Exchange
      Commission on August 16, 2000.)10.2
                
                2000
      Stock Option Plan, as amended*(Filed as an
      exhibit to the Company’s Registration Statement on Form S-1 (File No.
      333-39008) as declared effective by
      the Securities and Exchange Commission on August 16,
      2000.)10.3
                
                2000
      Director Option Plan, as amended*(Filed as
      an exhibit to the Registrant’s Annual
      Report on Form 10-K for the year ended December 31, 2005 filed with theSecurities and Exchange Commission on
      April 28, 2006.)10.4
                
                Form
      of Director Option Agreement*(Filed as an
      exhibit to the Company’s Registration Statement on Form S-1 (File No.
      333-39008) as declared effective by the Securities and Exchange Commission
      on August 16,
      2000.)10.5
                
                2000
      Employee Stock Purchase Program, as amended*(Filed as an exhibit to the Registrant’s Quarterly
      Report on Form  10-Q for the three months ended September 30,
      2006 filed with the Securities and Exchange Commission on
      November14,
      2006.)
  49


10.6
            
            Form
      of Indemnification Agreement* (Filed as an exhibit to the Company’s
      Registration Statement on Form S-1 (File No. 333-39008) as declared
      effective by the Securities and Exchange Commission on August 16,
      2000.)10.7
            
            Settlement
      Agreement and Release between the Registrant and R. Stephen Heinrichs
      dated April 26, 2001* (Filed as an exhibit to the Registrant’s Current
      Report on Form 8-K filed with the Securities and Exchange Commission on
      May 8, 2001.)10.8
            
            Lease
      Agreement among the Registrant and Crossroads Associates and Clocktower
      Associates dated December 1, 2006 (Filed as an exhibit to the
      Registrant’s Annual Report on Form 10-K for the year ended December 31,
      2006 filed with the Securities and Exchange Commission on March 22,
      2007.)10.9
            
            Common
      Stock Purchase Agreement by and among the Registrant and The Gerald J.
      Burnett and Marjorie J. Burnett Revocable Trust, Grady Burnett and
      Wendolyn Hearn dated October 15, 2003 (Filed as an exhibit to the
      Registrant’s Quarterly Report on Form 10-Q for the three months ended
      September 30, 2003 filed with the Securities and Exchange Commission on
      October 23, 2003.)10.10
            
            Stock
      Purchase Agreement among the Registrant, Fuller & Thaler Behavioral
      Finance Fund, Ltd. and Fuller & Thaler Avalanche Fund, L.P. dated
      March 23, 2004 (Filed as an exhibit to the Registrant’s Quarterly Report
      on Form 10-Q for the quarter ended March 31, 2004 filed with the
      Securities and Exchange Commission on May 11, 2004.)10.11
            
            Settlement
      Agreement among the Registrant, Collaboration Properties, Inc. and
      Polycom, Inc. dated November 12, 2004 (Filed as an exhibit to the
      Registrant’s Annual Report on Form 10-K for the year ended December 31,
      2004 filed with the Securities and Exchange Commission on March 28,
      2005.)10.12†
            
            Patent
      Cross-License Agreement Among the Company, Collaboration Properties, Inc.
      and Polycom, Inc. dated November 12, 2004 (Filed as an exhibit to the
      Registrant’s Annual Report on Form 10-K for the year ended December 31,
      2005 filed with the Securities and Exchange Commission on April 28,
      2006.)10.13†
              
              
              10.14†
            
            Patent
      License Agreement dated May 15, 2006 among the Registrant, Collaboration
      Properties, Inc., Sony Corporation and Sony Computer Entertainment, Inc.
      (Filed as an exhibit to the Registrant’s Quarterly Report on Form 10-Q for
      the three months ended September 30, 2006 filed with the Securities and
      Exchange Commission on November 14, 2006.)
              Patent
      License Agreement dated February 15, 2007 by and among the Registrant,
      Collaboration Properties, Inc., Tandberg ASA, Tandberg Telecom AS, and
      Tandberg, Inc. (Filed on May 14, 2007 as an exhibit to the Registrant’s
      Quarterly Report on Form 10-Q for the quarter ended March 31,
      2007)10.15†
            
            Patent
      License Agreement dated May 15, 2007 by and among the Registrant, Avistar
      Systems (UK) Limited, and Radvision LTD.  (Filed on August 3,
      2007 as an exhibit to the Registrant’s Quarterly Report on Form 10-Q for
      the quarter ended June 30, 2007)10.16
            
            Employment
      Agreement between the Registrant and Simon B. Moss effective July 16,
      2007. * (Filed on November 13, 2007 as an exhibit to the Registrant’s
      Quarterly Report on Form 10-Q for the quarter ended September 30,
      2007)10.17
            
            Amended
      and restated Security Agreement dated December 17, 2007 between the
      Registrant and JPMorganChase Bank, N.A. originally dated December 23,
      2006. (Filed herewith)10.18
            
            Amendment
      dated December 17, 2007 to the Revolving Credit Promissory Note issued by
      the Registrant in favor of JPMorgan originally dated December 23, 2006.
      (Filed herewith)10.19
            
            Second
      amendment dated December 17, 2007 to the Revolving Credit Promissory Note
      issued by the Registrant in favor of JPMorgan originally dated December
      23, 2006. (Filed herewith)10.20
            
            Amendment
      dated December 17, 2007 to the Guaranty issued by Gerald J. Burnett and
      The Gerald J. Burnett and Marjorie J. Burnett Revocable Trust in favor of
      JPMorgan originally dated December 23, 2006. (Filed
    herewith)


50




10.21
              
              Convertible Note Purchase Agreement among the
      Company and the Purchasers named therein dated January 4, 2008 (Filed on January 9,
      2008 as an exhibit to the Registrant’s Current
      Report on Form 8-K)10.22
              
              Security Agreement among the Company, Baldwin
      Enterprises, Inc., as Collateral Agent, and the Purchasers named therein
      dated January4, 2008 (Filed on
      January 9, 2008 as an exhibit to the Registrant’s Current
      Report on Form 8-K)10.23
              
              Form of 4.5% Convertible Subordinated Secured Note
      Due 2010 (Filed on January 9, 2008 as an exhibit to the
      Registrant’s Current Report on Form
    8-K)10.24
              
              Inter-creditor Agreement among the Purchasers of
      the 4.5% Convertible Subordinated Secured Notes Due 2010 dated January 4,
      2008 (Filed on January 9, 2008 as an exhibit to the Registrant’s Current
      Report on Form 8-K)21.1
              
              Subsidiaries
      of the Company23.1
              
              Consent
      of Independent Registered Public Accounting Firm: Burr, Pilger & Mayer
      LLP24.1
              
              Power
      of Attorney (see page 56)31.1
              
              Rule
      13a-14(a)/15d-14(a) Certification by the Chief Executive
      Officer31.2
              
              Rule
      13a-14(a)/15d-14(a) Certification by the Chief Financial
      Officer32
              
              Certification
      by the 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
  *Indicates
      management contract or compensatory plan or arrangement required to be
      filed an exhibit pursuant to Item 14(c) of Form
  10-K.
  †
              Portions
      of the exhibit have been omitted pursuant to a request for confidential
      treatment and the omitted portions have been separately filed with the
      Commission.









51





SIGNATURES




Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, as amended, the Registrant has duly caused this annual report to be
signed on its behalf by the undersigned, thereunto duly authorized.




AVISTAR
      COMMUNICATIONS CORPORATIONBy:
            /s/   Simon
      B. MossSimon
      B. MossChief
      ExecutiveOfficer
      and DirectorDate:
      March 31, 2008







POWER
OF ATTORNEY




KNOW ALL
PERSONS BY THESE PRESENTS, that each person whose signature appears below
constitutes and appoints Simon B. Moss and Robert J. Habig, his true and lawful
attorneys-in-fact and agents, with full power of substitution and
resubstitution, to sign any and all amendments (including post- effective
amendments) to this Annual Report on Form 10-K and to file the same, with
all exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorneys-in-fact and
agents, full power and authority to do and perform each and every act and thing
requisite and necessary to be done in connection therewith, as fully to all
intents and purposes as he or she might or could do in person, hereby ratifying
and confirming all that said attorneys-in-fact and agents, or his substitute or
substitutes, or any of them, shall do or cause to be done by virtue
hereof.




Pursuant
to the requirements of the Securities Exchange Act of 1934, as amended, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated:




Signature
            
            
            
            Title
            
            
            
            Date/s/   Gerald
      J. Burnett
            
            Chairman
            
            March 31,
      2008Gerald
      J. Burnett/s/   Simon
      B. Moss
            
            Chief
      Executive Officer and Director
            
            March 31,
      2008Simon
      B. Moss/s/   Robert
      J. Habig
            
            Chief
      Financial Officer (Principal
            
            March 31,
      2008Robert
      J. Habig
            
            Financial
      and Accounting Officer)/s/   William
      L. Campbell
            
            Director
            
            March 31,
      2008William
      L. Campbell/s/   Craig
      F. Heimark
            
            Director
            
            March 31,
      2008Craig
      F. Heimark/s/   R.
      Stephen Heinrichs
            
            Director
            
            March 31,
      2008R.
      Stephen Heinrichs/s/   Robert
      M. Metcalfe
            
            Director
            
            March 31,
      2008Robert
      M. Metcalfe/s/   James
      W. Zeigon
            
            Director
            
            March 31,
      2008James
      W. Zeigon





52





INDEX
TO FINANCIAL STATEMENTS




PageReport
      of Independent Registered Public Accounting Firm
            
            F-2Consolidated
      Balance Sheets as of December 31, 2007 and 2006
            
            F-3Consolidated
      Statements of Operations for the years ended December 31, 2007, 2006
      and 2005
            
            F-4Consolidated
      Statements of Stockholders’ Equity (Deficit) for the years ended
      December 31, 2007, 2006 and 2005
            
            F-5Consolidated
      Statements of Cash Flows for the years ended December 31, 2007, 2006
      and 2005
            
            F-6Notes
      to the Consolidated Financial Statements
            
            F-7










F-1





Report
of Independent Registered Public Accounting Firm




To the
Board of Directors and Stockholders of




Avistar
Communications Corporation




We have
audited the accompanying consolidated balance sheets of Avistar Communications
Corporation and its subsidiary as of December 31, 2007 and 2006, and the
related consolidated statements of operations, stockholders’ equity (deficit),
and cash flows for each of the three years in the period ended December 31,
2007. Our audits also included the related financial statement schedule listed
in Item 15(a)(2). These consolidated financial statements and financial
statement schedule are the responsibility of the Company’s management. Our
responsibility is to express an opinion on these consolidated financial
statements and financial statement schedule based on our audits.




We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor have we been engaged to perform, an audit of the Company’s internal
control over financial reporting. Our audits included consideration of internal
control over financial reporting as a basis for designing audit procedures that
are appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company’s internal control over financial
reporting. Accordingly, we express no such opinion. An audit includes examining,
on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.




In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Avistar Communications
Corporation and its subsidiary as of December 31, 2007 and 2006, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2007, in conformity with accounting
principles generally accepted in the United States of America. Also, in our
opinion, the related financial statement schedule, when considered in relation
to the consolidated financial statements taken as a whole, presents fairly, in
all material respects, the information set forth therein.




As
discussed in Note 2 to the consolidated financial statements, on January 1, 2006
the Company changed its method of accounting for stock-based compensation as a
result of adopting Statement of Financial Accounting Standards No. 123 (R),
“Share-Based Payment”, applying the modified prospective method.









/s/
      BURR, PILGER & MAYER LLPSan
      Jose, CaliforniaMarch 28,
      2008












F-2





AVISTAR
COMMUNICATIONS CORPORATION AND SUBSIDIARY




CONSOLIDATED
BALANCE SHEETS




as
of December 31, 2007 and 2006




(in
thousands, except share and per share data)




December 31,
              2007
            
            December 31,
              2006Assets:Current
      assets:Cash
      and cash equivalents
            
            $
            4,077
            
            
            $
            7,854Short-term
      investments
            
            
            799
            
            
            
            —Accounts
      receivable, net of allowance for doubtful accounts of $24 and $51 at
      December 31, 2007 and 2006, respectively
            
            
            1,385
            
            
            
            1,409Inventories,
      including inventory shipped to customers’ sites, not yet installed of $0
      and $70 at December 31, 2007 and 2006, respectively
            
            
            428
            
            
            
            712Deferred
      settlement and patent licensing costs
            
            
            1,256
            
            
            
            1,256Prepaid
      expenses and other current assets
            
            
            462
            
            
            
            534Total
      current assets
            
            
            8,407
            
            
            
            11,765Property
      and equipment, net
            
            
            767
            
            
            
            256Long-term
      deferred settlement and patent licensing costs
            
            
            1,117
            
            
            
            2,391Other
      assets
            
            
            286
            
            
            
            287Total
      assets
            
            $
            10,577
            
            
            $
            14,699Liabilities
      and Stockholders’ Equity (Deficit):Current
      liabilities:Line
      of credit
            
            $
            5,100
            
            
            $
            3,000Accounts
      payable
            
            
            1,287
            
            
            
            1,578Deferred
      income from settlement and patent licensing
            
            
            5,520
            
            
            
            5,520Deferred
      services revenue and customer deposits
            
            
            2,231
            
            
            
            1,979Accrued
      liabilities and other
            
            
            1,451
            
            
            
            2,263Total
      current liabilities
            
            
            15,589
            
            
            
            14,340Long-term
      liabilities:Long-term
      deferred income from settlement and patent licensing
            
            
            4,814
            
            
            
            10,308Total
      liabilities
            
            
            20,403
            
            
            
            24,648Commitments
      and contingencies (Notes 4 and 8)Stockholders’
      equity (deficit):Common
      stock, $0.001 par value; 250,000,000 shares authorized at
      December 31, 2007 and 2006; 35,678,807 and 35,219,768 shares issued
      at December 31, 2007 and 2006, respectively
            
            
            36
            
            
            
            35Less:
      treasury common stock, 1,182,875 shares at December 31, 2007 and
      2006, at cost
            
            
            (53
            )
            
            
            (53
            )Additional
      paid-in-capital
            
            
            95,925
            
            
            
            92,865Accumulated
      deficit
            
            
            (105,734
            )
            
            
            (102,796
            )Total
      stockholders’ equity (deficit)
            
            
            (9,826
            )
            
            
            (9,949
            )Total
      liabilities and stockholders’ equity (deficit)
            
            $
            10,577
            
            
            $
            14,699







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





F-3





AVISTAR
COMMUNICATIONS CORPORATION AND SUBSIDIARY




CONSOLIDATED
STATEMENTS OF OPERATIONS




for
the years ended December 31, 2007, 2006 and 2005




(in
thousands, except per share data)




Year Ended December 31,2007
            
            
            2006
            
            
            2005Revenue:Product
            
            $
            3,462
            
            
            $
            4,528
            
            
            $
            3,403Licensing
            
            
            5,016
            
            
            
            5,155
            
            
            
            —Services,
      maintenance and support
            
            
            3,477
            
            
            
            3,542
            
            
            
            3,508Total
      revenue
            
            
            11,955
            
            
            
            13,225
            
            
            
            6,911Costs
      and expenses:Cost
      of product revenues*
            
            
            2,684
            
            
            
            3,185
            
            
            
            1,892Cost
      of services, maintenance and support revenues*
            
            
            2,243
            
            
            
            1,820
            
            
            
            2,220Income
      from settlement and patent licensing
            
            
            (16,226
            )
            
            
            (4,226
            )
            
            
            (4,226
            )Research
      and development*
            
            
            7,670
            
            
            
            5,753
            
            
            
            3,544Sales
      and marketing*
            
            
            6,192
            
            
            
            5,488
            
            
            
            3,379General
      and administrative*
            
            
            12,465
            
            
            
            9,682
            
            
            
            5,697Total
      costs and expenses
            
            
            15,028
            
            
            
            21,702
            
            
            
            12,506Loss
      from operations
            
            
            (3,073
            )
            
            
            (8,477
            )
            
            
            (5,595
            )Other
      income (expense):Interest
      income
            
            
            346
            
            
            
            299
            
            
            
            537Other
      (expense) income, net
            
            
            (188
            )
            
            
            (2
            )
            
            
            (94
            )Total
      other income, net
            
            
            158
            
            
            
            297
            
            
            
            443Loss
      before provision for (recovery from) income taxes
            
            
            (2,915
            )
            
            
            (8,180
            )
            
            
            (5,152
            )Provision
      for (recovery from) income taxes
            
            
            23
            
            
            
            (31
            )
            
            
            22Net
      loss
            
            $
            (2,938
            )
            
            $
            (8,149
            )
            
            $
            (5,174
            )Net
      loss per share—basic and diluted
            
            $
            (0.09
            )
            
            $
            (0.24
            )
            
            $
            (0.15
            )Weighted
      average shares used in calculating basic and diluted net loss per
      share
            
            
            34,290
            
            
            
            33,928
            
            
            
            33,600




*Including
      stock-based compensation of:Cost
      of product, services, maintenance and support revenue
            
            $
            188
            
            
            $
            155
            
            
            $
            —Research
      and development
            
            
            879
            
            
            
            618
            
            
            
            —Sales
      and marketing
            
            
            614
            
            
            
            497
            
            
            
            —General
      and administrative
            
            
            1,008
            
            
            
            764
            
            
            
            100







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





F-4





AVISTAR
COMMUNICATIONS CORPORATION AND SUBSIDIARY




CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)




for
the years ended December 31, 2007, 2006 and 2005




(in
thousands, except share amounts)


Additional
              
              Other
              
              
              
              TotalCommon Stock
              Treasury Stock
              
              Paid-In
              
              Comprehensive
              
              Accumulated
              
              Stockholders’shares
              
              amount
              shares
              
              amount
              
              Capital
              
              Income (Loss)
              
              Deficit
              
              Equity (Deficit)Balance
      at December 31, 2004
              34,542,334
              
              $
              35
              
              1,182,875
              
              $
              (53
              )
              
              $
              90,005
              
              
              $
              —
              
              
              $
              (89,473
              )
              
              $
              514Issuance
      of common stock to employees pursuant to employee stock purchase
      plan
              182,594
              
              
              —
              
              —
              
              
              —
              
              
              
              143
              
              
              
              —
              
              
              
              —
              
              
              
              143Issuance
      of common stock to employees pursuant to exercise of
    options
              214,196
              
              
              —
              
              —
              
              
              —
              
              
              
              271
              
              
              
              —
              
              
              
              —
              
              
              
              271Non-employee
      stock-based compensation
              —
              
              
              —
              
              —
              
              
              —
              
              
              
              100
              
              
              
              —
              
              
              
              —
              
              
              
              100Unrealized
      loss on short and long-term investments
              —
              
              
              —
              
              —
              
              
              —
              
              
              
              —
              
              
              
              (12
              )
              
              
              —
              
              
              
              (12
              )Net
      loss
              —
              
              
              —
              
              —
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (5,174
              )
              
              
              (5,174
              )Balance
      at December 31, 2005
              34,939,124
              
              
              35
              
              1,182,875
              
              
              (53
              )
              
              
              90,519
              
              
              
              (12
              )
              
              
              (94,647
              )
              
              
              (4,158
              )Issuance
      of common stock to employees pursuant to employee stock purchase
      plan
              225,657
              
              
              —
              
              —
              
              
              —
              
              
              
              266
              
              
              
              —
              
              
              
              —
              
              
              
              266Issuance
      of common stock to employees pursuant to exercise of
    options
              54,987
              
              
              —
              
              —
              
              
              —
              
              
              
              46
              
              
              
              —
              
              
              
              —
              
              
              
              46Non-employee
      stock-based compensation
              —
              
              
              —
              
              —
              
              
              —
              
              
              
              93
              
              
              
              —
              
              
              
              —
              
              
              
              93Employee
      stock-based compensation
              —
              
              
              —
              
              —
              
              
              —
              
              
              
              1,941
              
              
              
              —
              
              
              
              —
              
              
              
              1,941Unrealized
      gain on short and long-term investments
              —
              
              
              —
              
              —
              
              
              —
              
              
              
              —
              
              
              
              12
              
              
              
              —
              
              
              
              12Net
      loss
              —
              
              
              —
              
              —
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (8,149
              )
              
              
              (8,149
              )Balance
      at December 31, 2006
              35,219,768
              
              
              35
              
              1,182,875
              
              
              (53
              )
              
              
              92,865
              
              
              
              —
              
              
              
              (102,796
              )
              
              
              (9,949
              )Issuance
      of common stock to employees pursuant to employee stock purchase
      plan
              176,072
              
              
              1
              
              —
              
              
              —
              
              
              
              219
              
              
              
              —
              
              
              
              —
              
              
              
              220Issuance
      of common stock to employees pursuant to exercise of
    options
              282,967
              
              
              —
              
              —
              
              
              —
              
              
              
              210
              
              
              
              —
              
              
              
              —
              
              
              
              210Repurchase
      of stock options from employees
              —
              
              
              —
              
              —
              
              
              —
              
              
              
              (58
              )
              
              
              —
              
              
              
              —
              
              
              
              (58
              )Non-employee
      stock-based compensation
              —
              
              
              —
              
              —
              
              
              —
              
              
              
              66
              
              
              
              —
              
              
              
              —
              
              
              
              66Employee
      stock-based compensation
              —
              
              
              —
              
              —
              
              
              —
              
              
              
              2,623
              
              
              
              —
              
              
              
              —
              
              
              
              2,623Net
      loss
              —
              
              
              —
              
              —
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (2,938
              )
              
              
              (2,938
              )Balance
      at December 31, 2007
              35,678,807
              
              $
              36
              
              1,182,875
              
              $
              (53
              )
              
              $
              95,925
              
              
              $
              —
              
              
              $
              (105,734
              )
              
              $
              (9,826
              )
  The
accompanying notes are an integral part of these financial
statements.





F-5





AVISTAR
COMMUNICATIONS CORPORATION AND SUBSIDIARY




CONSOLIDATED
STATEMENTS OF CASH FLOWS




for
the years ended December 31, 2007, 2006 and 2005




(in
thousands)




Year Ended December 31,2007
            
            
            2006
            
            
            2005Cash
      Flows from Operating Activities:Net
      loss
            
            $
            (2,938
            )
            
            $
            (8,149
            )
            
            $
            (5,174
            )Adjustments
      to reconcile net loss to net cash used in operating
      activities:Depreciation
            
            
            468
            
            
            
            345
            
            
            
            273Employee
      stock-based compensation
            
            
            2,623
            
            
            
            1,941
            
            
            
            —Compensation
      on options issued to consultants
            
            
            66
            
            
            
            93
            
            
            
            100Provision
      for doubtful accounts
            
            
            (27
            )
            
            
            (70
            )
            
            
            99Changes
      in assets and liabilities:Accounts
      receivable
            
            
            51
            
            
            
            89
            
            
            
            (641
            )Inventories
            
            
            284
            
            
            
            (37
            )
            
            
            62Prepaid
      expenses and other current assets
            
            
            72
            
            
            
            (71
            )
            
            
            (9
            )Deferred
      settlement and patent licensing costs
            
            
            1,274
            
            
            
            1,294
            
            
            
            1,256Other
      assets
            
            
            1
            
            
            
            84
            
            
            
            (85
            )Accounts
      payable
            
            
            (291
            )
            
            
            574
            
            
            
            (101
            )Deferred
      income from settlement and patent licensing and other
            
            
            (5,494
            )
            
            
            (5,481
            )
            
            
            (5,445
            )Deferred
      services revenue and customer deposits
            
            
            252
            
            
            
            1,267
            
            
            
            (36
            )Accrued
      liabilities and other
            
            
            (812
            )
            
            
            772
            
            
            
            204Net
      cash used in operating activities
            
            
            (4,471
            )
            
            
            (7,349
            )
            
            
            (9,497
            )Cash
      Flows from Investing Activities:Purchase
      of short and long-term investments
            
            
            (799
            )
            
            
            —
            
            
            
            (3,965
            )Maturities
      of short and long-term investments
            
            
            —
            
            
            
            3,965
            
            
            
            —Purchase
      of property and equipment
            
            
            (979
            )
            
            
            (290
            )
            
            
            (392
            )Net
      cash (used in) provided by investing activities
            
            
            (1,778
            )
            
            
            3,675
            
            
            
            (4,357
            )Cash
      Flows from Financing Activities:Proceeds
      from line of credit
            
            
            2,100
            
            
            
            3,000
            
            
            
            —Net
      proceeds from issuance of common stock
            
            
            372
            
            
            
            312
            
            
            
            414Net
      cash provided by financing activities
            
            
            2,472
            
            
            
            3,312
            
            
            
            414Net
      decrease in cash and cash equivalents
            
            
            (3,777
            )
            
            
            (362
            )
            
            
            (13,440
            )Cash
      and cash equivalents, beginning of year
            
            
            7,854
            
            
            
            8,216
            
            
            
            21,656Cash
      and cash equivalents, end of year
            
            $
            4,077
            
            
            $
            7,854
            
            
            $
            8,216Supplemental
      Cash Flow Information:Cash
      paid for income taxes
            
            $
            —
            
            
            $
            —
            
            
            $
            357Cash
      paid for interest
            
            $
            138
            
            
            $
            2
            
            
            $
            1





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










F-6










AVISTAR
COMMUNICATIONS CORPORATION AND SUBSIDIARY




NOTES
TO FINANCIAL STATEMENTS




1.Business,
      Organization, Basis of Presentation, and Risks and
      Uncertainties




Business




Avistar
Communications Corporation (Avistar or the Company) creates technology that
provides the missing critical element in unified communications: bringing people
in organizations face-to-face, through enhanced communications, for true
collaboration anytime, anyplace. The Company’s latest product, Avistar C3, draws
on over a decade of market experience to deliver a single-click desktop
videoconferencing and collaboration experience that moves business
communications into a new era. Available as a stand-alone solution, or
integrated with existing unified communications software from other vendors,
Avistar C3 users gain instant messaging-style ability to initiate video
communications across and outside the enterprise. Patented bandwidth management
enables thousands of users to access desktop videoconferencing, Voice over IP
(VoIP) and streaming media without requiring substantial new network investment
or impairing network performance.  By integrating Avistar C3 tightly
into the way they work, customers can use Avistar’s solutions to help reduce
costs and improve productivity and communications within their enterprise and
between enterprises, to enhance their relationships with customers, suppliers
and partners. Using Avistar C3 software and leveraging video, telephony and
Internet networking standards, Avistar solutions are designed to be scalable,
reliable, cost effective, easy to use, and capable of evolving with
communications networks as bandwidth increases and as new standards and
protocols emerge. The Company currently sells the Avistar system directly and
indirectly to small and medium size businesses, or SMBs, and large globally
distributed organizations, or Enterprise, markets comprising the Global 5000.
The Company’s objective is to establish its technology as the standard for
networked visual unified communications and collaboration through direct sales,
indirect channel sales/partnerships and the licensing of the Company’s
technology to others. Avistar also seeks to license its broad portfolio of
patents covering, among other areas, video and rich media collaboration
technologies, networked real-time text and non-text communications and desktop
workstation echo cancellation.




Organization




The
Company was founded as a Nevada limited partnership in 1993. The Company filed
articles of incorporation in Nevada in December 1997 under the name Avistar
Systems Corporation. The Company reincorporated in Delaware in March 2000 and
changed the Company name to Avistar Communications Corporation in April 2000.
The operating assets and liabilities of the business were then contributed to
the Company’s wholly owned subsidiary, Avistar Systems Corporation, a Delaware
corporation. In July 2001, the Company’s Board of Directors and the Board of
Directors of Avistar Systems approved the merger of Avistar Systems with and
into Avistar Communications Corporation. The merger was completed in July
2001.   In October 2007, the Company merged Collaboration
Properties, Inc., the Company's wholly-owned subsidiary, with and into the
Company, with the Company being the surviving corporation. Avistar has one
wholly-owned subsidiary, Avistar Systems U.K. Limited (ASUK).




Basis
      of Presentation




The
accompanying financial statements present the consolidated financial position,
results of operations, and cash flows of Avistar and ASUK after elimination of
all intercompany accounts and transactions. The consolidated results are
referred to, collectively, as those of Avistar or the Company in these notes.
The Company has prepared the accompanying consolidated financial statements in
conformity with accounting principles generally accepted in the United States of
America.




The
functional currency of ASUK is the United States dollar. Accordingly, all gains
and losses resulting from transactions denominated in currencies other than the
United States dollar are included in the statements of operations and have not
been material.




The
Company’s fiscal year end is December 31.











F-7





Risks and
Uncertainties




The markets
for the Company’s products and services are in the early stages of development.
Some of the Company’s products utilize changing and emerging technologies. As is
typical in industries of this nature, demand and market acceptance are subject
to a high level of uncertainty, particularly when there are adverse conditions
in the economy. Acceptance of the Company’s products, over time, is critical to
the Company’s success. The Company’s prospects must be evaluated in light of
difficulties encountered by it and its competitors in further developing this
evolving marketplace. The Company has generated losses since inception and had
an accumulated deficit of $105.7 million as of December 31, 2007. The
Company’s operating results may fluctuate significantly in the future as a
result of a variety of factors, including, but not limited to, the economic
environment, the adoption of different distribution channels, and the timing of
new product announcements by the Company or its competitors.




The
Company’s future liquidity and capital requirements will depend upon numerous
factors, including, but not limited to, the costs and timing of its expansion of
product development efforts and the success of these development efforts, the
costs and timing of its expansion of sales and marketing activities, the extent
to which its existing and new products gain market acceptance, competing
technological and market developments, the costs involved in maintaining,
enforcing and defending patent claims and other intellectual property rights,
the level and timing of revenue, and other factors.




2.Summary
      of Significant Accounting Policies and Balance Sheet
    Details




Use
      of Estimates




The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues, income and expenses during the period. Actual
results could differ from those estimates.




Cash
      and Cash Equivalents and Short and Long-term
  Investments




The
Company considers all investment instruments purchased with an
original maturity of three months or less to be cash equivalents.
Investment securities with original or remaining maturities of more than three
months but less than one year are considered short-term investments. Auction
rate securities with original or remaining maturities of more than three months
are considered short-term investments even if they are subject to re-pricing
within three months. Investment securities with original or remaining maturities
of one year or more are considered long-term investments. The Company’s cash
equivalents at December 31, 2007 and 2006 consisted of money market funds
and short-term commercial paper with original maturities of three months or
less.




The
Company accounts for its short-term and long-term investments in accordance with
Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for Certain Investments
in Debt and Equity Securities. The Company’s short and long-term
investments in securities are classified as available-for-sale and are reported
at fair value, with unrealized gains and losses, net of tax, recorded in other
comprehensive income (loss). Realized gains or losses and declines in value
judged to be other than temporary, if any, on available- for-sale securities are
reported in other income, net. The Company reviews the securities for
impairments considering current factors including the economic environment,
market conditions and the operational performance and other specific factors
relating to the business underlying the securities. The Company records
impairment charges equal to the amount that the carrying value of its
available-for-sale securities exceeds the estimated fair market value of the
securities as of the evaluation date. The fair value for publicly held
securities is determined based on quoted market prices as of the evaluation
date. In computing realized gains and losses on available-for-sale securities,
the Company determines cost based on amounts paid, including direct costs such
as commissions, to acquire the security using the specific identification
method.







F-8





Cash,
cash equivalents, short and long-term investments consisted of the following at
December 31, 2007 and 2006 (in thousands):




December 31,2007
            
            
            2006DescriptionCash
      and cash equivalents:Cash
            
            $
            740
            
            
            $
            4,224Commercial
      paper cash equivalents
            
            
            3,337
            
            
            
            3,630Total
      cash and cash equivalents
            
            
            4,077
            
            
            
            7,854Short-term
      investments (average 27 remaining days to maturity in
2007)
            
            
            799
            
            
            
            —Total
      cash, cash equivalents and short- term investments
            
            $
            4,876
            
            
            $
            7,854







Significant
      Concentrations




A
relatively small number of customers have accounted for a significant percentage
of the Company’s net sales. Sales to major customers as a percentage of sales
for each fiscal year are as follows:


F-9
  2007
              
              2006
              
              2005Customer
      A
              
              
              33
              %
              
              
              *
              %
              
              
              *
              %Customer
      B
              
              
              24
              %
              
              
              25
              %
              
              
              39
              %Customer
      C
              
              
              18
              %
              
              
              20
              %
              
              
              45
              %Customer
      D
              
              
              *
              %
              
              
              38
              %
              
              
              *
              %





*Less
      than 10%




Any
change in the relationship with these customers could have a potentially adverse
effect on the Company’s financial position.




Financial
instruments that potentially subject the Company to concentrations of credit
risk consist primarily of temporary cash investments and trade receivables. The
Company has cash and investment policies that limit the amount of credit
exposure to any one financial institution, or restrict placement of these
investments to financial institutions evaluated as highly credit worthy. As of
December 31, 2007, the Company had cash and cash equivalents on deposit
with a major financial institution that were in excess of FDIC insured limits.
Historically, the Company has not experienced any loss of its cash and cash
equivalents due to such concentration of credit risk. Concentrations of credit
risk with respect to trade receivables relate to those trade receivables from
both United States and foreign entities, primarily in the financial services
industry. As of December 31, 2007, three customers represented 38%, 30% and
10% of the Company’s gross accounts receivable balance. As of December 31,
2006, three customers represented 44%, 20% and 20% of the Company’s gross
accounts receivable.




Allowance
      for Doubtful Accounts




The
Company uses estimates in determining the allowance for doubtful accounts based
on historical collection experience, historical write-offs, current trends and
the credit quality of the Company’s customer base, and the characteristics of
accounts receivable by aging category. Accounts are generally considered
delinquent when thirty days past due. Uncollectible accounts are written off
directly to the allowance for doubtful accounts. If the allowance for doubtful
accounts was understated, operating income could be significantly reduced. The
impact of any such change or deviation may be increased by the Company’s
reliance on a relatively small number of customers for a large portion of its
total revenue.




Fair
      Value of Financial Instruments




The
carrying amounts of the Company’s financial assets and liabilities, including
cash and cash equivalents, short -term investments, accounts receivable, line of
credit, and accounts payable at December 31, 2007 and 2006, approximate
fair value because of the short maturity of these instruments.








F-10


Inventories





Inventories
are stated at the lower of cost (first-in, first-out method) or market. When
required, provisions are made to reduce excess and obsolete inventories to their
estimated net realizable value. Inventories consisted of the following (in
thousands):




December 31,_2007
            
            
            2006Raw
      materials and sub-assemblies
            
            $
            25
            
            
            $
            59Finished
      goods
            
            
            403
            
            
            
            583Inventory
      shipped to customer sites, not yet installed
            
            
            —
            
            
            
            70$
            428
            
            
            $
            712







Inventory
shipped to customer sites, not yet installed, represents product shipped to
customer sites pending completion of the installation process by the Company. As
of December 31, 2007, the Company did not have any shipments to customers that
were pending the installation process by the Company. As of December 31,
2006, the Company had billed approximately $70,000 to customers related to these
shipments, but did not record the revenue, as the installations had not been
completed and confirmed by the customer. Although customers are billed in
accordance with purchasing agreements, these deferred revenue amounts are netted
against accounts receivable until the customer confirms
installation.




Property
      and Equipment




Property
and equipment are stated at cost and are depreciated using the double declining
balance method over the estimated useful lives (three or five years) of the
assets. Repairs and maintenance are expensed as incurred. The company has net
property and equipment of $728,000 in the US and $39,000 in all foreign
countries.  Property and equipment consisted of the following (in
thousands):




December 31,2007
            
            
            2006Computer
      equipment
            
            $
            1,408
            
            
            $
            1,013Computer
      software
            
            
            339
            
            
            
            389Furniture,
      fixtures and equipment
            
            
            304
            
            
            
            190Leasehold
      improvements
            
            
            268
            
            
            
            1142,319
            
            
            
            1,706Less:
      Accumulated depreciation
            
            
            (1,552
            )
            
            
            (1,450
            )$
            767
            
            
            $
            256







Accrued
      Liabilities and Other




Accrued
liabilities and other consisted of the following (in thousands):




December 31,2007
            
            
            2006Accrued
      consulting and professional fees
            
            $
            478
            
            
            $
            1,029Accrued
      payroll and related benefits
            
            
            630
            
            
            
            705Accrued
      commissions and bonuses
            
            
            57
            
            
            
            157Other
            
            
            286
            
            
            
            372$
            1,451
            
            
            $
            2,263







Patent
      Costs




Due to
uncertainties about the estimated future economic benefits and lives of the
Company’s patents and patent applications, all related outside patent costs have
been expensed as incurred. Outside patent costs were approximately $1.8 million,
$0.7 million, and $0.4 million for 2007, 2006, and 2005, respectively, and are
reflected in general and administrative expenses in the accompanying statements
of operations.











F-11


Revenue Recognition
and Deferred Revenue





The Company
recognizes product and services revenue in accordance with Statement of Position
(SOP)  97-2, Software
Revenue Recognition(SOP 97-2), as amended by SOP 98-9,
Modification of SOP 97-2, Software Revenue Recognition, With
Respect to Certain Transactions(SOP 98-9). The Company derives
product revenue from the sale and licensing of a set of desktop (endpoint)
products (hardware and software) and infrastructure products (hardware and
software) that combine to form an Avistar video-enabled collaboration solution.
Services revenue includes revenue from installation services, post-contract
customer support, training and software development. The installation services
that the Company offers to customers relate to the physical set-up and
configuration of desktop and infrastructure components of the Company’s
solution. The fair value of all product, installation services, post-contract
customer support and training offered to customers is determined based on the
price charged when such products or services are sold separately.




Arrangements
that include multiple product and service elements may include software and
hardware products, as well as installation services, post-contract customer
support and training. Pursuant to SOP 97-2, the Company recognizes revenue
when all of the following criteria are met: (i) persuasive evidence of an
arrangement exists, (ii) delivery has occurred, (iii) the fee is fixed
or determinable, and (iv) collectibility is probable. The Company applies
these criteria as discussed below:




·
            Persuasive evidence of an
      arrangement exists. The Company requires a written contract, signed
      by both the customer and the Company, or a purchase order from those
      customers that have previously negotiated a standard end-user license
      arrangement or volume purchase agreement, prior to recognizing revenue on
      an arrangement.




·
            Delivery has occurred.
      The Company delivers software and hardware to customers physically. The
      standard delivery terms are FOB shipping
point.




·
            The fee is fixed or
      determinable. The Company’s determination that an arrangement fee
      is fixed or determinable depends principally on the arrangement’s payment
      terms. The Company’s standard terms generally require payment within 30 to
      90 days of the date of invoice. Where these terms apply, the Company
      regards the fee as fixed or determinable, and recognizes revenue upon
      delivery (assuming other revenue recognition criteria are met). If the
      payment terms do not meet this standard, but rather, involve “extended
      payment terms,” the fee may not be considered to be fixed or determinable
      and the revenue would then be recognized when customer installments are
      due and payable.




·
            Collectibility is
      probable. To recognize revenue, the Company judges collectibility
      of the arrangement fees on a customer-by-customer basis pursuant to a
      credit review policy. The Company typically sells to customers with which
      it has had a history of successful collections. For new customers, the
      Company evaluates the customer’s financial position and ability to pay. If
      the Company determines that collectibility is not probable based upon the
      credit review process or the customer’s payment history, revenue is
      recognized when cash is collected.




If there
are any undelivered elements, the Company defers revenue for those elements, as
long as Vendor Specific Objective Evidence (VSOE) exists for the undelivered
elements. Additionally, per paragraph 14 of SOP 97-2, when the Company provides
installation services, the product and installation revenue is recognized upon
completion of the installation process and receipt of customer confirmation,
subject to the satisfaction of the revenue recognition criteria described above.
The Company believes that the fee associated with the delivered product elements
does not meet the collectibility criteria if the installation services have not
been completed. Customer confirmation is obtained and documented by means of a
standard form indicating the installation services have been provided and the
hardware and software components installed. When the customer or a third party
provides installation services, the product revenue is recognized upon shipment,
subject to satisfaction of the revenue recognition criteria described
above.




Payment
for product is due upon shipment, subject to specific payment terms. Payment for
installation and professional services is due upon providing the services,
subject to specific payment terms. Reimbursements received for out-of-pocket
expenses and shipping costs incurred during installation and support services,
which have not been significant to date, are recognized as revenue in accordance
with Emerging Issues Task Force (EITF) Issue No. 01-14 (EITF 01-14), Income
Statement Characterization of Reimbursements Received for “Out of Pocket”
Expenses Incurred.




The price
charged for maintenance and/or support is defined in the contract, and is based
on a fixed price for both hardware and software components as stipulated in the
customer agreement. Customers have the option to renew the maintenance and/or
support arrangement in subsequent periods at the same or similar rate as paid in
the initial year subject to contractual adjustments for inflation in some cases.
Revenue from maintenance and support services is deferred and







F-12





recognized
pro-rata over the maintenance and/or support term, which is typically one year
in length. Payments for services made in advance of the provision of services
are recorded as deferred revenue and customer deposits in the accompanying
balance sheets. Training services are offered independently of the purchase of
product. The value of these training services is determined based on the price
charged when such services are sold separately. Training revenue is recognized
upon performance of the service.




The
Company recognizes service revenue from software development contracts in
accordance with SOP 81-1, Accounting for Performance of Construction-Type and
Certain Production-Type Contracts. Revenue related to contracts for software
development is recognized using the percentage of completion method, when all of
the following conditions are met: a contract exists with the customer at a fixed
price, the Company has fulfilled all of its material contractual obligations to
the customer for each deliverable of the contract, verification of completion of
the deliverable has been received, and collection of the receivable is probable.
The amounts billed to customers in excess of revenues recognized to date are
deferred and recorded as deferred revenue and customer deposits in the
accompanying balance sheets. Assumptions used for recording revenue and earnings
are adjusted in the period of change to reflect revisions in contract value and
estimated costs to complete the contract. Any anticipated losses on contracts in
progress are charged to earnings when identified.




The
Company also derives revenue from the licensing of its intellectual property
portfolio. The Company recognizes revenue from the licensing of its intellectual
property portfolio according to SOP 97-2, based on the terms of the
royalty, partnership and cross-licensing agreements involved. In the event that
a license to the Company’s intellectual property is granted after the
commencement of litigation proceedings between the Company and the licensee, the
proceeds of such transaction are recognized as licensing revenue by us only if
sufficient historical evidence exists for the determination of fair value of the
licensed patents to support the segregation of the proceeds between a gain on
litigation settlement and patent license revenues consistent with Financial
Accounting Standards Board (FASB) Concepts Statement No. 6, Elements of Financial
Statements (CON 6). As of December 31, 2007, these criteria for
recognizing license revenue following the commencement of litigation had not
been met.




In
July 2006, Avistar entered into a Patent License Agreement with Sony
Corporation (Sony) and Sony Computer Entertainment, Inc. (SCEI). Under the
license agreement, Avistar granted Sony and its subsidiaries, including SCEI a
license to all of the Company’s patents with a filing date on or before
January 1, 2006 for a specific field of use relating to video conferencing.
The license covers Sony’s video conferencing apparatus as well as other
products, including video-enabled personal computer products and certain SCEI
PlayStation products. The $5.0 million upfront payment was recognized by
the Company as licensing revenue in the three months ending September 30,
2006 and future royalties are being recognized as they occur in accordance with
SOP 97-2.




In
June 2007, Avistar entered into a Patent License Agreement with Radvision
Ltd. Under the license agreement, Avistar granted Radvision a license to all of
the Company patents and certain patent applications for a specific field of use
relating to video conferencing. The $4.0 million upfront payment was
recognized by the Company as licensing revenue in the three months ending
June 30, 2007 in accordance with SOP 97-2.




Income
      from Settlement and Patent
Licensing




The
Company recognizes the proceeds from settlement and patent licensing agreements
based on the terms involved. When litigation has been filed prior to a
settlement and patent licensing agreement, and insufficient historical evidence
exists for the determination of fair value of the patents licensed to support
the segregation of the proceeds between a gain on litigation settlement and
patent license revenues, the Company reports all proceeds in “income from
settlement and patent licensing” within operating costs and expenses. The gain
portion of the proceeds, when sufficient historical evidence exists to segregate
the proceeds, would be reported according to SFAS No. 5, Accounting for Contingencies.
When a patent license agreement is entered into prior to the commencement of
litigation, the Company reports the proceeds of such transaction as licensing
revenue in the period in which such proceeds are received, subject to the
revenue recognition criteria described above.




On
November 12, 2004, the Company entered into a settlement and a patent
cross-license agreement with Polycom, thus ending litigation against Polycom for
patent infringement. As part of the settlement and patent cross-license
agreement with Polycom, Avistar granted Polycom a non-exclusive, fully paid-up
license to its entire patent portfolio. The settlement and patent cross-license
agreement includes a five year capture period from the date of the settlement,
adding all new patents with







F-13





a
priority date extending up to five years from the date of execution of the
agreement. Polycom, as part of the settlement and patent cross-licensing
agreement, made a one time payment to the Company of $27.5 million and Avistar
paid $6.4 million in contingent legal fees to Avistar’s litigation counsel upon
completion of the settlement and patent cross-licensing agreement. The
contingent legal fees were payable only in the event of a favorable outcome from
the litigation with Polycom. The Company is recognizing the gross proceeds of
$27.5 million from the settlement and patent cross-license agreement as income
from settlement and patent licensing within operations over the five-year
capture period, due to a lack of evidence necessary to apportion the proceeds
between an implied punitive gain element in the settlement of the litigation,
and software license revenues from the cross-licensing of Avistar’s patented
technologies for prior and future use by Polycom. Additionally, the $6.4 million
in contingent legal fees was deferred and is being amortized to income from
settlement and patent licensing over the five year capture period, resulting in
a net of $21.1 million being recognized as income within operations over the
five year capture period.




On
February 15, 2007, the Company entered into a Patent License Agreement with
Tandberg ASA, Tandberg Telecom AS and Tandberg, Inc.  Under this agreement,
Avistar dismissed its infringement suit against Tandberg, Tandberg dismissed its
infringement suit against us, and we cross-licensed each other’s patent
portfolios.  The agreement resulted in a payment of $12.0 million to us
from Tandberg.
Avistar recognized the gross proceeds of $12.0 million from the patent license
agreement as income from settlement and patent licensing within operations in
the three months ended March 31, 2007.  To recognize the proceeds as
revenue, the Company would have required a sufficient history of transactions to
allow us to isolate the aspect of the settlement attributable to the gain
associated with the process of litigation, separate from commercial compensation
for the use of our intellectual property.  Sufficient evidence was not
available to allow this distinction. The Patent License Agreement with Tandberg
includes a ten year capture period, extending from the date of the agreement,
during which patents filed with a priority date within the capture period would
be licensed in addition to existing patents on the agreement date. 
However, such additional patents would be licensed under the agreement solely
for purposes of the manufacture, sale, license or other transfer of existing
products of Tandberg and products that are closely related enhancements of such
products based primarily and substantially on the existing products.
 Avistar reviewed the existing products of Tandberg and considered the
likelihood that future patent filings by the Company would relate to or
otherwise affect existing Tandberg products and closely related enhancements
thereto.  Avistar concluded that the filing for such additional patents was
unlikely, and therefore concluded that the ten year capture period was not
material from an accounting perspective related to revenue
recognition.




The
presentation within operating expenses is supported by a determination that the
transaction is central to the activities that constitute Avistar’s ongoing major
or central operations, but may contain a gain element related to the settlement,
which is not considered as revenue under the FASB CON 6. The Company did not have
sufficient historical evidence to support a reasonable determination of value
for the purposes of segregating the transaction into revenue related to the
patent licensing and an operating or non-operating gain upon settlement of
litigation, resulting in the determination that the entire transaction is more
appropriately classified as “income from settlement and patent licensing” within
operations, as opposed to revenue.




Taxes
      Collected from Customers and Remitted to Governmental
      Authorities




Taxes
collected from customers and remitted to governmental authorities are recognized
on a net basis in the accompanying statement of operations.


Warranty




The
Company accrues the estimated costs of fulfilling the warranty provisions of its
contracts over the warranty period, which is typically 90 days. There was no
warranty accrual as of December 31, 2007 and approximately $1,000 as of
December 31, 2006 which was included in accrued liabilities in the
accompanying balance sheets.




Research
      and Development




Research
and development costs include engineering expenses, such as salaries and related
benefits, depreciation, professional services and overhead expenses related to
the general development of Avistar’s products, and are expensed as incurred.
Software development costs are capitalized beginning when a product’s
technological feasibility has been established and ending when a product is
available for general release to customers. Avistar has not capitalized any
software development costs since the period between establishing technological
feasibility and general release of the product is relatively short, and these
costs have not been significant.




Stock-Based
Compensation




On
December 16, 2004, the FASB issued SFAS No. 123 (revised 2004),
Share-Based Payment
(SFAS No. 123R), which establishes the accounting for stock-based awards granted
for employee services. Effective January 1, 2006, the







F-14





Company
adopted the fair value recognition provisions of SFAS No. 123R, using the
modified prospective transition method, and therefore has not restated results
for prior periods. Under this transition method, stock-based compensation
expense for fiscal 2007 and 2006 includes compensation expense for all
stock-based compensation awards granted prior to, but not yet vested as of
January 1, 2006, based on the grant date fair value estimated in accordance
with the original provision of SFAS No. 123, Accounting for Stock-Based
Compensation (SFAS No. 123). Stock-based compensation expense
for all stock-based compensation awards granted after January 1, 2006 is
based on the grant-date fair value estimated in accordance with the provisions
of SFAS No. 123R. The Company recognizes these compensation costs on a
straight-line basis over the requisite service period of the award. In
March 2005, the SEC issued Staff Accounting Bulletin No. 107
(SAB No.107) regarding the SEC’s interpretation of SFAS No. 123R and
the valuation of share-based payments for public companies. The Company has
applied the provisions of SAB 107 in its adoption of SFAS No. 123R.
Avistar incurred $2.6 and $1.9 million in employee stock-based compensation in
2007 and 2006, all of which was recorded as operating expenses, respectively.
Had the Company continued to account for stock-based compensation under
Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to
Employees (APB No. 25), and related interpretations, no employee
compensation expense would have been recorded in 2007 and 2006. The impact on
both basic and diluted loss per share of the adoption of SFAS No. 123R for the
year ended December 31, 2007 and 2006 was $0.08 per share and $0.06 per
share, respectively.




In
November 2005, the FASB issued FASB Staff Position SFAS No. 123R-3,
Transition Election Related to
Accounting for the Tax Effects of Share-Based Payment Awards, which
provides a practical exception when a company transitions to the accounting
requirements in SFAS No. 123R. SFAS No. 123R requires a company to
calculate the pool of excess tax benefits available to absorb tax deficiencies
recognized subsequent to adopting SFAS No. 123R, otherwise know as the
“APIC Pool”, assuming the company had been following the recognition provisions
prescribed by SFAS No. 123. Avistar has elected to use the shortcut method
under FASB Staff Position SFAS No. 123R-3 to calculate our APIC
Pool.




The
Company previously applied APB No. 25 and provided the required pro forma
disclosures of SFAS No. 123. Prior to the adoption of SFAS No. 123R,
the Company provided the disclosures required under SFAS No. 123 as amended
by SFAS No. 148, Accounting for Stock-Based
Compensation—Transition and Disclosures. The pro forma information for
2005 was as follows and illustrates the effect on net loss if the
fair-value-based method had been applied to all outstanding and unvested awards
in the period (in thousands, except per share data):




Year Ended December 31,
      2005Net
      loss, as reported
            
            $
            (5,174
            )Add
      stock-based employee compensation expense included in reported net
      loss, net of tax
            
            
            —Deduct
      total stock-based employee compensation expense determined under
      fair-value-based method for all awards, net of tax
            
            
            (1,886
            )Pro
      forma net loss
            
            $
            (7,060
            )Basic
      and diluted net loss per shareAs
      reported
            
            $
            (0.15
            )Pro
      forma
            
            $
            (0.21
            )







The
weighted average fair value of options granted during 2005 estimated on the date
of grant using the Black-Scholes-Merton option pricing model was $2.40. The
Black-Scholes-Merton option-pricing model was developed for use in estimating
the fair value of traded options that have no vesting restrictions and are fully
transferable. In addition, option-pricing models require the input of highly
subjective assumptions, including a factor to represent expected stock price
volatility. Because the Company’s employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management’s opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of the Company’s options. Although the fair
value of employee stock options is determined in accordance with SFAS
No. 123R and SAB 107 using an option-pricing model, that value may not be
indicative of the fair value observed in a willing buyer/willing seller market
transaction. The effects of applying SFAS No. 123 for providing pro
forma disclosure for 2005 are not likely to







F-15





be
representative of the effects on reported net income and net income per share
for future years since options vest over several years, additional awards are
made each year and stock-based compensation under SFAS No. 123R may be
higher or lower than stock-based compensation under SFAS
No. 123.




Other
      Comprehensive Income




SFAS
No. 130 (SFAS 130), Reporting Comprehensive
Income, establishes standards for the reporting and the display of
comprehensive income (loss) and its components. This standard defines
comprehensive income as the changes in equity of an enterprise, except those
resulting from stockholder transactions. Accordingly, comprehensive income
includes certain changes in equity that are excluded from the net income or
loss. The comprehensive loss was $2.9 million, $8.1 million and $5.2 million for
the years ended December 31, 2007, 2006 and 2005, respectively.




The
components of comprehensive loss were as follows (in thousands):




Year Ending December 31,2007
            
            
            2006
            
            
            2005Net
      loss
            
            $
            (2,938
            )
            
            $
            (8,149
            )
            
            $
            (5,174
            )Other
      comprehensive income (loss):Change
      in net unrealized gains and losses on investments
            
            
            —
            
            
            
            12
            
            
            
            (12
            )Total
      comprehensive loss
            
            $
            (2,938
            )
            
            $
            (8,137
            )
            
            $
            (5,186
            )







Recent
      Accounting Pronouncements




In
June 2006, the FASB reached a consensus on Emerging Issues Task Force
(EITF) Issue No. 06-3, How Taxes Collected from Customers
and Remitted to Governmental Authorities Should Be Presented in the Income
Statement (That Is, Gross versus Net Presentation), (“EITF 06-03”). EITF
06-3 indicates that the income statement presentation on either a gross basis or
a net basis of the taxes within the scope of the issue is an accounting policy
decision that should be disclosed. EITF 06-3 is effective for interim and annual
periods beginning after December 15, 2006. The adoption of EITF 06-3 did
not change the Company’s policy of presenting taxes within
the scope of EITF 06-3 on a net basis and had no impact on the consolidated
financial statements.
   In September 2006,
the FASB issued Statement No. 157, Fair
Value Measurements (SFAS No. 157). The standard provides guidance
for using fair value to measure assets and liabilities and responds to
investors’ requests for expanded information about the extent to which companies
measure assets and liabilities at fair value, the information used to measure
fair value, and the effect of fair value measurements on earnings. The standard
applies whenever other standards require or permit assets or liabilities to be
measured at fair value. The standard does not expand the use of fair value in
any new circumstances. SFAS No.  157 must be adopted prospectively as
of the beginning of the year it is initially applied. SFAS 157 is effective
for financial statements issued for fiscal years beginning after
November 15, 2007, and interim periods within those fiscal years. The
Company is evaluating the impact this standard will have on its financial
position or results of operations.




In
February 2007, the FASB issued Statement No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities, including an amendment of FASB Statement
No. 115 (SFAS No. 159). The standard allows an entity the
irrevocable option to elect fair value for the initial and subsequent
measurement for certain financial assets and liabilities under an
instrument-by-instrument election. Subsequent measurements for the financial
assets and liabilities an entity elects to fair value will be recognized in
earnings. SFAS No. 159 also establishes additional disclosure requirements. SFAS
No. 159 is effective for fiscal years beginning after November 15,
2007.  The Company is evaluating the impact this standard will have on its
financial position or results of operations.




In
December 2007, the FASB issued SFAS No. 141(Revised), Business Combinations (SFAS
No. 141(R)), which replaces SFAS No. 141, Business Combinations, and
requires an acquirer to recognize the assets acquired, the liabilities assumed,
and any non-controlling interest in the acquiree at the acquisition date,
measured at their fair values as of that date, with limited exceptions. This
statement also requires the acquirer in a business combination achieved in
stages to recognize the identifiable assets and liabilities, as well as the
non-controlling interest in the acquiree, at the full amounts of their fair
values. SFAS No. 141(R) makes various other amendments to authoritative
literature intended to provide additional guidance or to confirm the guidance in
that literature to that provided in this statement. This statement applies
prospectively to business combinations for which the acquisition date is on or
after the beginning of the first annual reporting period beginning on or after
December 15, 2008. The Company expects to adopt this statement on January 1,
2009.  SFAS No. 141(R)’s impact on accounting for business
combinations is dependent upon acquisition activity on or after its effective
date.




In
December 2007, FASB issued SFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statements, which amends Accounting Research
Bulletin No. 51, Consolidated
Financial Statements, to improve the relevance,
comparability,







F-16





and
transparency of the financial information that a reporting entity provides in
its consolidated financial statements. SFAS No. 160 establishes accounting and
reporting standards that require the ownership interests in subsidiaries not
held by the parent to be clearly identified, labeled and presented in the
consolidated statement of financial position within equity, but separate from
the parent’s equity. This statement also requires the amount of consolidated net
income attributable to the parent and to the non-controlling interest to be
clearly identified and presented on the face of the consolidated statement of
income. Changes in a parent’s ownership interest while the parent retains its
controlling financial interest must be accounted for consistently, and when a
subsidiary is deconsolidated, any retained non-controlling equity investment in
the former subsidiary must be initially measured at fair value. The gain or loss
on the deconsolidation of the subsidiary is measured using the fair value of any
non-controlling equity investment. The statement also requires entities to
provide sufficient disclosures that clearly identify and distinguish between the
interests of the parent and the interests of the non-controlling owners. This
statement applies prospectively to all entities that prepare consolidated
financial statements and applies prospectively for fiscal years, and interim
periods within those fiscal years, beginning on or after December 15, 2008. The
Company is currently evaluating the effect, if any, of this statement on its
financial condition and results of operations.




3.Line
      of Credit




On
December 23, 2006, the Company entered into a Revolving Credit and
Promissory Note and a Security Agreement with a financial institution to borrow
up to $10.0 million under a revolving line of credit. The agreement includes a
first priority security interest in all of our assets. Gerald Burnett, our
Chairman and Chief Executive Officer, provided a collateralized guarantee to the
financial institution, assuring payment of our obligations under the agreement
and as a consequence, there are no restrictive covenants, allowing us greater
access to the full amount of the facility. The line of credit requires monthly
interest-only payments based on LIBOR plus 0.75%, or 6.0% at December 31,
2007 or Prime Rate minus 2.0%, or 5.3% at December 31, 2007. The Company
borrowed $2.1 million and $3.0 million under the revolving line of credit for
the years ended December 31, 2007 and 2006, respectively, with an ending balance
of $5.1 million as of December 31, 2007. The Revolving Credit and Promissory
Note was renewed on December 23, 2007 and matures on December 23, 2008, and
is subject to annual renewal with the consent of the Company and the
lender.




4.Commitments
      and Contingencies




At
December 31, 2007, the Company had open purchase orders and other
contractual obligations of approximately $755,000, primarily related to
inventory purchases. These purchase order commitments and contractual
obligations will be reflected in the Company’s financial statements once goods
or services have been received, or payments related to the obligations become
due.




The
Company leases its facilities under operating leases that expire through
March 2017. As of December 31, 2007, the future minimum lease
commitments under all leases were as follows (in thousands):




Year Ending December 31,
            
            Amount2008
            
            $
            1,2502009
            
            
            1,1292010
            
            
            1,0092011
            
            
            1,0292012
            
            
            491thereafter
            
            
            1,318Total
      minimum lease payments
            
            $
            6,226







Rent
expense under all operating leases for 2007, 2006 and 2005 was approximately
$1.2 million, $0.8 million and $0.7 million, respectively.







F-17





Software
Indemnifications




Avistar
enters into standard indemnification agreements in the ordinary course of
business. Pursuant to these agreements, Avistar indemnifies, holds harmless, and
agrees to reimburse the indemnified party for losses suffered or incurred by the
indemnified party, generally Avistar’s business partners or customers, in
connection with any patent, copyright or other intellectual property
infringement claim by any third party with respect to its products. The term of
these indemnification agreements is generally perpetual. The maximum potential
amount of future payments Avistar could be required to make under these
indemnification agreements is unlimited. Avistar has never incurred costs to
defend lawsuits or settle claims related to these indemnification agreements.
Accordingly, Avistar has no liabilities recorded for these agreements as of
December 31, 2007.




5.Related
      Party Transactions




Certain
directors with controlling interests in the Company are also the majority owners
of one entity that conducted business with the Company, Vicor Inc. (Vicor).
Descriptions of certain transactions between the Company and this related entity
follow.




Revenue
      from a Related Party




UBS
Warburg LLC, which is an affiliate of UBS AG, is a stockholder of the Company
and is also a customer of the Company. As of December 31, 2007 and 2006,
UBS Warburg LLC held less than 5% of the Company’s stock. Revenue from UBS
Warburg LLC and its affiliates represented 18%, 20% and 45% of total revenue for
2007, 2006 and 2005, respectively. Management believes the transactions with UBS
Warburg LLC and its affiliates are at terms comparable to those provided to
unrelated third parties. As of December 31, 2007 and 2006, the Company had
accounts receivable outstanding from UBS Warburg LLC and its affiliates of
approximately $143,000 and $298,000, respectively.




Revenue
from Vicor represented less than 10% of total revenue for 2007, 2006 and 2005.
Management believes the transactions with Vicor are at terms comparable to those
provided to unrelated third parties. As of December 31, 2007, 2006 and
2005, the Company did not have any accounts receivable outstanding from
Vicor.




Fees
      to Related Parties




Robert P.
Latta, a member of the law firm Wilson Sonsini Goodrich & Rosati, a
Professional Corporation (WSGR), served as a director of the Company since
February 2001 until June 2007. Mr. Latta and WSGR have represented the
Company and its predecessors as corporate counsel since 1997. During 2007, 2006
and 2005, payments of $203,000, $118,000 and $119,000, respectively, were made
to WSGR for legal services provided to the Company. The Company had outstanding
payables of $50,000 to WSGR as of December 31, 2007.




6.
      Stockholders’ Equity




Stock
      Repurchase Plan




On
March 22, 2001, the Company announced that its Board of Directors
authorized the repurchase of up to $2.0 million of its common stock in the open
market. No shares of common stock were repurchased by the Company during 2007,
2006 or 2005.




Preferred
      Stock




In
April 2000, the stockholders of the Company authorized 10,000,000 shares of
convertible preferred stock, effective upon completion of its initial public
offering in August 2000. As of December 31, 2007, the Company had
10,000,000 shares of convertible preferred stock authorized, at $0.001 per share
par value. No shares of convertible preferred stock were issued or outstanding
as of December 31, 2007.




7. Stock
      Option Plans




1997
      Stock Option Plan




In
December 1997, the Board established the 1997 Stock Option Plan (the 1997
Plan) and authorized the issuance of 1,828,602 shares of common stock
thereunder. In December 1999 and May 2000, respectively, the Board
authorized an additional 1,065,625 shares and 100,000 shares to be issued under
the Plan. In connection with the initial public offering in







F-18





August 2000,
the Board terminated the 1997 Plan as to future grants, effective
August 17, 2000. Under the 1997 Plan, incentive stock options to purchase
shares of common stock were granted only to employees at not-less-than 100% of
the fair market value at the grant date as determined by the Board.
Additionally, nonqualified stock options to purchase shares of common stock were
granted to employees and consultants at not-less-than 85% of the fair market
value at the grant date. Options granted generally have had a contractual life
of ten years.




Options
granted under the plan vest over a four-year period, with 25% vesting after one
year and the remaining balance vesting 6.25% per quarter. At December 31,
2007, options to purchase a total of 480,150 shares were outstanding under the
1997 Plan, and no options were available for grant.




2000
      Stock Option Plan




In
April 2000, the Board established the 2000 Stock Option Plan (the 2000
Plan). Initially, a total of 3,000,000 shares of common stock were approved by
the Board for issuance under the 2000 Plan, together with annual increases in
the number of shares of common stock reserved under the plan beginning on the
first day of the Company’s fiscal year, commencing January 1, 2001. In
January 2001, the Board approved an increase of 1,004,936 shares. In
January 2002, the Board approved an increase of 1,007,858 shares. In
January 2003, the Board approved an increase of 1,011,957 shares. In
January 2004, 2005, 2006 and 2007 the Board approved an increase of
1,200,000 shares. As of December 31, 2007, a total of 10,824,751 shares had
been reserved for issuance under the 2000 Plan. The contractual term of the
options granted under this plan may not exceed 10 years and in the case of the
grantees who own more than 10% of the Company’s outstanding stock at the time of
grant, the contractual term of the option may not exceed five years. Options
granted under the 2000 Plan vest and become exercisable as set forth in each
option agreement; generally one quarter vest after one year and one-twelfth vest
quarterly thereafter. In the event of a merger or sale of substantially all
assets, these options must be assumed by the successor and if not assumed, will
fully vest. The 2000 Plan will terminate in 2010. As a result of past and future
increases, a maximum of 15,000,000 shares of common stock could be issued under
the 2000 Plan. The Company granted options to purchase approximately 4.4
million, 1.4 million and 2.0 million shares under the plan in 2007, 2006 and
2005, respectively. At December 31, 2007 options to purchase a total of
9,318,672 shares were outstanding under the 2000 Plan and 996,976 options were
available for future grant.




2000
      Director Option Plan




In
April 2000, the Company adopted the 2000 Director Option Plan (the
“Director Plan”). Initially, a total of 90,000 shares of common stock were
approved by the Board for issuance under the plan, together with an annual
increase in the number of shares of common stock reserved thereunder as provided
in the plan beginning on the first day of the Company’s fiscal year, commencing
January 1, 2001. In January 2001, the Board approved an annual
increase of 12,000 shares. In May 2001, the Board approved an additional
198,000 shares under this plan. In January 2002, the Board approved the
annual increase of 30,000 shares. In January 2003, the Board approved the
annual increase of 30,000 shares. In April 2003, the Board approved an
additional 104,000 shares under this plan. In January 2004, 2005, 2006 and
2007, the Board approved annual increases of 175,000 shares. As of
December 31, 2007, the Company has authorized a total of 1,164,000 shares
for issuance under this plan. As a result of past and future annual increases, a
maximum of 1,689,000 shares of common stock could be issued over the 10-year
life of the plan. The Company granted options to purchase 145,000, 145,000, and
170,000 shares under this plan in 2007, 2006 and 2005 respectively. At
December 31, 2007 options to purchase a total of 766,270 shares were
outstanding under the Director Plan and 336,480 options were available for
future grant.




In
April 2005, the Board authorized further amendments to the Director Plan,
subject to stockholder approval, to: (i) provide that annual grants under
the plan shall take place on January 1 of each year starting in 2006,
(ii) provide that, after the first year, options granted under the plan
vest at a rate of 1/48 per month rather than 1/4 per year, (iii) provide
that options granted under the plan shall continue to vest and be exercisable
for so long as the option holder remains a director or consultant to the
Company, subject to the term of the option; (iv) extend the time period for
optionees to exercise options following the date on which they are no longer a
director or consultant to the Company, and (v) to provide the Board with
the authority to make amendments to the Director Plan applicable to all options
granted under the Director Plan, including options granted prior to the
effective date of the amendment. The proposed amendments were approved by
stockholders in June 2005 but did not affect options already granted under
the Director Plan prior to the effective date of the amendments.







F-19





A summary
of the 1997 Plan, the 2000 Plan, and the Director Plan activity and related
information for the years ended December 31, 2007, 2006 and 2005 is as
follows:


Options OutstandingShares
                Available for
                Option Grant
              
              Shares
              
              Weighted
                Average
                Exercise PriceBalance,
      December 31, 2004
              
              
              1,873,235
              
              
              6,648,063
              
              
              $3.20Authorized
              
              
              1,375,000
              
              
              —
              
              
              —Granted
              
              
              (2,180,500
              )
              
              2,180,500
              
              
              2.71Exercised
              
              
              —
              
              
              (214,196
              )
              
              1.27Expired
              
              
              150,000
              
              
              (150,000
              )
              
              9.35Canceled/repurchased
              
              
              460,720
              
              
              (484,720
              )
              
              1.69Balance,
      December 31, 2005
              
              
              1,678,455
              
              
              7,979,647
              
              
              $3.06Authorized
              
              
              1,375,000
              
              
              —
              
              
              —Granted
              
              
              (1,511,000
              )
              
              1,511,000
              
              
              1.39Exercised
              
              
              —
              
              
              (54,987
              )
              
              0.87Expired
              
              
              150,000
              
              
              (150,000
              )
              
              1.52Canceled
              
              
              396,938
              
              
              (396,938
              )
              
              1.72Balance,
      December 31, 2006
              
              
              2,089,393
              
              
              8,888,722
              
              
              $2.87Authorized
              
              
              1,375,000
              
              
              —
              
              
              —Granted
              
              
              (4,550,000
              )
              
              4,550,000
              
              
              1.21Exercised
              
              
              —
              
              
              (282,967
              )
              
              0.74Canceled
              
              
              2,419,063
              
              
              (2,590,663
              )
              
              2.59Balance,
      December 31, 2007
              
              
              1,333,456
              
              
              10,565,092
              
              
              $2.28




The
pretax intrinsic value of outstanding options is the difference between the
closing price of Avistar shares as quoted on the NASDAQ Capital Market for
December 31, 2007 and the exercise price, multiplied by the number of
in-the-money options. The aggregate intrinsic value of the options outstanding
at December 31, 2007 for all options outstanding was $1.1 million and $0.3
million for only vested options outstanding. Vested and exercisable options
outstanding at December 31, 2007 had a weighted average remaining
contractual life of 5.1 years. The intrinsic value of options changes based on
the fair market value of Avistar stock. The Company had 9,846,794 options vested
and exercisable and expected to be vested and exercisable at December 31,
2007 with a weighted average exercise price of $2.36, a weighted average
remaining contractual term of 6.8 years, and an aggregate intrinsic value
of $1.0 million. Total intrinsic value of options exercised for the years
ended December 31, 2007 and 2006 were $138,000 and $47,000, respectively.
The following table summarizes significant ranges of outstanding and exercisable
options as of December 31, 2007.




Options Outstanding
            
            Options ExercisableRange of
              Exercise Prices
            
            Number
              Outstanding at
              December 31, 2007
            
            Weighted-Average
              Remaining
              Contractual Life
            
            Weighted-Average
              Exercise Price
            
            Number
              Exercisable at
              December 31, 2007
            
            Weighted-Average
              Exercise Price$0.40
      - $0.83
            
            
            1,769,687
            
            
            
            9.42
            
            
            
            $0.68
            
            
            
            199,028
            
            
            
            $0.78$0.90
      - $1.16
            
            
            1,650,635
            
            
            
            5.56
            
            
            
            1.02
            
            
            
            1,554,322
            
            
            
            1.01$1.20
      - $1.41
            
            
            2,482,625
            
            
            
            8.35
            
            
            
            1.32
            
            
            
            680,812
            
            
            
            1.23$1.42
      - $1.60
            
            
            1,528,333
            
            
            
            7.54
            
            
            
            1.55
            
            
            
            546,829
            
            
            
            1.49$1.62
      - $2.91
            
            
            2,329,562
            
            
            
            6.48
            
            
            
            2.43
            
            
            
            1,631,367
            
            
            
            2.45$3.95
      - $8.50
            
            
            416,900
            
            
            
            2.78
            
            
            
            7.83
            
            
            
            416,900
            
            
            
            7.83$17.25
            
            
            387,350
            
            
            
            2.25
            
            
            
            17.25
            
            
            
            387,350
            
            
            
            17.2510,565,092
            
            
            
            7.12
            
            
            
            $2.28
            
            
            
            5,416,608
            
            
            
            $3.20







As of
December 31, 2007, the Company had an unrecognized stock-based compensation
balance related to stock options of approximately $6.8 million before
estimated forfeitures. SFAS No. 123R requires forfeitures to be
estimated at the time of grant and revised if necessary in subsequent periods if
actual forfeitures differ from those estimates. Based on the Company’s
historical experience of option pre-vesting cancellations, the Company has
assumed an annualized forfeiture rate of 3% for its







F-20





executive
options and 20% for non-executive options. Accordingly, as of December 31,
2007, the Company estimated that the stock-based compensation for the awards not
expected to vest was approximately $1.1 million and therefore, the
unrecognized deferred stock-based compensation balance related to stock options
was adjusted to approximately $5.7 million after estimated forfeitures.
This amount will be recognized over an estimated weighted average period of 2.6
years. For the years ended December 31, 2007 and 2006, the Company granted
4,550,000 and 1,486,000 stock options to employees, with an estimated total
grant-date fair value of $5.0 million and $1.9 million, or $1.10 and $1.29 per
share, respectively. For the years ended December 31, 2007 and 2006, 1.6 million
and 1.4 million options vested with a total fair value of $2.6 million and $2.5
million, respectively.




2000
Employee Stock Purchase Plan




In
April 2000, the Company adopted the 2000 Employee Stock Purchase Plan
(“Employee Stock Purchase Plan”). Initially, a total of 1,500,000 shares of
common stock were approved by the Board for issuance under the plan, together
with an annual increase in the number of shares of common stock reserved
thereunder as provided in the plan beginning on the first day of the Company’s
fiscal year, commencing January 1, 2001. In January 2001, the Board
approved an increase of 753,702 shares. As of December 31, 2007, the
Company has authorized a total of 2,253,702 shares for issuance under this plan.
As a result of past and future annual increases, a maximum of 10,500,000 shares
could be sold over the 10-year life of the plan. The Employee Stock Purchase
Plan permits employees to purchase common stock through payroll deductions,
which may not exceed 15% of an employee’s compensation, at 85% of the lower of
the fair market value of the Company’s common stock on the first or the last day
of each offering period. A total of 176,072, 225,657 and 182,594 shares were
sold under this plan during 2007, 2006 and 2005, respectively.




On
July 19, 2006, the Compensation Committee of the Board of Directors of the
Company approved amendments to the 2000 Employee Stock Purchase Plan to
(i) change the offering periods under the plan from approximately 24 months
to approximately six months, commencing on the first trading day on or after
February 1 and August 1 of each year, and (ii) eliminate the
section of the plan that provided for automatic withdrawal and re-enrollment in
the event that the fair market value of the common stock on any exercise date
was lower than the fair market value of the common stock on the enrollment date
of the same offering period.




Valuation
      Assumptions




The
Company estimated the fair value of stock options granted during 2007 and 2006,
using a Black-Scholes-Merton valuation model, consistent with the provisions of
SFAS No. 123R, and SEC Staff Accounting Bulletin (SAB) No. 107. The
Company’s prior period pro forma disclosures of stock-based compensation for
2005 were determined under a fair value method as prescribed by SFAS
No. 123. The fair value of each option grant is estimated on the date of
grant using the Black-Scholes-Merton option valuation model and the
straight-line attribution approach with the following average
assumptions:




Year Ended December 31,2007
            
            2006
            
            2005Employee
      Stock Option PlanExpected
      dividend
            
            
            0
            %
            
            
            0
            %
            
            
            0
            %Average
      risk-free interest rate
            
            
            4.4
            %
            
            
            4.9
            %
            
            
            4.4
            %Expected
      volatility
            
            
            132
            %
            
            
            143
            %
            
            
            152
            %Expected
      term (years)
            
            
            6.1
            
            
            
            6.1
            
            
            
            4.0







Year Ended December 31,2007
            
            2006
            
            2005Employee
      Stock Purchase PlanExpected
      dividend
            
            
            0
            %
            
            
            0
            %
            
            
            0
            %Average
      risk-free interest rate
            
            
            5.1
            %
            
            
            4.0
            %
            
            
            3.3
            %Expected
      volatility
            
            
            155
            %
            
            
            89
            %
            
            
            96
            %Expected
      term (months)
            
            
            6
            
            
            
            6
            
            
            
            6







The
dividend yield of zero is based on the fact that the Company has never paid cash
dividends and has no present intention to pay cash dividends. The risk-free
interest rates are taken from the Daily Federal Yield Curve Rates as of the
grant dates as published by the Federal Reserve, and represent the yields on
actively traded Treasury securities for terms equal to







F-21





the
expected term of the options. Expected volatility is based on the historical
volatility of the Company’s common stock over a period consistent with the
expected term of the stock option. The expected term calculation is based on an
average prescribed by SAB No. 107, based on the vesting periods, which is
generally over four years, and the term of the option, which is generally 10
years, divided by 2.




For the
year ended December 31, 2007, stock-based compensation expense associated
with employee stock options and ESPP shares amounted to $2.5 million and
$0.1 million, respectively.




Common
      Stock Reserved for Future Issuance




As of
December 31, 2007, the Company had reserved the following shares of common
stock for issuance in connection with:




Stock
      options under stock option plans
            
            11,898,548Employee
      stock purchase plan
            
            1,301,968Total
            
            13,200,516







8. Legal
      Proceedings




On
May 11, 2005, Avistar commenced a patent infringement lawsuit against
Tandberg ASA and Tandberg, Inc., alleging that numerous Tandberg
videoconferencing products infringe three patents held the Company. The suit was
filed in the United States District Court for the Northern District of
California. Both of the Tandberg entities answered the complaint on
July 15, 2005, at which time they asserted that they did not infringe the
patents and that the patents were invalid and unenforceable.




On
January 30, 2006, Tandberg Telecom AS, a wholly-owned subsidiary of
Tandberg ASA, filed a patent infringement lawsuit against Avistar in the United
States District Court for the Eastern District of Texas. The suit alleged that
Avistar videoconferencing products infringe one patent purchased by Tandberg
Telecom AS.




On
February 15, 2007, Avistar entered into a Patent License Agreement with
Tandberg ASA, Tandberg Telecom AS and Tandberg, Inc. Under this agreement,
the Company agreed to dismiss its infringement suit against Tandberg, Tandberg
agreed to dismiss its infringement suit against Avistar, and the companies
agreed to cross-license each other’s patent portfolios. The agreement resulted
in a payment to Avistar from Tandberg in the amount of $12.0 million, which has
been included in income from settlement and patent licensing in the cost and
expenses section of the accompanying statement of operations.




9.
      Income Taxes




The
Company accounts for income taxes in accordance with SFAS No. 109, Accounting for Income Taxes
(SFAS 109). SFAS 109 provides for an asset and liability approach to account for
income taxes under which deferred tax assets and liabilities are recognized for
the future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities, and their
respective tax basis. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. Deferred
tax assets are reduced by a valuation allowance when, in the opinion of
management, it is more likely than not that some or all of the deferred tax
assets will not be realized. The effect on deferred tax assets and liabilities
of a change in tax rates is recognized in income in the period of
enactment.




In July
2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income
Taxes (FIN 48). FIN 48 clarifies the accounting for uncertainty in income
taxes recognized in any entity’s financial statements in accordance
with SFAS 109 and prescribes a recognition threshold and measurement
attributes for financial statement disclosure of tax positions taken or expected
to be taken on a tax return. Under FIN 48, the impact of an uncertain income tax
position on the income tax return must be recognized at the largest amount that
is more-likely-than-not to be sustained upon audit by the relevant taxing
authority. An uncertain income tax position will not be recognized if it has
less than a 50% likelihood of being sustained. Additionally, FIN 48 provides
guidance on de-recognition, classification, interest and penalties, accounting
in interim periods, disclosure and transition. FIN 48 is effective for fiscal
years beginning after December 15, 2006. Avistar adopted FIN 48 effective
January 1, 2007 and as a result of the adoption, the Company







F-22





recognized
no adjustment to retained earnings and a reduction of $676,000 in the deferred
tax asset for unrecognized tax benefits due to an estimate of the sustainability
of income tax positions taken.




Avistar
files income tax returns in the U.S. federal jurisdiction and in various states,
and the tax returns filed for the years 2001 through 2006 have not been examined
and the applicable statues of limitation have not expired with respect to those
returns.  Because of net operating loss and research credit
carryovers, substantially all of the Company’s tax years remain open to
examination.




Our
policy is that we recognize interest and penalties accrued on any unrecognized
tax benefits as a component of income tax expense.




The
(recovery from) provision for income taxes relates to Federal, State and Foreign
tax. The Company provided for income taxes for its subsidiary in the United
Kingdom (ASUK) of approximately $23,000, $22,000 and $22,000 in 2007, 2006 and
2005, respectively. Federal and State overpayments of 2004 income taxes of
$33,000 and $22,000, respectively,were refunded in 2006.




The
(recovery from) provision for income taxes consisted of the following (in
thousands):




Year Ended December 31,2007
            
            
            2006
            
            
            2005Current:Federal
            
            $
            —
            
            
            $
            (33
            )
            
            $
            —State
            
            
            —
            
            
            
            (20
            )
            
            
            —Foreign
            
            
            23
            
            
            
            22
            
            
            
            22$
            23
            
            
            $
            (31
            )
            
            $
            22







For
financial reporting purposes, loss before provision for income taxes included
the following components (in thousands):




Year Ended December 31,2007
            
            
            2006
            
            
            2005Domestic
            
            $
            (3,021
            )
            
            $
            (9,611
            )
            
            $
            (4,839
            )Foreign
            
            
            106
            
            
            
            1,431
            
            
            
            (313
            )Loss
      before provision for income taxes
            
            $
            (2,915
            )
            
            $
            (8,180
            )
            
            $
            (5,152
            )







The
Company’s effective income tax provision differed from the federal statutory
rate of 34% due to the following (in thousands):




Year Ended December 31,2007
            
            
            2006
            
            
            2005Expected
      tax benefit at federal statutory rate
            
            $
            (991
            )
            
            $
            (2,771
            )
            
            $
            (1,652
            )Foreign
      and state taxes, net
            
            
            23
            
            
            
            2
            
            
            
            22Recovery
      of federal tax payments
            
            
            —
            
            
            
            (33
            )
            
            
            —Non-deductible
      stock compensation and other
            
            
            629
            
            
            
            463
            
            
            
            17Current
      year operating losses and temporary differences for which no tax benefit
      is recognized
            
            
            362
            
            
            
            2,308
            
            
            
            1,635Provision
      for income taxes
            
            $
            23
            
            
            $
            (31
            )
            
            $
            22









F-23





The net
deferred income tax asset consisted of the following as of December 31,
2007 and 2006 (in thousands):




2007
            
            
            2006Deferred
      income tax assets:Federal
      net operating loss carry-forwards
            
            $
            16,664
            
            
            $
            15,178State
      net operating loss carry-forwards
            
            
            1,604
            
            
            
            956Tax
      credit carry-forwards
            
            
            2,325
            
            
            
            2,992Deferred
      settlement and patent licensing, net
            
            
            3,058
            
            
            
            4,728Reserves
            
            
            873
            
            
            
            522Property
      and Equipment
            
            
            253
            
            
            
            24024,777
            
            
            
            24,616Valuation
      allowance
            
            
            (24,777
            )
            
            
            (24,616
            )Net
      deferred income tax asset
            
            $
            —
            
            
            $
            —







Net
operating loss carry-forwards at December 31, 2007 were approximately $49.0
million and $33.3 million, for Federal and state income tax purposes,
respectively. The Federal net operating loss carry-forwards expire on various
dates through the year 2027.




As of
December 31, 2007, unused research and development tax credits of
approximately $1.2 million and $1.3 million are available to reduce future
Federal and California income taxes, respectively. Federal credit carry-forwards
expire beginning in year 2014. California credits will carry forward
indefinitely.




The
Internal Revenue Code of 1986, as amended, contains provisions that may limit
the net operating loss carry-forwards to be used in any given year upon the
occurrence of certain events, including a significant change in ownership
interest. The Company believes significant uncertainty exists regarding the
realizability of the net operating loss and tax credit carry-forwards and other
timing differences. Accordingly, a valuation allowance has been provided for the
entire net deferred tax asset.




10.
      Net Loss Per Share




Basic and
diluted net loss per share of common stock is presented in conformity with SFAS
No. 128 (SFAS 128), Earnings Per Share, for all
periods presented.




In
accordance with SFAS 128, basic net loss per share has been computed using the
weighted average number of shares of common stock outstanding during the period,
less shares subject to repurchase. Diluted net loss per share is computed on the
basis of the weighted average number of shares and potential common shares
outstanding during the period. Potential common shares result from the assumed
exercise of outstanding stock options that have a dilutive effect when applying
the treasury stock method. The Company has excluded all outstanding stock
options and shares subject to repurchase from the calculation of diluted net
loss per share for 2007, 2006, and 2005, because all such securities are
antidilutive (owing to the fact that the Company is in a loss position).
Accordingly, diluted net loss per share is equal to basic net loss per share for
all years presented.




The total
number of potential dilutive common shares excluded from the calculations of
diluted net loss per share was 590,788, 846,929 and 1,668,006 for 2007, 2006,
and 2005, respectively.




The
following table presents the calculation of basic and diluted net loss per share
(in thousands, except per share data):




Year Ended December 31,2007
            
            
            2006
            
            
            2005Net
      loss
            
            $
            (2,938
            )
            
            $
            (8,149
            )
            
            $
            (5,174
            )Weighted
      average shares of common stock used in computing net loss per
      share
            
            
            34,290
            
            
            
            33,928
            
            
            
            33,600Net
      loss per share basic and diluted
            
            $
            (0.09
            )
            
            $
            (0.24
            )
            
            $
            (0.15
            )










F-24





11.
      Segment Reporting




Disclosure
of segments is presented in accordance with SFAS No. 131 (SFAS 131), Disclosures About Segments of an
Enterprise and Related Information. SFAS 131 establishes standards for
disclosures regarding operating segments, products and services, geographic
areas and major customers. The Company is organized and operates as two
operating segments: (1) the design, development, manufacturing, sale and
marketing of networked video communications products (products division) and
(2) the prosecution, maintenance, support and licensing of the intellectual
property and technology, some of which is used in the Company’s products
(intellectual property division). Service revenue relates mainly to the
maintenance, support, training, software development and installation of
products, and is included in the products division for purposes of reporting and
decision-making. The products division also engages in corporate functions, and
provides financing and services to its intellectual property division. The
Company’s chief operating decision-maker, its Chief Executive Officer (CEO),
monitors the Company’s operations based upon the information reflected in the
following table (in thousands). The table includes a reconciliation of the
revenue and expense classification used by the Company’s CEO with the
classification of revenue, other income and expenses as set forth in the
Company’s audited financial statements included elsewhere herein. The
reconciliation for the revenue category reflects the fact that the CEO views
activity recorded in the account “income from settlement and patent licensing”
as revenue within the intellectual property division.




Intellectual
      Property Division
            
            
            Products
      Division
            
            
            Reconciliation
            
            
            TotalYear
      Ended December 31, 2007Revenue
            
            $
            21,162
            
            
            $
            7,019
            
            
            $
            (16,226
            )
            
            $
            11,955Depreciation
      expense
            
            
            —
            
            
            
            (468
            )
            
            
            —
            
            
            
            (468
            )Stock-based
      compensation
            
            
            240
            
            
            
            2,449
            
            
            
            —
            
            
            
            2,689Total
      costs and expenses
            
            
            (7,513
            )
            
            
            (23,741
            )
            
            
            16,226
            
            
            
            (15,028
            )Interest
      income
            
            
            —
            
            
            
            346
            
            
            
            —
            
            
            
            346Interest
      expense
            
            
            —
            
            
            
            187
            
            
            
            —
            
            
            
            187Net
      income (loss)
            
            
            13,649
            
            
            
            (16,587
            )
            
            
            —
            
            
            
            (2,938
            )Assets
            
            
            2,808
            
            
            
            7,769
            
            
            
            —
            
            
            
            10,577Year
      Ended December 31, 2006Revenue
            
            $
            9,381
            
            
            $
            8,070
            
            
            $
            (4,226
            )
            
            $
            13,225Depreciation
      expense
            
            
            —
            
            
            
            (345
            )
            
            
            —
            
            
            
            (345
            )Stock-based
      compensation
            
            
            440
            
            
            
            1,594
            
            
            
            —
            
            
            
            2,034Total
      costs and expenses
            
            
            (5,701
            )
            
            
            (20,227
            )
            
            
            4,226
            
            
            
            (21,702
            )Interest
      income
            
            
            —
            
            
            
            299
            
            
            
            —
            
            
            
            299Interest
      expense
            
            
            —
            
            
            
            1
            
            
            
            —
            
            
            
            1Net
      loss
            
            
            3,680
            
            
            
            (11,829
            )
            
            
            —
            
            
            
            (8,149
            )Assets
            
            
            3,752
            
            
            
            10,947
            
            
            
            —
            
            
            
            14,699Year
      Ended December 31, 2005Revenue
            
            $
            4,226
            
            
            $
            6,911
            
            
            $
            (4,226
            )
            
            $
            6,911Depreciation
      expense
            
            
            —
            
            
            
            (273
            )
            
            
            —
            
            
            
            (273
            )Total
      costs and expenses
            
            
            (2,535
            )
            
            
            (14,197
            )
            
            
            4,226
            
            
            
            (12,506
            )Interest
      income
            
            
            —
            
            
            
            537
            
            
            
            —
            
            
            
            537Interest
      expense
            
            
            —
            
            
            
            1
            
            
            
            —
            
            
            
            1Net
      loss
            
            
            1,691
            
            
            
            (6,865
            )
            
            
            —
            
            
            
            (5,174
            )Assets
            
            
            5,081
            
            
            
            15,277
            
            
            
            —
            
            
            
            20,358






International
revenue, which consists of sales to customers with operations principally in
Western Europe and Asia, comprised 72%, 75% and 63% of total revenue for 2007,
2006, and 2005, respectively. Revenue is allocated to individual countries and
geographical region by customer, based on where the product is shipped to,
location of services performed or the location of equipment that is under an
annual maintenance agreement. In the case of patent licensing and income from
settlement and patent licensing, revenue is allocated to geographical region
based on the location of the customer For 2007, 2006, and 2005, respectively,
international revenues to customers in the United Kingdom accounted for 12%,
12%, and 23% respectively, of total revenue. The Company had no significant
long-lived assets in any country other than the United States for any period
presented.







F-25







12.
      Subsequent Events




On
November 16, 2007, the Company received a deficiency letter from The NASDAQ
Stock Market indicating that it did not comply with Marketplace Rule
4310(c)(3), which requires that it have a minimum of $2,500,000 in stockholders’
equity or $35 million in market value of listed securities or $500,000 of
net income from continuing operations for the most recently completed fiscal
year or two of the three most recently completed fiscal years.  The
NASDAQ staff noted that the market value of the Company’s listed securities had
been below the minimum $35 million for the previous 10 consecutive trading
days.  On March 20, 2008, the Company received notification from the
NASDAQ Hearings Panel that it had regained compliance with the continued listing
standards of The NASDAQ Stock Market, but will be subject to an additional
compliance monitoring period through June 1, 2008.  In its
determination, the Panel noted that if at any time before June 1, 2008, the
market value of the Company’s securities falls below the required minimum of $35
million for 30 consecutive trading days, the Panel will promptly conduct a
hearing with respect to such failure and the Company’s securities would be
subject to immediate delisting. Failure to comply with any other continued
listing requirement would be subject to standard notice, hearing and restoration
periods.




On
January 4, 2008, Avistar issued $7,000,000 of 4.5% Convertible Subordinated
Secured Notes (Notes). The Notes were sold pursuant to a Convertible Note
Purchase Agreement, to Baldwin Enterprises, Inc., a subsidiary of Leucadia
National Corporation, directors Gerald Burnett, R. Stephen Heinrichs, William
Campbell, Simon Moss and Craig Heimark, officer Darren Innes, and WS Investment
Company. The Company’s obligations under the Notes are secured by the grant of a
security interest in substantially all tangible and intangible assets of the
Company pursuant to a Security Agreement among the Company and the Purchasers.
The Notes have a two year term and will be due on January 4, 2010 and are
convertible prior to maturity.  Interest on the Notes will accrue at
the rate of 4.5% per annum and will be payable semi-annually in arrears on June
4 and December 4 of each year, commencing on June 4, 2008.  From the
one year anniversary of the issuance of the Notes until maturity, the holders of
the Notes will be entitled to convert the Notes into shares of common stock at
an initial conversion price per share of $0.70.




On
February 25, 2008, the Company announced that Microsoft Corporation had filed
requests for re-examination of 24 of the Company’s 29 U.S.
patents.  Subsequently, Microsoft also filed requests for
re-examination of the remaining 5 U.S. patents.  The United States
Patent Office (USPTO) has approximately two months to decide whether to grant
the requests and engage in a formal re-examination. Patent re-examination, if
undertaken by the USPTO, could take between six months and two
years.  The Company believes that its U.S. patents are valid and the
Company intends to defend its patents through any re-examination
process.  However, the re-examination of patents by the USPTO is a
lengthy, time consuming and expensive process in which the ultimate outcome is
uncertain.   If the USPTO elects to re-examine some or all of the
Company’s U.S. patents, Avistar will be required to spend substantial time and
resources defending its patents, including the fees and expenses of its legal
advisors.




13.Selected
      Quarterly Results of Operations
(unaudited)




The
following tables set forth, for the periods indicated, the Company’s unaudited
financial information for the last eight quarters. The Company believes that the
financial statements used to prepare this information include all adjustments,
consisting only of normal recurring adjustments, necessary for a fair
presentation of this information when read in conjunction with the Company’s
financial statements and notes to financial statements. The operating results
for any quarter do not necessarily indicate the results expected for any future
period. In July 2006, the Company entered into a Patent License Agreement
with Sony and SCEI. Under the license agreement, the Company granted Sony and
its subsidiaries, including SCEI a license to all of its patents with a filing
date on or before January 1, 2006 for a specific field of use relating to
video conferencing. As consideration for the licenses granted under the
agreement, Sony agreed to make an upfront license payment of $5.0 million.
The $5.0 million upfront payment was recognized by Avistar as licensing
revenue in the three months ended September 30, 2006.




On
February 15, 2007, the Company entered into a Patent License Agreement with
Tandberg ASA, Tandberg Telecom AS and Tandberg, Inc. Under this agreement,
the Company agreed to dismiss its infringement suit against Tandberg, Tandberg
agreed to dismiss its infringement suit against Avistar, and the companies
agreed to cross-license each other’s patent portfolios. The agreement resulted
in a payment to Avistar from Tandberg in the amount of $12.0 million, which was
recognized as income from settlement and patent licensing in the three months
ended March 31, 2007.







F-26





In June
2007, The Company entered into a Patent License Agreement with Radvision
Ltd.  Under the license agreement, the Company granted Radvision and its
subsidiaries a license in the field of videoconferencing to all of the Company’s
patents, patent applications and patents issuing therefrom with a filing date on
or before May 15, 2007.  Also under the license agreement, Radvision
granted the Company a license in the field of videoconferencing to all of
Radvision’s patents, patent applications and patents issuing there from with a
filing date on or before May 15, 2007.  As partial consideration for the
licenses and releases granted under the agreement, Radvision made a one-time
license payment of $4.0 million, which was recognized as licensing revenue in
the three months ended June 30, 2007.




As
described in the Summary of Significant Accounting Policies, Income from
Settlement and Patent Licensing, we expect to recognize the payment received
from Polycom and the associated deferred contingent legal costs paid in
settlement and patent licensing in equal installments over a five-year period
starting November 12, 2004. The payment from Polycom and its recognition in
income from settlement and patent licensing may affect the comparability of the
Company’s financial statements for periods before and after the recognition
periods.




Quarter EndedDecember 31,
              2007
            
            September 30,
              2007
            
            June 30,
              2007
            
            March 31,
              2007(In thousands except per share data)Total
      revenue
            
            $
            1,914
            
            
            $
            1,751
            
            $
            5,898
            
            $
            2,392Cost
      of product revenue
            
            
            586
            
            
            
            658
            
            
            711
            
            
            729Cost
      of services, maintenance and support revenue
            
            
            503
            
            
            
            493
            
            
            571
            
            
            676Net
      (loss) income
            
            $
            (3,693
            )
            
            $
            (4,126
            )
            $
            388
            
            $
            4,493Net
      (loss) income per share—Basic/Diluted
            
            $
            (0.11
            )
            
            $
            (0.12
            )
            $
            0.01
            
            $
            0.13Weighted
      average shares—Basic
            
            
            34,448
            
            
            
            34,379
            
            
            34,230
            
            
            34,101Weighted
      average shares—Diluted
            
            
            34,448
            
            
            
            34,379
            
            
            35,008
            
            
            35,146







Quarter EndedDecember 31,
              2006
            
            September 30,
              2006
            
            June 30,
              2006
            
            
            March 31,
              2006(In thousands except per share data)Total
      revenue
            
            $
            2,337
            
            
            $
            7,276
            
            $
            1,754
            
            $
            1,858Cost
      of product revenue
            
            
            834
            
            
            
            998
            
            
            721
            
            
            632Cost
      of services, maintenance and support revenue
            
            
            454
            
            
            
            374
            
            
            385
            
            
            607Net
      (loss) income
            
            $
            (3,191
            )
            
            $
            1,818
            
            $
            (3,720
            )
            $
            $(3,056
            )Net
      (loss) income per share—Basic/Diluted
            
            $
            (0.09
            )
            
            $
            0.05
            
            $
            (0.11
            )
            
            $(0.09
            )Weighted
      average shares—Basic
            
            
            34,031
            
            
            
            33,965
            
            
            33,880
            
            
            33,834Weighted
      average shares—Diluted
            
            
            34,031
            
            
            
            34,860
            
            
            33,880
            
            
            33,834










F-27





Item
      15(a)




AVISTAR
COMMUNICATIONS CORPORATION AND SUBSIDIARY




SCHEDULE
II—VALUATION AND QUALIFYING ACCOUNTS




Balance at
              Beginning of
              Year
            
            Additions
              Charged to
              Operations
            
            Write-Offs
            
            Balance at
              End of Year(In thousands)Allowance
      for Doubtful AccountsPeriod
      Ended:December 31,
      2007
            
            $
            51
            
            
            $
            17
            
            
            $
            (44
            )
            
            $
            24December 31,
      2006
            
            $
            121
            
            
            $
            (61
            )
            
            $
            (9
            )
            
            $
            51December 31,
      2005
            
            $
            22
            
            
            $
            120
            
            
            $
            (21
            )
            
            $
            121










S-1


INDEX
TO EXHIBITS




3.2
            
            Restated
      Certificate of Incorporation (Filed as an exhibit to the Company’s
      Registration Statement on Form S-1 (File No. 333-39008) as declared
      effective by the Securities and Exchange Commission on August 16,
      2000.)3.3
            
            Bylaws
      of Avistar Communications Corporation (Filed as an exhibit to the
      Registrant’s Annual Report on Form 10-K for the year ended December 31,
      2004 filed with the Securities and Exchange Commission on March 28,
      2005.)4.1
            
            Specimen
      Certificate evidencing shares of Common Stock (Filed as an exhibit to the
      Company’s Registration Statement on Form S-1 (File No. 333-39008) as
      declared effective by the Securities and Exchange Commission on August 16,
      2000.)10.1
            
            1997
      Stock Option Plan, as amended* (Filed as an exhibit to the Company’s
      Registration Statement on Form S-1 (File No. 333-39008) as declared
      effective by the Securities and Exchange Commission on August 16, 2000.)10.1.1
            
            1997
      Stock Option Plan Form of Stock Option Agreement* (Filed as an exhibit to
      the Company’s Registration Statement on Form S-1 (File No. 333-39008) as
      declared effective by the Securities and Exchange Commission on August 16,
      2000.)10.2
            
            2000
      Stock Option Plan, as amended* (Filed as an exhibit to the Company’s
      Registration Statement on Form S-1 (File No. 333-39008) as declared
      effective by the Securities and Exchange Commission on August 16,
      2000.)10.3
            
            2000
      Director Option Plan, as amended* (Filed as an exhibit to the Registrant’s
      Annual Report on Form 10-K for the year ended December 31, 2005 filed with
      the Securities and Exchange Commission on April 28,
  2006.)10.4
            
            Form
      of Director Option Agreement* (Filed as an exhibit to the Company’s
      Registration Statement on Form S-1 (File No. 333-39008) as declared
      effective by the Securities and Exchange Commission on August 16,
      2000.)10.5
            
            2000
      Employee Stock Purchase Program, as amended* (Filed as an exhibit to the
      Registrant’s Quarterly Report on Form  10-Q for the three months
      ended September 30, 2006 filed with the Securities and Exchange Commission
      on November 14, 2006.)10.6
            
            Form
      of Indemnification Agreement* (Filed as an exhibit to the Company’s
      Registration Statement on Form S-1 (File No. 333-39008) as declared
      effective by the Securities and Exchange Commission on August 16,
      2000.)10.7
            
            Settlement
      Agreement and Release between the Registrant and R. Stephen Heinrichs
      dated April 26, 2001* (Filed as an exhibit to the Registrant’s Current
      Report on Form 8-K filed with the Securities and Exchange Commission on
      May 8, 2001.)10.8
            
            Lease
      Agreement among the Registrant and Crossroads Associates and Clocktower
      Associates dated December 1, 2006 (Filed as an exhibit to the
      Registrant’s Annual Report on Form 10-K for the year ended December 31,
      2006 filed with the Securities and Exchange Commission on March 22,
      2007.)10.9
            
            Common
      Stock Purchase Agreement by and among the Registrant and The Gerald J.
      Burnett and Marjorie J. Burnett Revocable Trust, Grady Burnett and
      Wendolyn Hearn dated October 15, 2003 (Filed as an exhibit to the
      Registrant’s Quarterly Report on Form 10-Q for the three months ended
      September 30, 2003 filed with the Securities and Exchange Commission on
      October 23, 2003.)10.10
            
            Stock
      Purchase Agreement among the Registrant, Fuller & Thaler Behavioral
      Finance Fund, Ltd. and Fuller & Thaler Avalanche Fund, L.P. dated
      March 23, 2004 (Filed as an exhibit to the Registrant’s Quarterly Report
      on Form 10-Q for the quarter ended March 31, 2004 filed with the
      Securities and Exchange Commission on May 11, 2004.)10.11
            
            Settlement
      Agreement among the Registrant, Collaboration Properties, Inc. and
      Polycom, Inc. dated November 12, 2004 (Filed as an exhibit to the
      Registrant’s Annual Report on Form 10-K for the year ended December 31,
      2004 filed with the Securities and Exchange Commission on March 28,
      2005.)10.12†
            
            Patent
      Cross-License Agreement Among the Company, Collaboration Properties, Inc.
      and Polycom, Inc. dated November 12, 2004 (Filed as an exhibit to the
      Registrant’s Annual Report on Form 10-K for the year ended December 31,
      2005 filed with the Securities and Exchange Commission on April 28,
      2006.)10.13†
              
              
              10.14†
            
            Patent
      License Agreement dated May 15, 2006 among the Registrant, Collaboration
      Properties, Inc., Sony Corporation and Sony Computer Entertainment, Inc.
      (Filed as an exhibit to the Registrant’s Quarterly Report on Form 10-Q for
      the three months ended September 30, 2006 filed with the Securities and
      Exchange Commission on November 14, 2006.)
              Patent
      License Agreement dated February 15, 2007 by and among the Registrant,
      Collaboration Properties, Inc., Tandberg ASA, Tandberg Telecom AS, and
      Tandberg, Inc. (Filed on May 14, 2007 as an exhibit to the Registrant’s
      Quarterly Report on Form 10-Q for the quarter ended March 31,
      2007)10.15†
            
            Patent
      License Agreement dated May 15, 2007 by and among the Registrant, Avistar
      Systems (UK) Limited, and Radvision LTD.  (Filed on August 3,
      2007 as an exhibit to the Registrant’s Quarterly Report on Form 10-Q for
      the quarter ended June 30, 2007)10.16
            
            Employment
      Agreement between the Registrant and Simon B. Moss effective July 16,
      2007. * (Filed on November 13, 2007 as an exhibit to the Registrant’s
      Quarterly Report on Form 10-Q for the quarter ended September 30,
      2007)10.17
            
            Amended
      and restated Security Agreement dated December 17, 2007 between the
      Registrant and JPMorganChase Bank, N.A. originally dated December 23,
      2006. (Filed herewith)10.18
            
            Amendment
      dated December 17, 2007 to the Revolving Credit Promissory Note issued by
      the Registrant in favor of JPMorgan originally dated December 23, 2006.
      (Filed herewith)10.19
            
            Second
      amendment dated December 17, 2007 to the Revolving Credit Promissory Note
      issued by the Registrant in favor of JPMorgan originally dated December
      23, 2006. (Filed herewith)10.20
            
            Amendment
      dated December 17, 2007 to the Guaranty issued by Gerald J. Burnett and
      The Gerald J. Burnett and Marjorie J. Burnett Revocable Trust in favor of
      JPMorgan originally dated December 23, 2006. (Filed
    herewith)10.21
            
            Convertible
      Note Purchase Agreement among the Company and the Purchasers named therein
      dated January 4, 2008 (Filed on January 9, 2008 as an exhibit to the
      Registrant’s Current Report on Form 8-K)10.22
            
            Security
      Agreement among the Company, Baldwin Enterprises, Inc., as Collateral
      Agent, and the Purchasers named therein dated January 4, 2008 (Filed on
      January 9, 2008 as an exhibit to the Registrant’s Current Report on Form
      8-K)10.23
            
            Form
      of 4.5% Convertible Subordinated Secured Note Due 2010 (Filed on January
      9, 2008 as an exhibit to the Registrant’s Current Report on Form
      8-K)10.24
            
            Inter-creditor
      Agreement among the Purchasers of the 4.5% Convertible Subordinated
      Secured Notes Due 2010 dated January 4, 2008 (Filed on January 9, 2008 as
      an exhibit to the Registrant’s Current Report on Form
  8-K)21.1
            
            Subsidiaries
      of the Company23.1
            
            Consent
      of Independent Registered Public Accounting Firm: Burr, Pilger & Mayer
      LLP24.1
            
            Power
      of Attorney (see page 56)31.1
            
            Rule
      13a-14(a)/15d-14(a) Certification by the Chief Executive
      Officer31.2
            
            Rule
      13a-14(a)/15d-14(a) Certification by the Chief Financial
      Officer32
            
            Certification
      by the 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




*Indicates
      management contract or compensatory plan or arrangement required to be
      filed an exhibit pursuant to Item 14(c) of
      Form 10-K.


†Portions
      of the exhibit have been omitted pursuant to a request for confidential
      treatment and the omitted portions have been separately filed with the
      Commission.