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, 2008




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 companyx




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, 2008 was $11,617,788. 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 3, 2009, the registrant had outstanding 34,756,861 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 2009 Annual
Meeting of Stockholders.







Table of Contents


AVISTAR COMMUNICATIONS CORPORATION




ANNUAL
REPORT ON FORM 10-K




YEAR
ENDED DECEMBER 31, 2008




TABLE OF CONTENTS
            
            PagePART IItem 1. Business
            
            
            3Item 1a. Risk Factors
            
            
            16Item 1b. Unresolved Staff Comments
            
            
            23Item 2. Properties
            
            
            23Item 3. Legal Proceedings
            
            
            24Item 4. Submission of Matters to a Vote of Security
      Holders
            
            
            24PART IIItem 5. Market for Registrant’s Common Equity, Related
      Stockholder Matters and Issuer Purchases of Equity
      Securities
            
            
            24Item 6. Omitted
            
            
            24Item 7. Management’s Discussion and Analysis of Financial
      Condition and Results of Operations
            
            
            24Item 7a. Omitted
            
            
            35Item 8. Financial Statements and Supplementary
      Data
            
            
            35Item 9. Changes in and Disagreements with Accountants on
      Accounting and Financial Disclosure
            
            
            35Item 9a. Controls and Procedures
            
            
            36Item 9b. Other Information
            
            
            36PART IIIItem 10. Directors, Executive Officers and Corporate
      Governance
            
            
            36Item 11. Executive Compensation
            
            
            37Item 12. Security Ownership of Certain Beneficial Owners
      and Management and Related Stockholder
              Matters
            
            
            37Item 13. Certain Relationships and Related Transactions and
      Director Independence
            
            
            37Item 14. Principal Accountant Fees and
      Services
            
            
            37PART IVItem 15. Exhibits, Financial Statement
      Schedules
            
            
            38Signatures
            
            
            41Index to Financial Statements
            
            
            F-1












2
 Table of Contents


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.




PART I




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.  In October 2007, the Company merged Collaboration
Properties, Inc., a wholly-owned subsidiary of the Company, with and into the
Company, with the Company being the surviving corporation.  Avistar
has one remaining wholly-owned subsidiary, Avistar Systems U.K. Limited
(ASUK).




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 100 F Street, NE, Washington, D.C. 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 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
limited 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.




3
 Table of Contents




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, 2008, we held 96 U.S. and foreign patents, which we look to
license to others in the collaboration technology marketplace.




In late
2007 and 2008, we implemented 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 these initiatives include:




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




·
            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 software-only
      product set with video as the primary, empowering
    technology;




·
            Implementing
      aggressive cost control measures structured to effectively align
      operations and to address Microsoft's requests for re-examination of our
      U.S. Patents, while still allowing us to continue to invest in our product
      line and to license our intellectual property and
    technology,




·
            A
      reduction in our employees from an average of 88 in 2007 to approximately
      50 on December 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 in order 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.




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
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.




4
 Table of Contents




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:




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;




5
 Table of Contents


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.




We
believe high quality visual unified communications allow businesses to improve
collaboration and thereby offer them the opportunity to increase productivity,
enhance customer service and revenue generation, and facilitate
business-to-business interactions that reduce costs, all on an accelerated
basis. We also believe that, just as every organization now relies on a
telephone network, and most businesses increasingly rely on the Internet, a
market is emerging in which businesses and other organizations will choose to
rely on fully integrated video, audio and data collaboration, regardless of
networks, to make their business applications more effective.




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 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.




6
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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 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.




7
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·
            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 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.




8
 Table of Contents


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
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.




9
 Table of Contents


·
            Expandable to thousands of
      users:Because
      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 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.




10
 Table of Contents


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., Radvision, LifeSize
Communications, Inc. and International Business Machines Corp. (IBM). 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, 2008, we had 96 U.S. and
foreign patents covering various aspects of our technology, with expiration
dates ranging from 2013 to 2018, and have over 28 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.




·
            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, 2008, can be found in our Consolidated Financial
Statements attached hereto.




Customers




Video
      Communications Products




As of
December 31, 2008, we have licensed and recognized revenue with respect to
over 22,000 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, 2008, Deutsche Bank AG and its affiliates, UBS Warburg
LLC and its affiliates,  IBM and Sony Corporation accounted for 40%,
19%, 18% and 11% of our total revenues, respectively. 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.
The level of sales to any customer may vary from quarter to quarter, and while
we continue to expand our indirect sales channel, 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 51%, 72% and 75% of total revenue for 2008,
2007and 2006, respectively. For 2008, 2007and 2006, revenues to customers in the
United Kingdom accounted for 22%, 12% and 12% of total revenue,
respectively.




Licensing
      Activities




We
derived 11% or $954,000, 42%, or $5.0 million and 39%, or $5.2 million, of our
annual revenues in 2008, 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 2008 was
primarily generated by licenses granted to Sony Corporation and its
subsidiaries.  License revenue in 2007 was primarily generated by
licenses granted to 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.




11
 Table of Contents


Sales
and Marketing




Direct 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.




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 a
backlog of $326,000 in product orders at December 31, 2008. 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, 2008, 2007 and 2006 was $5.2 million, $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.




12
 Table of Contents


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
37 United States patents and 59 foreign patents as of December 31, 2008.
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
our remaining five U.S. patents.  On June 10, 2008 we announced that
the U.S. Patent and Trademark Office (USPTO) had completed its review of
Microsoft’s requests for re-examination and had rejected 19 of the
re-examination applications in their entirety, and the majority of the arguments
for one additional application. The USPTO agreed to re-examine, either in part
or fully, 10 of our existing U.S. patents.  Subsequently, Microsoft
submitted five petitions for reconsideration of the USPTO’s rejection of
Microsoft’s re-examination applications.  The USPTO’s review of the
five petitions for reconsideration is currently in process, with an
indeterminate time period established for their decision on Microsoft’s
request.




Once
undertaken, the USPTO may take between six months and two years to complete
patent re-examinations.  We believe that our U.S. patents are valid
and we intend to defend our patents through the 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.  The re-examination process by the USPTO may adversely
impact our licensing negotiations in process, and may require us to spend
substantial time and resources defending our patents, including the fees and
expenses of our legal advisors.  The potential impact to our results
of operations may require us to reduce our other operating expenses and seek
additional financing to fund our operations and the defense of our patents.




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.




13
 Table of Contents


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 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.




14
 Table of Contents




Employees




As of
December 31, 2008, we had 50 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 them
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 of the Registrant




Our
officers and their ages as of December 31, 2008 were as
follows:




Name
            
            
            
            
            Age
            
            
            PositionSimon
      B. Moss
            
            43
            
            Chief
      Executive OfficerElias
      MurrayMetzger
            
            38
            
            Acting
      Chief Financial OfficerJ.
      Chris Lauwers
            
            48
            
            Chief
      Technology and Product OfficerDarren
      Innes
            
            43
            
            General
      Manager – Global SalesAnton
      F. Rodde
            
            66
            
            President,
      Intellectual Property DivisionStephen
      Epstein
            
            49
            
            Chief
      Marketing OfficerMichael
      Horn
            
            35
            
            Vice
      President, Operations and Customer
Support




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.




Elias MurrayMetzger has
served as Acting Chief Financial Officer of Avistar since January
2009.  From January 2006 to January 2009, Mr. MurrayMetzger served as
Avistar's worldwide Corporate Controller, playing a key role in the Company’s
financial reporting and compliance functions. From April 2004 to January 2006,
Mr. MurrayMetzger served as Assistant Controller of Centra Software, Inc., a
provider of software solutions for online business communication, collaboration
and learning. During his tenure at Centra, Mr. MurrayMetzger successfully
navigated Centra’s Sarbanes-Oxley compliance effort and SEC reporting functions.
Mr. MurrayMetzger worked in the technology audit practice of
PricewaterhouseCoopers from February 2000 to March 20004. He is a Certified
Public Accountant and has a Bachelors of Science in Agribusiness with a
concentration in finance from California Polytechnic State University, San Luis
Obispo.




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.




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.




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.




Stephen Epstein joined
Avistar in January 2008. Prior to Avistar he was Vice President, Head of Product
Management at Mantas, Inc. from July 2003 to January 2008, where he was
responsible for global product strategy, managing product requirements, defining
go to market plans and marketing strategy, while evaluating the financial
services market. Previously to joining Mantas, Epstein was Head of Product &
Business Development at Bang Networks from May 2002 to July 2003 where he
spearheaded product and business development efforts, focusing on delivering
real-time information distribution products. Mr. Epstein held senior-level
management and product development positions including Head of Global Foreign
Exchange Sales Technology and Group CTO at Deutsche Bank from March 1995 to May
2002.




Michael Horn has served as
Avistar's Vice President, Operations and Customer Support since August
2007.  He joined Avistar in April 2007 as Director of Managed
Services.  From January 2005 to April 2007, Mr. Horn worked as an
independent technology and strategy consultant at Caddis Consulting, a company
he founded to work with companies ranging from small venture-backed startups to
Fortune 500 companies.  From May 2004 to January 2005, Mr. Horn was
the Director, Product Management at Level 3 Communications. From May
2000 to May 2004, he served as Director, Engineering and Architecture
at Virtela Communications.  Mr. Horn has a Bachelor of Science in
Electrical Engineering from George Mason University and a MBA from University of
Denver.




15
 Table of Contents


Item
1a.Risk
Factors




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 $6.4 million for 2008, $2.9 million for 2007 and $8.1
million for 2006. As of December 31, 2008, our accumulated deficit was
$112.1 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, distribution partners and licensees. If our revenue
does not increase adequately, we may not become 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.




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.




We may need to arrange for the
availability of additional funding in order to meet our future business
requirements. We have a
revolving credit facility under which $7.0 million was outstanding on December
31, 2008, which matures on December 21, 2009, and $7.0 million in outstanding
convertible promissory notes that become due and payable on January 4, 2010 if
not earlier converted.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 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 by reducing 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
have implemented significant changes in our organizational structure, sales,
marketing and distribution strategies, 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 on January 1, 2008 Gerald Burnett
resigned from his position as our Chief Executive Officer and was replaced in
that position by Simon Moss.  In January 2009, Bob Habig resigned from
the position of Chief Financial Officer and he was replaced in that position by
Elias MurrayMetzger, the Company’s Corporate Controller.  In addition,
during the second half of 2007 and in 2008, we implemented a number of other
management changes.   In 2007 and 2008, we implemented 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:




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




·
            Implementing
      aggressive cost control measures structured to effectively align
      operations  with predictable revenues and to address Microsoft's
      requests for re-examination of our U.S. Patents, while still allowing us
      to continue to invest in our product line and to license our intellectual
      property and technology;




·
            A
      reduction in our employees from an average of 88 in 2007 to approximately
      50 at December 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 fully 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.




16
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We
may not satisfy the criteria for continued
listing on The NASDAQ Capital Market and
our securitiescould be subject todelisting, which could materially
and adversely affect the price and liquidity of our stock, our business and our
financial condition.




On
November 21, 2008, we received a deficiency letter from The NASDAQ Stock Market
indicating that we did 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.  We were granted a 30 day
grace period, or until December 22, 2008 to regain compliance with the
$35,000,000 provision of the Rule by recording a minimum closing bid price
of $1.02 for a minimum of ten consecutive business days.




On
December 24, 2008, we received a notice from The Nasdaq Stock Market stating
that Avistar has not regained compliance with Nasdaq Marketplace Rule
4310(c)(3)(B) and, as a result, our securities are subject to de-listing from
The Nasdaq Capital Market unless we appealed the Nasdaq Staff’s determination to
a Nasdaq Listing Qualifications Panel.




We
appealed the Nasdaq Staff’s determination to the Listing Qualifications Panel
which automatically resulted in the stay of the Staff’s de-listing of our common
stock.  The appeal took place on January 29, 2009 and the Listing
Qualifications Panel has the authority to grant Avistar a further extension of
time in which to regain compliance with the Marketplace Rules, though there can
be no assurance that the Panel will grant a further extension of
time.   In the event that the Panel rejects our appeal, our
securities will be subject to immediate delisting from The Nasdaq Capital
Market.




There can
be no assurance that our securities will continue to be listed on The NASDAQ
Capital Market, which may cause 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 or enter
      into technology or distribution
partnerships;




·
            developments
      in the examination of our patent applications and the re-examination of
      some 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;




·
            limited
      trading volume of shares; 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 recently experienced significant price and volume
fluctuations, which have particularly affected the market prices for high
technology and micro-cap companies, and which often are unrelated and
disproportionate to the operating performance of specific companies. These broad
market fluctuations, as well as general economic, political and market
conditions, may negatively affect the market price of our common
stock.




17
 Table of Contents




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 and which may affect the value of
your investment.




Our
executive officers, directors and entities affiliated with them, in the
aggregate, beneficially owned approximately 62% of our common stock as of
December 31, 2008. 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.




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.




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, distributors and technology partners about the
uses and benefits of our system and the value added through the adoption of our
technology. Our efforts to educate potential customers and partners 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 or technology. 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, large follow-on orders,
distributors and technology partners 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 through direct
sales.   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.  Our shift to indirect distribution partners further limits the
visibility we have on the progress and timing of large initial or follow-on
orders. 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.




18
 Table of Contents


Because
we still 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.




To date,
a significant portion of our revenue and income from settlement and patent
licensing has resulted from sales or licenses to a limited number of customers,
particularly Deutsche Bank AG, UBS AG, Polycom, Inc., IBM, and Sony and their
affiliates.  Collectively, Deutsche Bank AG, UBS AG, Polycom, Inc., IBM,
Sony Corporation, and their affiliates accounted for approximately 92% of
combined revenues and income from settlement and patent licensing for the year
2008. As of December 31, 2008, approximately 98% of our gross accounts
receivable was concentrated with four customers, each of whom represented more
than 10% of our gross accounts receivable. As of December 31, 2007,
approximately 78% of our gross accounts receivable was concentrated with three
customers, each of whom represented more than 10% of our 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 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. Additionally, we expect to complete
the amortization of the Polycom, Inc. 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, Inc. and Tandberg, our licensing revenue and
our income from settlement and 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
reflects:


·
              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;
  ·
              transition
      from hardware appliances and infrastructure to software;
    and
  ·
              transition
      to Internet protocol connectivity for video at the desktop, with
      increasing availability of bandwidth and quality of
    service.


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 integrating our products with technology partner’s 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. Under certain circumstances initial
product and installation revenue is recognized under the percentage of
completion method. The estimate of current period percentage of completion
requires significant management judgment and is subject to updates in future
periods until the project is complete. If we experience difficulties with
installations or do not meet deadlines due to delays caused by our customers or
ourselves, we could be required to devote more customer support, technical,
engineering and other resources to a particular installation, modification or
enhancement project, and revenue may be delayed.




19
 Table of Contents


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, Inc., Tandberg ASA,
Sony Corporation, Apple Inc., Radvision Ltd. and Emblaze-VCON
Ltd.  Many of these companies, including Polycom, Inc., 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 U.S.
and global economy has entered a recession, and our customers and potential
customers, partners and distributors may delay or forego ordering our products,
and we could fall short of our revenue expectations for 2009 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. The reexamination of our patents by the USPTO as
described below or other challenges to our patent portfolio further complicate
and delay our patent licensing efforts.  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. To finance litigation to defend or
enforce our intellectual property rights, we may enter into contingency
arrangements and other strategic transactions with investors, legal counsel or
other advisors that would give such parties a significant portion of any future
licensing and settlement amounts derived from our patent portfolio. 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.




20
 Table of Contents


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 our remaining five U.S. patents.  On
June 10, 2008 we announced that the USPTO had completed its review of
Microsoft’s requests for re-examination and had rejected 19 of the
re-examination applications in their entirety, and the majority of the arguments
for one additional application. The USPTO agreed to re-examine, either in part
or fully, 10 of our existing patents.  Subsequently, Microsoft
submitted five petitions for reconsideration of USPTO’s rejection of Microsoft’s
re-examination applications.  The USPTO’s review of the five petitions
for reconsideration is currently in process, with an indeterminate time period
established for their decision on Microsoft’s request.




Once
undertaken, the USPTO may take between six months and two years to complete
patent re-examinations.  We believe that our U.S. patents are valid
and we intend to defend our patents through the 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.  The re-examination process by the USPTO may adversely
impact our licensing negotiations in process, and may require us to spend
substantial time and resources defending our patents, including the fees and
expenses of our legal advisors.  The potential impact to our results
of operations may require us to seek additional financing to fund our operations
and the defense of our patents.




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, partners 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 is possible that a third party could 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 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, inadequate licensing controls, unauthorized copying, and 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. 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.




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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.




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.




If we are unable to
expand our indirect distribution channel, our business will suffer.




To
increase our revenue, we must increase our indirect distribution channels, such
as systems integrators, product partners and/or value-added resellers, which is
a focus of our go-to market strategy, and/or effect sales through our customers.
If we are unable to increase our indirect distribution channel due to our own
cost constraints, limited availability of qualified partners 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 and channel partners.
Furthermore, it can take several months before a new hire or channel partner
becomes a productive member of our sales force effort. 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.




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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 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 51% of total revenue for 2008, 72% for 2007
and 75% for 2006.  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;




·
            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 (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
continue to have negative effects on financial markets, 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.




Item
      1b.Unresolved
      Staff Comments




None.




Item
      2.Properties




We lease
approximately 29,000 square feet of office space in San Mateo, California as our
corporate headquarters and technology licensing activities, of which we occupy
19,000 square feet and sublease 10,000 square feet.  In addition, we
lease approximately 7,000 square feet of office space in New York for sales and
marketing functions, of which we sublease substantially all of the office space
to third parties.  The above leases expire in March 2012 and 2017
respectively.  We believe that our existing facilities are adequate to
meet our current requirements, and foresee no difficulties in meeting any future
space requirements.




23
 Table of Contents


Item
      3.Legal
      Proceedings




We are
not currently party to any legal proceedings and are not aware of any threatened
legal proceedings against us.




From time
to time we may 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.




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 sale prices
for our common stock, as reported by the NASDAQ Capital Market.




Year Ended
                  December 31, 2008
                
                
                Year Ended
                  December 31, 2007High
                
                
                Low
                
                
                High
                
                
                LowFirst
      Quarter
                
                $
                1.30
                
                
                $
                0.33
                
                
                $
                1.91
                
                
                $
                1.32Second
      Quarter
                
                $
                1.53
                
                
                $
                0.81
                
                
                $
                1.75
                
                
                $
                1.28Third
      Quarter
                
                $
                1.70
                
                
                $
                0.65
                
                
                $
                1.44
                
                
                $
                1.10Fourth
      Quarter
                
                $
                1.45
                
                
                $
                0.52
                
                
                $
                1.27
                
                
                $
                0.31




On
December 31, 2008, the last reported sale price of our common stock on the
NASDAQ Capital Market was $0.88 per share. According to the records of our
transfer agent, as of December 31, 2008, there were 69 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.




Item
      6.Omitted




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. 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.




24
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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 limited 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, 2008, we held 96 U.S. and foreign patents, which we look to
license to others in the collaboration technology marketplace.




In late
2007 and 2008, we implemented 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 these initiatives included:




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




·
            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 software-only
      product set with video as the primary, empowering
    technology;




·
            Implementing
      aggressive cost control measures structured to effectively align
      operations and to address Microsoft's requests for re-examination of our
      U.S. Patents, while still allowing us to continue to invest in our product
      line and to license our intellectual property and
    technology,




·
            A
      reduction in our employees from an average of 88 in 2007 to approximately
      50 on December 31, 2008; and




·
            Pursuing
      multiple distribution, services and technology
  partners.






These and
other changes in our business were aimed at reducing our structural costs,
increasing our organizational and partner-driven capacity, and leveraging our
reputation for innovation and intellectual property leadership in order 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.




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 our remaining five U.S. patents.  On
June 10, 2008 we announced that the U.S. Patent and Trademark Office (USPTO) had
completed its review of Microsoft’s requests for re-examination and had rejected
19 of the re-examination applications in their entirety, and the majority of the
arguments for one additional application. The USPTO agreed to re-examine, either
in part or fully, 10 of our existing U.S. patents.  Subsequently,
Microsoft submitted five petitions for reconsideration of the USPTO’s rejection
of Microsoft’s re-examination applications.  The USPTO’s review of the
five petitions for reconsideration is currently in process, with an
indeterminate time period established for their decision on Microsoft’s
request.




Once
undertaken, the USPTO may take between six months and two years to complete
patent re-examinations.  We believe that our U.S. patents are valid
and we intend to defend our patents through the 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.  The re-examination process by the USPTO may adversely
impact and delay our present and future licensing negotiations, and may require
us to spend substantial time and resources defending our patents, including the
fees and expenses of our legal advisors.  The potential impact to our
results of operations may require us to reduce our other operating expenses and
seek additional financing to fund our operations and the defense of our
patents.




25
 Table of Contents


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




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 45%, 29% and 34% for 2008, 2007 and 2006, 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), or
Emerging Issues Task Force (EITF) Issue  No. 00-21, Revenue Arrangements with Multiple
Deliverables. 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 and we have
      no further obligations with respect to the agreement for which it does not
      have vendor specific objective evidence of fair value. 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.




26
 Table of Contents


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 incurred during installation and support services and shipping costs
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.




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.
Product and implementation revenue related to contracts for software development
is recognized using the percentage of completion method, in accordance with the
“Input Method”, when all of the following conditions are met: a contract exists
with the customer at a fixed price, we expect to fulfill all of our material
contractual obligations to the customer for each deliverable of the contract, a
reasonable estimate of the costs to complete the contract can be made, and
collection of the receivable is probable.  The amount of revenue
recognized is based on the total project fee under the agreement and the
percentage of completion achieved.  The percentage of completion is
measured by monitoring progress using records of actual time incurred to date in
the project compared to the total estimated project requirements, which
corresponds to the costs related to the earned revenues. 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, 2008, 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
July 2006, we entered into a Patent License Agreement with Sony Corporation
(Sony) and Sony Computer Entertainment, Inc. (SCEI). Under the license
agreement, we granted Sony 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. The license covers Sony’s
video conferencing apparatus as well as other products, including video-enabled
personal computer products and certain SCEI PlayStation products. Future
royalties under this license are being recognized as estimated royalty-based
sales occur in accordance with SOP 97-2.  We use historical and
forward looking sales forecasts provided by SCEI and third party sources in
conjunction with actual royalty reports provided periodically by SCEI directly
to us, to develop an estimate of royalties recognized for each quarterly
reporting period.  The royalty reports issued directly from SCEI to us
are delayed beyond the period in which the actual royalties occur, and thus the
estimate of current period royalties requires significant management judgment
and is subject to corrections in a future period once actual royalties become
known.




27
 Table of Contents


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 therefrom 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.




On
September 8, 2008 and on September 9, 2008, we entered into a Licensed Works
Agreement, Licensed Works Agreement Statement of Work and a Patent License
Agreement with International Business Machines Corporation, or IBM, under which
we agreed to integrate our bandwidth management technology and related
intellectual property into future Lotus Unified Communications offerings by IBM,
and to provide maintenance support services. An initial cash payment of $3.0
million was made by IBM to us on November 7, 2008.  We expect IBM to
make two additional non-refundable payments of $1.5 million, each associated
with scheduled phases of delivery.  IBM has agreed to make future
royalty payments to us equal to two percent of the world-wide net revenue
derived by IBM from Lotus Unified Communications products sold that exceeds a
contractual base amount, and maintenance payments received from existing
customers, which incorporate our technology.  The agreements have a
five year term and are non-cancelable except for material default by either
party.  The agreements also convey to IBM a non-exclusive world-wide
license to our patent portfolio existing at the time of the agreements and for
all subsequent patents issued with an effective filing date of up to five years
from the date of the agreements.  The agreements also provide for a
release of each party for any and all claims of past infringement.  We
have determined the value of maintenance based on VSOE, and allocated the
residual portion of the initial $6.0 million to the integration
project.  The residual portion is being recognized under the
percentage of completion method in accordance with the “Input Method”, and the
maintenance revenue will be recognized over the future maintenance service
period.  We believe there are no future deliverables associated with
the intellectual property patent licenses, therefore no additional provision for
this element has been made.  For the year ended December 31, 2008, we
recognized $1.3 million in product revenue and $255,000 in service revenue from
our agreements with IBM. The remaining $3.8 million is expected to be recognized
in product revenue under the percentage of completion method over the projected
development time of 12 months. The estimate of current period percentage of
completion requires significant management judgment and is subject to updates in
future periods until the project is complete.




To date,
a significant portion of our revenue has resulted from sales to Deutsche Bank
AG, UBS AG and their affiliates. In 2008, these customers, IBM, Sony and its
subsidiaries including SCEI collectively accounted for $7.7 million, or 88% of
our total revenue.  In 2007, these customers and Radvision Ltd.,
collectively 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. No other customers
individually contributed greater than 10% of our total revenue for 2008, 2007 or
2006. 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 51% of total revenue for 2008, 72% for 2007
and 75% for 2006.




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
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 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
November 12, 2004, we entered into a settlement and a patent cross-license
agreement with Polycom Inc., thus ending litigation against Polycom, Inc. for
patent infringement. As part of the settlement and patent cross-license
agreement with Polycom, Inc, we granted Polycom, Inc. 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 a priority date extending up to five
years from the date of execution of the agreement. Polycom, Inc, as part of the
settlement and patent cross-licensing agreement, made a one-time payment to the
Company of $27.5 million and we paid $6.4 million in contingent legal fees to
our 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,
Inc.  We are 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 our patented technologies for prior and future use
by Polycom, Inc. 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.




28
 Table of Contents


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” and Note 7 “Stock Option Plans and Employee Stock
Purchase Plan” 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, 2008, approximately 98% of our gross accounts receivable was
concentrated with four customers, each of whom represented more than 10% of our
gross receivables.  As of December 31, 2007, approximately 78% of our
gross accounts receivable was concentrated with three customers, each of whom
represented more than 10% of our gross accounts receivable.




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.




29
 Table of Contents


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 31,2008
                
                2007
                
                2006Revenue:Product
                
                
                45
                %
                
                
                29
                %
                
                
                34
                %Licensing
                
                
                11
                
                
                
                42
                
                
                
                39Services,
      maintenance and support
                
                
                44
                
                
                
                29
                
                
                
                27Total
      revenue
                
                
                100
                
                
                
                100
                
                
                
                100Costs
      and expenses:Cost
      of product revenues
                
                
                25
                
                
                
                22
                
                
                
                24Cost
      of services, maintenance and support revenues
                
                
                27
                
                
                
                19
                
                
                
                14Income
      from settlement and patent licensing
                
                
                (48
                )
                
                
                (136
                )
                
                
                (32
                )Research
      and development
                
                
                59
                
                
                
                64
                
                
                
                44Sales
      and marketing
                
                
                40
                
                
                
                52
                
                
                
                41General
      and administrative
                
                
                66
                
                
                
                104
                
                
                
                73Total
      costs and expenses
                
                
                169
                
                
                
                125
                
                
                
                164Loss
      from operations
                
                
                (69
                )
                
                
                (25
                )
                
                
                (64
                )Other
      income (expense):Interest
      income
                
                
                1
                
                
                
                3
                
                
                
                2Other
      (expense) income, net
                
                
                (5
                )
                
                
                (2
                )
                
                
                —Total
      other (expense) income, net
                
                
                (4
                )
                
                
                1
                
                
                
                2Loss
      before provision for (recovery from) income taxes
                
                
                (73
                )
                
                
                (24
                )
                
                
                (62
                )Provision
      for (recovery from) income taxes
                
                
                —
                
                
                
                —
                
                
                
                —Net
      loss
                
                
                (73
                )%
                
                
                (24
                )%
                
                
                (62
                )%





COMPARISON
      OF 2008 AND 2007




Revenue




Total
revenue decreased by $3.2 million or 27%, to $8.8 million for 2008, from $12.0
million for 2007, primarily due to decreases in licensing revenue.




·
            Product
      revenue increased by $0.5 million or 14%, to $4.0 million for 2008 from
      $3.5 million for 2007. The increase was primarily due to revenue of $1.3
      million from IBM, offset by decreased sales to existing customers in 2008
      compared to 2007.




·
            Licensing
      revenue, relating to the licensing of our patent portfolio, decreased by
      $4.1 million, or 81%, to $954,000 for 2008, from $5.0 million for
      2007.  The decrease was primarily attributable to the lack of
      new licensing agreements in 2008 compared to the Radvision licensing
      agreement, which resulted in $4.0 million in licensing revenue in
      2007.




·
            Services,
      maintenance and support revenue, which includes our installation services,
      funded software development and maintenance and support, increased by
      $367,000, or 11%, to $3.8 million for 2008, from $3.5 million for 2007,
      due primarily to an increase in revenue from professional on-site services
      provided to an existing customer.




In 2008,
revenue from four customers accounted for 88% of total revenue compared to three
customers and 75% in 2007. No other customer accounted for greater than 10% of
total revenue.  The level of sales to any customer may vary from quarter to
quarter. While we continue to expand our indirect sales channel, we expect that
there will be significant customer concentration in future quarters. The loss of
any one of those customers would have a materially adverse impact on our
financial condition and operating results.




30
 Table of Contents


Costs
      and expenses




Cost of product
revenue.  Cost of product revenue decreased by $489,000, or
18%, to $2.2 million in 2008 from $2.7 million for 2007. The decrease was
primarily attributable to a decrease in personnel and personnel related expenses
for the assembly and testing of products, including a decrease of $47,000 in
stock based compensation expense.  We expect the cost of product
revenue to vary with the mix of products sold in 2009.




Cost of services, maintenance and
support revenue. Cost of services, maintenance and support revenue
increased by $109,000, or 5%, to $2.4 million in 2008 from $2.2 million in 2007,
primarily due to a net increase in allocated overhead cost. We expect the cost
to vary with the mix of services, maintenance and support provided to our
customers in 2009.




Income from settlement and patent
licensing.Income from settlement
and patent licensing decreased by $12 million, or 74%, to $4.2 million in 2008
from $16.2 million for 2007. The decrease was due to the Settlement and Patent
License Agreement entered into with Tandberg ASA and its subsidiaries in
February 2007, which resulted in a cash payment to us of $12.0 million, that was
fully recognized in 2007. The years ended December 31, 2008 and 2007 each also
reflect $4.2 million of amortization of the net proceeds from the November 2004
Polycom settlement and cross-license agreement, recognized over a five year
period beginning in November 2004 and ending in November 2009.




Research and
development.Research
and development expenses decreased by $2.5 million, or 32%, to $5.2 million in
2008 from $7.7 million in 2007. The decrease was primarily attributable to a
decrease in personnel and personnel related expenses, including a decrease of
$368,000 in stock based compensation expense. Research and development expenses
in 2009 are expected to decrease as part of the aggressive ongoing cost control
measures.




Sales and marketing.Sales
and marketing expenses decreased by $2.7 million, or 43% to $3.5 million in 2008
from $6.2 million in 2007. The decrease was primarily attributable to a decrease
in personnel and personnel related expenses, including a decrease of $576,000 in
stock based compensation expense.  Sales and marketing expenses are
expected to remain relatively flat in 2009.




General and
administrative.General
and administrative expenses decreased by $6.8 million, or 54%  to $5.7
million in 2008 from $12.5 million in 2007. The decrease was due primarily to
$4.3 million in legal fees associated with our litigation against Tandberg for
patent infringement that occurred during 2007, with no comparable expense in the
same period during 2008.   Additionally, to a lesser extent,
there was a decrease in personnel and personnel related expenses including a
decrease of $191,000 in stock based compensation expense, partially offset by
increased employee severance expense, incurred primarily during the first
quarter of 2008. General and administrative expenses in 2009 are expected to
decrease as part of the aggressive ongoing cost control measures.




Other
      income (expense)




Interest income.Interest
income decreased by $252,000, or 73%, to $94,000 in 2008 from $346,000 in 2007.
The decrease was due to both a decrease in interest rates and a decrease in the
average outstanding balance of investments that earned interest in 2008, as
compared to 2007.




Other expense, net.Other
expense, net increased by $251,000, or 134%, to $439,000 in 2008 from $188,000
in 2007.  The increase was due to higher interest expense due to a
higher outstanding balance of debt outstanding during 2008, as compared to
2007.




Provision
      for (recovery from) income
taxes




There was
no significant change in the provision for income taxes in 2008 as compared to
2007.  Both provisions for income taxes of $23,000 in 2008 and 2007
were related to foreign tax expense.




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 remained relatively flat at $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.




31
 Table of Contents


Costs
      and expenses




Cost of product
revenue.  Total cost of revenue decreased by $501,000, or 16%,
in 2007 to $2.7 million from $3.2 million for 2006. The decrease in total cost
of revenue in 2007 relative to 2006 was primarily due to declines in product
sales, offset by an increase in personnel salary and benefits.




Cost of services, maintenance and
support revenue. Cost of services, maintenance and support revenues
increased by $423,000 or 23% to $2.2 million for 2007, from $1.8 million for
2006.  This increase was attributable to an increase in funded software
development project costs in 2007.




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.




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.




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.




Other
      income (expense)




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.




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.




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, and
the proceeds of $7.0 million from issuance of Convertible Subordinated Secured
Notes in January 2008.




We had
cash and cash equivalents of $4.9 million as of December 31, 2008, and cash,
cash equivalents and short-term investments of $4.9 million as of December 31,
2007. For the year ended December 31, 2008, we had a net increase in cash and
cash equivalents of $821,000. The net cash used by operations of $8.9 million
for the year ended December 31, 2008 resulted primarily from the net loss of
$6.4 million, a decrease in deferred income from settlement and patent licensing
of $5.6 million, an increase in accounts receivable of $1.3 million, a decrease
in account payable of $708,000, all offset by an increase in deferred services
revenue and customer deposits of $1.5 million, non-cash expenses of $2.0
million,  and a decrease in deferred settlement and patent licensing
costs of $1.3 million.  The net cash provided by investing activities of
$718,000 for the year ended December 31, 2008 was primarily due to the
maturities of short-term investments of $799,000.  The net cash provided
by financing activities of $9.0 million for the year ended December 31,
2008 related primarily to $7.0 million in proceeds from the issuance of
convertible debt in January 2008, and $7.0 million of borrowings on our line of
credit, offset by payments made on our line of credit of $5.1 million.Our accounts
receivable at December 31, 2008 increased 95% over the December 31, 2007 balance
from $1.4 million to $2.7 million mainly due to a $1.0 million advance billing
of services to a customer in December 2008 which was subsequently collected in
January 2009.




32
 Table of Contents


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.




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.




Expenditures
for property and equipment in 2008 were approximately $89,000. At
December 31, 2008, we did not have any material commitments for future
capital expenditures. We anticipate spending approximately $105,000 in capital
expenditures during the next 12 months.




The
following table summarizes our known contractual obligations and commitments as
of December 31, 2008 (in thousands) for the periods presented.




Payments due by periodTotal
                
                
                Less than 1
                  Year
                
                
                1
      – 3
                  Years
                
                
                3
      – 5
                  Years
                
                
                More than
                  5 YearsContractual
      obligationsLong-term
      debt obligations
                
                $
                7,000
                
                
                $
                —
                
                
                $
                7,000
                
                
                $
                —
                
                
                $
                —Operating
      lease obligations, net of projected sublease proceeds
                
                
                2,998
                
                
                
                715
                
                
                
                1,814
                
                
                
                344
                
                
                
                125Purchase
      obligations
                
                
                47
                
                
                
                47
                
                
                
                —
                
                
                
                —
                
                
                
                —Total
                
                $
                10,045
                
                
                $
                762
                
                
                $
                8,814
                
                
                $
                344
                
                
                $
                125




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.




33
 Table of Contents


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,
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.  In
addition to the guarantee provided to the financial institution, on March 29,
2009, Dr. Burnett provided a personal guarantee to us assuring us a line of
credit of $10.0 million with the same terms and mechanisms as the existing
revolving line of credit in the event the existing revolving line of credit from
the financial institution was unavailable for any reason during the period from
its termination on December 21, 2009 to March 31, 2010.The line of
credit requires monthly interest-only payments based on Adjusted LIBOR plus
1.25%, or 4.5% at December 31, 2008 or Prime Rate plus 1.25%, or 4.5% at
December 31, 2008. The Company borrowed $7.0 million and $2.1 million under
the revolving line of credit for the years ended December 31, 2008 and 2007,
respectively, with an ending balance of $7.0 million as of December 31, 2008.
Balance of $5.1 million as of December 31, 2007 was fully repaid during 2008.
The Revolving Credit and Promissory Note was renewed on December 22, 2008 and
matures on December 21, 2009, and is subject to annual renewal with the
consent of the Company and the lender.




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 accrues at
the rate of 4.5% per annum and is 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.




As of
December 31, 2008, we had no material off-balance sheet arrangements, other than
the operating leases described in the contractual obligations table
above.   We enter into indemnification provisions under
agreements with other companies in our ordinary course of business, typically
with our contractors, customers, landlords and our investors. Under these
provisions, we generally indemnify and hold harmless the indemnified party for
losses suffered or incurred by the indemnified party as a result of our
activities or, in some cases, as a result of the indemnified party's activities
under the agreement. These indemnification provisions generally survive
termination of the underlying agreement. The maximum potential amount of future
payments we could be required to make under these indemnification provisions is
generally unlimited. As of December 31, 2008, we have not incurred material
costs to defend lawsuits or settle claims related to these indemnifications
agreements and therefore, we have no liabilities recorded for these agreements
as of December 31, 2008.




We are
currently in discussions with the holders of the Notes to convert the Notes into
shares of common stock in January 2010 or extend the term of the
Notes.  Assuming the conversion or extension of the Notes in
conjunction with the results of our cost reduction efforts and Dr. Burnett's
personal guarantee to Avistar to support an extension of the revolving line of
credit, we believe that our existing cash and cash equivalents balance
and line of credit 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, whether or not the holders of the Notes elect to
convert such Notes into our common stock, general economic conditions and
conditions in the financial services industry in particular, the level and
timing of product, services and patent licensing revenues and income, the
maintenance of our cost control measures structured to align operations with
predictable revenues,the costs and timing of our product development
efforts and the success of these development efforts, the costs and timing of
our sales, partnering and marketing activities, the extent to which our existing
and new products gain market acceptance, competing technological and market
developments, and the costs involved in maintaining, defending and enforcing
patent claims and other intellectual property rights, all of which may impact
our ability to achieve and maintain profitability or generate positive cash
flows.




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
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 permits entities to choose,
at specified election dates, to measure eligible financial assets, financial
liabilities and firm commitments at fair value, on an instrument-by-instrument
basis, that are otherwise not permitted to be accounted for at fair value under
other generally accepted accounting principles. The fair value measurement
election is irrevocable and subsequent changes in fair value must be recorded in
earnings. SFAS No. 159 became effective for us on January 1, 2008. We did not
elect to measure any eligible items at fair value in accordance with this new
standard either at the date we adopted this new standard or subsequently during
2008; therefore the adoption of this standard did not have an impact on our
financial position and results of operations.




34
 Table of Contents


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  adopted 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
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   adopted this statement on January 1,
2009.  The adoption of SFAS 160 did not have an impact on our
financial condition and results of operations.




In
December 2007, the FASB Emerging Issues Task Force reached a consensus and
published Issue No. 07-01, Accounting for Collaborative
Arrangements (EITF 07-01). EITF 07-01 defines a collaborative arrangement
as a contractual arrangement in which the parties are active participants to the
arrangements and exposed to significant risks and rewards that depend on the
commercial success of the endeavor. EITF 07-01 requires that costs incurred and
revenues generated from transactions with third parties should be reported by
the collaborators on the appropriate line item in their respective income
statements. EITF 07-01 also states that the income statement characterization of
payments between the participants to a collaborative arrangement should be based
on other authoritative literature if the payments are within the scope of such
literature. EITF 07-01 requires collaborators to disclose, in the footnotes to
financial statements in the initial period of adoption and annually thereafter,
the income statement classification and amounts attributable to transactions
arising from collaborative arrangements between participants for each period for
which an income statement is presented and information regarding the nature and
purpose of the collaborative arrangement, the collaborators' rights and
obligations under the arrangement, and any accounting policies for the
collaborative arrangement. EITF 07-01 is effective for fiscal years beginning
after December 15, 2008. We adopted this statement on January 1,
2009.  The adoption of EITF 07-01 did not have material impact on our
financial condition and results of operations.




In
February 2008, the FASB issued FASB Staff Position No. FAS 157-2, Effective Date of FASB Statement No.
157 (FSP 157-2), to partially defer SFAS 157, Fair Value Measurements. FSP
157-2 defers the effective date of SFAS 157 for nonfinancial assets and
nonfinancial liabilities, except those that are recognized or disclosed at fair
value in the financial statements on a recurring basis (at least annually), to
fiscal years, and interim periods within those fiscal years, beginning after
November 15, 2008. We adopted this statement on January 1, 2009.  The
adoption of FSP 157-2 did not have material impact on our financial condition
and results of operations.




Item
      7a.  Omitted




Item
      8. Financial Statements and Supplementary
      Data




Our
consolidated financial statements and Report of Independent Registered Public
Accounting Firm appears on pages F-1 through F-25 of this
Report.




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




None


35
 Table of Contents




Item
      9a.Controls and
      Procedures




Evaluation
of disclosure controls and procedures




Our
management evaluated, with the participation of our Chief Executive Officer and
Acting 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 (the Evaluation Date). Based on this evaluation, our Chief
Executive Officer and Acting Chief Financial Officer have concluded as of the
Evaluation Date 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)) were effective such 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 Acting 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 Acting Chief Financial
Officer, we conducted an evaluation of the effectiveness of our internal control
over financial reporting as of December 31, 2008 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, 2008.




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, 2008 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




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
2009 Annual Meeting of Stockholders, to be filed with the Securities and
Exchange Commission within 120 days of December 31, 2008, 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.




36
 Table of Contents




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, 2008 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
                    
                    
                    11,629,599
                    (1)
                    
                    $
                    1.97
                    
                    
                    
                    2,797,294
                    (2)Equity
      compensation plans not approved by security holders
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —Total
                    
                    
                    11,629,599
                    
                    
                    $
                    1.97
                    
                    
                    
                    2,797,294








(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. 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
      1,220,219 shares available for issuance under the 2000 Option Plan,
      341,480 shares available for issuance under the Director Plan and
      1,235,595 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,
      2008, 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, 2008.




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.




37
 Table of Contents


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, 2008 and
      2007
              
              
              F-3Consolidated Statements of Operations for the years ended
      December 31, 2008, 2007 and 2006
              
              
              F-4Consolidated Statements of Stockholders’ Equity (Deficit) for
      the years ended December 31, 2008, 2007 and 2006
              
              
              F-5Consolidated Statements of Cash Flows for the years ended
      December 31, 2008, 2007 and 2006
              
              
              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 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
      onAugust 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.)




38
 Table of Contents




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†
              
              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.)10.14†
              
              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 theRegistrant, 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 as an exhibit to the Registrant’s Annual
      Report on Form 10-K for the year ended December 31, 2007 filed with the
      Securities and Exchange Commission on March 31,
    2008)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 as an exhibit to the Registrant’s Annual
      Report on Form 10-K for the year ended December 31, 2007 filed with the
      Securities and Exchange Commission on March 31,
    2008)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 as an
      exhibit to the Registrant’s Annual
      Report on Form 10-K for the year ended December 31, 2007 filed with the
      Securities and Exchange Commission on March 31,
    2008)10.20
              
              Amendment dated December 17, 2007 to the Guaranty
      issued by Gerald J. Burnett and The GeraldJ. Burnett and Marjorie J. Burnett Revocable
      Trust in favor of JPMorgan originally dated December 23, 2006.(Filed as an exhibit to the
      Registrant’s Annual Report on Form 10-K for the year ended
      December 31, 2007 filed with the Securities and Exchange Commission on March 31,
  2008)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)




39
 Table of Contents




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 (Filedon January 9, 2008 as an
      exhibit to the Registrant’s Current
      Report on Form 8-K)10.25†
              
              Licensed
      Works Agreement between Avistar Communications Corporation and
      International Business Machines Corporation dated September 8, 2008.(Filed as an exhibit tothe Registrant’s Quarterly
      Report on Form 10-Q for the three months ended September 30, 2008 filed
      with the Securities and Exchange Commission on November 14,
      2008.)10.26†
              
              Licensed
      Works Agreement Statement of Work between Avistar Communications
      Corporation and International Business Machines Corporation dated
      September 8, 2008.(Filed as an exhibit to
      the Registrant’s Quarterly Report on Form 10-Q for the three
      months ended September 30, 2008 filed with the Securities and Exchange
      Commission on November14,
      2008.)10.27†
              
              Patent
      License Agreement between Avistar Communications Corporation and
      International Business Machines Corporation dated September 9, 2008. (Filed as an exhibit to the Registrant’s Quarterly
      Report on Form 10-Q for the three monthsended September 30, 2008 filed with the
      Securities and Exchange Commission on November 14,
      2008.)10.28
              
              Amended
      and Restated Revolving Credit Promissory Note issued by the Registrant to
      JPMorgan Chase Bank, N.A. dated December 22, 200810.29
              
              Facility
      Agreement between the Registrant and JPMorgan Chase Bank, N.A. dated
      December 22, 200810.30
              
              Amended
      and Restated Collateral Agreement dated December 22, 2008 between the
      Registrant and JPMorgan Chase Bank, N.A. dated December 22,
      200810.31
              
              Second
      Amended and Restated Security Agreement between the Registrant and
      JPMorgan Chase Bank, N.A.10.32
              
              Amended
      and Restated Guaranty issued by Gerald J. Burnett and The Gerald J.
      Burnett and Marjorie J. Burnett Revocable Trust in favor of JPMorgan Chase
      Bank, N.A. dated December  22, 200810.33
              
              Amended
      and Restated Form of Note Sale Agreement among Gerald J. Burnett, The
      Gerald J. Burnett and Marjorie J. Burnett Revocable Trust and JPMorgan
      Chase Bank, N.A.10.34
              
              Personal
      guarantee  issued by Gerald J. Burnett in favor of Avistar
      Communications Corporation dated March 29, 200921.1
              
              Subsidiaries
      of the Company23.1
              
              Consent
      of Independent Registered Public Accounting Firm: Burr, Pilger & Mayer
      LLP24.1
              
              Power
      of Attorney (see page 41)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.




40
 Table of Contents


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, 2009







POWER OF ATTORNEY




KNOW ALL PERSONS BY THESE PRESENTS, that each person whose
signature appears below constitutes and appoints Simon B. Moss and Elias A.
MurrayMetzger, 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, 2009Gerald J. Burnett/s/   Simon
      B. Moss
            
            Chief Executive Officer and
Director
            
            March 31, 2009Simon B. Moss/s/   Elias
      A. MurrayMetzger
            
            Acting Chief Financial Officer
      (Principal
            
            March 31, 2009Elias A. MurrayMetzger
            
            Financial and Accounting Officer)/s/   William
      L. Campbell
            
            Director
            
            March 31, 2009William L. Campbell/s/   Craig
      F. Heimark
            
            Director
            
            March 31, 2009Craig F. Heimark/s/  R.
      Stephen Heinrichs
            
            Director
            
            March 31, 2009R. Stephen Heinrichs/s/   Robert
      M. Metcalfe
            
            Director
            
            March 31, 2009Robert M. Metcalfe/s/  James
      W. Zeigon
            
            Director
            
            March 31, 2009James W. Zeigon









41
 Table of Contents


INDEX
TO FINANCIAL STATEMENTS




PageReport of Independent Registered Public Accounting
      Firm
            
            F-2Consolidated Balance Sheets as of December 31,
      2008 and 2007
            
            F-3Consolidated Statements of Operations for the years
      ended December 31, 2008, 2007 and 2006
            
            F-4Consolidated Statements of Stockholders’ Equity
      (Deficit) for the years ended December 31, 2008, 2007 and
      2006
            
            F-5Consolidated Statements of Cash Flows for the years
      ended December 31, 2008, 2007 and 2006
            
            F-6Notes to the Consolidated Financial
      Statements
            
            F-7




F-1
 Table of Contents


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,
2008 and 2007, 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, 2008. 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, 2008 and 2007, and the results of their operations and their
cash flows for each of the three years in the period ended December 31,
2008, 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.









/s/ BURR, PILGER & MAYER
      LLPSan Jose, CaliforniaMarch 30,
2009









F-2
 Table of Contents


AVISTAR COMMUNICATIONS CORPORATION AND SUBSIDIARY




CONSOLIDATED BALANCE SHEETS




as of December 31, 2008 and 2007




(in thousands, except share and per share
data)




December 31,
                  2008
                
                December 31,
                  2007Assets:Current assets:Cash and cash equivalents
                
                $
                4,898
                
                
                $
                4,077Short-term investments
                
                
                -
                
                
                
                799Total cash, cash equivalents
      and short-term investments
                
                
                4,898
                
                
                
                4,876Accounts receivable, net of allowance for doubtful
      accounts of $20 and $24 at December 31, 2008 and 2007,
      respectively
                
                
                2,701
                
                
                
                1,385Inventories
                
                
                307
                
                
                
                428Deferred settlement and patent licensing
      costs
                
                
                1,100
                
                
                
                1,256Prepaid expenses and other current
      assets
                
                
                320
                
                
                
                462Total current assets
                
                
                9,326
                
                
                
                8,407Property and equipment, net
                
                
                310
                
                
                
                767Long-term deferred settlement and patent licensing
      costs
                
                
                -
                
                
                
                1,117Other assets
                
                
                157
                
                
                
                286Total assets
                
                $
                9,793
                
                
                $
                10,577Liabilities and Stockholders’ Equity
      (Deficit):Current liabilities:Line of credit
                
                $
                7,000
                
                
                $
                5,100Accounts payable
                
                
                579
                
                
                
                1,287Deferred income from settlement and patent
      licensing
                
                
                4,751
                
                
                
                5,520Deferred services revenue and customer
      deposits
                
                
                3,687
                
                
                
                2,231Accrued liabilities and other
                
                
                1,382
                
                
                
                1,451Total current liabilities
                
                
                17,399
                
                
                
                15,589Long-term liabilities:Long term convertible
      debt
                
                
                7,000
                
                
                
                -Long-term deferred income from settlement and patent
      licensing and other
                
                
                23
                
                
                
                4,814Total liabilities
                
                
                24,422
                
                
                
                20,403Commitments and contingencies (Notes 4 and
      8)Stockholders’ equity (deficit):Common stock, $0.001 par value; 250,000,000 shares
      authorized at December 31, 2008 and 2007; 35,750,680 and 35,678,807
      shares issued at December 31, 2008 and 2007,
      respectively
                
                
                36
                
                
                
                36Less: treasury common stock, 1,182,875 shares at
      December 31, 2008 and 2007, at cost
                
                
                (53
                )
                
                
                (53
                )Additional paid-in-capital
                
                
                97,506
                
                
                
                95,925Accumulated deficit
                
                
                (112,118
                )
                
                
                (105,734
                )Total stockholders’ equity
(deficit)
                
                
                (14,629
                )
                
                
                (9,826
                )Total liabilities and stockholders’ equity
      (deficit)
                
                $
                9,793
                
                
                $
                10,577







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


F-3
 Table of Contents


AVISTAR COMMUNICATIONS CORPORATION AND SUBSIDIARY




CONSOLIDATED STATEMENTS OF OPERATIONS




for the years ended December 31, 2008, 2007 and
2006




(in thousands, except per share data)




Year Ended December 31,2008
                
                
                2007
                
                
                2006Revenue:Product
                
                $
                3,957
                
                
                $
                3,462
                
                
                $
                4,528Licensing
                
                
                954
                
                
                
                5,016
                
                
                
                5,155Services, maintenance and support
                
                
                3,844
                
                
                
                3,477
                
                
                
                3,542Total revenue
                
                
                8,755
                
                
                
                11,955
                
                
                
                13,225Costs and expenses:Cost of product revenues*
                
                
                2,195
                
                
                
                2,684
                
                
                
                3,185Cost of services, maintenance and support
      revenues*
                
                
                2,352
                
                
                
                2,243
                
                
                
                1,820Income from settlement and patent
      licensing
                
                
                (4,226
                )
                
                
                (16,226
                )
                
                
                (4,226
                )Research and development*
                
                
                5,200
                
                
                
                7,670
                
                
                
                5,753Sales and marketing*
                
                
                3,521
                
                
                
                6,192
                
                
                
                5,488General and administrative*
                
                
                5,729
                
                
                
                12,465
                
                
                
                9,682Total costs and expenses
                
                
                14,771
                
                
                
                15,028
                
                
                
                21,702Loss from operations
                
                
                (6,016
                )
                
                
                (3,073
                )
                
                
                (8,477
                )Other (expense) income:Interest income
                
                
                94
                
                
                
                346
                
                
                
                299Other (expense) income, net
                
                
                (439
                )
                
                
                (188
                )
                
                
                (2
                )Total other (expense) income, net
                
                
                (345
                )
                
                
                158
                
                
                
                297Loss before provision for (recovery from) income
      taxes
                
                
                (6,361
                )
                
                
                (2,915
                )
                
                
                (8,180
                )Provision for (recovery from) income
      taxes
                
                
                23
                
                
                
                23
                
                
                
                (31
                )Net loss
                
                $
                (6,384
                )
                
                $
                (2,938
                )
                
                $
                (8,149
                )Net loss per share – basic and
    diluted
                
                $
                (0.18
                )
                
                $
                (0.09
                )
                
                $
                (0.24
                )Weighted average shares used in calculating basic and
      diluted net loss per share
                
                
                34,551
                
                
                
                34,290
                
                
                
                33,928





*Including stock-based compensation
    of:Cost of product, services, maintenance and support
      revenue
                    
                    $
                    141
                    
                    
                    $
                    188
                    
                    
                    $
                    155Research and development
                    
                    
                    511
                    
                    
                    
                    879
                    
                    
                    
                    618Sales and marketing
                    
                    
                    38
                    
                    
                    
                    614
                    
                    
                    
                    497General and administrative
                    
                    
                    817
                    
                    
                    
                    1,008
                    
                    
                    
                    764







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


F-4
 Table of Contents


AVISTAR COMMUNICATIONS CORPORATION AND SUBSIDIARY




CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(DEFICIT)




for the years ended December 31, 2008, 2007 and
2006




(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, 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
                                            )Issuance of common stock to employees pursuant to
      employee stock purchase plan
                                            
                                            
                                            66,373
                                            
                                            
                                            
                                            —
                                            
                                            
                                            
                                            —
                                            
                                            
                                            
                                            —
                                            
                                            
                                            
                                            67
                                            
                                            
                                            
                                            —
                                            
                                            
                                            
                                            —
                                            
                                            
                                            
                                            67Issuance of common stock to employees pursuant to
      exercise of options
                                            
                                            
                                            5,500
                                            
                                            
                                            
                                            —
                                            
                                            
                                            
                                            —
                                            
                                            
                                            
                                            —
                                            
                                            
                                            
                                            7
                                            
                                            
                                            
                                            —
                                            
                                            
                                            
                                            —
                                            
                                            
                                            
                                            7Non-employee stock-based
    compensation
                                            
                                            
                                            —
                                            
                                            
                                            
                                            —
                                            
                                            
                                            
                                            —
                                            
                                            
                                            
                                            —
                                            
                                            
                                            
                                            18
                                            
                                            
                                            
                                            —
                                            
                                            
                                            
                                            —
                                            
                                            
                                            
                                            18Employee stock-based compensation
                                            
                                            
                                            —
                                            
                                            
                                            
                                            —
                                            
                                            
                                            
                                            —
                                            
                                            
                                            
                                            —
                                            
                                            
                                            
                                            1,489
                                            
                                            
                                            
                                            —
                                            
                                            
                                            
                                            —
                                            
                                            
                                            
                                            1,489Net loss
                                            
                                            
                                            —
                                            
                                            
                                            
                                            —
                                            
                                            
                                            
                                            —
                                            
                                            
                                            
                                            —
                                            
                                            
                                            
                                            —
                                            
                                            
                                            
                                            —
                                            
                                            
                                            
                                            (6,384
                                            )
                                            
                                            
                                            (6,384
                                            )Balance at December 31, 2008
                                            
                                            
                                            35,750,680
                                            
                                            
                                            $
                                            36
                                            
                                            
                                            
                                            1,182,875
                                            
                                            
                                            $
                                            (53
                                            )
                                            
                                            $
                                            97,506
                                            
                                            
                                            $
                                            —
                                            
                                            
                                            $
                                            (112,118
                                            )
                                            
                                            $
                                            (14,629
                                            )







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










F-5
 Table of Contents


AVISTAR COMMUNICATIONS CORPORATION AND SUBSIDIARY




CONSOLIDATED STATEMENTS OF CASH FLOWS




for the years ended December 31, 2008, 2007 and
2006




(in thousands)




Year Ended December 31,2008
                  
                  
                  2007
                  
                  
                  2006Cash Flows from Operating
    Activities:Net loss
                  
                  $
                  (6,384
                  )
                  
                  $
                  (2,938
                  )
                  
                  $
                  (8,149
                  )Adjustments to reconcile net loss to net cash used in
      operating activities:Depreciation
                  
                  
                  538
                  
                  
                  
                  468
                  
                  
                  
                  345Compensation on options issued to consultants and
      employees
                  
                  
                  1,507
                  
                  
                  
                  2,689
                  
                  
                  
                  2,034Provision for doubtful accounts
                  
                  
                  (4
                  )
                  
                  
                  (27
                  )
                  
                  
                  (70
                  )Changes in assets and liabilities:Accounts receivable
                  
                  
                  (1,312
                  )
                  
                  
                  51
                  
                  
                  
                  89Inventories
                  
                  
                  121
                  
                  
                  
                  284
                  
                  
                  
                  (37
                  )Prepaid expenses and other current
      assets
                  
                  
                  142
                  
                  
                  
                  72
                  
                  
                  
                  (71
                  )Deferred settlement and patent licensing
      costs
                  
                  
                  1,273
                  
                  
                  
                  1,274
                  
                  
                  
                  1,294Other assets
                  
                  
                  129
                  
                  
                  
                  1
                  
                  
                  
                  84Accounts payable
                  
                  
                  (708
                  )
                  
                  
                  (291
                  )
                  
                  
                  574Deferred income from settlement and patent licensing
      and other
                  
                  
                  (5,560
                  )
                  
                  
                  (5,494
                  )
                  
                  
                  (5,481
                  )Deferred services revenue and customer
      deposits
                  
                  
                  1,456
                  
                  
                  
                  252
                  
                  
                  
                  1,267Accrued liabilities and other
                  
                  
                  (69
                  )
                  
                  
                  (812
                  )
                  
                  
                  772Net cash used in operating
    activities
                  
                  
                  (8,871
                  )
                  
                  
                  (4,471
                  )
                  
                  
                  (7,349
                  )Cash Flows from Investing
    Activities:Purchase of short and long-term
      investments
                  
                  
                  —
                  
                  
                  
                  (799
                  )
                  
                  
                  —Maturities of short and long-term
      investments
                  
                  
                  799
                  
                  
                  
                  —
                  
                  
                  
                  3,965Sale of property and equipment
                  
                  
                  8
                  
                  
                  
                  —
                  
                  
                  
                  —Purchase of property and equipment
                  
                  
                  (89
                  )
                  
                  
                  (979
                  )
                  
                  
                  (290
                  )Net cash (used in) provided by investing
      activities
                  
                  
                  718
                  
                  
                  
                  (1,778
                  )
                  
                  
                  3,675Cash Flows from Financing
    Activities:Line of credit payments
                  
                  
                  (5,100
                  )
                  
                  
                  —
                  
                  
                  
                  —Proceeds from line of credit
                  
                  
                  7,000
                  
                  
                  
                  2,100
                  
                  
                  
                  3,000Proceeds from convertible debt
    issuance
                  
                  
                  7,000
                  
                  
                  
                  —
                  
                  
                  
                  —Net proceeds from issuance of common
      stock
                  
                  
                  74
                  
                  
                  
                  372
                  
                  
                  
                  312Net cash provided by financing
      activities
                  
                  
                  8,974
                  
                  
                  
                  2,472
                  
                  
                  
                  3,312Net increase (decrease) in cash and cash
      equivalents
                  
                  
                  821
                  
                  
                  
                  (3,777
                  )
                  
                  
                  (362
                  )Cash and cash equivalents, beginning of
      year
                  
                  
                  4,077
                  
                  
                  
                  7,854
                  
                  
                  
                  8,216Cash and cash equivalents, end of
    year
                  
                  $
                  4,898
                  
                  
                  $
                  4,077
                  
                  
                  $
                  7,854Supplemental Cash Flow Information:Cash paid for income taxes
                  
                  $
                  —
                  
                  
                  $
                  —
                  
                  
                  $
                  —Cash paid for interest
                  
                  $
                  412
                  
                  
                  $
                  138
                  
                  
                  $
                  2





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







F-6
 Table of Contents







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 overadecade of market experienceto 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 andcommunications within their enterprise and between
enterprises, to enhance their relationships with customers, suppliers and
partners.UsingAvistar C3software
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 withcommunications 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 andcollaboration through limited 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 AvistarCommunications
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. 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.




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 $112.1 million as of
December 31, 2008. 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
ability to become profitable or generate positive cash flow from operations,
current discussions with the holders of the convertible debt (Notes) to convert
the Notes into shares of common stock at or prior to maturity in January
2010 or extend the term of the Notes, the Company’s cost reduction
efforts, Dr. Burnett’s personal guarantee to Avistar to support an
extension of the revolving line of credit through March 31, 2010, the Company’s
ability to obtain a renewal of its existing line of credit or a new line of
credit with another bank,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. If
adequate funds are not available on acceptable terms or at all, the Company’s
ability to achieve or sustain positive cash flows, maintain current operations,
fund any potential expansion, take advantage of unanticipated opportunities,
develop or enhance products or services, or otherwise respond to competitive
pressures would be significantly limited.




F-7
 Table of Contents


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.  The Company was not invested in any auction rate
securities as of December 31, 2008 and 2007. Investment securities held with the
intent to reinvest or hold for longer than a year, or with remaining maturities
of one year or more, are considered long-term investments. The Company’s cash
equivalents at December 31, 2008 and 2007 consisted of money market funds
and short-term commercial paper respectively with original maturities of three
months or less, and are therefore classified as cash and cash equivalents in the
accompanying balance sheets.




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. The Company did not have any short or long-term investments at December
31, 2008. The Company had no net unrealized losses on its short-term investment
securities at December 31, 2007.




Cash,
cash equivalents and short -term investments consisted of the following at
December 31, 2008 and 2007 (in thousands):




December 31,2008
                
                
                2007Cash
      and cash equivalents:Cash
      and money market funds
                
                $
                4,898
                
                
                $
                740Commercial
      paper cash equivalents
                
                
                —
                
                
                
                3,337Total
      cash and cash equivalents
                
                
                4,898
                
                
                
                4,077Short-term
      investments (average 27 remaining days to maturity in
2007)
                
                
                —
                
                
                
                799Total
      cash, cash equivalents and short- term investments
                
                $
                4,898
                
                
                $
                4,876







Fair
      Value Measurements




Effective
January 1, 2008, the Company adopted SFAS No. 157, Fair Value Measurements (SFAS
157). SFAS 157 defines fair value, establishes a framework for measuring fair
value, and expands disclosures about fair value measurements. Fair value is
defined under SFAS 157 as the exchange price that would be received for an asset
or paid to transfer a liability (an exit price) in the principal or most
advantageous market for the asset or liability in an orderly transaction between
market participants on the measurement date. Valuation techniques used to
measure fair value under FAS 157 must maximize the use of observable inputs and
minimize the use of unobservable inputs. The standard describes a fair value
hierarchy based on three levels of inputs, of which the first two are considered
observable and the last unobservable, that may be used to measure fair value,
which are the following:




Level
      1 – Quoted prices in active markets for identical assets or
      liabilities.




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




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




F-8
 Table of Contents


In
accordance with FAS 157, the following table represents the Company’s fair value
hierarchy for its financial assets (cash equivalents) as of December 31, 2008
(in thousands):




Fair
      Value
                                                
                                                
                                                Level
      1
                                                
                                                
                                                Level
      2
                                                
                                                
                                                Level
      3Cash
      Equivalents:Money
      market funds
                                                
                                                $
                                                4,704
                                                
                                                
                                                $
                                                4,704
                                                
                                                
                                                $
                                                —
                                                
                                                
                                                $
                                                —Total
      cash equivalents
                                                
                                                $
                                                4,704
                                                
                                                
                                                $
                                                4,704
                                                
                                                
                                                $
                                                —
                                                
                                                
                                                $
                                                —





Significant
      Concentrations




A
relatively small number of customers have accounted for a significant percentage
of the Company’s revenue for the years ended December 31, 2008, 2007 and 2006.
Revenues from these customers as a percentage of total revenues for each fiscal
year are as follows:




2008
                  
                  2007
                  
                  2006Customer
      A
                  
                  
                  40
                  %
                  
                  
                  24
                  %
                  
                  
                  25
                  %Customer
      B
                  
                  
                  19
                  %
                  
                  
                  18
                  %
                  
                  
                  20
                  %Customer
      C
                  
                  
                  18
                  %
                  
                  
                  *
                  %
                  
                  
                  *
                  %Customer
      D
                  
                  
                  11
                  %
                  
                  
                  *
                  %
                  
                  
                  38
                  %Customer
      E
                  
                  
                  *
                  %
                  
                  
                  33
                  %
                  
                  
                  *
                  %





*
            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, 2008, 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, 2008, approximately 98% of our gross accounts
receivable was concentrated with four customers, each of whom represented more
than 10% of our gross accounts receivable. As of December 31, 2007,
approximately 78% of our gross accounts receivable was concentrated with three
customers, each of whom represented more than 10% of our gross accounts
receivable. No other customer individually accounted for greater than 10% of
total accounts receivable as of December 31, 2008 and 2007.




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, 2008 and 2007, approximate
fair value because of the short maturity of these instruments.




The
long-term convertible debt was stated at cost at December 31, 2008 since there
were no unamortized discounts and the Company did not elect to measure the
instrument at fair value in accordance with SFAS No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities, including an amendment of FASB Statement No.
115.  The carrying amount of the long-term convertible debt is
$7.0 million and the estimated fair value is $11.2 million at December 31,
2008.The
fair value is estimated as the sum of the present value of future interest and
principal payments of the debt based on rates available to the Company for debt
with similar terms and remaining maturities, and the fair value of the
conversion feature calculated based on the Black-Scholes method.See Note
3 for further details on the terms of the convertible debt.




F-9
 Table of Contents


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,_2008
                  
                  
                  2007Raw
      materials and sub-assemblies
                  
                  $
                  10
                  
                  
                  $
                  25Finished
      goods
                  
                  
                  297
                  
                  
                  
                  403$
                  307
                  
                  
                  $
                  428







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 $303,000 in the United States and $7,000 in United
Kingdom.  Property and equipment consisted of the following (in
thousands):




December 31,2008
                
                
                2007Computer
      equipment
                
                $
                1,512
                
                
                $
                1,408Computer
      software
                
                
                377
                
                
                
                339Furniture,
      fixtures and equipment
                
                
                228
                
                
                
                304Leasehold
      improvements
                
                
                201
                
                
                
                2682,318
                
                
                
                2,319Less:
      Accumulated depreciation
                
                
                (2,008
                )
                
                
                (1,552
                )$
                310
                
                
                $
                767







Accrued
      Liabilities and Other




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




December 31,2008
                
                
                2007Accrued
      consulting and professional fees
                
                $
                410
                
                
                $
                478Accrued
      payroll and related benefits
                
                
                424
                
                
                
                630Accrued
      commissions and bonuses
                
                
                186
                
                
                
                57Deferred
      rent payable
                
                
                171
                
                
                
                69Accrued
      loss on subleases
                
                
                63
                
                
                
                -Other
                
                
                128
                
                
                
                217$
                1,382
                
                
                $
                1,451






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 $1.0 million,
$1.8 million and $0.7 million for 2008, 2007 and 2006, respectively, and are
reflected in general and administrative expenses in the accompanying statements
of operations.




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), or
Emerging Issues Task Force (EITF) Issue  No. 00-21, Revenue Arrangements with Multiple
Deliverables. 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.




F-10
 Table of Contents


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) collectability 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 and the
      Company has no further obligations with respect to the agreement for which
      it does not have vendor specific objective evidence of fair value. 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 incurred during installation and support services, which have not been
significant to date and shipping costs, 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 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. Product and
implementation revenue related to contracts for software development is
recognized using the percentage of completion method, in accordance with the
“Input Method”, when all of the following conditions are met: a contract exists
with the customer at a fixed price, the Company expects to fulfill all of its
material contractual obligations to the customer for each deliverable of the
contract, a reasonable estimate of the costs to complete the contract can be
made, and collection of the receivable is probable. The amount of revenue
recognized is based on the total project fee under the agreement and the
percentage of completion achieved.  The percentage of completion is
measured by monitoring progress using records of actual time incurred to date in
the project compared to the total estimated project requirements, which
corresponds to the costs related to the earned revenues. 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.




F-11
 Table of Contents


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 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, 2008, 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. Future royalties under this license are being recognized
as estimated royalty-based sales occur in accordance with
SOP 97-2.  The Company uses historical and forward looking sales
forecasts provided by SCEI and third party sources, in conjunction with actual
royalty reports provided periodically by SCEI directly to the Company, to
develop an estimate of royalties recognized for each quarterly reporting
period.  The royalty reporting directly from SCEI to the Company is
delayed beyond the period in which the actual royalties are generated, and thus
the estimate of current period royalties requires significant management
judgment and is subject to corrections in a future period once actual royalties
become known.




On
September 8, 2008 and on September 9, 2008, Avistar entered into a Licensed
Works Agreement, Licensed Works Agreement Statement of Work and a Patent License
Agreement with International Business Machines Corporation, or IBM, under which
Avistar agreed to integrate its bandwidth management technology and related
intellectual property into future Lotus Unified Communications offerings by IBM,
and to provide maintenance support services. An initial cash payment of $3.0
million was made by IBM to Avistar on November 7, 2008.  Avistar
expects IBM to make two additional non-refundable payments of $1.5 million, each
associated with scheduled phases of delivery.  IBM has agreed to make
future royalty payments to Avistar equal to two percent of the world-wide net
revenue derived by IBM from Lotus Unified Communications products sold that
exceeds a contractual base amount, and maintenance payments received from
existing customers, which incorporate Avistar’s technology.  The
agreements have a five year term and are non-cancelable except for material
default by either party.  The agreements also convey to IBM a
non-exclusive world-wide license to Avistar’s patent portfolio existing at the
time of the agreements and for all subsequent patents issued with an effective
filing date of up to five years from the date of the agreements.  The
agreements also provide for a release of each party for any and all claims of
past infringement.  The Company has determined the value of
maintenance based on VSOE, and allocated the residual portion of the initial
$6.0 million to the integration project.  The residual portion is
being recognized under the percentage of completion method, in accordance with
the “Input Method”, and the maintenance revenue will be recognized over the
future maintenance service period.  As the Company believes there are
no future deliverables associated with the intellectual property patent
licenses, no additional provision for this element has been made.  For
fiscal year ended December 31, 2008, the Company has recognized $1.3 million in
product revenue and $255,000 in service revenue. The remaining $3.8 million is
expected to be recognized in product revenue under the percentage of completion
method over the projected development time of 12 months. The estimate of current
period percentage of completion requires significant management judgment and is
subject to updates in future periods until the project is complete.




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 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.




F-12
 Table of Contents


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 Avistar, and the companies cross-licensed each other’s
patent portfolios.  The agreement resulted in a payment of $12.0 million to
Avistar 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, 2008 and 2007.




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




Effective
January 1, 2006, the Company adopted the provisions of SFAS No. 123
(R), Share-Based
Payment (SFAS 123R), which establishes accounting for
stock-based awards exchanged for employee services. Accordingly, stock-based
compensation cost is measured at grant date, based on the fair value of the
award, and is recognized as expense over the employee’s service
period.




Stock-based
compensation expense for fiscal 2008, 2007 and 2006 included 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 compensation expense on a
straight-line basis over the requisite service period of the award.




F-13
 Table of Contents


The
effect of recording stock-based compensation for the years ended December 31,
2008, 2007 and 2006 was as follows (in thousands):




Year Ended December 31,2008
                      
                      
                      2007
                      
                      
                      2006Stock-based
      compensation expense by type of award:Employee stock
      options
                      
                      $
                      1,482
                      
                      
                      $
                      2,513
                      
                      
                      $
                      1,815Non-employee stock
      options
                      
                      
                      18
                      
                      
                      
                      66
                      
                      
                      
                      93Employee stock purchase
      plan
                      
                      
                      7
                      
                      
                      
                      110
                      
                      
                      
                      126Total
      stock-based compensation
                      
                      
                      1,507
                      
                      
                      
                      2,689
                      
                      
                      
                      2,034Tax
      effect of stock-based compensation
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      —Net
      effect of stock-based compensation on net loss
                      
                      $
                      1,507
                      
                      
                      $
                      2,689
                      
                      
                      $
                      2,034







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 (loss) as the changes in equity of an enterprise, except
those resulting from stockholder transactions. Accordingly, comprehensive income
(loss) includes certain changes in equity that are excluded from the net income
or loss. The comprehensive loss was $6.4 million, $2.9 million and $8.1 million
for the years ended December 31, 2008, 2007 and 2006, respectively.




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




Year Ended December 31,2008
                
                
                2007
                
                
                2006Net
      loss
                
                $
                (6,384
                )
                
                $
                (2,938
                )
                
                $
                (8,149
                )Other
      comprehensive income (loss):Change
      in net unrealized gains and losses on investments
                
                
                —
                
                
                
                —
                
                
                
                12Total
      comprehensive loss
                
                $
                (6,384
                )
                
                $
                (2,938
                )
                
                $
                (8,137
                )







Recent
      Accounting Pronouncements




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 permits entities to choose,
at specified election dates, to measure eligible financial assets, financial
liabilities and firm commitments at fair value, on an instrument-by-instrument
basis, that are otherwise not permitted to be accounted for at fair value under
other generally accepted accounting principles. The fair value measurement
election is irrevocable and subsequent changes in fair value must be recorded in
earnings. SFAS No. 159 became effective for the Company on January 1, 2008. The
Company did not elect to measure any eligible items at fair value in accordance
with this new standard either at the date it adopted this new standard or
subsequently during 2008; therefore the adoption of this standard did not have
an impact on the Company’s financial position and 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 adopted 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 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 adopted this statement on January 1, 2009.  The adoption of
SFAS 160 did not have an impact on the Company’s financial condition and results
of operations.




F-14
 Table of Contents


In
December 2007, the FASB Emerging Issues Task Force reached a consensus and
published Issue No. 07-01, Accounting for Collaborative
Arrangements (EITF 07-01). EITF 07-01 defines a collaborative arrangement
as a contractual arrangement in which the parties are active participants to the
arrangements and exposed to significant risks and rewards that depend on the
commercial success of the endeavor. EITF 07-01 requires that costs incurred and
revenues generated from transactions with third parties should be reported by
the collaborators on the appropriate line item in their respective income
statements. EITF 07-01 also states that the income statement characterization of
payments between the participants to a collaborative arrangement should be based
on other authoritative literature if the payments are within the scope of such
literature. EITF 07-01 requires collaborators to disclose, in the footnotes to
financial statements in the initial period of adoption and annually thereafter,
the income statement classification and amounts attributable to transactions
arising from collaborative arrangements between participants for each period for
which an income statement is presented and information regarding the nature and
purpose of the collaborative arrangement, the collaborators' rights and
obligations under the arrangement, and any accounting policies for the
collaborative arrangement. EITF 07-01 is effective for fiscal years beginning
after December 15, 2008. The Company  adopted this statement on
January 1, 2009.  The adoption of EITF 07-01 did not have material
impact on the Company’s financial condition and results of
operations.




In
February 2008, the FASB issued FASB Staff Position No. FAS 157-2, Effective Date of FASB Statement No.
157 (FSP 157-2), to partially defer SFAS 157, Fair Value Measurements. FSP
157-2 defers the effective date of SFAS 157 for nonfinancial assets and
nonfinancial liabilities, except those that are recognized or disclosed at fair
value in the financial statements on a recurring basis (at least annually), to
fiscal years, and interim periods within those fiscal years, beginning after
November 15, 2008. The Company  adopted this statement on January 1,
2009.  The adoption of FSP 157-2 did not have material impact on the
Company’s financial condition and results of operations.




3.
            Borrowings




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 the Company’s assets. Gerald Burnett,
Chairman of the Company, provided a collateralized guarantee to the financial
institution, assuring payment of the Company’s obligations under the agreement
and as a consequence, there are no restrictive covenants, allowing the Company
greater access to the full amount of the facility. In
addition to the guarantee provided to the financial institution, on March 29,
2009, Dr. Burnett provided a personal guarantee to Avistar, assuring the Company
a line of credit of $10.0 million with the same terms and mechanisms as the
existing revolving line of credit in the event the existing revolving line of
credit from the financial institution was unavailable for any reason during the
period from its termination on December 21, 2009 to March 31, 2010.The
line of credit required monthly interest-only payments based on Adjusted LIBOR
plus 1.25% or Prime Rate plus 1.25% at December 31, 2008, and Adjusted LIBOR
plus 0.75% or Prime Rate minus 2.0% at December 31, 2007, respectively. The
Company elected Prime Rate plus 1.25% or 4.5% at December 31, 2008, and
Prime Rate minus 2.0% or 5.3% at December 31, 2007, respectively. The Company
borrowed $7.0 million and $2.1 million under the revolving line of credit for
the years ended December 31, 2008 and 2007, respectively, and has a balance of
$7.0 million outstanding as of December 31, 2008.  The balance of $5.1
million as of December 31, 2007 was fully repaid during 2008. The Revolving
Credit and Promissory Note was renewed on December 22, 2008 and matures on
December 21, 2009, and is subject to annual renewal with the consent of the
Company and the lender.




Convertible
      Debt




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, and Craig Heimark, officers Simon Moss and Darren Innes, and
WS Investment Company (collectively, the Purchasers). 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,
will be due on January 4, 2010 and are convertible prior to
maturity.  Interest on the Notes accrues at the rate of 4.5% per annum
and is 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.




4.
            Commitments
      and Contingencies




At
December 31, 2008, the Company had open purchase orders and other
contractual obligations of approximately $47,000, 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.




F-15
 Table of Contents




Facilities
Leases




The
Company leases its facilities under operating leases that expire through
March 2017.  During 2008, the Company has subleased some of its
operating facilities in San Mateo, California and New York, New York, and
assigned its primary facility lease in London, United Kingdom. As a result of
these subleases and assignment, the future minimum lease commitments under all
facility leases as of December 31, 2008, net of sublease proceeds, are as
follows (in thousands):




Minimum
      lease payments
                        
                        
                        Estimated
      sublease proceeds
                        
                        
                        NetYear
      Ending December 31,2009
                        
                        $
                        1,251
                        
                        
                        $
                        (536
                        )
                        
                        $
                        7152010
                        
                        
                        1,280
                        
                        
                        
                        (476
                        )
                        
                        
                        8042011
                        
                        
                        1,333
                        
                        
                        
                        (323
                        )
                        
                        
                        1,0102012
                        
                        
                        567
                        
                        
                        
                        (270
                        )
                        
                        
                        2972013
                        
                        
                        310
                        
                        
                        
                        (263
                        )
                        
                        
                        47thereafter
                        
                        
                        1,008
                        
                        
                        
                        (883
                        )
                        
                        
                        125Total
      future minimum lease payments
                        
                        $
                        5,749
                        
                        
                        $
                        (2,751
                        )
                        
                        $
                        2,998


Gross
rent expense for 2008, 2007 and 2006 was approximately $1.4 million, $1.2
million, and $0.8 million, respectively.  Sublease rental income under
non-cancelable subleases was $219,000 for 2008.  There was no sublease
rental income for 2007 and 2006.


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, 2008.




Microsoft




During
2008, Microsoft Corporation had filed requests for re-examination of 29 U.S.
patents held by Avistar. In June 2008, the U.S. Patent and Trademark Office
(USPTO) had completed its review of Microsoft’s requests for re-examination and
had rejected 19 of the re-examination applications in their entirety, and the
majority of the arguments for one additional application. The USPTO agreed to
re-examine, either in part or fully, 10 of the Company’s existing U.S.
patents.  Subsequently, Microsoft submitted five petitions for
reconsideration of the USPTO’s rejection of Microsoft’s re-examination
applications.  The USPTO’s review of the five petitions for
reconsideration is currently in process, with an indeterminate time period
established for their decision on Microsoft’s request.




Once
undertaken, the USPTO may take between six months and two years to complete
patent re-examinations.  Avistar believes that its U.S. patents are
valid and intends to defend its patents through the 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.  The re-examination process by the USPTO may adversely
impact the Company’s licensing negotiations in process, and may require the
Company to spend substantial time and resources defending its patents, including
the fees and expenses of legal advisors.  The potential impact to the
Company’s results of operations may require reduction of other operating
expenses and seeking additional financing to fund the operations and the defense
of our patents.




The
Company has not recorded an expense related to damages in this matter because
any potential loss is not currently probable or reasonably estimable under SFAS
No. 5, Accounting for
Contingencies.




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). Revenue from Vicor
represented less than 10% of total revenue for 2007 and 2006. There was no
revenue from Vicor in 2008. Management believes the transactions with Vicor are
at terms comparable to those provided to unrelated third parties. As of
December 31, 2008 and 2007, the Company did not have any accounts
receivable outstanding from Vicor.




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, 2008, 2007 and
2006, UBS Warburg LLC held less than 5% of the Company’s stock. Revenue from UBS
Warburg LLC and its affiliates represented 19%, 18% and 20% of total revenue for
2008, 2007 and 2006, 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, 2008 and 2007, the Company had
accounts receivable outstanding from UBS Warburg LLC and its affiliates of
approximately $350,000 and $143,000, respectively.




F-16
 Table of Contents


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 from
February 2001 until June 2007. Mr. Latta and WSGR have represented the
Company and its predecessors as corporate counsel since 1997. During 2007 and
2006, payments of $203,000 and $118,000, 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.




Borrowings
from Related Parties




On
January 4, 2008, Avistar issued $7,000,000 of 4.5% Convertible Subordinated
Secured Notes (the Notes), which are due in 2010. 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, a fund associated with
WSGR.  See Note 3 for further details.




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 2008,
2007 or 2006.




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, 2008, 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, 2008.




7.
            Stock
      Option Plans and Employee Stock Purchase
Plan




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 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,
2008, options to purchase a total of 403,400 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 of each year from 2004 to 2008 the Board approved an increase of
1,200,000 shares. As of December 31, 2008, a total of 12,024,751 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 2.3
million, 4.4 million and 1.4 million shares under the plan in 2008, 2007 and
2006, respectively. At December 31, 2008 options to purchase a total of
10,289,929 shares were outstanding under the 2000 Plan and 1,220,219 options
were available for future grant.




F-17
 Table of Contents


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 of each year from 2004
through 2008, the Board approved annual increases of 175,000 shares. As of
December 31, 2008, the Company has authorized a total of 1,339,000 shares
for issuance under this plan. As a result of past and future annual increases, a
maximum of 1,689,000 share of common stock could be issued over the 10-year life
of the plan. The Company granted options to purchase 170,000, 145,000 and
145,000 shares under this plan in 2008, 2007 and 2006 respectively. At
December 31, 2008 options to purchase a total of 936,270 shares were
outstanding under the Director Plan and 341,480 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.




A summary
of the 1997 Plan, the 2000 Plan, and the Director Plan activity and related
information for the years ended December 31, 2008, 2007 and 2006 is as
follows:




Options OutstandingShares
                                              Available for
                                              Option Grant
                                            
                                            Shares
                                            
                                            Weighted
                                              Average
                                              Exercise PriceBalance,
      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
                                            
                                            $2.28Authorized
                                            
                                            
                                            1,375,000
                                            
                                            
                                            —
                                            
                                            —Granted
                                            
                                            
                                            (2,459,318
                                            )
                                            
                                            2,459,318
                                            
                                            0.85Exercised
                                            
                                            
                                            —
                                            
                                            
                                            (5,500
                                            )
                                            0.99Canceled
                                            
                                            
                                            1,312,561
                                            
                                            
                                            (1,389,311
                                            )
                                            2.40Balance,
      December 31, 2008
                                            
                                            
                                            1,561,699
                                            
                                            
                                            11,629,599
                                            
                                            $1.97







F-18
 Table of Contents


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, 2008 and the exercise price, multiplied by the number of
in-the-money options. The aggregate intrinsic value of the options outstanding
at December 31, 2008 for all options outstanding was $436,000 and $109,000
for only vested options outstanding. Vested and exercisable options outstanding
at December 31, 2008 had a weighted average remaining contractual life of
4.24 years. The intrinsic value of options changes based on the fair market
value of Avistar stock. The Company had 10,981,943 options vested and
exercisable and expected to be vested and exercisable at December 31, 2008
with a weighted average exercise price of $2.02, a weighted average remaining
contractual term of 5.11 years, and an aggregate intrinsic value of
$377,000. Total intrinsic value of options exercised for the years ended
December 31, 2008, 2007 and 2006 were $1,500, $138,000 and $47,000,
respectively. The following table summarizes significant ranges of outstanding
and exercisable options as of December 31, 2008.




Options Outstanding
                                  
                                  Options ExercisableRange of
                                    Exercise Prices
                                  
                                  Number
                                    Outstanding at
                                    December 31, 2008
                                  
                                  Weighted-Average
                                    Remaining
                                    Contractual Life
                                  
                                  Weighted-Average
                                    Exercise Price
                                  
                                  Number
                                    Exercisable at
                                    December 31, 2008
                                  
                                  Weighted-Average
                                    Exercise Price$0.36
      - $0.83
                                  
                                  
                                  1,832,687
                                  
                                  
                                  
                                  7.98
                                  
                                  
                                  
                                  $0.66
                                  
                                  
                                  
                                  581,312
                                  
                                  
                                  
                                  $0.72$0.86
                                  
                                  
                                  1,759,506
                                  
                                  
                                  
                                  2.22
                                  
                                  
                                  
                                  0.86
                                  
                                  
                                  
                                  754,045
                                  
                                  
                                  
                                  0.86$0.90
      - $1.16
                                  
                                  
                                  1,831,510
                                  
                                  
                                  
                                  4.75
                                  
                                  
                                  
                                  1.00
                                  
                                  
                                  
                                  1,519,510
                                  
                                  
                                  
                                  1.01$1.21
      - $1.41
                                  
                                  
                                  2,305,313
                                  
                                  
                                  
                                  7.31
                                  
                                  
                                  
                                  1.33
                                  
                                  
                                  
                                  1,123,750
                                  
                                  
                                  
                                  1.29$1.42
      - $2.21
                                  
                                  
                                  1,965,333
                                  
                                  
                                  
                                  4.62
                                  
                                  
                                  
                                  1.74
                                  
                                  
                                  
                                  1,412,447
                                  
                                  
                                  
                                  1.80$2.25
      - $8.50
                                  
                                  
                                  1,604,650
                                  
                                  
                                  
                                  4.72
                                  
                                  
                                  
                                  3.82
                                  
                                  
                                  
                                  1,469,649
                                  
                                  
                                  
                                  3.92$17.25
                                  
                                  
                                  330,600
                                  
                                  
                                  
                                  1.25
                                  
                                  
                                  
                                  17.25
                                  
                                  
                                  
                                  330,600
                                  
                                  
                                  
                                  17.2511,629,599
                                  
                                  
                                  
                                  5.26
                                  
                                  
                                  
                                  $1.97
                                  
                                  
                                  
                                  7,191,313
                                  
                                  
                                  
                                  $2.51




As of
December 31, 2008, the Company had an unrecognized stock-based compensation
balance related to stock options of approximately $3.5 million before
estimated forfeitures and after actual cancellations. 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 9% for its executive options and 38% for non-executive options. Accordingly,
as of December 31, 2008, the Company estimated that the stock-based
compensation for the awards not expected to vest was approximately
$1.2 million and therefore, the unrecognized deferred stock-based
compensation balance related to stock options was adjusted to approximately
$2.3 million after estimated forfeitures and after actual cancellations.
This amount will be recognized over an estimated weighted average period of 2.2
years. For the years ended December 31, 2008, 2007 and 2006, the Company granted
2,459,318, 4,550,000 and 1,486,000 stock options to employees, with an estimated
total grant-date fair value of $1.3 million,  $5.0 million and $1.9
million, or $0.54, $1.10 and $1.29 per share, respectively. For the years ended
December 31, 2008, 2007 and 2006, 2.5 million , 1.6 million and 1.4 million
options vested with a total fair value of $2.6 million, $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, 2008, 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 66,373, 176,072 and 225,657 shares were sold
under this plan during 2008, 2007 and 2006, 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.




F-19
 Table of Contents


Valuation
      Assumptions




The
Company estimated the fair value of stock options granted during 2008, 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 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 weighted-average
assumptions for the years ended December 31, 2008, 2007 and 2006:




Year Ended December 31,2008
                  
                  2007
                  
                  2006Employee
      Stock Option PlanExpected
      dividend
                  
                  
                  0
                  %
                  
                  
                  0
                  %
                  
                  
                  0
                  %Average
      risk-free interest rate
                  
                  
                  2.2
                  %
                  
                  
                  4.4
                  %
                  
                  
                  4.9
                  %Expected
      volatility
                  
                  
                  115
                  %
                  
                  
                  132
                  %
                  
                  
                  143
                  %Expected
      term (years)
                  
                  
                  2.9
                  
                  
                  
                  6.1
                  
                  
                  
                  6.1




Year Ended December 31,2008
                  
                  2007
                  
                  2006Employee
      Stock Purchase PlanExpected
      dividend
                  
                  
                  0
                  %
                  
                  
                  0
                  %
                  
                  
                  0
                  %Average
      risk-free interest rate
                  
                  
                  2.0
                  %
                  
                  
                  5.1
                  %
                  
                  
                  4.0
                  %Expected
      volatility
                  
                  
                  144
                  %
                  
                  
                  155
                  %
                  
                  
                  89
                  %Expected
      term (months)
                  
                  
                  6.0
                  
                  
                  
                  6
                  .0
                  
                  
                  6.0




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 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 107, based on the weighted average of the vesting periods, which is
generally one quarter vesting after one year and one sixteenth vesting quarterly
for twelve quarters, and adding the term of the option, which is generally ten
years, and dividing by two. The Company uses this method because it does not
have sufficient historical exercise data to provide a reasonable basis upon
which to estimate expected term due to the limited number of exercises that have
occurred over the previous eight years during which its equity shares have been
publicly traded.  In April 2008, the Company granted 1.9 million
options to employees, with one third vesting after six months and the remaining
two thirds vesting monthly thereafter until the entire grant is fully vested
after 20 months.  These options have a 3 year contractual term, with
the expected term calculation also based on an average prescribed by SAB
107.




For the
year ended December 31, 2008, stock-based compensation expense associated
with employee stock options and ESPP shares amounted to $1.5 million and
$6,500, respectively.




Common
      Stock Reserved for Future
Issuance




As of
December 31, 2008, the Company had reserved the following shares of common
stock for issuance in connection with:




Stock
      options under stock option plans
                
                
                13,191,298Employee
      stock purchase plan
                
                
                1,235,595Total
                
                
                14,426,893







8.
            Legal
      Proceedings




Avistar
is not currently party to any legal proceedings and is not aware of any
threatened legal proceedings against us.




From time
to time Avistar may 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.




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.




F-20
 Table of Contents


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 an 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 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. At December 31, 2008 and 2007, respectively, the
total amount of unrecognized tax benefits was $915,000 and
$817,000.  A reconciliation of unrecognized tax benefits
follows:




Balance
      at January 1, 2007
                  
                  $
                  676Additions
      for 2007 tax positions
                  
                  
                  141Balance
      at December 31, 2007
                  
                  
                  817Additions for 2008 tax
      positions
                  
                  
                  98Balance
      at December 31, 2008
                  
                  $
                  915




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 2007 have not been examined
and the applicable statues of limitationhave 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.




The
Company’s policy is to 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, $23,000 and $22,000 in 2008, 2007 and
2006, respectively. Federal and State overpayments of 2004 income taxes of
$33,000 and $20,000, respectively, were refunded in 2006.




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




Year Ended December 31,2008
                  
                  
                  2007
                  
                  
                  2006Current:Federal
                  
                  $
                  —
                  
                  
                  $
                  —
                  
                  
                  $
                  (33
                  )State
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  (20
                  )Foreign
                  
                  
                  23
                  
                  
                  
                  23
                  
                  
                  
                  22$
                  23
                  
                  
                  $
                  23
                  
                  
                  $
                  (31
                  )




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




Year Ended December 31,2008
                  
                  
                  2007
                  
                  
                  2006Domestic
                  
                  $
                  (6,444
                  )
                  
                  $
                  (3,021
                  )
                  
                  $
                  (9,611
                  )Foreign
                  
                  
                  83
                  
                  
                  
                  106
                  
                  
                  
                  1,431Loss
      before provision for income taxes
                  
                  $
                  (6,361
                  )
                  
                  $
                  (2,915
                  )
                  
                  $
                  (8,180
                  )




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




Year Ended December 31,2008
                  
                  
                  2007
                  
                  
                  2006Expected
      tax benefit at federal statutory rate
                  
                  $
                  (2,163
                  )
                  
                  $
                  (991
                  )
                  
                  $
                  (2,771
                  )Foreign
      and state taxes, net
                  
                  
                  23
                  
                  
                  
                  23
                  
                  
                  
                  2Recovery
      of federal tax payments
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  (33
                  )Non-deductible
      stock compensation and other
                  
                  
                  397
                  
                  
                  
                  629
                  
                  
                  
                  463Current
      year operating losses and temporary differences for which no tax benefit
      is recognized
                  
                  
                  1,766
                  
                  
                  
                  362
                  
                  
                  
                  2,308Provision
      for income taxes
                  
                  $
                  23
                  
                  
                  $
                  23
                  
                  
                  $
                  (31
                  )




F-21
 Table of Contents


The net
deferred income tax asset consisted of the following as of December 31,
2008 and 2007 (in thousands):




December 31,2008
                          
                          
                          2007Deferred
      income tax assets:Federal
      net operating loss carry-forwards
                          
                          $
                          19,700
                          
                          
                          $
                          16,664State
      net operating loss carry-forwards
                          
                          
                          1,868
                          
                          
                          
                          1,604Tax
      credit carry-forwards
                          
                          
                          2,524
                          
                          
                          
                          2,325Deferred
      settlement and patent licensing, net
                          
                          
                          1,416
                          
                          
                          
                          3,058Reserves
      and other
                          
                          
                          1,095
                          
                          
                          
                          873Property
      and Equipment
                          
                          
                          212
                          
                          
                          
                          25326,815
                          
                          
                          
                          24,777Valuation
      allowance
                          
                          
                          (26,815
                          )
                          
                          
                          (24,777
                          )Net
      deferred income tax asset
                          
                          $
                          —
                          
                          
                          $
                          —




Net
operating loss carry-forwards at December 31, 2008 were approximately $57.9
million and $39.1 million, for Federal and state income tax purposes,
respectively. The Federal net operating loss carry-forwards expire on various
dates through the year 2028. The valuation allowance increased by $2.0 million
in 2008, $161,000 in 2007 and $3.1 million in 2006.




As of
December 31, 2008, unused research and development tax credits of
approximately $1.3 million and $1.4 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 2008, 2007 and 2006, 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 206,756, 590,788 and 846,929 for 2008, 2007 and
2006, respectively.




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




Year Ended December 31,2008
                  
                  
                  2007
                  
                  
                  2006Numerator
      – basic and diluted:Net loss
                  
                  $
                  (6,384
                  )
                  
                  $
                  (2,938
                  )
                  
                  $
                  (8,149
                  )Denominator
      – basic and diluted:Weighted
      average shares of common stock used in computing net loss per
      share
                  
                  
                  34,551
                  
                  
                  
                  34,290
                  
                  
                  
                  33,928Net
      loss per share - basic and diluted
                  
                  $
                  (0.18
                  )
                  
                  $
                  (0.09
                  )
                  
                  $
                  (0.24
                  )







F-22
 Table of Contents


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, 2008Revenue
                  
                  $
                  5,180
                  
                  
                  $
                  7,801
                  
                  
                  $
                  (4,226
                  )
                  
                  $
                  8,755Depreciation
      expense
                  
                  
                  —
                  
                  
                  
                  (538
                  )
                  
                  
                  —
                  
                  
                  
                  (538
                  )Stock-based
      compensation
                  
                  
                  (248
                  )
                  
                  
                  (1,259
                  )
                  
                  
                  —
                  
                  
                  
                  (1,507
                  )Total
      costs and expenses
                  
                  
                  (2,030
                  )
                  
                  
                  (16,967
                  )
                  
                  
                  4,226
                  
                  
                  
                  (14,771
                  )Interest
      income
                  
                  
                  —
                  
                  
                  
                  94
                  
                  
                  
                  —
                  
                  
                  
                  94Interest
      expense
                  
                  
                  —
                  
                  
                  
                  (439
                  )
                  
                  
                  —
                  
                  
                  
                  (439
                  )Net
      income (loss)
                  
                  
                  3,150
                  
                  
                  
                  (9,534
                  )
                  
                  
                  —
                  
                  
                  
                  (6,384
                  )Assets
                  
                  
                  1,610
                  
                  
                  
                  8,183
                  
                  
                  
                  —
                  
                  
                  
                  9,793Year
      Ended December 31, 2007Revenue
                  
                  $
                  21,162
                  
                  
                  $
                  7,019
                  
                  
                  $
                  (16,226
                  )
                  
                  $
                  11,955Depreciation
      expense
                  
                  
                  —
                  
                  
                  
                  (468
                  )
                  
                  
                  —
                  
                  
                  
                  (468
                  )Stock-based
      compensation
                  
                  
                  (240
                  )
                  
                  
                  (2,449
                  )
                  
                  
                  —
                  
                  
                  
                  (2,689
                  )Total
      costs and expenses
                  
                  
                  (7,513
                  )
                  
                  
                  (23,741
                  )
                  
                  
                  16,226
                  
                  
                  
                  (15,028
                  )Interest
      income
                  
                  
                  —
                  
                  
                  
                  346
                  
                  
                  
                  —
                  
                  
                  
                  346Interest
      expense
                  
                  
                  —
                  
                  
                  
                  (187
                  )
                  
                  
                  —
                  
                  
                  
                  (187
                  )Net
      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
                  )
                  
                  
                  —
                  
                  
                  
                  (2,034
                  )Total
      costs and expenses
                  
                  
                  (5,701
                  )
                  
                  
                  (20,227
                  )
                  
                  
                  4,226
                  
                  
                  
                  (21,702
                  )Interest
      income
                  
                  
                  —
                  
                  
                  
                  299
                  
                  
                  
                  —
                  
                  
                  
                  299Interest
      expense
                  
                  
                  —
                  
                  
                  
                  (1
                  )
                  
                  
                  —
                  
                  
                  
                  (1
                  )Net
      income (loss)
                  
                  
                  3,680
                  
                  
                  
                  (11,829
                  )
                  
                  
                  —
                  
                  
                  
                  (8,149
                  )Assets
                  
                  
                  3,752
                  
                  
                  
                  10,947
                  
                  
                  
                  —
                  
                  
                  
                  14,699




International
revenue, which consists of sales to customers with operations principally in
Western Europe and Asia, comprised 51%, 72% and 75% of total revenue for 2008,
2007 and 2006, 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, revenue is
allocated to geographical region based on the location of the customer. For
2008, 2007 and 2006, respectively, international revenues from customers in the
United Kingdom accounted for 22%, 12% and 12% respectively, of total revenue.
The Company had no significant long-lived assets in any country other than the
United States for any period presented.




12.
            Subsequent
      Events




On
November 21, 2008, the Company received a deficiency letter from The NASDAQ
Stock Market indicating that the Company did not comply with Marketplace Rule
4310(c)(3), which requires that Avistar 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.  Avistar was granted a 30 day grace period, or until December
22, 2008 to regain compliance with the $35,000,000 provision of the Rule by
recording a minimum closing bid price of $1.02 for a minimum of ten consecutive
business days.




On
December 24, 2008, Avistar received a notice from The Nasdaq Stock Market
stating that Avistar has not regained compliance with Nasdaq Marketplace Rule
4310(c)(3)(B) and, as a result, Avistar’s securities are subject to de-listing
from The Nasdaq Capital Market unless Avistar appeals the Nasdaq Staff’s
determination to a Nasdaq Listing Qualifications Panel.




Avistar
appealed the Nasdaq Staff’s determination to the Listing Qualifications Panel
which automatically resulted in the stay of the Staff’s de-listing of Avistar’s
common stock.  The appeal took place on January 29, 2009 and the
Listing Qualifications Panel has the authority to grant Avistar a further
extension of time in which to regain compliance with the Marketplace Rules,
though there can be no assurance that the Panel will grant a further extension
of time.




In
January 2009, Bob Habig resigned from the position of Chief Financial Officer
and he was replaced in that position by Elias MurrayMetzger, the Company’s
Corporate Controller.




On
February 5, 2009, the Company repaid $3.9 million of the $7.0 million revolving
line of credit outstanding as of December 31, 2008.




F-23
 Table of Contents


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.




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.




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,
                                                      2008
                                                    
                                                    September 30,
                                                      2008
                                                    
                                                    
                                                    June 30,
                                                      2008
                                                    
                                                    
                                                    March 31,
                                                      2008(In thousands except per share data)Total
      revenue
                                                    
                                                    $
                                                    3,109
                                                    
                                                    
                                                    $
                                                    2,705
                                                    
                                                    
                                                    $
                                                    1,790
                                                    
                                                    
                                                    $
                                                    1,151Cost
      of product revenue
                                                    
                                                    
                                                    551
                                                    
                                                    
                                                    
                                                    720
                                                    
                                                    
                                                    
                                                    565
                                                    
                                                    
                                                    
                                                    359Cost
      of services, maintenance and support revenue
                                                    
                                                    
                                                    646
                                                    
                                                    
                                                    
                                                    584
                                                    
                                                    
                                                    
                                                    603
                                                    
                                                    
                                                    
                                                    519Net
      loss
                                                    
                                                    $
                                                    (231
                                                    )
                                                    
                                                    $
                                                    (774
                                                    )
                                                    
                                                    $
                                                    (1,612
                                                    )
                                                    
                                                    $
                                                    (3,767
                                                    )Net
      loss per share—Basic/Diluted
                                                    
                                                    $
                                                    (0.01
                                                    )
                                                    
                                                    $
                                                    (0.02
                                                    )
                                                    
                                                    $
                                                    (0.05
                                                    )
                                                    
                                                    $
                                                    (0.11
                                                    )Weighted
      average shares—Basic/Diluted
                                                    
                                                    
                                                    34,568
                                                    
                                                    
                                                    
                                                    34,561
                                                    
                                                    
                                                    
                                                    34,547
                                                    
                                                    
                                                    
                                                    34,532Quarter 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












F-24
 Table of Contents


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 AccountsYear
      Ended:December
      31, 2008
                    
                    $
                    24
                    
                    
                    $
                    4
                    
                    
                    $
                    (8
                    )
                    
                    $
                    20December 31,
      2007
                    
                    
                    51
                    
                    
                    
                    17
                    
                    
                    
                    (44
                    )
                    
                    
                    24December 31,
      2006
                    
                    $
                    121
                    
                    
                    $
                    (61
                    )
                    
                    $
                    (9
                    )
                    
                    $
                    51







S-1
 Table of Contents


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 onForm 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 December31, 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 Securitiesand 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†
                    
                    Patent
      License Agreement dated May 15, 2006 among the Registrant, Collaboration
      Properties, Inc., Sony Corporation and Sony Computer Entertainment,
      Inc.(Filed asan 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.)10.14†
                    
                    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 forthe quarter ended March 31,
      2007)




Table of Contents




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 September30, 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 as an exhibit to the Registrant’s Annual
      Report on Form 10-K for the year endedDecember 31, 2007 filed with the Securities and
      Exchange Commission on March 31, 2008)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 as an exhibit to the Registrant’s Annual
      Report on Form 10-K for the year ended December 31, 2007 filed with the
      Securities and Exchange Commission on March 31,
    2008)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 as an exhibit to the Registrant’s Annual
      Report on Form 10-K for the year ended December 31, 2007 filed with the
      Securities and Exchange Commission on March 31, 2008)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 as an exhibit to the Registrant’s
      Annual Report on Form 10-K for the
      year ended December 31, 2007 filed with the Securities and Exchange
      Commission on March 31, 2008)10.21
              
              Convertible Note Purchase Agreement among the
      Company and the Purchasers named therein dated January 4, 2008 (Filed
      onJanuary 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 asan 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)10.25†
              
              Licensed
      Works Agreement between Avistar Communications Corporation and
      International Business Machines Corporation dated September 8, 2008.(Filed as an exhibit to the
      Registrant’s Quarterly Report on Form 10-Q for the three
      months ended September 30, 2008 filed with the Securities and Exchange
      Commission on November14,
      2008.)10.26†
              
              Licensed
      Works Agreement Statement of Work between Avistar Communications
      Corporation and International Business Machines Corporation dated
      September 8, 2008.(Filed as an exhibit to
      the Registrant’s Quarterly Report on Form 10-Q for the three months ended September 30, 2008 filed
      with the Securities and Exchange Commission on November 14,
      2008.)10.27†
              
              Patent
      License Agreement between Avistar Communications Corporation and
      International Business Machines Corporation dated September 9, 2008. (Filed as an exhibit to the Registrant’s Quarterly
      Report on Form 10-Q for the three months ended September 30, 2008 filed
      with the Securities and Exchange Commission on November 14,
      2008.)10.28
              
              Amended
      and Restated Revolving Credit Promissory Note issued by the Registrant to
      JPMorgan Chase Bank, N.A. dated December 22, 200810.29
              
              Facility
      Agreement between the Registrant and JPMorgan Chase Bank, N.A. dated
      December 22, 200810.30
              
              Amended
      and Restated Collateral Agreement dated December 22, 2008 between the
      Registrant and JPMorgan Chase Bank, N.A. dated December 22,
      200810.31
              
              Second
      Amended and Restated Security Agreement between the Registrant and
      JPMorgan Chase Bank, N.A.10.32
              
              Amended
      and Restated Guaranty issued by Gerald J. Burnett and The Gerald J.
      Burnett and Marjorie J. Burnett Revocable Trust in favor of JPMorgan Chase
      Bank, N.A. dated December  22, 200810.33
              
              Amended
      and Restated Form of Note Sale Agreement among Gerald J. Burnett, The
      Gerald J. Burnett and Marjorie J. Burnett Revocable Trust and JPMorgan
      Chase Bank, N.A.10.34
              
              Personal
      guarantee  issued by Gerald J. Burnett in favor of Avistar
      Communications Corporation dated March 29, 200921.1
              
              Subsidiaries
      of the Company23.1
              
              Consent
      of Independent Registered Public Accounting Firm: Burr, Pilger & Mayer
      LLP24.1
              
              Power
      of Attorney (see page 41)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.