**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

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**FORM 10-K**

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**x**                                 ANNUAL REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934

**For the fiscal year ended December 31, 2005**

**OR**

**o**                                   TRANSITION REPORTPURSUANT TO SECTION 13 OF 15(d) OF THE SECURITIES EXCHANGE ACT OF1934

**For the transition period from                       to                       .**

**Commission File Number: 000-31121**

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**AVISTARCOMMUNICATIONS CORPORATION**

(Exactname of registrant as specified in its charter)

| **Delaware**                                |   | **88-0463156**         |
|---------------------------------------------|--------|------------------------|
| (State or other jurisdiction of             |   | (I.R.S. Employer       |
| incorporation or organization)              |   | Identification Number) |
| **555 Twin  Dolphin Drive, Suite 360** |   | ** **             |
| **Redwood Shores, California**              |   | **94065**              |
| (Address of Principal Executive  Offices)   |   | (Zip Code)             |

 

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

**Securities registered pursuant to Section 12(b) ofthe Act:**

|      | **Title of each class** | ** ** |   |  | **Name of each exchange on which registered** | ** ** |
|------|-------------------------|------------|--------|--|-----------------------------------------------|------------|
| None |                    | None       |

 

**Securities registered pursuant to Section 12(g) ofthe Act:Common Stock, $0.001 par value**

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

Indicateby check mark if the registrant is not required to file the reports pursuant toSection 13 or 15(d) of the Securities Exchange Act of 1934. Yes o  No x

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

Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to the bestof the registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K. x

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer or a non-accelerated filer. (See definition of “acceleratedfiler” and “large accelerated filer” in Rule 12b-2 of the ExchangeAct). (Check One)

Large accelerated filer o  Acceleratedfiler o  Non-acceleratedfiler x

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

Aggregatemarket value of the voting and non-voting common equity held by non-affiliatescomputed by reference to the price at which the common equity was last sold on June 30,2005 was $20,491,504. Shares of Common Stock held by each executive officer anddirector and by each person who owns 10% or more of the outstanding CommonStock have been excluded in that such persons may be deemed to be affiliates.This determination of affiliate status is not necessarily a conclusivedetermination for other purposes.

As ofApril 20, 2006, the registrant had outstanding 35,056,045 shares of CommonStock.

**DOCUMENTS INCORPORATED BY REFERENCE**

The Registrant incorporatesby reference into Part III of this Annual Report on Form 10-Kspecific portions of its Proxy Statement for its 2006 Annual Meeting ofStockholders.

 

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**AVISTAR COMMUNICATIONS CORPORATION ANNUAL REPORT ON FORM 10-K YEAR ENDED DECEMBER 31, 2005**

**TABLEOF CONTENTS**

|                                                                                                                                    | ** ** | **Page** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
| *PART I*                                                                                                                      |       |     |       |   |   |
| *Item 1. Business*                                                                                                                 |       |     | *3*        |   |   |
| *Item 1a.  Risk Factors*                                                                                                           |       |     | *21*       |   |   |
| *Item  1b. Unresolved Staff Comments*                                                                                              |       |     | *30*       |   |   |
| *Item 2.  Properties*                                                                                                              |       |     | *30*       |   |   |
| *Item 3.  Legal Proceedings*                                                                                                       |       |     | *31*       |   |   |
| *Item 4. Submission of  Matters to a Vote of Security Holders*                                                                     |       |     | *31*       |   |   |
| *PART II*                                                                                                                     |       |     | * *   |   |   |
| *Item 5. Market for Registrant’s  Common Equity, Related Stockholder Matters and Issuer Purchases  of Equity Securities* |       |     | *32*       |   |   |
| *Item  6. Selected Financial Data*                                                                                                 |       |     | *33*       |   |   |
| *Item 7. Management’s  Discussion and Analysis of Financial Condition and Results of Operations*                              |       |     | *34*       |   |   |
| *Item 7a. Quantitative and  Qualitative Disclosures About Market Risk*                                                             |       |     | *45*       |   |   |
| *Item 8. Financial Statements  and Supplementary Data*                                                                             |       |     | *46*       |   |   |
| *Item 9. Changes in and  Disagreements with Accountants on Accounting and Financial Disclosure*                                    |       |     | *46*       |   |   |
| *Item  9a. Controls and Procedures*                                                                                                |       |     | *47*       |   |   |
| *Item  9b. Other Information*                                                                                                      |       |     | *47*       |   |   |
| *PART III*                                                                                                                    |       |     | * *   |   |   |
| *Item 10. Directors and  Executive Officers of the Registrant*                                                                     |       |     | *48*       |   |   |
| *Item  11. Executive Compensation*                                                                                                 |       |     | *48*       |   |   |
| *Item 12. Security Ownership  of Certain Beneficial Owners and Management and Related  Stockholder Matters*                   |       |     | *48*       |   |   |
| *Item 13. Certain  Relationships and Related Transactions*                                                                         |       |     | *49*       |   |   |
| *Item 14. Principal  Accounting Fees and Services*                                                                                 |       |     | *49*       |   |   |
| *PART IV*                                                                                                                     |       |     | * *   |   |   |
| *Item 15. Exhibits, Financial  Statement Schedules*                                                                                |       |     | *50*       |   |   |
| *Index to Financial Statements*                                                                                                    |       |     | *F-1*      |   |   |

 

 

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**Forward Looking Statements**

*This Annual Report on Form 10-K, theexhibits hereto and the information incorporated by reference herein contain “forwardlooking statements” within the meaning of Section 27A of the SecuritiesAct of 1933, as amended (the “Securities Act”) and Section 21E of theSecurities Exchange Act of 1934, as amended (the “Exchange Act”), and suchforward looking statements involve risks and uncertainties. When used in thisReport, 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 regarding our futurerevenues and profits, income from settlement and patent licensing , customerconcentration, customer buying patterns, research and development expenses,sales and marketing expenses, general and administrative expense, litigationand legal fees, income tax provision and effective tax rate, realization ofdeferred tax assets, liquidity and sufficiency of existing cash, cashequivalents, and investments for near-term requirements, sufficiency of leasedfacilities, purchase commitments, product development and transitions,expansion and licensing of our patent portfolio, competition and competingtechnologies, and financial condition and results of operations as a result ofrecent accounting pronouncements. Such statements are subject to risks anduncertainties that could cause actual results to differ materially from thoseprojected. These risks and uncertainties include those discussed below andthose discussed in “Management’s Discussion and Analysis of Financial Conditionand Results of Operations—Factors Affecting Future Operating Results” orincorporated by reference herein. Avistar Communications Corporation (the “Company,”“we,” or “us”) undertakes no obligation to publicly release any revisions tothese forward looking statements to reflect events or circumstances after thedate this Annual Report is filed with the Securities and Exchange Commission orto reflect the occurrence of unanticipated events.*

**PART I**

**Item 1.**   *Business*

We were founded as a Nevadalimited partnership in 1993. We filed our articles of incorporation in Nevadain December 1997 under the name Avistar Systems Corporation. Wereincorporated in Delaware in March 2000 and changed our name to AvistarCommunications Corporation in April 2000. The operating assets andliabilities of the business were then contributed to our wholly ownedsubsidiary, Avistar Systems Corporation, a Delaware corporation. In July 2001,our Board of Directors and the Board of Directors of Avistar Systems approvedthe merger of Avistar Systems with and into Avistar Communications Corporation(Avistar). The merger was completed in July 2001.

Our principal executive officesare located at 555 Twin Dolphin Drive, Suite 360, Redwood Shores,California, 94065. Our telephone number is (650) 610-2900. Our trademarksinclude Avistar and the Avistar logo, AvistarVOS, Shareboard, vBrief and TheEnterprise Video Company. This Annual Report on Form 10-K alsoincludes our and other organizations’ product names, trade names andtrademarks. Our corporate website is www.avistar.com.

OurAnnual Report on Form 10-K, Quarterly Reports on Form 10-Q,Current Reports on Form 8-K, and amendments to reports filedpursuant to Sections 13(a) and 15(d) of the Securities ExchangeAct of 1934, as amended, are available free of charge on our website when suchreports are available on the U.S. Securities and Exchange Commission (SEC) website(see “Company—Investor Relations—SEC Information”). The public may read andcopy any materials filed by us with the SEC at the SEC’s Public Reference Room at450 Fifth Street, NW, Washington, DC 20549. The public may obtaininformation on the operation of the Public Reference Room by calling theSEC at 1-800-SEC-0330. The SEC maintains an Internet sitethat contains reports, proxy and information statements and other informationregarding issuers that file electronically with the SEC at http://www.sec.gov.The contents of these websites are not incorporated into this filing.

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**Overview**

Wedevelop, market and support an integrated suite of vBusiness—video-enabledeBusiness—applications, all powered by the AvistarVOSTM software. From thedesktop, we deliver business-quality interactive video calling, contentcreation and publishing, broadcast origination and distribution, video-on-demand, and integrated data sharing. The Avistarvideo and data collaboration applications are all managed by the AvistarVOSvideo operating system. By integrating video tightly into the way they work,our customers can use our system to save costs and improve productivity andcommunications within the enterprise and between enterprises to enhancerelationships with customers, suppliers and partners. Using AvistarVOS software and leveraging video, telephony and Internetnetworking standards, Avistar applications are designed to be scalable,reliable, cost effective, easy to use, and capable of evolving with communications networks as bandwidth increasesand as new standards and protocols emerge. We currently sell our systemdirectly to enterprises in selected strategic vertical markets, and havefocused initially on the financial services industry. Additionally, we havelicensed our technology and patents to companies in the video conferencingmarket. Our objective is to establish our technology as the standard fornetworked video through direct sales, indirect channel sales/partnerships andthe licensing of our technology to others.

We operate in twosegments. Avistar Communications Corporation engages in the design,development, manufacture, sale and marketing of networked video communicationsproducts and associated support services. Collaboration Properties, Inc.,or CPI, our wholly owned subsidiary, engages in the prosecution, maintenance,support and licensing of the intellectual property that we have developed, someof which is used in our products.

Since inception, we haverecognized the innovative value of our research and development efforts, andhave invested in securing protection for these innovations through domestic andforeign patent application and issuance. As of December 31, 2005, we hold70 U.S. and foreign patents, some or all of which have been licensed. Wecontinue to pursue licensing to others in the collaboration technologymarketplace.

**Industry Background**

Globalization, supportedby the near ubiquity of communications networks such as the Internet, hasallowed companies to lower costs, reach new markets, change business processes(e.g., eBusiness) and distribute and outsource operations. It also has meantincreased competition, a faster business pace and less differentiation. Thesefactors, coupled with the difficulty and cost of travel and increased risks dueto socio-political uncertainties and pandemic concerns, are causing businessesto look for new tools that will help them increase productivity, take advantageof revenue opportunities, and minimize business continuity risks. Enterprises of all sizes stand to benefit fromnew and advanced communication and collaboration tools that enable theiremployees, partners, suppliers and customers to collaborate more effectivelyand form tighter relationships within and across buildings and over disparategeographies and time zones, recognizing that speed in decision-making and inbuilding trust-based relationships are becoming even more critical in today’sincreasingly complex business environment.

For years, enterpriseshave relied on communication tools used principally in a point-to-point manner,such as telephone and fax. More recently, businesses have also embracednetwork-based collaboration applications, such as teleconferencing, voicemailand email. The emergence of the Internet has accelerated the adoption of thesenetwork-based collaboration applications. The increasing availability andaffordability of bandwidth on communication networks is further drivingbusinesses to utilize new communication tools, such as web conferencing, toenhance collaboration among users.

As technology advances andbecomes more affordable and modes of communication expand, enterprises areseeking widely deployable and cost effective technology to replicate, at thedesktop, the impact of visual communication that occurs in a face-to-facemeeting. Individuals generally prefer 

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face-to-faceencounters to less personal forms of communication because they can see oneanother and benefit from the non-verbal cues that speed communication anddeepen understanding. This is particularly true for more complex interactionssuch as negotiations, sales, product development, project management anddecision making across geography/functions/cultures. However, in today’sglobalized, fast-paced business environment, face-to-face interactions areoften forgone due to the difficulty and time required for travel, and the needto act quickly. These time and distance challenges become increasinglydifficult to deal with as the number of potential participants increase. Beyondtraditional teleconferencing and data sharing communications, attempts toconduct virtual meetings as an alternative to face-to-face meetings havegenerally been limited to conference room-based video conferencing and web-baseddata teleconferences. Most individuals do not have immediate access to thesevideo technologies, and the reservation and set-up time make them unlikely tobe used on a spontaneous basis.

**Limitations of Current Means ofCollaboration**

Toaddress 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, instantmessaging, Internet audio and video delivery and data sharing applications.Many of these technologies have been widely adopted, and collectively indicatethe need for collaboration tools including networked video. However, thesediscrete technologies are not good substitutes by themselves for face-to-facemeetings and presentations because they do not provide an integratedcommunications solution that fosters team interaction and deliverscritical, time-sensitive information quickly and reliably. By providing face-to-face collaboration in anintegrated communications solution, video can speed problem resolution andmotivate action, trust and understanding. Additionally, users want to leverageknowledge and expertise by being able to create and publish video content fromtheir desktop, either spontaneously, as with email or voicemail, or in a moreformal manner for broader distribution through the Internet or corporate datanetwork.

Althoughvideo technologies are already in use at many enterprises, businesses and otherorganizations require increasingly comprehensive, integrated and scalablevideo-enabled communication capabilities. For example, video conferencing isoften limited to scheduled point-to-point communication from designated roomsor through the use of “roll-about” products, where call set-up procedures, lackof networking, bandwidth requirements and room availability greatly constrainfunctionality, usability, reliability and efficiency. Few of these videosolutions are deployed widely to individuals to support them where and how theynormally work—at their desks, integrated into the business applications theyuse. Usage and adoption of these systems is thus often limited.

Similarly,broadcasting of stored video or television programming at a desktop or in aconference room is of highly varying quality, and generally cannot be added ona real-time basis to a live videoconference. Additionally, the difficulties ofcreating and publishing video content have limited its use to select groups, ifat all.

**Elementsof a Complete Collaboration Solution**

Tobecome a critical tool in the enterprise, a communications solution must firstand foremost provide application functionality that boosts worker productivity.It also has to be self service and provide high quality at scale, highreliability, low total cost of ownership, and be available to people where andwhen they do most of their work, which typically means at their desks. It mustalso effectively utilize existing and evolving network infrastructure. Webelieve a complete collaboration solution must provide the following:

Applications and functionality

·       supportthe applications people use, in the way they use them, to deliver real-time andnon real-time self service personal collaboration and visualcommunication

·       doso in an intuitive, “easy” manner in order to foster expanding usage

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Quality

·       approximatethe video and audio quality of television for natural and easy interaction

·       makeinteractions as realistic as possible by minimizing visual artifacts whentransmitting and receiving video calls such as latency, jitter, freeze-frame,stutter and small frame size

·       seamlessly integrate all forms of audio, video and data communicationincluding interactive video calling, content creation and publishing, broadcastvideo and video-on-demand retrieval

Scalability

·       like the Internet and public telephone networks, the communicationssolution must be designed for size independence and should scalecost-effectively to support a very large numbers of users

Reliability

·       operatedependably and reliably to avoid user frustration, while minimizing supportcosts

·       provide to video communications the ease of use, speed, quality,functionality, flexibility and global access of the telephone, while easilysupporting more complex applications and situations

Adaptability

·       offer anupgradeable architecture that can evolve as bandwidth availability, protocols,standards and compression technologies change

·       includepowerful software to manage an integrated suite of collaborativeapplications, relying on networked infrastructure

·       leverage current and future business investments in local and wide areanetworks, Internet protocol and standards-based infrastructures

Affordability

·       operate andscale cost effectively

·       utilizestandard, low cost and widely available hardware components

·       becost-effective compared to other pervasive forms of enterprise communicationsuch as email

·       deliver costsavings through innovations in support, network and resource management

Webelieve high quality networked video communication allows businesses to improvecollaboration and thereby offers them the opportunity to increase productivity,enhance customer service and revenue generation, and facilitatebusiness-to-business interactions that reduce costs, all on an acceleratedbasis. We also believe that, just as every organization now relies on atelephone network, and most businesses increasingly rely on the Internet, amarket is emerging in which businesses and other organizations will choose torely on fully integrated video, audio and data collaboration, regardless ofnetworks, to make their business applications more effective.

**The Avistar Solution**

Avistar’s goal is tovideo-enable enterprises—a concept we term vBusiness—by delivering a suite ofvideo applications which support users where and how they work with aself-serve, easy-to-use system that fosters usage and adoption. It is through atight coupling of various forms of video into daily work processes that webelieve the benefits described above can be realized. To fulfill this, wedeliver a video 

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collaborationplatform enabled by a unique architecture and powerful software—the AvistarVOSvideo operating system. This software provides a comprehensive, integratedsuite of video applications that include on-demand access to interactive videocalling and conferencing, content creation and publishing, broadcastorigination and video distribution, and video-on-demand, as well as datasharing, presence-based directory services and network management. Theseapplications support users within and amongst enterprises and over datanetworks, telephony networks and the Internet. Our system architecture is openand flexible in order to embrace continued technological innovation andstandardization. It is designed to use existing and emerging communication andvideo standards such as session initiation protocol, or SIP. It also providescustomers the choice and flexibility in designing and implementing networktopologies to best deliver high-quality video applications to desktops acrossthe entire enterprise.

Avistar has builta complete video collaboration solution that is delivering business-quality video to thousands of desktopsacross hundreds of buildings. Each of our applications can be used, integratedand managed in conjunction with one another. People often conceive of video inthe enterprise only as two-way, real-time conferencing. Our system allowsbroadcast video to be included in a video call, and allows the entire sessionto be recorded simultaneously, and made available as stored video. Our systemjoins users in a high-quality video network to improve their ability to solvecomplex problems, connect to co-workers, customers and suppliers, manage largeprojects and quickly act together on opportunities. Our system does this costeffectively and reliably, and is designed to be able to serve the wide range ofbusinesses from a single office operation to global corporations with branchoffices and/or geographically dispersed operations.

*Interactivevideo calling.**  *Our system allows users to participate inspontaneous interactive video collaborations from their desktops. Users cansimultaneously see multiple participants in windows on their workstations or anexternal monitor. Additionally, our system provides full duplex audio, whichallows 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 threeother video sources. These sources can include other participants in real-time,broadcast content or recorded video. The participants can include individualusers or conference-room groups located at multiple sites and/or variousenterprises, all without requiring advance reservations or conferencingservices. Each participant has the full ability to utilize all the call functionsof the system, such as adding or removing participants. The system supports thecommunications needs of users by allowing them to add a third or fourthparticipant into a call spontaneously for a quick conference, and then revertback to a two party call. This ability helps speed decision-making andleverages the knowledge of experts. As an example, a sales trader can beon a video call with a client portfolio manager and spontaneously add aresearch analyst to the call for added insight on a particular security, thendrop the analyst and add a trader to review execution strategy.

*Videocontent creation and publishing.**  *With oursolution, users can create and publish video content from their desktops byrecording themselves, recording a multi-point conference or adding commentaryto a broadcast and recording the entire session. Recorded content can be playedback on demand, and can be published in various forms inside and outside theenterprise. This includes video emails, called vBriefs, which allow users toeasily create video messages which recipients, with common mail clients andbrowsers, can watch. This helps differentiate and highly personalize the sender’semail. As an example, research analysts can record introductory commentary anddistribute their research reports in a way that cuts through the email clutterof their audiences’ inbox. Similarly, video can be simply and quickly bepublished to web sites from a user’s desk.

*Interactivebroadcasts and presentations.**  *Interactivebroadcasts, introduced during 2005, allow moderated presentation to an audienceof viewers, who have the ability to send questions to the presenters. Moderatorscan dynamically control who’s presenting, bring audience members into thebroadcast, select what views are broadcast, and monitor questions. Salesmeetings, training seminars, analyst reports, management presentations and livenews broadcasts can be delivered real-time to every user’s workstation 

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andstreamed to browser-based users. For example, a customer employed its Avistarvideo network to maximize the reach and impact of an educational seminar. Thecustomer broadcast the seminar to an estimated 300 desktops and meeting rooms,with more than 2,000 employees and clients watching in the United States andEurope. As another example, one customer has shifted its international salesmeetings to broadcasts and recorded presentations on its Avistar system,thereby saving travel time and costs, while expanding the broadcast to a wideraudience. Additionally, video feeds from broadcast TV channels or other videosources can be distributed to users through the Avistar system.

*Video-on-demand.**  *Users anywhere on the Avistar network can easilyretrieve stored videos. For example, a corporation uses our system to recordits sales training seminars. Salespeople who are unable to attend theseface-to-face presentations are now able to watch the seminars by retrieving andplaying the stored videos on their desktops when it is convenient for them.Another customer uses our system to record and broadcast their daily morningmeetings so colleagues in other time zones around the world can be updated on theissues of the day when they report to work. The ability to both archive andretrieve stored content can facilitate the establishment of a visual “institutionalmemory” and support training efforts.

*Integrateddata sharing.**  *In addition to viewing the four quadrants of ourvideo window, multiple users can simultaneously create and annotate a shareddocument using text or drawing tools color-coded specifically for each user.All participants can access the contents of any shared window and save themarked changes for later reference. Our system can also be utilized inconjunction with other application-sharing programs that utilize datanetworks or the Internet including popular web-based data collaborationsolutions. As one example, while participating in an interactive video call,users can access Microsoft NetMeeting’s application sharing capabilitiesthrough a button on our tool bar, and jointly view and edit a document.Multiple design engineers, for example, can share a technical drawing in orderto resolve an issue with a defective part.

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

*Easy to use interface.**  *Our applications combine the rich interaction ofa face-to-face meeting with a self-service interface that’s as easy to use asthe telephone. Key features include:

·       *Click-to-connectsimplicity.*To initiate calls oradd another user to a session already underway, a user simply clicks on eithera “direct connect” button or a name in the directory. Standard telephone-likefeatures 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 thedesktop of colleagues, customers, suppliers and others on other Avistarnetworks. If the person being called is logged-in but unavailable, users canleave a personalized call back message that allows the person to automaticallyreturn the video call without having to look up the address. A portion of thisfunctionality is protected under certain patents held by CPI.

·       “*Find Me, Follow Me.”*Avistar video calling is built on directories andpresence-based features referred to as “Find Me, Follow Me.” Using this feature, our system is able todetermine the presence and location of any user on an Avistar network at anytime. To call any user in the Avistar network, it is not necessary to knowtheir number or current location. As long as the Avistar user is logged intohis or her Avistar application, the Find Me, Follow Me applicationautomatically registers where that user is logged in, regardless of site orgeography, and routes all calls to the user’s location. Using this Find Me, Follow Me technology, Avistar’s system makes video callinga one-click process and enables what we call “Video Instant Messaging.” Aportion of this functionality is protected under certain patents held by CPI.

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·       *Comprehensivedirectory*. The Avistar networkdirectory is a comprehensive list of Avistar numbers that can be called with aclick. All users currently logged intoan enterprise’s Avistar network will be shown, providing immediate ‘presence’information as to availability. The global directory can be tailored to includeonly a subset of a more specific business’ community of users. In addition, aprivate directory feature allows users to create their own directory and reachfrequently called parties with a one-click “direct connect” tool. Both globaland private directories can also include other non-Avistar sites that usestandards-based video conferencing systems. Through the Avistar CommunityExchange and AvistarVOS Proxy products, presence information can be sharedacross participating organizations. The result is one-click, presence-based,cross-enterprise calling which helps form a community of users. A portionof this functionality is protected under certain patents held by CPI.

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

*Seamlessintegration of system applications.**  *All of our applications are seamlessly integratedwith one user interface. As a user adds an additional video source during anongoing video call—such as an additional live participant, a one-way broadcastor a stored video clip—there is virtually no delay in launching anotherapplication or downloading data. In addition, each application is synchronizedwith the others so that all participants in a video call see and hear the samecontent simultaneously. Thus, recorded or broadcast video can be added to alive session and shown to all participants. The entire session can also berecorded. Our system enables common network and application management, so thesame directory can be used for two-way calls, one-way broadcasts and datasharing in the same session. Usage can be determined with our integratedcall-reporting tool that provides summary data for analysis and cost management.A portion of this functionalityis protected under certain patents held by CPI.

*Officetools integration.**  *Our video application can be tightly linked intocommon collaboration software tools such as Microsoft Office and IBM WorkplaceManaged Client. As a partner with IBM and Microsoft, we have integrated ourapplications functionality with these products to add video communicationoptions to common applications such as email, contacts, and calendar events. Thuswhile in the context of reading an email or looking up a contact, the user caninitiate a video call to that person.

*Networkmanagement.**  *Our network architecture provides systemadministrators with the ability to flexibly and proactively manage each of thevarious components of the network. Within our system, the most costly andcomplex equipment and software applications are shared as networked resources.This arrangement allows for redundancy and dynamic allocation of theseresources to users who need them, and ensures that users experience the bestvideo quality possible at the highest reliability and lowest cost of use.Servers and switches can be maintained, installed and repaired centrally, andmany network support functions can be performed remotely over the data network,thereby limiting the disruption of service to an individual user. Similarly,additional desktops and meeting rooms can be easily and inexpensively added tothe Avistar network, with those new users concurrently added to the Avistardirectory. Additionally, our software makes call routing decisions to minimizecommunications costs and control bandwidth utilization. A portion of this functionalityis protected under certain patents held by CPI.

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

·       *Speedbusiness processes.*We provide afully integrated Internet protocol-based video collaboration solution that seamlesslyallows individuals to make video calls, view broadcasts and create, store andaccess video content or other forms of data from the desktop making visualcommunications widely 

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andeasily available which can speed business processes by enhancing collaborationand communication.

·       *Increasedavailability of knowledge within the enterprise.*At many businesses, individuals who possessvaluable knowledge often cannot effectively distribute their knowledge to therest of the organization. Our system enables these businesses to access theseindividuals and disseminate their knowledge more efficiently and effectively byoffering them the ability to call, broadcast or record from their desktops, andoffering other users the ability to receive this information real-time, oraccess video recordings at a convenient time and location. The ability tospontaneously add additional participants to a call encourages personalcommunications between individuals who otherwise might not enjoy this access.In addition, our system gives every desktop the ability to create and publishvaluable visual content, which can be distributed inside and outside theorganization to support employee and customer needs worldwide.

·       *Improvedproductivity and revenue generation.*Our system helps companies increase the productivity of their employeesand accelerate time critical decision-making. By creating a network of Avistarusers, our customers can have face-to-face meetings within the enterprise andwith customers and partners, without the costs and time delays of travel.Negotiations, sales, advisory services, decision-making and otherpersuasive communications are more effective when done face-to-face. Oursolution allows interactions to happen in real-time, speeding up the manner inwhich business is done, freeing up time for employees, enhancingbusiness-to-business communications, and potentially increasing revenuegeneration.

·       *Enhancedcustomer and partner relationships.*Our system helps companies to be more responsive to and develop strongerbusiness relationships with their customers, partners and suppliers. An Avistarcall is generally as easy and reliable as a telephone call, while being morepersonal. One of our customers has provided Avistar networks to their clientsand business partners, including offshore outsource partners, in order tofacilitate interactions and improve relationships.

·       *Opportunityto leverage existing and future communication infrastructures.*We provide an open architecture that usesexisting standards and is designed to take advantage of emerging standards. Oursystem integrates into our customers’ existing network communicationsinfrastructure, and supports the protocols a company may choose to use forvideo broadcasts, data sharing and the transport of information. However, videoquality varies depending on the protocol selected. Our system utilizes existingdata networks for transporting video, and is designed to support real-timedigital networking and video transmission. We have designed our system to continueto work with Internet protocol-based technologies as standards evolve andquality of service improves. We expect this flexibility, together withsimplified software and hardware at the desktop, to allow companies to makeeffective use of their existing local area and wide area networks, as well astheir next generation networks.

·       *Better communication to face new business challenges such asglobalization, business continuity planning, and distributed locations.* Within global corporations, professionalscollaborate daily with customers, partners and associates who are often locatedin different offices and/or different time zones. This has increasingly becomethe case as firms, due to economic and security concerns, have restrictedtravel, begun decentralizing their personnel across a more distributed set oflocations, taking advantage of lower costs of real estate and increasedbusiness resiliency with distributed operations, and shifted more operations tooutsourcing providers. In this context, critical information must be deliveredon a timely basis and without confusion, as smoothly as if colleagues wereworking together in person. By offering a combination of conference room anddesktop systems, Avistar’s video product suite enables companies that arereducing travel and/or distributing their operations to easily and quicklyconnect small, remote offices to the central organization and 

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still benefit fromface-to-face interaction. Basedon our experience in helping existing customers choose their optimalconfigurations, we are able to advise new customers on setups andconfigurations that will be most effective for a large central office, a smallbranch office, an outsourcing provider, or other remote locations.

**System Architectureand Technology**

Our networked video system isbased on our eighth major release of our open architecture, which enables usersto communicate visually using various networking protocols and transport media,including IP networks and the Internet. We developed our architecture toaddress the necessary elements of a complete video-enabled collaborationsolution.

We believe that the following technical factors will transform andconsolidate the existing video collaboration applications marketplace, creatinga strong need for a software platform that will support this consolidation andevolution:

·       improvedcompression technologies;

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

·       developingavailability of converged audio, video and data networks;

·       improvedcomputer processing speeds; and

·       adoption ofcritical digital video and multimedia standards.

Our software platform supportsthis consolidation and evolution by integrating industry standards for audio,video and data transport, but separating them from application functionalityand system management. This allows the video operating system to manage theinteroperation and transcoding of various standards to seamlessly integratevideo, audio and data into complex applications, and not be limited by thefunctionality built into one particular, application-specific standard. It alsoallows the system to accommodate new and evolving standards with minimaldisruption. Current industry and widely accepted proprietary standardssupported include H.263, H.320, H.323, SIP, NTSC, PAL, MPEG, Microsoft WindowsMedia Video and Real Networks RealMedia.

We believe our AvistarVOS videooperating system positions us to lead the transformation described above.Further, we provide a suite of collaboration applications that seamlesslyoperate with the AvistarVOS system allowing users to access this functionalityin an easy and intuitive manner. We expect to make this platform moreaccessible to developers and to allow integration with other applications andnetwork hardware.

Our system uses TCP/IP, thestandard Internet protocol, for initiating video calls, scheduling and startingbroadcast presentations, and managing the creation and access of stored videomaterials. In addition, we use TCP/IP for overall systems and networkmanagement throughout our software platform. This approach allows us to deliverconnectivity throughout an enterprise and allows us to leverage existingInternet infrastructure. For delivery of live high-quality video streams in thelocal area network, we offer a choice of IP or traditional circuit switchedtechnologies, including the ability to mix and match network types. WithAvistar, customers can successfully deploy desktop video across the enterprise,even if portions of their network, in older buildings for example, aren’tcapable of supporting real-time video on their data networks. We use ourgateways to translate between the various network technologies used in oursystem. These gateways are managed and controlled by our systems software withTCP/IP-based protocols.

EachAvistar endpoint functions as a node on the network, like personal computers,printers or file servers on a local area network. Just as color printers andfile servers are often shared network resources 

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on the local area network, the more costly equipment inan Avistar system, such as servers, media servers, switches, and gateways, arecentralized and made available to multiple users. Network nodes and resources,like those of a data network, are managed through centralized, Internetprotocol-based applications and administration tools, such as web-based reportsof video call activity.

Because of the tight integration of various videonetwork components, namely, IP or circuit-switched endpoints, the AvistarSwitch, Media Server, Conference Center, and gateways, all controlled by theAvistarVOS software, our architecture has the following key features:

·       *Videonetwork choice*: Many IP datanetworks are not capable of reliably supporting real-time video traffic atscale. Avistar provides a choice of using data networks for video traffic insome locations and, through the use of Avistar video switches, circuit-switchednetworks in others. These networks are fully integrated and interoperable, thusensuring that our system can scale to support large numbers of users.

·       *Networkmanagement:*The AvistarVOSsystem utilizes open protocols for call set-up, call control and directoryservices. It also complies with standards and interfaces and connects withvideo networks through shared Avistar gateways, which are further connected viaprivate or public telephony or TCP/IP networks. Servers communicate through oursignaling system for video protocol, SSV, which is based on TCP/IP, thestandard Internet protocol. Through this signaling system, servers exchangeconfiguration information and allocate call resources during call set-up, andexchange network status information. The signaling system selects the optimalroute for all video calls, helping to minimize call costs and performancedemands on wide area network resources. Most videoconferencing equipment usingindustry standard compression technologies also can communicate with an Avistarnetwork.

·       *Transportstandard independence:* Oursystem selects the appropriate transport standards for transmitting informationover networks to help deliver the highest quality video possible and fullduplex audio in the most efficient manner. For example, the AvistarVOS softwareautomatically exchanges information among servers and switches to determine thebest network route for video calls. For the transport of video over a localarea network, our system uses either data networks with our IP Endpoints orexisting spare Ethernet wires to deliver standards-compliant television qualitysignals with our circuit-switched endpoints. This allows customers to choosethe transport type to best fit their network capabilities in the local area. Ina wide area network, we use industry video compression standards across thepublic telephony network, a customer’s private IP network, or VPN’s or theInternet. Product releases during 2005 enhanced our ability to support mobileand home workers who may have lower bandwidth connections. For the transmissionof recorded content on corporate data networks or via the Internet, our systemuses standard digital storage formats and transport technologies.

·       *Expandableto thousands of users:*Becauseshared resources, such as servers, are attached to the Avistar switch and aremanaged through the data network, new users and new capabilities can be addedwithout replacing existing infrastructure, but rather, by simply adding videosoftware and hardware at each desktop. Just as local area network switches andpublic telephony networks can be linked together without the use of routers,Avistar switches can be similarly linked without the use of video networkgateways. As a result, customers can easily add capacity as their needs grow.

·       *Evolveswith digital technology:*OurAvistarVOS software is designed to facilitate utilization of all-digital,local area networks, including Internet protocol video transmission, wheresufficient bandwidth and quality of service (QOS) are available. This all-digitalsystem also maintains compatibility with our existing circuit-switched videonetworks. The AvistarVOS software allows evolution of the transport of audioand video based on the customer’s local area data network capabilities. Asimple and inexpensive swap of endpoint hardware allows customers to migrate toall IP networks, while preserving the same user interface system functionality.

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**System Products and Applications**

Oursystem-level products and applications consist of shared resources and anetwork of desktop and conference room endpoints which connect to each otherand these shared resources.

*Shared Resources*

Likethe architecture of most data networks, our system is designed to maximize theuse of shared resources on the network. This configuration results in a desktopthat is not burdened with processor-intensive software and hardware. Eachuser can access higher quality software, gateways, multi-point conferencecenters, media servers and video broadcasts with lower per user acquisition andmanagement costs than is possible with non-networked video solutions. Thesedevices are expected to move to software-only resources over time. Theseshared resources consist of the following products and applications:

*Infrastructure, Server and Software Products*

·       *AvistarVOSServer.*All systems requireAvistarVOS Server software. It enables the seamless integration of videoapplications, comprehensive network and bandwidth management andadministration. The AvistarVOS software supports a highly-distributed topology,and multiple instances may be deployed. Digital IP endpoints require networkaccess to servers running AvistarVOS software configured for IP endpoints.Servers in the Avistar Switch also run instances of AvistarVOS Server softwareas noted below.

·       *AvistarSwitch.*Each Avistar switch runsthe AvistarVOS Server software that provides application services and networkmanagement. The Switch hostsshared video services and infrastructure such as Avistar conference centers,media servers, gateways, television broadcasts, VCR’s and other video serviceswhich are accessed by both types of endpoints. It also serves as the video switch for our local area circuit-switchednetwork, connecting video calls placed among Avistar desktop and conferenceroom users. Each switch supports up to 120 circuit-switched desktop usersand/or conference rooms, and switches can be networked together in a building orcampus to scale to many hundreds or even thousands of users. With IP endpointdeployments, a switch is required only for video services beyond point-to-pointcalling and may be located anywhere with appropriate network access.

·       *AvistarGateways.*Gateways provideconnectivity to the wide area network for circuit-switched endpoints,interoperability with third-party video systems that are H.320 or H.323compliant, interoperability between IP endpoints and circuit-switchedendpoints, and access to shared video services for IP endpoints. The gatewayssupport various protocol standards, using public telephony, TCP/IP networks orthe customer’s private networks.

·       *AvistarConference Center.*Ourconference center enables multi-point conferences for up to four video sources,with continuous presence that allows all participants to see and hear oneanother continuously and simultaneously. Multiple conference centers can beinstalled on each switch to support a corresponding number of simultaneousmulti-party calls. Conference centers also support interactive broadcastfunctionality.

·       *AvistarMedia Server.*Our media serverallows users to create, publish and view video content from any desktop orconference room. Any form of video, including a four-way video call, can besaved on the media server in high quality, digital MPEG format. Any user canretrieve and replay video at any time from the media server using the desktopAvistar interface or any industry standard MPEG player. The Avistar MediaServer also has a publishing capability, allowing Avistar users to publishvideo content on intranets, extranets or the Internet, including web servers,video servers or content 

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distributionnetworks. Publishing to vBriefÔ video email messages is one example. The MediaServer software manages format plug-ins to simplify transcoding to other videostandards and formats, such as Real Networks and Microsoft Windows Media Video.

·       *AvistarInteractive Broadcast.*Ourinteractive broadcast feature, enhanced during 2005, allows Avistar desktop orconference room users to broadcast one-way, real-time presentations to anaudience of other Avistar users at both local and remote sites. A Moderator UIpanel includes an audience list, a text-based chat-back channel for viewerquestions, broadcast view control, and the ability to drag and drop presentersand viewers into and out of the broadcast. An individual or a conference callcan be broadcast to thousands of users, and, via third party products, to bestreamed simultaneously over the Internet.

·       *AvistarDirectory Software.*Ourdirectories allow a user to place a video call by simply clicking on a name inthe user’s directory of local and remote Avistar users. If the other party islogged-on, our system will route the call to the correct location over thelocal area network or the wide area as appropriate. The user can look upaddresses in private and global address books, utilize browser style type-inboxes, and access speed-dial ‘direct connect buttons’. This server-baseddirectory integrates with LDAP directories, simplifies administration, andallows users to get started quickly, without having to manually enter manyvideo phone numbers into their desktop directory.

·       *AvistarCommunity Exchange and AvistarVOS Proxy*. These products provide secure, cross-enterprise communications betweenindependent Avistar systems. This provides directory and presence informationand system resource reservation for easy and fast connections between firms.These products facilitate the building of communities of video-enabled usersacross enterprises

·       *Shareboard®Software.*Our Shareboardapplication allows users to collaborate on graphics, data or text during avideo call. By clicking on the “share” button, users are linked to theShareboard data sharing application. Users can share any application window orimage with all conference participants, see all users’ color-keyed pointers andtext and paintbrush annotations, and save or print shared images from anydesktop or conference room.

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

*Desktop and Conference Room Endpoint Products*

Client PC’s run the AvistarVOSClient software applications, including Avistar Conference, the primary userinterface to server-based video applications. Endpoints access video servicesmanaged by the AvistarVOS Server software through the AvistarVOS Clientsoftware and Client Access Licenses. Endpoints are either IP (digital) orcircuit-switched (analog).

*Desktop Endpoints.**  *The standard Avistar two-way desktop systemconsists of the following hardware components:

·       A highquality camera with built-in directional microphone;

·       A videocodec (with IP endpoints for signal compression and decompression) or videonetwork interface unit (with circuit-switched endpoints) with ports for camera,microphone, speakers, auxiliary video and audio, headset, built inecho-cancellation circuitry and full duplex audio, without requiring a headset;and

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·       IP endpointsdisplay video either directly on a computer display or external monitor.Circuit-switched endpoints include a video overlay card that allows videoto be viewed from a computer or an external monitor.

*Avistar Room Systems.**  *We deliver complete video systems for a widerange of room sizes and layouts. We believe that one key advantage of oursystem is that the interface used in a conference room system is consistentwith the interface used on individual desktops, allowing for all forms ofvideo-enabled communications: interactive video calling, content creation andpublishing, broadcasting and video-on-demand. Therefore, desktopusers are familiar with the controls used in Avistar room systems and do notneed additional training to operate the room system, nor do they need anadditional technician to set-up and connect conference room calls (as is commonwith traditional room systems). In addition, since rooms are simple additionalnodes on the network, they can be less expensive than self-contained,traditional room systems.

**Customers**

As of December 31, 2005, we have licensed andrecognized revenue with respect to over 11,000 end-users at over 400customer sites in approximately 150 cities in over 40 countries. Because manyof our customers operate on a decentralized basis, decisions to purchase oursystems are often made independently by individual business units. As such, asingle company may represent several separate accounts and multiple customersites may relate to the same company.

For the year ended December 31, 2005, UBS WarburgLLC and its affiliates and Deutsche Bank AG and its affiliates accounted for45% and 39% of our total revenues, respectively. For the year ended December 31,2004, Deutsche Bank AG and its affiliates represented 55% of our total revenueand UBS Warburg LLC and its affiliates accounted for 16% of our totalrevenue. For the year ended December 31, 2003, Deutsche Bank AG and itsaffiliates represented 62% of our total revenue. The level of sales to anycustomer may vary from quarter to quarter, and we expect that significantcustomer 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 ourfinancial condition or results of operations.

Internationalrevenue, which consists of sales to customers with operations principally inWestern Europe and Asia  comprised63%, 52% and 58% of total revenue for 2005, 2004 and 2003, respectively. For2005, 2004 and 2003, revenues to customers in the United Kingdom accounted for23%, 31% and 40% of total revenue, respectively.

**Segment Information**

We operate through two segments:

·       AvistarCommunications Corporation engages in the design, development, manufacturing,sale and marketing of networked video communications products.

·       CollaborationProperties, Inc., our wholly owned subsidiary, engages in the development,prosecution, maintenance, support and licensing of the intellectual propertyused in our video communications system.

Financial informationregarding these segments is provided in Note 12 to our consolidated financialstatements included in this Annual Report on Form 10-K. Financialinformation relating to revenues and other operating income, net loss,operating expenses and total assets for the three years ended December 31,2005, can be found in Item 6 “Selected Financial Data” and also in ourConsolidated Financial Statements attached hereto.

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**Sales and Marketing**

*Sales.**  *We have a direct sales force in the United Statesand Europe consisting of sales managers located in New York, New York andLondon, England. Sales managers have direct responsibility for selling andaccount management, system utilization and expansion at existing customersites.

*IndirectSales.**  *Through our partnership organization, we seek tobuild a set of relationships with strategic partners and value added resellers,in order to establish and the expand an indirect channel of sales for ourproducts

*Marketing.**  *Our marketing efforts are directed towards selectvertical markets, with a current emphasis on the financial services industry.We have identified specific collaboration needs for enterprises, specific tothe vertical market. We then help our customers understand how our system cansatisfy these needs, thereby increasing the number of users. We emphasize initiativesto develop market awareness of our system and services, as well as increasedusage of our installed systems. We also use marketing programs to buildrecognition of our corporate brand, foster partnerships and promote ourtechnology in regards to licensing opportunities.

**Installation, Maintenance, Training and Support Services**

We provide a wide variety of services forinstallation, design and adoption of our video communications products. Thismay include the analysis of workflows in order to identify patterns ofcollaboration between workgroups so that the best configuration of networkedresources can be designed and implemented for the enterprise. We generallyinstall our systems for new customers. In an increasing number of cases, ourcustomers’ information technology group or services partner install follow-onorders. In the future, we expect our customers or their services partners willincreasingly perform the installation of additional systems.

The installation that we offerto our customers as a separately-priced service relates to the physical set upand configuration of desktop and infrastructure components of our solution. Toaccomplish this activity, our representatives frequently interface with thecustomer’s internal Information Technology (I.T.) staff and external suppliers,in order to provide for connectivity to the customer’s local and wide areanetworks, and for the physical placement (arranging for rack space andappropriate environmental conditions) and connections between the variouscomponents purchased. The effective operation of software and hardware ischecked 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, thecoordination necessary for accommodating the equipment and establishingconnectivity frequently creates cycle times of between two and six weeks fromproduct shipment to installation at the customer’s site.

Ourmaintenance services ensure that customers benefit from the latest networkedvideo technology through software upgrades and expedited repair and replacementservices. Our customer support center provides voice and video call assistanceto Avistar users and administrators throughout the world. On-site support isalso available from each of our major regional offices for a separate fee. Inaddition, training for users is available onsite or at an Avistar facility andfor system administrators at an Avistar facility on a for-fee basis.

**Backlog**

Theestimated backlog of product orders believed to be firm was $100,000 at December 31,2005 and $700,000 at December 31, 2004. We expect most of the orders as ofDecember 31, 2005 will be shipped in the first two quarters of 2006.Backlog is not necessarily indicative of past or future operating results.

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**Research and Development**

Webelieve that strong system development capabilities are essential to ourstrategy. Our research and development efforts focus on enhancing our coretechnology, developing additional applications, addressing emergingtechnologies, standards and protocols, and engaging in patent and licensingactivities. Our system development team consists of engineers and softwaredevelopers with experience in video and data networking, voice communications,video and data compression, email and Internet technologies. We believe thatour diverse technical expertise contributes to the highly integratedfunctionality of our system. Research and development expenses were $3.5million in 2005, $2.6 million in 2004 and $2.4 million in 2003. We expect todevote a significant amount of our resources to research and development in theforeseeable future.

**Manufacturing**

Weuse contract manufacturers to produce and/or purchase components, and toperform some material assembly. Our operations staff develops manufacturingstrategies and qualifies and audits manufacturing processes and suppliers. Wework with our contract manufacturers to reduce manufacturing costs and toresolve quality control issues, as we perform the final assembly and testing ofour standard products. We believe our manufacturing strategy enables us toutilize the manufacturing capabilities of our contract manufacturers, whileallowing us to focus on rapid system development and deployment, softwarearchitecture and development of video communication applications. We use thirdparty, commercially available camera components, microphones, speakers andmonitors for desktop and room systems, as well as third party compression anddecompression components for our gateways.

**Intellectual Property and Proprietary Rights**

Our ability to compete, and tocontinue to provide technological innovation depends substantially uponinternally developed technology. We rely on a combination of patent, copyright,trademark and trade secret laws, as well as licensing, non-disclosure and otheragreements with our consultants, suppliers, customers and employees, to protectour technology. We believe that other factors such as the technological andcreative skills of our personnel, new system developments, frequent system andfeature enhancements and reliable system support and maintenance are alsoessential to maintaining our leadership position in technology.

We have pursued registration ofour key trademarks and service marks in the United States, the United Kingdomand certain other European countries, and intend to pursue additionalregistrations in additional countries where we plan to establish a significantbusiness presence. We own several United States, Canadian and United Kingdomtrademarks, including Avistar and the Avistar logo, AvistarVOS, Shareboard,vBrief and The Enterprise Video Company.

Through Collaboration Properties, Inc., ourwholly owned subsidiary, as of December 31, 2005, we held 25 United Statespatents and 45 non-United States patents. The patents that have been issuedexpire at varying dates between 2013 and 2019. In addition, numerous patentapplications are pending in the United States and several other jurisdictions.Specifically, these patent applications, some of which relate to and claimpriority from an application originally filed in 1993, include both method andapparatus claims. These patents and pending patent applications disclose and/orclaim aspects of our analog or digital desktop video conferencing technology,video and multimedia storage technology for messaging and publishing, directoryservices, and public wide area networking access, switching and architecture. Aportion of these technologies is currently utilized in our system. To date, CPIhas focused on expanding our patent portfolio and expediting patent issuance.We plan to continue these efforts and to seek to license our patents toreinforce the adoption of our technology.

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We generally enter intoconfidentiality, license and nondisclosure agreements with our employees,consultants, prospective customers, licensees, and partners that seek to limitthe use and distribution of our proprietary materials and prohibitreverse-engineering of our proprietary technologies. In addition, we controlaccess to and distribution of our software, documentation and other proprietaryinformation. Several of our license agreements with our customers require us toplace our software source code into escrow. In these cases, these agreementsprovide 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 underthe terms of the agreements if we fail to cure a contractual breach by us on atimely basis, or if we become the subject of a bankruptcy or similarproceeding.

Wemaintain a strong working relationship with vendors whom we identify as keysuppliers, and assign preferred provider status to these vendors underagreements that secure ordering and extended warranty rights for us.

**Competition**

The market for videocollaboration products and systems is highly competitive and fragmented. As aresult of advances in technology, increases in communications capability andreductions in communications costs in the past several years, the market is nowcharacterized by many competitors, rapidly changing technology, evolving userneeds, developing industry standards and protocols and the frequentintroduction of new products and services. Within the market for videocollaboration products and systems, we compete primarily with Polycom, Inc.,Tandberg Inc. and Emblaze-VCON Ltd.

We believe we may faceincreasing competition in the future from alternative video communicationssolutions that employ new technologies or new combinations of technologies fromcompanies such as Cisco Systems, Inc., Avaya, Inc., Nortel NetworksCorporation, Microsoft Corporation, and WebEx Communications, Inc., thatenable web-based or network-based video communications with low-cost digitalcamera systems.

We believe that the principal factors affecting competition in ourmarkets include:

·       productfeatures, functionality and scalability;

·       productquality and performance;

·       productreliability and ease of installation;

·       use of openstandards;

·       quality ofservice and support;

·       companyreputation, size and financial stability;

·       price andoverall cost of ownership;

·       integrationwith other desktop collaboration products; and

·       documentsharing, including internet-based collaboration.

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

·       room-basedpoint-to-point video communication products;

·       desktopvideo communications products;

·       broadcastvideo products;

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·       videoretrieval and viewing products;

·       desktopcontent creation products; and

·       web-baseddata collaboration products.

While a number of companies havemarketed applications that enable users to use individual features similar toour system, we do not believe that any single competitor currently offers afully integrated system that provides all the features of our system. Webelieve these companies in many cases can also represent complementaryopportunities to extend the reach of our system by potentially expanding themarket for video networking.

Weexpect competition to increase significantly in the future from existingproviders of specialized video communications products, voice over IP solutionproviders and companies that may enter our existing or future markets, possiblyincluding major telephone companies or communications equipment providers.These companies may develop similar or substitute solutions, which may be lesscostly or provide better performance or functionality than our systems. Anumber of our existing and potential competitors have longer operatinghistories, significantly greater financial, marketing, service, support,technical and other resources, significantly greater name recognition and alarger installed base of customers than we do. In addition, many of our currentor potential competitors have well-established relationships with our currentand potential customers, and have extensive knowledge of our industry. It ispossible that new competitors or alliances among competitors may emerge andacquire significant market share. To be successful, we must continue to respondpromptly and effectively to the challenges of developing customer requirements,technological change and competitors’ innovations. Accordingly, we cannotpredict what our relative competitive position will be as the market evolvesfor video collaboration products and services.

**Employees**

Asof December 31, 2005, we had 77 employees, including personnel dedicatedto research and development, customer service, including installation andsupport services, sales and marketing, and finance and administration. Ourfuture performance depends in significant part upon the continued service ofour key technical, sales and marketing, and senior management personnel, noneof whom are obligated to remain with us by an employment agreement. The loss ofthe services of one or more of our key employees could harm our business.

**Executive Officers**

Our officers and their ages as of December 31, 2005were as follows:

| **Name**             | ** ** | ** ** | ** ** | **Age**                                                  | ** ** | **Position** |
|----------------------|------------|------------|------------|----------------------------------------------------------|------------|--------------|
| Gerald  J. Burnett   |       | 63         |       | Chairman  of the Board and Chief Executive Officer       |
| William  L. Campbell |       | 57         |       | Vice Chairman, and Chief Operating Officer and Secretary |
| Robert  J. Habig     |       | 51         |       | Chief Financial Officer                                  |
| J.  Chris Lauwers    |       | 45         |       | Chief Technology and Product Officer                     |
| Anton  F. Rodde      |       | 63         |       | President, Collaboration Properties, Inc.           |
| Robert  T. Garrigan  |       | 44         |       | Vice President, Sales                                    |
| Stephen F. Arisco    |       | 47         |       | Vice  President, Operations and Customer Support         |

 

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*Gerald J. Burnett*is one of our founders and has been Chairman of our Board ofDirectors and our Chief Executive Officer since March 2000. He served asChief Executive Officer of Avistar Systems from December 1998 until March of2000. From 1993 to 1997, he was a director of Avistar Systems or a principal ofits predecessor limited partnership. He is a member of the Corporation (Boardof Trustees) of the Massachusetts Institute of Technology. Dr. Burnettholds a B.S. and an M.S. from the Massachusetts Institute of Technology inelectrical engineering and computer science, and a Ph.D. from PrincetonUniversity in computer science and communications.

*William L. Campbell*is one of our founders and has been a member of our Board ofDirectors and our Executive Vice President since March 2000. He has beenour Corporate Secretary since June 2001 and served as our interim ChiefFinancial Officer from April 2001 to May 2001. He has been ChiefExecutive Officer of CPI since December 1997. In July 2005 hereceived the title of Chief Operating Officer. Mr. Campbell holds a B.S.in general engineering from the U.S. Military Academy and an M.S. in managementfrom the Sloan School of the Massachusetts Institute of Technology.

*Robert J.Habig* has been our Chief Financial Officer since May 2001.He had previously served as Chief Financial Officer at think3 Corporation, aprivate computer-aided design software company from March 1999 to February 2001,as Chief Financial Officer at CrossWorlds Software, Inc., an enterprisesoftware company from July 1998 to February 1999, as Executive VicePresident at First Data Corporation, a financial transactions processingcompany, from May 1997 to June 1998, as a business unit ChiefFinancial Officer at AlliedSignal Corporation, an automotive, aerospace andchemical manufacturing company from 1994 to 1997, and held a number ofpositions with PepsiCo from 1979 to 1994. Mr. Habig holds a B.A. ineconomics and business from Lafayette College and an M.B.A. from the SimonGraduate School of Business at the University of Rochester.

*J. ChrisLauwers*has been our Chief Technology and Product Officersince February 2000. He served as Vice President of Engineering of AvistarSystems from 1994 to 2000. He previously served as Principal Software Architectat Vicor Inc., a private e-business productsolutions and engineering consulting company, from 1990 to 1994, and asa research associate at Olivetti Research Center from 1987 to 1990. Mr. Lauwersholds a B.S. in electrical engineering from the Katholieke Universiteit Leuvenof Belgium. Mr. Lauwers also holds an M.S. and a Ph.D. in electricalengineering and computer science from Stanford University.

*Anton F. Rodde*has been the President of Collaboration Properties, Inc.,since December 2003. Prior to joining CPI, he served as President and CEOof Western Data Systems, an ERP software company, from 1991 to 2003, asPresident and General Manager of several subsidiaries of Teknekron Corporation,a technology incubator, from 1984 to 1991, as founder and President of ControlAutomation, a robotics company, from 1980 to 1984, and held a variety oftechnical and management positions at AT&T from 1970 to 1980. Mr. Roddeholds a B.S. in physics from Benedictine University and an M.S. and Ph.D. inphysics from the Illinois Institute of Technology.

*RobertGarrigan*joined Avistarin May 2005 as Vice President of Sales. Prior to joining Avistar, Mr. Garriganwas senior vice president of sales at The NewsMarket, Incorporated, a broadcastnews distribution service delivering video content for Fortune 500 companies,and government and non-government organizations via an Internet-based platformfrom September 2004 to May 2005. With over twenty years ofexperience, Mr. Garrigan has held senior positions at Thomson Financial inboth the US and Europe and with IntraLinks in New York. Mr. Garrigan holdsa B.A. in Economics from State University of New York.

*Stephen F. Arisco*has been our Vice President of Operations andCustomer Service since February 2000. He previously served as the Directorof Operations and Customer Service of Avistar Systems from December 1997to January 2000. From 1987 through December 1997, he was Director of 

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Customer Service and Operations at TRW Financial Systems, Inc.,a systems integration company. Mr. Arisco holds a B.S. in Business fromthe University of Phoenix.

**Item 1a.**   *Risk Factors*

**Factors Affecting Future Operating Results**

**Our market is in the early stages of development, and our system may notbe widely accepted.**

Our ability to achieveprofitability depends in part on the widespread adoption of networked videocommunications systems and the adoption of our video operating system inparticular. If the market for our system fails to grow or grows more slowlythan we anticipate, we may not be able to increase revenue or achieveprofitability. The market for our system is relatively new and evolving. Wehave to devote substantial resources to educating prospective customers aboutthe uses and benefits of our system. Our efforts to educate potential customersmay not result in our system achieving broad market acceptance. In addition,businesses that have invested or may invest substantial resources in othervideo products may be reluctant or slow to adopt our system. Similarly,customers using existing information systems in which they have madesignificant investments may refuse to adopt our system if they perceive thatour offerings will not complement their existing systems. Consequently, theconversion from traditional methods of communication to the extensive use ofnetworked video may not occur as rapidly as we wish.

**We have incurred substantial losses in the past and may not be profitablein the future.**

We incurred net losses of $5.2million for 2005, $8.7 million for 2004 and $8.6 million for 2003. As of December 31, 2005, our accumulated deficit was $94.6million. Our revenue and income from settlement and patent licensing may notincrease, or even remain at its current level. In addition, our operatingexpenses may increase as we continue to develop our business in the future. Asa result, to become profitable, we will need to increase our revenue byincreasing sales to existing customers and by attracting additional customersthrough both direct and indirect sales channels. If our expenses increase morerapidly than our revenue, or if revenue and expense levels remain the same, wemay never become profitable.  If wedo become profitable, we may not be able to sustain or increase profitabilityon a quarterly or annual basis. In addition, if we fail to reach profitabilityor to sustain or grow our profits within the time frame expected by investors,the market price of our common stock may be adversely impacted.

**General economicconditions have and may continue to reduce our revenues and harm our business.**

The international economicenvironment has negatively affected our business in the past, and may continueto do so in the future. During the most recent economic slowdown, which beganin 2000, the investment banking industry suffered a sharp decline, which causedmany of our existing and potential customers to cancel or delay orders for ourproducts. Although the U.S. economy has improved, our customers and potentialcustomers may continue to delay ordering our products, and we could fall shortof our revenue expectations for 2006 and beyond. Slower growth among our customers,constraints on our customers’ operating budgets, retrenchment in the capitalmarkets and other general economic factors all have had and could in the futurehave a materially adverse effect on our revenue, capital resources, financialcondition and results of operations.

**Our lengthy sales cycle to acquire new customers or large follow-onorders may cause our operating results to vary significantly and make it moredifficult to forecast our revenue.**

We have generally experienced a product sales cycle ofapproximately five months for new customers or large follow-on orders fromexisting customers due to the time needed to educate customers about the usesand benefits of our system, and the significant investment decisions that ourprospective customers must make when they decide to buy our system. Many of ourprospective customers have neither budgeted expenses for networked videocommunications systems, or for personnel specifically dedicated to the 

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procurement, installationor support of these systems. As a result, our customers spend a substantialamount of time before purchasing our system in performing internal reviews andobtaining capital expenditure approvals. Economic conditions over the lastseveral years have contributed to additional deliberation and an associateddelay in the sales cycle.

Our lengthy sales cycle is oneof the factors that has caused, and may in the future continue to cause, ouroperating results to vary significantly from quarter to quarter and year toyear. This makes it difficult for us to forecast revenue, and could causevolatility in the market price of our common stock. A lost or delayed ordercould result in lower revenue than expected in a particular quarter or year.

**Since a majority of our revenue has come from follow-on orders, ourfinancial performance could be harmed if we fail to obtain follow-on orders inthe future.**

Our customers typically placelimited initial orders for our networked video communications system, as theyseek to evaluate its usefulness and value. Our strategy is to pursue additionaland larger follow-on orders after these initial orders. Product revenuegenerated from follow-on orders accounted for approximately 99% of our revenuein 2005, 78% in 2004 and 96% in 2003. Economic conditions have contributed todecreases in our clients’ capital spending in the past, and we have experienceda decrease in the size and number of follow-on orders. Our future financialperformance depends on successful initial installations of our system, andsuccessful generation of follow-on orders as the Avistar network expands withina customer organization. If our system does not meet the needs and expectationsof customers, we may not be able to generate follow-on orders.

**Because we depend on a few customers for a majority of our revenue, theloss of one or more of them could cause a significant decrease in our revenue.**

We have historically derived the majority of ourrevenue from a limited number of customers, particularly Deutsche Bank AG andtheir affiliates and UBS Warburg LLC and their affiliates. In 2005, thesecustomers accounted for 84% our total revenue. Deutsche Bank AG and theiraffiliates and UBS Warburg LLC and their affiliates accounted for 71% ofour revenue for 2004. No other customers individually contributed greater than10% of our total revenue for 2005 or 2004. In 2003, Deutsche Bank AG and theiraffiliates accounted for 62% of our revenue. No other customers individuallyaccounted for greater than 10% of our total revenue for 2003. We expect that wewill continue to depend upon a limited number of customers for a substantialportion of our revenue. As of December 31, 2005, three customersrepresented 48%, 32% and 17% of accounts receivable. As of December 31,2004, approximately 81% of our accounts receivable were concentrated with onecustomer. As of December 31, 2003, approximately 89% of our accountsreceivable were concentrated with one customer.

The loss of a major customer orthe reduction, delay or cancellation of orders from one or more of our significantcustomers could cause our revenue to decline and our losses to increase.Because we currently depend on a limited number of customers with lengthybudgeting cycles and unpredictable buying patterns, our revenue from quarter toquarter or year to year may be volatile. Adverse changes in our revenue oroperating results as a result of these budgeting cycles or any other reductionin capital expenditures by our large customers could substantially reduce thetrading price of our common stock.

**We may not be able to modify and improve our products in a timely andcost effective manner to respond to technological change and customer demands.**

Future hardware and software platforms embodying new technologies and theemergence of new industry standards and customer requirements could render oursystem non-competitive or even obsolete. The market for our system ischaracterized by:

·       rapidtechnological change;

·       theemergence of new competitors and partnerships;

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·       significantdevelopment costs;

·       changes inthe requirements of our customers and their communities of users;

·       evolvingindustry standards; and

·       transitionto Internet protocol connectivity for video at the desktop, with the increasingavailability of bandwidth.

Our system is designed to workwith a variety of hardware and software configurations and data networkinginfrastructures used by our customers. The majority of these customer networksrely on Microsoft Windows servers. However, our software may not operatecorrectly on other hardware and software platforms or with other programminglanguages, database environments and systems that our customers use. Also, wemust constantly modify and improve our system to keep pace with changes made toour customers’ platforms, data networking infrastructures, and their evolvingability to transport video and other applications. This may result inuncertainty relating to the timing and nature of our new release announcements,introductions or modifications, which in turn may cause confusion in themarket, with a potentially harmful effect on our business. If we fail topromptly modify or improve our system in response to evolving industrystandards or customers’ demands, our system could become less competitive,which would harm our financial condition and reputation.

**Difficulties or delays in installing our products could harm our revenueand margins.**

We recognize revenue upon theinstallation of our system in those cases where we are responsible forinstallation, which often entails working with sophisticated software andcomputing and communications systems. If we experience difficulties withinstallation or do not meet deadlines due to delays caused by our customers orourselves, we could be required to devote more customer support, technical andother resources to a particular installation. If we encounter delays ininstalling our products for new or existing customers or installation requiressignificant amounts of our professional services support, our revenuerecognition could be delayed, our costs could increase, and our margins couldsuffer.

**Competition could reduce our market share and decrease our revenue.**

Currently, our competition comesfrom 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 primarilyagainst Polycom, Inc., Tandberg Inc. and Emblaze-VCON Ltd. We believewe face increasing competition from alternative video communications solutionsthat employ new technologies or new combinations of technologies from companiessuch as Cisco Systems, Inc., Avaya, Inc., Microsoft Corporation,Nortel Networks Corporation and WebEx Communications, Inc., that enableweb-based or network-based video communications with low-cost digital camerasystems. The market in which we operate is highly competitive. In addition,because our industry is relatively new and one which is characterized by rapidtechnological change, evolving user needs, developing industry standards andprotocols and the introduction of new products and services, it is difficultfor us to predict whether or when new competing technologies or new competitorswill enter our market.

We expect competition to increase in the future fromexisting competitors, partnerships of competitors, and from new market entrantswith products that may be less expensive than ours or that may provide betterperformance or additional features not currently provided by our products. Manyof our current and potential competitors have substantially greater financial,technical, manufacturing, marketing, distribution and other resources, greatername recognition and market presence, longer operating histories, lower coststructures and larger customer bases than we do. As a result, they may be ableto adapt more quickly to new or emerging technologies and changes in customerrequirements.

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**We maybe required to reduce prices or increase spending in response to competition inorder to retain or attract customers, pursue new market opportunities or investin additional research and development efforts. As a result, our revenue,margins and market share may be harmed. We cannot assure you that we will beable to compete successfully against current and future competitors, andpartnerships of our competitors, or that competitive pressures faced by us willnot harm our business, financial condition and results of operations.**

**Infringement of our proprietaryrights could affect our competitive position, harm our reputation or cost usmoney.**

Weregard our system as open but proprietary. In an effort to protect ourproprietary rights, we rely primarily on a combination of patent, copyright,trademark and trade secret laws, as well as licensing, non-disclosure and otheragreements with our consultants, suppliers, customers and employees. However,these laws and agreements provide only limited protection of our proprietaryrights. In addition, we may not have signed agreements in every case and thecontractual provisions that are in place and the protection they produce maynot provide us with adequate protection in all circumstances. Although CPIholds patents and has filed patent applications covering some of the inventionsembodied in our systems, our means of protecting our proprietary rights may notbe adequate. It may be possible for a third party to copy or otherwise obtainand use our technology without authorization and without our detection. Inthe event that we believe a third party is infringing our intellectual propertyrights, an infringement claim brought by us could, regardless of the outcome,result in substantial cost to us, divert our management’s attention andresources, be time consuming to prosecute and result in unpredictable damageawards. A third party may also developsimilar technology independently, without infringing upon our patents andcopyrights. In addition, the laws of some countries in which we sell our systemmay not protect our software and intellectual property rights to the sameextent as the laws of the United States or other countries where we holdpatents. Unauthorized copying, use or reverse engineering of our system couldharm our business, financial condition or results of operations.

**Others may bring infringementclaims against us, which could be time-consuming and expensive to defend.**

In recent years, there hasbeen significant litigation in the United States involving patents and otherintellectual property rights and we have been a party to such litigation. On January 30,2006, Tandberg Telecom AS, a wholly-owned manufacturing and patent holdingsubsidiary of Tandberg ASA, filed a patent infringement lawsuit against Avistarin the United States District Court for the Eastern District of Texas. The suitalleges that Avistar videoconferencing products infringe one patent purchasedby Tandberg Telecom AS. The patent involved is U.S. Patent No. 6,621,515,which covers a method and system for routing video calls. In this action,Tandberg Telecom AS has requested injunctive relief, money damages tocompensate for its actual damages, costs associated with the litigation andsuch further relief as the Court deems just and proper. We responded to thecomplaint on March 23, 2006, at which time we asserted that we did notinfringe the patent and that the patent was invalid. The prosecution of thislawsuit and defense of the Tandberg claims may require us and CPI to expendsignificant financial and managerial resources, and therefore may have amaterial negative impact on our financial position and results of operations. Theduration and ultimate outcome of these proceedings are uncertain. We may be aparty to additional litigation in the future, to protect our intellectualproperty or as a result of an alleged infringement of the intellectual propertyof others. These claims and any resulting lawsuit, could subject us tosignificant liability for damages and invalidation of proprietary rights. Theselawsuits, regardless of their success, would likely be time-consuming andexpensive to resolve and would divert management’s time and attention. Anypotential intellectual property litigation also could force us to do one ormore of the following:

·       stopselling, incorporating or using products or services that use the challengedintellectual property;

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·       obtainfrom the owner of the infringed intellectual property a license to the relevantintellectual property, which may require us to license our intellectualproperty to such owner, or may not be available on reasonable terms or atall; and

·       redesignthose products or services that use technology that is the subject of aninfringement claim.

If we are forced to take any of the foregoing actions,we may be unable to manufacture, use, sell, import and export our products,which would reduce our revenues.

**Our inability to protect theintellectual property created by us would cause our business to suffer.**

We rely on a combination oflicense, development and nondisclosure agreements, trademark, trade secret andcopyright law, and contractual provisions to protect our other, non-patentableintellectual property rights. If we fail to protect these intellectual propertyrights, our licensees, potential licensees and others may seek to use ourtechnology without the payment of license fees and royalties, which couldweaken our competitive position, reduce our operating results and increase thelikelihood of costly litigation. The growth of our business depends in part onthe applicability of our intellectual property to the products of thirdparties, and our ability to enforce intellectual property rights against them.In addition, effective trade secret protection may be unavailable or limited incertain foreign countries. Although we intend to protect our rights vigorously,if we fail to do so, our business will suffer.

**Future revenues and income aredifficult to predict for several reasons, including our lengthy and costlylicensing cycle, and our failure to predict revenues  and income accurately may cause us to missanalysts’ estimates and result in our stock price declining.**

Because our licensing cycle is alengthy process, the accurate prediction of future revenues and settlement andpatent licensing income from new licenses is difficult. By way of example, theprocess of persuading companies to adopt our technologies or convincing themthat their products infringe our intellectual property rights can be lengthy. Thesefactors make it difficult to predict future licensing revenue and settlementand patent licensing income, and may result in us missing analysts’ estimateswhich would likely cause our stock price to decline.

**Our system could have defectsfor 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 acceptanceof our system in the market.**

Our system may contain errors ordefects, especially when new products are introduced or when new versions are released.Despite internal system testing, we have in the past discovered software errorsin some of the versions of our system after their introduction. Errors in newsystems or versions could be found after commencement of commercial shipments,and this could result in additional development costs, diversion of technicaland other resources from our other development efforts, or the loss ofcredibility with current or future customers. Any of these events could resultin a loss of revenue or a delay in market acceptance of our system, and couldharm our reputation.

In addition, we have warrantedto some of our customers that our software is free of viruses. If a virusinfects a customer’s computer software, the customer could assert claimsagainst us, which, regardless of their merits, could be costly to defend andcould require us to pay damages, and potentially harm our reputation.

Our license agreements with ourcustomers typically contain provisions designed to limit our exposure topotential product liability and certain contract claims. Our license agreementsalso typically limit a customer’s entire remedy to either a refund of the pricepaid or modification of our system to satisfy our warranty. However, theseprovisions vary as to their terms and may not be effective under the laws ofsome jurisdictions. Although we maintain product liability (“errors andomissions”) insurance coverage, we cannot assure you that such coverage will beadequate. A product liability, warranty or other claim could 

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harmour business, financial condition and/or results of operations. Performanceinterruptions at a customer’s site could negatively affect the demand for oursystem or give rise to claims against us.

The third party software we license with our systemmay also contain errors or defects for which we do not maintain insurance.Typically, our license agreements transfer any warranty from the third party toour customers to the extent permitted. Product liability, warranty or otherclaims brought against us with respect to such warranties could, regardless oftheir merits, harm our business, financial condition or results of operations.

**The loss of any of our outsidecontract manufacturers or third party equipment suppliers that produce keycomponents of our system could significantly disrupt our manufacturing and newproduct development process.**

We depend on outside contract manufacturers to produce components of oursystems, such as cameras, microphones, gateway, speakers and monitors that weinstall at desktops and in conference rooms. One supplier, Pacific Corporation,is a single source supplier for a key component of our product. Anothersupplier, Equator Technologies Inc., is our only current source of a componentused in our IP gateway product. Our reliance on these third parties involves anumber of risks, including:

·       the possibleunavailability of critical services and components on a timely basis, oncommercially reasonable terms or at all;

·       if thecomponents necessary for our system were to become unavailable due toenvironmental legislation such as Restriction of Hazardous Substances (RoHS) inthe United Kingdom or other reasons, the need to qualify new or alternativecomponents for our use or reconfigure our system and manufacturing processcould be lengthy and expensive;

·       thelikelihood that, if particular components were not available, we would sufferan interruption in the manufacture and shipment of our systems until thesecomponents or alternatives become available;

·       reducedcontrol by us over the quality and cost of our system and over our ability torespond to unanticipated changes and increases in customer orders, andconversely, price changes from suppliers if committed volumes are not met; and

·       the possibleunavailability of, or interruption in, access to some technologies due toinfringement claims, production/supply issues or other hindrances.

If these manufacturers orsuppliers cease to provide us with the assistance or the components necessaryfor the operation of our business, we may not be able to identify alternatesources in a timely fashion. Any transition to alternate manufacturers orsuppliers would likely result in operational problems and increased expensesand could cause delays in the shipment of or otherwise limit our ability to provideour products. We cannot assure you that we would be able to enter intoagreements with new manufacturers or suppliers on commercially reasonableterms, or at all. Any disruption in product flow may limit our revenue, delayour product development, seriously harm our competitive position and/or resultin additional costs or cancellation of orders by our customers.

**If we are unable to expand ourdirect sales force and/or add distribution channels, our business will suffer.**

To increase our revenue, we mustincrease the size of our direct sales force and add indirect distributionchannels, such as systems integrators, product partners and/or value-addedresellers, and/or effect sales through our customers. If we are unable tomaintain or increase our direct sales force or add indirect distributionchannels due to our own cost constraints, limited availability of qualifiedpersonnel or other reasons, our future revenue growth may be limited, and ourfuture operating results may suffer. We 

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cannotassure you that we will be successful in attracting, integrating, motivatingand retaining sales personnel. Furthermore, it can take several months before anew hire becomes a productive member of our sales force. The loss of existingsalespeople, or the failure of new salespeople and/or indirect sales partnersto develop the necessary skills in a timely manner, could reduce our revenuegrowth.

**We may not be able to retain ourexisting key personnel, or hire and retain the additional personnel that weneed to sustain and grow our business.**

Our products and technologies are complex, and tosuccessfully implement our business strategy and manage our business, anin-depth understanding of video communication and collaboration technologiesand their potential uses is required. We depend on the continued services ofour executive officers and other key personnel. We do not have long-termemployment agreements with our executive officers or other key personnel, andwe do not carry any “key man” life insurance. The loss of the services of anyof our executive officers or key personnel could harm our business, financialcondition and results of operations.

We need to attract and retain highly skilled technicaland managerial personnel for whom there is intense competition. If we areunable to attract and retain qualified technical and managerial personnel dueto our own cost constraints, limited availability of qualified personnel orother reasons, our results of operations could suffer and we may never achieveprofitability. The failure of new personnel to develop the necessary skills ina timely manner could harm our business.

**Our plans call for growth in ourbusiness, and our inability to achieve or manage growth could harm ourbusiness.**

Failure to achieve or managegrowth effectively will harm our business, financial condition and operatingresults. Furthermore, in order to remain competitive or to expand our business,we may find it necessary or desirable in the future to acquire otherbusinesses, products or technologies. If we identify an appropriate acquisitioncandidate, we may not be able to negotiate the terms of the acquisitionsuccessfully, to finance the acquisition or to integrate the acquiredbusinesses, products or technologies into our existing business and operations.In addition, completing a potential acquisition and integrating an acquiredbusiness may strain our resources and require significant management time.

**Our international operationsexpose us to potential tariffs and other trade barriers, unexpected changes inforeign regulatory requirements and laws and economic and politicalinstability, as well as other risks that could adversely affect our results ofoperations.**

International revenue, which consists of sales to customers withoperations principally in Western Europe and Asia,  comprised 63% of total revenue for 2005, 52% for2004 and 58% for 2003. Some of the risks we may encounter in conductinginternational business activities include the following:

·       tariffs andother trade barriers;

·       unexpectedchanges in foreign regulatory requirements and laws;

·       economic andpolitical instability;

·       increasedrisk of infringement claims;

·       protectionof our intellectual property;

·       restrictionson the repatriation of funds;

·       potentiallyadverse tax consequences;

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·       timing, costand potential difficulty of adapting our system to the local language standardsin those foreign countries that do not use the English language or adapting oursystem to be compliant with local environmental legislation;

·       fluctuationsin foreign currencies; and

·       limitationsin communications infrastructures in some foreign countries.

**International politicalinstability 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 nationalsecurity measures and/or sustained military action may halt or hinder ourability to do business, may increase our costs and may adversely affect ourstock price. This increased instability has had and may continue to havenegative effects on financial markets in the future, including significantprice and volume fluctuations in securities markets. If this internationalpolitical instability continues or escalates, our business and results ofoperations could be harmed and the market price of our common stock coulddecline.

**If our customers do not perceiveour system or services to be effective or of high quality, our brand and namerecognition would suffer.**

We believe that establishing and maintaining brand andname recognition is critical for attracting and expanding our targeted customerbase. We also believe that the importance of reputation and name recognitionwill increase as competition in our market increases. Promotion and enhancementof our name will depend on the success of our marketing efforts, and on ourability to continue to provide high quality systems and services, neither ofwhich can be assured. If our customers do not perceive our system or servicesto be effective or of high quality, our brand and name recognition will suffer,which would harm our business.

**We may not meet the continued listing criteria for the NASDAQ CapitalMarket, which could materially and adversely affect the price and liquidity ofour stock, our business and our financial condition.**

For continued listing of our common stock on TheNASDAQ Capital Market, we are required to, among other things (i) maintainstockholders’ equity of at least $2.5 million, or a market value of listedsecurities of at least $35 million or annual net income from continuingoperations of at least $500,000, and (ii) maintain a minimum closing bidprice of our common stock of at least $1.00. If we do not meet the continuedlisting requirements, our common stock could be subject to delisting fromtrading on The NASDAQ Capital Market. There can be no assurance that we willcontinue to meet all requirements for continued listing on The NASDAQ CapitalMarket.

If we are unable to continue to list our common stockfor trading on The NASDAQ Capital Market, there may be adverse impact on themarket price and liquidity of our common stock, and our stock may be subject tothe “penny stock rules” contained in Section 15(g) of the SecuritiesExchange Act of 1934, as amended, and the rules promulgated there under.Delisting of our common stock from The NASDAQ Capital Market could alsomaterially adversely affect our business, including, among other things: ourability to raise additional financing to fund our operations; our ability toattract and retain customers; and our ability to attract and retain personnel,including management personnel. In addition, if we were unable to list ourcommon stock for trading on NASDAQ, many institutional investors would nolonger be able to retain their interests in and/or make further investments inour common stock because of their internal rules and protocols.

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**Our common stock has been andwill likely continue to be subject to substantial price and volume fluctuationsdue to a number of factors, many of which will be beyond our control, which mayprevent our stockholders from reselling our common stock at a profit.**

The trading priceof our common stock has in the past been and could in the future be subject tosignificant fluctuations in response to:

·       generaltrends in the equities market, and/or trends in the technology sector;

·       quarterlyvariations in our results of operations;

·       announcementsregarding our product developments;

·       announcementsof technological innovations or new products by us, our customers orcompetitors;

·       announcementsof competitive product introductions by our competitors or our customers;

·       sales or theperception in the market of possible sales of a large number of shares of ourcommon stock by our directors, officers, employees or principal stockholders;and

·       developmentsor disputes concerning patents or proprietary rights, or other events.

If our revenue and results of operations are below theexpectations of public market securities analysts or investors, thensignificant fluctuations in the market price of our common stock could occur.In addition, the securities markets have, from time to time, experiencedsignificant price and volume fluctuations, which have particularly affected themarket prices for high technology companies, and which often are unrelated anddisproportionate to the operating performance of particular companies. Thesebroad market fluctuations, as well as general economic, political and marketconditions, may negatively affect the market price of our common stock.

**If our share price is volatile,we may be the target of securities litigation, which is costly andtime-consuming to defend.**

In the past, following periodsof market volatility in the price of a company’s securities, security holdershave often instituted class action litigation. Many technology companies havebeen 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 themarket value of our common stock experiences adverse fluctuations and we becomeinvolved in this type of litigation, regardless of the merits or outcome, wecould incur substantial legal costs and our management’s attention could bediverted, causing our business, financial condition and operating results tosuffer.

**Our expected future workingcapital needs may require that we seek additional debt or equity funding which,if not available, could cause our business to suffer.**

We may need to arrange for the availability ofadditional funding in order to meet our future business requirements. If we areunable to obtain additional funding when needed on acceptable terms, we may notbe able to develop or enhance our products, take advantage of futureopportunities, 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 ofoperations and ability to continue operations.

**Provisions of our certificate ofincorporation, our bylaws and Delaware law may make it difficult for a thirdparty to acquire us, despite the possible benefits to our stockholders.**

Our certificate ofincorporation, our bylaws, and Delaware law contain provisions that may inhibitchanges in our control that are not approved by our Board of Directors. Forexample, the Board of 

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Directorshas the authority to issue up to 10,000,000 shares of preferred stock and todetermine the terms of this preferred stock, without any further vote or actionon the part of the stockholders.

These provisions may have theeffect of delaying, deferring or preventing a change in the control of Avistardespite possible benefits to our stockholders, may discourage bids at a premiumover the market price of our common stock, and may adversely affect the marketprice of our common stock and the voting and other rights of our stockholders.

**Our principal stockholders can exercise a controllinginfluence over our business affairs and they may make business decisions withwhich you disagree that will affect the value of your investment.**

Our executive officers,directors and entities affiliated with them, in the aggregate, beneficiallyowned approximately 67% of our common stock as of December 31, 2005. If they were to act together, thesestockholders would be able to exercise control over most matters requiringapproval by our stockholders, including the election of directors and approvalof significant corporate transactions. These actions may be taken even if theyare opposed by other investors. This concentration of ownership may also havethe effect of delaying or preventing a change in control of Avistar, whichcould cause the market price of our common stock to decline.

**Changes in stock option accounting rules enactedas scheduled will adversely impact our reported operating results prepared inaccordance with generally accepted accounting principles, which may in turnadversely impact our stock price and our ability to attract and retainemployees.**

In December 2004,the Financial Accounting Standards Board (FASB) issued Statements of FinancialAccounting Standards (SFAS) No. 123R  (revised 2004), “Share-Based Payment (SFAS No. 123R).” SFAS No. 123Rrequires employee stock options and rights to purchase shares under stockparticipation plans to be accounted for under the fair value method, andeliminates the ability to account for these instruments under the intrinsicvalue method prescribed by Accounting Principles Board (APB) Opinion No. 25,and allowed under the original provisions of SFAS No. 123. SFAS No. 123Rrequires the use of an option pricing model for estimating fair value, which isamortized to expense over the service periods. The requirements of SFAS No. 123Rare effective for fiscal years beginning after June 15, 2005. SFAS No. 123Rallows for either a modified prospective recognition of compensation expense orretrospective recognition back to the original issuance of SFAS No. 123.

Avistarwill adopt SFAS 123R in the first quarter of 2006 using the modifiedprospective method. SFAS 123R requires companies that chose under SFAS 123 torecognize actual forfeitures when they occur rather than estimate them at thegrant date make a one-time cumulative adjustment at the adoption date forestimated forfeitures, regardless of the transition method. We are currentlyanalyzing the estimated forfeiture adjustment amount for outstanding awards atadoption. Avistar will apply the Black-Scholes-Merton model to estimate thefair value of share-based payments to employees, which will then be amortizedon a ratable basis over the requisite service period.

The pro forma impact ofthe adoption of SFAS 123 on our historical financial statements is included inthe notes to the consolidated financial statements presented elsewhere in this Form 10-K.We expect to continue to grant stock options to employees. The impact of thenew standard is expected to have a material impact on our future results ofoperations.

**Item 1b.**   *Unresolved Staff Comments*

None.

**Item 2.**   *Properties*

Ourcorporate headquarters are located in Redwood Shores, California, where weoccupy approximately 15,000 square feet under a lease that expires in March 2007.We believe that our current 

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leased facilities, together with facilities that areavailable to us or are being negotiated, will be sufficient to meet our needsfor the next twelve months. In addition, we lease a combined total ofapproximately 9,000 square feet of office space in New York, New York, andLondon, England. As of December 31, 2005, approximately 1,000 square feetof our corporate headquarters was being utilized by CPI, our wholly-ownedsubsidiary.

**Item 3.**   *Legal Proceedings*

On May 11, 2005, CPI,Avistar’s wholly-owned patent prosecution and licensing subsidiary, commenced apatent infringement lawsuit against Tandberg ASA and Tandberg, Inc, allegingthat several Tandberg videoconferencing products infringe three patents held byCPI. The suit was filed in the United States District Court for the NorthernDistrict of California. The three patents involved are U.S. Patent Nos.5,867,654; 5,896,500; and 6,212,547. These patents cover technologies relatingto video and data conferencing over unshielded twisted pair (UTP) networks,distributed call-state management and separate monitors for simultaneous computer-baseddata sharing and videoconferencing. These technologies are core components ofthe AvistarVOS video operating system. In this action, CPI has requestedinjunctive relief, damages to compensate for past and present infringement,treble damages, costs associated with the litigation and such further relief asthe Court deems just and proper. Both of the Tandberg entities answered thecomplaint on July 15, 2005, at which time they asserted that they did notinfringe the patents and that the patents were invalid and unenforceable. On January 30,2006, Tandberg Telecom AS, a wholly-owned manufacturing and patent holdingsubsidiary of Tandberg ASA, filed a patent infringement lawsuit against Avistarin the United States District Court for the Eastern District of Texas. The suitalleges that Avistar videoconferencing products infringe one patent purchasedby Tandberg Telecom AS. The patent involved is U.S. Patent No. 6,621,515,which claims a method and system for routing video calls. In the Texas litigation,Tandberg Telecom AS has requested injunctive relief, monetary damages tocompensate for its actual damages, costs associated with the litigation andsuch further relief as the Court deems just and proper. We responded to thecomplaint on March 23, 2006, at which time we asserted that Avistar didnot infringe the patent, that the patent was invalid, and that the claim waswithout merit. Tandberg ASA and Tandberg, Inc. sought to add two defenses,and provisionally filed two motions for summary judgment in the Californialitigation on January 13, 2006 and February 24, 2006, respectively. Eachproposed defense asserts that we are subject to a different contractualprovision that either totally precludes or limits CPI’s remedies in theCalifornia litigation. Specifically, Tandberg alleged that (1) it had alicense to the subject patents and (2) that Avistar had released itsclaims against Tandberg with respect to the subject patents. Both motions forsummary judgment were determined to be procedurally defective in that Tandberghad not previously pled the contractual provisions as defenses to CPI’s claims.In the first case, on January 13, 2006, Tandberg voluntarily filed amotion to amend its complaint to add a license defense. That motion to amendhas been fully briefed and argued and is pending. If the court permits Tandbergto amend its complaint, the briefing on Tandberg’s motion for summary judgmentwill be completed and the issue will be submitted to the court for resolution.During a hearing on March 20, 2006 concerning the “release” defense, thecourt refused to permit Tandberg to amend its complaint, holding that Tandbergcould not prevail on that defense, and thereby prohibiting Tandberg frompursuing this defense in the California case. The Markman hearing for the CPIclaims, a pivotal stage of the litigation process at which time definitions aredetermined for the following proceeding, is currently scheduled for May 22,2006. The prosecution of this lawsuit and the defense of the Tandberg TelecomAS claim may require Avistar and CPI to expend significant financial andmanagerial resources, and therefore may have a material negative impact on ourbusiness, financial condition and results of operations. The duration andultimate outcome of this litigation are uncertain.

**Item 4.**   *Submission of Matters to aVote of Security Holders*

None.

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**PART II**

**Item 5.*   Market for Registrant’s CommonEquity, Related Stockholder Matters and Issuer Purchases of Equity Securities***

Ourcommon stock traded on the NASDAQ National Market from August 17, 2000 to October 29,2002 and has traded on the NASDAQ Capital Market since October 30, 2002under the symbol “AVSR.” Prior to August 17, 2000, there was no publicmarket for our Common Stock. The following table sets forth for the periodindicated the high and low closing sale prices for our common stock, as reportedby the NASDAQ Stock Market.

| ** **      | ** ** | **Year Ended  December 31, 2005** | ** ** | **Year Ended  December 31, 2004** | ** ** |
|-----------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **      | ** ** | **  High  **                 | ** ** | **  Low  **                  | ** ** | **  High  ** | ** ** | **  Low  ** | ** ** |
| First Quarter   |       |                                             | $          | 2.53                                             |       |   | $ | 1.11 |   |   | $ | 1.80 |   |   | $ | 1.30 |   |
| Second Quarter  |       |                                             | $          | 3.10                                             |       |   | $ | 2.08 |   |   | $ | 1.35 |   |   | $ | 0.76 |   |
| Third Quarter   |       |                                             | $          | 2.50                                             |       |   | $ | 1.99 |   |   | $ | 1.07 |   |   | $ | 0.75 |   |
| Fourth  Quarter |       |                                             | $          | 2.10                                             |       |   | $ | 1.52 |   |   | $ | 1.85 |   |   | $ | 0.89 |   |

 

On December 31,2005, the last reported sale price of our common stock on the NASDAQ CapitalMarket was $1.54 per share. According tothe records of our transfer agent, as of December 31, 2005 there were 65holders of record of our common stock and we believe there are a substantiallygreater number of beneficial holders.

**Dividend Policy**

Wehave never paid cash dividends on our common stock, and we do not anticipatepaying cash dividends in the foreseeable future.

**Equity Compensation Plan Information**

**The information required by this Item is included underItem 12 of Part III of this report on Form 10-K**

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**Item 6.*   Selected FinancialData***

The selected consolidatedfinancial data below should be read in conjunction with “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” andour consolidated financial statements and notes thereto. The selectedstatements of operations data for the years ended December 31, 2005, 2004and 2003 and the selected balance sheet data as of December 31, 2005 and2004 are derived from, and are qualified by reference to, the audited financialstatements included elsewhere in this Annual Report on Form 10-K.The selected statement of operations data for the year ended December 31,2002 and 2001 and the selected balance sheet data as of December 31, 2003,2002 and 2001 is derived from our financial statements not included in theAnnual Report on Form 10-K. The historical results presented beloware not necessarily indicative of future results.
|                                                                                          | ** ** | **Year Ended December 31,**                         | ** ** |
|------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                                               | ** ** | **2005**                                                           | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                                                               | ** ** | **(In thousands, except per share data)** | ** ** |
| ** **                                                                               | ** ** | ** **                                                         | ** ** | **Restated(1)** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Statements of Operations Data**                                                        | ** ** | ** **                                                         | ** ** |   | ** ** | ** ** |   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenue:                                                                                 |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |
| Product                                                                                  |       | $                                                                  | 3,503      |   |   | $ | 3,121 |   |   | $ | 2,817 |   | $ | 4,430 |   | $ | 11,366 |   |
| Services,  maintenance and support                                                       |       | 3,408                                                              |       |   | 3,200 |   |   | 3,775 |   | 4,369 |   | 4,830 |   |
| Total  revenue                                                                           |       | 6,911                                                              |       |   | 6,321 |   |   | 6,592 |   | 8,799 |   | 16,196 |   |
| Costs and expenses:                                                                      |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |
| Cost  of product revenue                                                                 |       | 1,892                                                              |       |   | 1,435 |   |   | 1,410 |   | 2,129 |   | 4,961 |   |
| Cost  of services, maintenance and support revenue                                  |       | 2,220                                                              |       |   | 1,937 |   |   | 2,119 |   | 2,348 |   | 2,683 |   |
| Income  from settlement and patent licensing                                             |       | (4,226                                                             | )          |   | (575 | ) |   | — |   | — |   | — |   |
| Research  and development                                                                |       | 3,544                                                              |       |   | 2,588 |   |   | 2,420 |   | 3,699 |   | 5,280 |   |
| Sales  and marketing                                                                     |       | 3,379                                                              |       |   | 2,456 |   |   | 3,598 |   | 3,728 |   | 6,066 |   |
| General  and administrative                                                              |       | 5,697                                                              |       |   | 6,956 |   |   | 6,034 |   | 4,593 |   | 5,002 |   |
| Amortization  of deferred stock compensation                                             |       | —                                                             |       |   | — |   |   | 135 |   | 358 |   | 898 |   |
| Total  costs and expenses                                                                |       | 12,506                                                             |       |   | 14,797 |   |   | 15,716 |   | 16,855 |   | 24,890 |   |
| Loss  from operations                                                                    |       | (5,595                                                             | )          |   | (8,476 | ) |   | (9,124 | ) | (8,056 | ) | (8,694 | ) |
| Other income (expenses):                                                                 |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |
| Interest  income                                                                         |       | 537                                                                |       |   | 118 |   |   | 44 |   | 269 |   | 758 |   |
| Other  income (expense), net                                                             |       | (94                                                                | )          |   | 15 |   |   | 481 |   | 227 |   | (2 | ) |
| Total  other income (expense), net                                                       |       | 443                                                                |       |   | 133 |   |   | 525 |   | 496 |   | 756 |   |
| Loss  before provision for (recovery from) income taxes         |       | (5,152                                                             | )          |   | (8,343 | ) |   | (8,599 | ) | (7,560 | ) | (7,938 | ) |
| Provision  for (recovery from) income taxes                                              |       | 22                                                                 |       |   | 363 |   |   | 20 |   | 18 |   | (19 | ) |
| Net  loss                                                                                |       | $                                                                  | (5,174     | ) |   | $ | (8,706 | ) |   | $ | (8,619 | ) | $ | (7,578 | ) | $ | (7,919 | ) |
| Net  loss per share—basic and diluted                                               |       | $                                                                  | (0.15      | ) |   | $ | (0.27 | ) |   | $ | (0.33 | ) | $ | (0.30 | ) | $ | (0.31 | ) |
| Weighted average shares used  in calculating basic and diluted  net  loss per share |       | 33,600                                                             |       |   | 32,610 |   |   | 26,368 |   | 25,260 |   | 25,168 |   |

 
|                                     | ** ** | **As of December 31,** | ** ** |
|-------------------------------------|------------|---------------------------------------|------------|
| ** **                          | ** ** | **2005**                              | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                          | ** ** | ** **                            | ** ** | **Restated(1)** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                          | ** ** | **(In thousands)**               | ** ** |
| **Balance  Sheet Data**             |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Cash  and cash equivalents          |       | $                                     | 8,216      |   |   | $ | 21,656 |   |   | $ | 4,438 |   | $ | 4,783 |   | $ | 7,455 |   |
| Short-term  investments             |       | 2,995                                 |       |   | — |   |   | 1,000 |   | 2,402 |   | 5,831 |   |
| Working  capital                    |       | 6,306                                 |       |   | 16,367 |   |   | 4,848 |   | 7,250 |   | 14,039 |   |
| Total  assets                       |       | 20,358                                |       |   | 30,408 |   |   | 8,228 |   | 10,400 |   | 19,265 |   |
| Stockholders’ equity (deficit) |       | (4,158                                | )          |   | 514 |   |   | 5,491 |   | 7,948 |   | 15,041 |   |
|                                     |            |                                       |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)   See Note 2 “Correction of an Error” ofthe Notes to Consolidated Financial Statements.

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

The following discussion should be read in conjunctionwith the Consolidated Financial Statements and Notes thereto included elsewherein this Annual Report on Form 10-K. Certain statements in this “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations” are forward looking statements.These statements relate to future events or our future financial performanceand involve known and unknown risks, uncertainties and other factors that maycause our or our industry’s actual results, levels of activity, performance orachievements to be materially different from any future results, levels ofactivity, performance or achievements expressed or implied by the forwardlooking statements. These risks and other factors include those listed under “FactorsAffecting Future Operating Results” elsewhere in this Annual Report on Form 10-K.In some cases, you can identify forward looking statements by terminology suchas “may”, “will”, “should”, “expects”, “intends”, “plans”, “anticipates”, “believes”,“estimates”, “predicts”, “potential”, “continue” or the negative of theseterms, 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 outlinedunder “Factors Affecting Future Operating Results.” These factors may cause ouractual results to differ materially from any forward looking statement.

Although we believe thatthe expectations reflected in the forward looking statements are reasonable, wecannot guarantee future results, levels of activity, performance orachievements. We are under no duty to update any of the forward-lookingstatements after the date of this Annual Report on Form 10-K toconform our prior statements to actual results.

**Overview**

We develop, market and support an integrated suite ofvBusiness—video-enabled eBusiness—applications, all powered by the AvistarVOSsoftware. From the desktop, we deliver TV-quality interactive video calling,content creation and publishing, broadcast origination and distribution,video-on-demand, and integrated data sharing. The Avistar video and datacollaboration applications are all managed by the AvistarVOS video operatingsystem. By integrating video tightly into the way they work, our customers canuse our system to help reduce costs and improve productivity and communicationswithin the enterprise and between enterprises, to enhance relationships withcustomers, suppliers and partners. Using AvistarVOSsoftware andleveraging video, telephony and Internet networking standards, Avistarapplications are designed to be scalable, reliable, cost effective, easy touse, and capable of evolving with communicationsnetworks as bandwidth increases and as new standards and protocols emerge. Wecurrently sell our system directly to enterprises in selected strategicvertical markets, and have focused initially on the financial servicesindustry. Our objective is to establish our technology as the standard fornetworked video through direct sales, indirect channel sales/partnerships andthe licensing of our technology to others.

We operate on a 52-weekfiscal year ending December 31. We operate in two segments. AvistarCommunications Corporation engages in the design, development, manufacture,sale and marketing of networked video communications products and associatedsupport services. Collaboration Properties, Inc., or CPI, our wholly ownedsubsidiary, engages in the prosecution, maintenance, support and licensing ofthe intellectual property that we have developed, some of which is used in ourproducts.

Since inception, we have recognized the innovativevalue of our research and development efforts, and have invested in securingprotection for these innovations through domestic and foreign patentapplications and issuance. As of December 31, 2005, we hold 70 U.S. andforeign patents, which we look to license to others in the collaborationtechnology marketplace.

On September 23,2002, CPI commenced a patent infringement lawsuit against Polycom, Inc. OnNovember 12, 2004, Avistar, CPI and Polycom, Inc. entered into asettlement and patent cross-license 

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agreement.Under the terms of the settlement and patent cross-license agreement, Avistarand CPI provided Polycom, Inc. and its subsidiaries with specific andgeneral releases of liability. Polycom, Inc., on behalf of itself and itssubsidiaries, provided Avistar and CPI with specific and general releases ofliability, and made a lump-sum payment to Avistar in the amount of $27.5million ($21.1 million net of expenses). Avistar and CPI granted Polycom, Inc.a fully-paid up license to Avistar’s patent portfolio, including subsequentpatents that have a priority date within five years of the date of theagreements. As described under Income from Settlement and Patent Licensing below,we expect to recognize the payment received from Polycom, Inc., net ofexpenses, to income from settlement and patent licensing ratably over a fiveyear period starting November 12, 2004.

**Change inAccounting Treatment**

In September 2005, wereceived a comment letter from the SEC relating to our 2004 Form 10-K,which included questions regarding our accounting for the November 2004settlement and patent cross-license agreement with Polycom, Inc.(“Polycom”). The settlement and patent cross-license agreement resulted in a$27.5 million one-time payment by Polycom to us, and a payment by Avistar toour own litigation counsel of $6.4 million in contingent legal fees. Our Form 10-Kfor the fiscal year ended December 31, 2004 and Form 10-Q forthe three, six and nine months ended March 31, 2005, June 30, 2005and September 30, 2005, respectively, reported the one time payment byPolycom as revenue, recognized ratably over a five-year period, net ofcontingent legal fees. As a result of the SEC’s inquiry as to whether thePolycom transaction should be characterized as revenue and after discussionswith the SEC, we concluded that a reclassification of license revenues fromrevenue to a component of operating expenses and reflected as “Income fromsettlement and patent licensing” was necessary for previously filed financialreports. The reclassification of the proceeds and expenses from the Polycomsettlement and patent cross-license agreement had no effect on reported netloss, loss per share, stockholders’ equity (deficit) or net cash flows fromoperating, investing or financing activities, but did have the effect ofoverstating revenues and operating expenses for previously issued interim andannual consolidated financial statements, as of and for the quarters andyear-to-date periods ended December 31, 2004, March 31, 2005, June 30,2005 and September 30, 2005. In addition, the balance sheet as of December 31,2004 has been amended to reflect the gross effect of the $27.5 million paymentby Polycom to us, and the payment of $6.4 million of contingent legal fees byAvistar, which was previously reported on a net basis as deferred revenue. Significant concentrations, revenue recognition,segment reporting footnotes and the unaudited interim results have been modified to reclassify the Polycomproceeds from revenue to “Income from settlement and patent licensing,” to beconsistent with the presentation of the net proceeds from the Polycomsettlement and patent cross-license agreement in the 2005 Statement ofOperations. The presentation within operations is supported by a determinationthat the Polycom licensing transaction is central to the activities thatconstitute our ongoing major or central operations, but that the settlement mayalso contain a gain element related to the settlement, which is not consideredrevenue under the Financial Accounting Standards Board (“FASB”) ConceptsStatement No. 6, *Elements of FinancialStatements.* We did not have sufficient historical evidence tosupport a reasonable determination of value for the purpose of segregating thetransaction into revenue related to the patent licensing and an operating ornon-operating gain upon settlement of litigation, resulting in thedetermination that the entire transaction is more appropriately classified as “Incomefrom settlement and patent licensing” within operations, as opposed to revenue.See Note 2 “Correction of an error” of the Notes to Consolidated FinancialStatements.

**Critical AccountingPolicies**

The preparation of our Consolidated FinancialStatements in accordance with accounting principles generally accepted in theUnited States requires us to make estimates and judgments that affect thereported amounts of assets, liabilities, revenues and expenses, and relateddisclosure of contingent assets 

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and liabilities. We baseour estimates on historical experience and assumptions that we believe to bereasonable under the circumstances, the results of which form the basis formaking judgments about the carrying values of assets and liabilities that arenot readily apparent from other sources. Actual results may differ from theseestimates.

We believe thefollowing critical accounting policies, among others, affect our moresignificant judgments and estimates used in the preparation of our ConsolidatedFinancial Statements:

·       Revenuerecognition;

·       Incomefrom settlement and patent licensing;

·       Valuationof accounts receivable; and

·       Valuation of inventories.

**Revenue Recognition**

We derive product revenue principally from the saleand licensing of our video-enabled networked communications system, consistingof a suite of Avistar-designed software and hardware products, including thirdparty components. We also derive revenue from fees for installation,maintenance, support, training services and software development. In addition,we derive revenue and income from settlement and patent licensing from thelicensing of our intellectual property portfolio. Product revenue as apercentage of total revenue was 51% for 2005, 49% for 2004 and 43% for 2003.

We recognize product andservices 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 toCertain Transactions (SOP 98-9). We derive product revenue from the saleand licensing of a set of desktop (endpoint) products (hardware and software)and infrastructure products (hardware and software) that combine to form anAvistar video-enabled collaboration solution. Services revenue includes revenuefrom installation services, post-contract customer support, training andsoftware development. The installation services that we offer to customersrelate to the physical set-up and configuration of desktop and infrastructurecomponents of our solution. The fair value of all product, installationservices, post-contract customer support and training offered to customers isdetermined based on the price charged when such products or services are soldseparately.

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

·       *Persuasive evidence of an arrangement exists*. Werequire a written contract, signed by both the customer and us, or a purchaseorder from those customers that have previously negotiated a standard end-userlicense arrangement or volume purchase agreement with us prior to recognizingrevenue on an arrangement.

·       *Delivery has occurred*. We deliversoftware and hardware to our customers physically. Our standard delivery termsare FOB shipping point.

·       *The fee is fixed or determinable*. Ourdetermination that an arrangement fee is fixed or determinable dependsprincipally on the arrangement’s payment terms. Our standard payment termsgenerally require the arrangement fee to be paid within 30 days. Where theseterms apply, we regard the fee as fixed or determinable, and we recognizerevenue upon delivery (assuming other revenue 

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recognition criteria aremet). If the payment terms do not meet this standard, which we refer to as “extendedpayment terms,” we may not consider the fee to be fixed or determinable andwould then recognize revenue when customer installments are due and payable.

·       *Collectibility is probable*. Torecognize revenue, we must judge collectibility of the arrangement fees, whichwe do on a customer-by-customer basis pursuant to our credit review policy. Wetypically sell to customers with whom we have a history of successfulcollection. For new customers, we evaluate the customer’s financial positionand ability to pay. If we determine that collectibility is not probable basedupon our credit review process or the customer’s payment history, we recognizerevenue when cash is collected.

If there are any undeliveredelements, we defer revenue for those elements, as long as Vendor SpecificObjective Evidence (VSOE) exists for the undelivered elements. Additionally,when we provide installation services, the product and installation revenue isrecognized upon completion of the installation process and receipt of customerconfirmation, subject to the satisfaction of the revenue recognition criteriadescribed above, as we believe that the fee associated with the deliveredproduct elements does not meet the definition of collectibility if theinstallation services have not been completed. Customer confirmation isobtained and documented by means of a standard form indicating the installationservices provided and the hardware and software components are installed. Whenthe customer or a third party provides installation services, the productrevenue is recognized upon shipment, subject to satisfaction of the revenuerecognition criteria described above.

Payment for product is due uponshipment, subject to specific payment terms. Payment for installationand professional services are due upon providing the services, subject tospecific payment terms. Reimbursementsreceived for out-of-pocket expensesincurred during installation and support services have not been significant todate. These expenses are recognized as revenue in accordance with EmergingIssues Task Force (EITF) Issue No. 01-14 (EITF 01-14), “IncomeStatement Characterization of Reimbursements Received for “Out of Pocket”Expenses Incurred.”

The price charged formaintenance and/or support is defined in the product contract, and is based ona fixed price for both hardware and software components as stipulated in thecustomer agreement. Customers have the option to renew the maintenance and/orsupport services in subsequent periods at the same rate as paid in the initialyear. Revenue from maintenance and support is recognized pro-rata over themaintenance and/or support term, which is typically one year in length.Payments for services made in advance of the provision of services are recordedas deferred revenue and customer deposits in the accompanying balance sheets.Training services are offered independently of the purchase of product. Thevalue of these training services is determined based on the price charged whensuch services are sold separately, and training revenue is recognized uponperformance of the service.

We recognize service revenuefrom software development contracts in accordance with SOP 81-1, “Accountingfor Performance of Construction-Type and Certain Production-Type Contracts.”Revenue related to contracts for software development is recognized using thepercentage of completion method, when all of the following conditions are met:a contract exists with the customer at a fixed price, we have fulfilled all ofits material contractual obligations to the customer for each deliverable ofthe contract, verification of completion of the deliverable has been received,and collection of the receivable is probable. The amounts billed to customersin excess of revenues recognized to date are deferred and recorded as deferredrevenue and customer deposits in the accompanying balance sheets. Assumptionsused for recording revenue and earnings are adjusted in the period of change toreflect revisions in contract value and estimated costs to complete thecontract. Any anticipated losses on contracts in progress are charged toearnings when identified.

Werecognize revenue from the licensing of our intellectual property portfoliobased on the terms of the royalty, partnership and cross-licensing agreementsinvolved.

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To date, a significant portion of our revenue hasresulted from sales to a limited number of customers. For 2005, we recordedrevenue of approximately $5.8 million, or 84% of total revenue, from DeutscheBank AG and their affiliates, and UBS Warburg LLC and their affiliates, each ofwhom accounted for greater than 10% of our total revenue for 2005. For 2004, werecorded revenue of approximately $4.5 million, or 71% of total revenue,from Deutsche Bank AG and their affiliates and UBS Warburg LLC and theiraffiliates, each of whom accounted for greater than 10% of our total revenuefor 2004. For 2003, we recorded revenue of approximately $4.1 million, or 62%of total revenue from Deutsche Bank AG and their affiliates. No other customersindividually accounted for greater than 10% of our total revenue for 2003. Weanticipate that our revenue, and therefore, our operating results for any givenperiod, will continue to depend to a significant extent on a limited number ofcustomers. As a result, the loss of or a reduction in sales to any one of thesecustomers would have a significant adverse impact on our operations andfinancial performance.

Internationalrevenue, which consists of sales to customers with operations principally inWestern Europe and Asia,  comprised63% of total revenue for 2005, 52% for 2004 and 58% for 2003.

**Income fromSettlement and Patent Licensing**

Werecognize the proceeds from settlement and patent licensing agreements based onthe terms involved. When litigation has been filed prior to a settlement andpatent licensing agreement, and insufficient historical evidence exists of fairvalue of the patents licensed to support the segregation of the proceedsbetween a gain on litigation settlement and patent license revenues, we reportall proceeds in income from settlement and patent licensing within operatingcosts and expenses. When litigation has been filed prior to a settlement andpatent licensing agreement, and sufficient historical evidence exists of fairvalue of the patents licensed to support the segregation of the proceedsbetween a gain on litigation settlement and patent license revenues, we reportas license revenue, consistent with FASB Concepts Statement No. 6, Elementsof Financial Statements. The gain portion of the proceeds, when sufficienthistorical evidence exists to segregate the proceeds, is reported in otherincome according to SFAS No. 5, *Accounting forContingencies*.

**Valuation of AccountsReceivable**

Estimates are used indetermining our allowance for doubtful accounts and are based on our historicalcollection experience, historical write-offs, current trends, and the creditquality of our customer base and the characteristics of our accounts receivableby aging category. If the allowance for doubtful accounts were to beunderstated, our operating income could be significantly reduced. The impact ofany such change or deviation may be increased by our reliance on a relativelysmall number of customers for a large portion of our total revenue. As of December 31,2005, three customers represented 48%, 32% and 17% of our accounts receivablebalance. As of December 31, 2004, approximately 81% of our accountsreceivable balance was concentrated with one customer. As of December 31,2003, approximately 89% of our accounts receivable were concentrated with onecustomer.

**Valuation ofInventories**

We record a provision forobsolete or excess inventory for systems and components that are no longer manufacturedor are at risk of being replaced with new versions of our product. Indetermining the allowance for obsolete or excess inventory, we look at ourforecasted demand versus quantities on hand and commitments. Any significantunanticipated changes in demand or technological developments could have asignificant impact on the value of our inventory and commitments and ourreported results. If actual market conditions are less favorable than thoseprojected, additional inventory write-downs, provision for purchase commitmentsand charges against earnings may be required, which would negatively affect ouroperating results for such period.

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**Results ofOperations**

Thefollowing table sets forth data expressed as a percentage of total revenue forthe periods indicated.
|                                                    | ** ** | **Percentage of Total Revenue** | ** ** |
|----------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                         | ** ** | **Year Ended December 31,**     | ** ** |
| ** **                                         | ** ** | **2005**                                       | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                         | ** ** | ** **                                     | ** ** | **Restated(1)** | ** ** | ** ** | ** ** |
| Revenue:                                           |       |                                           |       |   |   |   |   |   |   |   |   |
| Product                                            |       |                                           | 51         | % |   |   | 49 | % |   | 43 | % |
| Services, maintenance and  support                 |       |                                           | 49         |   |   |   | 51 |   |   | 57 |   |
| Total revenue                                      |       |                                           | 100        |   |   |   | 100 |   |   | 100 |   |
| Costs and expenses:                                |       |                                           |       |   |   |   |   |   |   |   |   |
| Cost of product revenue                            |       |                                           | 28         |   |   |   | 23 |   |   | 21 |   |
| Cost of services, maintenance  and support revenue |       |                                           | 32         |   |   |   | 30 |   |   | 32 |   |
| Income from settlement and  patent licensing       |       |                                           | (61        | ) |   |   | (9 | ) |   | — |   |
| Research and development                           |       |                                           | 51         |   |   |   | 41 |   |   | 37 |   |
| Sales and marketing                                |       |                                           | 49         |   |   |   | 39 |   |   | 55 |   |
| General and administrative                         |       |                                           | 82         |   |   |   | 110 |   |   | 92 |   |
| Amortization of deferred stock  compensation       |       |                                           | —     |   |   |   | — |   |   | 2 |   |
| Total costs and expenses                           |       |                                           | 181        |   |   |   | 234 |   |   | 239 |   |
| Loss from operations                               |       |                                           | (81        | ) |   |   | (134 | ) |   | (139 | ) |
| Other income (expense):                            |       |                                           |       |   |   |   |   |   |   |   |   |
| Interest income                                    |       |                                           | 8          |   |   |   | 2 |   |   | 1 |   |
| Other income (expense), net                        |       |                                           | (2         | ) |   |   | — |   |   | 7 |   |
| Total other income, net                            |       |                                           | 6          |   |   |   | 2 |   |   | 8 |   |
| Loss before provision for  income taxes            |       |                                           | (75        | ) |   |   | (132 | ) |   | (131 | ) |
| Provision for income taxes                         |       |                                           | —     |   |   |   | 6 |   |   | — |   |
| Net loss                                           |       |                                           | (75        | )% |   |   | (138 | )% |   | (131 | )% |

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(1)   SeeNote 2 “Correction of an Error” of the Notes to Consolidated FinancialStatements.

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***COMPARISON OF 2005, 2004 AND 2003***

**Revenue**

Total revenue increased by 9% in 2005 to $6.9 millionfrom $6.3 million for 2004. The increase in total revenue in 2005 relative to2004 was due to increases in product and services, maintenance and supportrevenues. Product revenue increased by $382,000 to $3.5 million in 2005 from$3.1 million in 2004 due primarily to additional sales to our existing customerbase. Services, maintenance and support revenue increased by $208,000 to $3.4million in 2005 from $3.2 million in 2004, due primarily to new servicesprovided within our existing customer base. In 2005, two customers accountedfor 84% of our revenue. The level of sales to any customer may vary fromquarter to quarter and year to year. We anticipate that our revenue willcontinue to depend on a limited number of major customers for the foreseeablefuture; although the companies considered to be major customers and thepercentage of revenue represented by each major customer may vary from periodto period. The loss of any one of those customers would have a material adverseimpact on our financial condition and operating results.

Total revenue decreased by4% in 2004 to $6.3 million from $6.6 million for 2003. The decrease in totalrevenue in 2004 relative to 2003 was due to reduced software developmentrevenue, offset by increased product revenue. The reduction in softwaredevelopment revenue was a result of software development contracts completed in2003. The increase in product sales was primarily due to new customers added in2004. For 2004, two customers accounted for 71% of our total revenue. For 2003,one customer accounted for 62% of our total revenue.

**Cost of Revenue**

Total cost of revenue increased by 22% in 2005 to $4.1million from $3.4 million for 2004. The increase in total cost of revenue in2005 relative to 2004 was attributable to increased personnel utilized tosupport our maintenance and services offerings and a shift among our existingcustomer base from the purchase of software offerings with no costs of revenueto more hardware focused offerings with significant costs of revenue. We expectthe product mixture of future revenues to vary between hardware, software andservices.

Cost of revenue declinedslightly by 4% in 2004 to $3.4 million from $3.5 million for 2003. The decreasein cost of revenue in 2004 relative to 2003 was primarily due to the reductionin software development contract costs associated with the decrease in softwaredevelopment contracts.

**Income fromSettlement and Patent Licensing**

Income from settlement andpatent licensing increased by $3.7 million to $4.2 million in 2005 from$575,000 in 2004, due to a full year of amortization of income associated withthe Polycom, Inc. settlement andpatent cross-license agreement. Total income from settlement and patentlicensing increased in 2004 to $575,000 from $0 in 2003. The increase in incomefrom settlement and patent licensing in 2004 relative to 2003 was due to thelicensing of our intellectual property portfolio for the first time in 2004 inconnection with Polycom settlement and patent cross-license agreement.

**Operating Expenses**

*Researchand development.**  *Researchand development expenses increased by 37% in 2005 to $3.5 million from$2.6 million in 2004. The increase in research and development expenses in 2005relative to 2004 was due to the hiring of new employees focused on research anddevelopment projects in 2005. Research and development expenses increased by 7%in 2004 to $2.6 million from $2.4 million for 2003. The increase inresearch and development expenses in 2004 relative to 2003 was primarily due tothe reduction in software development revenue, which resulted in research anddevelopment resources being 

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allocated to internalprojects and recorded as operating expenses. Research and development projectsassociated with customer funded development are expensed to cost of sales inthe period in which they are incurred.

*Salesand marketing.**  *Salesand marketing expenses increased by 38% in 2005 to $3.4 million from $2.5 millionin 2004. The increase in sales and marketing expenses in 2005 relative to 2004was due to hiring of additional sales and marketing personnel. Sales andmarketing expenses decreased by 32% in 2004 to $2.5 million from $3.6 millionfor 2003. The decrease in sales and marketing expenses in 2004 relative to 2003was primarily due to a reduction in personnel and personnel related costs as aresult of a 25% reduction in staffing levels and a reduction in property leasecosts.

*Generaland administrative.**  *Generaland administrative expenses decreased by 18% in 2005 to $5.7 million from$7.0 million in 2004. The decrease in general and administrative expenses in2005 relative to 2004 was due primarily to a decrease in legal fees associatedwith the litigation with Polycom, Inc., as a result of the settlement andpatent cross-licensing agreement signed on November 12, 2004. General andadministrative expenses increased by 15% in 2004 to $7.0 million from $6.0million for 2003. The increase in general and administrative expenses in 2004relative to 2003 was due primarily to an increase in legal fees associated withour litigation with Polycom, Inc.

*Amortizationof deferred stock compensation.**  *Noamortization of deferred stock compensation was recorded in 2005 nor 2004 dueto the completion of recognition of all stock-based compensation associatedwith pre-IPO options awards in 2003. Amortization of deferred stockcompensation decreased to $0 in 2004 from $135,000 for 2003. The decrease inamortization of deferred stock compensation in 2004 relative to 2003 was due tothe completion of pre-IPO option award amortization and the forfeitures ofstock options by employees no longer with our company.

*Otherincome, net.**  *Otherincome, net increased by 233% in 2005 to $443,000 from $133,000 in 2004. Theincrease in other income, net in 2005 relative to 2004 was due primarily to theeffect of higher short-term interest rates and higher cash, cash equivalentsand short and long-term investments in 2005 versus 2004, resulting in a 355%increase in interest income to $537,000 in 2005 from $118,000 in 2004. Otherincome, net decreased by 75% in 2004 to $133,000 from $525,000 for 2003. Thedecrease in other income, net in 2004 relative to 2003 was due primarily to netinsurance proceeds of $570,000 received in 2003 in satisfaction of a businessinterruption claim for losses incurred by our New York City office followingthe September 11, 2001 terrorist attack on the World Trade Center. Thedecrease in other income, net in 2004 relative to 2003 was offset by increasedinterest income associated with the increased balance of cash, cash equivalentsand short-term investments as a result of payment received under the settlementand patent cross-license patent agreement reached with Polycom, Inc. on November 12,2004.

*Provision for incometaxes.**  *Provisionfor income taxes decreased to $22,000 in 2005, from $363,000 in 2004 due to noUS taxes being due as a result of taxable losses in 2005. Provision for incometaxes increased significantly in 2004 to $363,000 from $20,000 for 2003. Theincrease in provision for income taxes in 2004 relative to 2003 was dueprimarily to federal, state and foreign income taxes due as a result of thedifference in taxable income versus reported income caused by the Settlement and Cross-License Patent Agreementwith Polycom, Inc. signed on November 12, 2004, where we granted toPolycom a non-exclusive, fully paid-up, license to our patent portfolio. Thenet $21.1 million license fee paid to us by Polycom was deferred for financialreporting purposes and will be recognized as income from settlement and patentlicensing ratably over the five year period beginning November 12, 2004.For tax reporting purposes, the $21.1 million license fee was accounted for astaxable income in 2004, thus generating a federal and state tax liability, netof utilization of our net operating losses and tax credits.

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**Liquidity andCapital Resources**

We have funded our operations since inceptionprimarily from product and services revenue, the net proceeds of $31.3 millionfrom our August 2000 initial public offering of common stock, lines ofcredit with related parties and financial institutions, the proceeds ofapproximately $6.4 million from the sale of Series B preferred stock in December 1999,the proceeds of approximately $5.7 million and $3.6 million from the privatesale of our common stock in October 2003 and March 2004,respectively, and the proceeds of approximately $21.1 million from thesettlement and patent cross-license agreement signed with Polycom on November 12,2004.

We had cash, cash equivalents and short and long-terminvestments of $12.2 million as of December 31, 2005 and $21.7 million asof December 31, 2004. For 2005, we had a net decrease in cash, cashequivalents and short and long-term investments of $9.5 million resultingprimarily from a net loss from operations of $5.2 million, and a decrease indeferred income from settlement and patent licensing of $5.4 million.

We had cash and cash equivalents of $8.2 million as ofDecember 31, 2005 and $21.7 million as of December 31, 2004. For2005, we had a net cash outflow of $13.4 million resulting primarily from netcash outflows from operations of $9.5 million and net cash outflows frominvesting activities of $4.4 million. The net cash outflows from operations areprimarily due to a net loss of $5.2 million, a decrease in deferred income fromsettlement and patent licensing of $5.4 million and an increase in accountsreceivable of $641,000, partially offset by a decrease in deferred costs fromsettlement and patenting licensing of $1.3 million and non cash expensesof $472,000. The net cash outflows from investing are due to $4.0 millionin purchases of short and long-term investments and the purchase of $392,000 ofproperty and equipment. The net cash inflows from financing activities are dueto $414,000 in proceeds from the issuance of common stock.

We had cash and cash equivalents of $21.7 million asof December 31, 2004. For 2004, we had a net cash inflow of $17.2 millionresulting primarily from net cash proceeds from issuance of common stock of$3.7 million and net cash provided by operations of $12.7 million. The netcash proceeds from issuance of common stock are primarily due to the privatesale of 3,000,000 shares of our common stock to Fuller & ThalerAvalanche Fund, L.P. and Fuller & Thaler Behavioral Finance Fund, Ltd.in March 2004. The price per share of this transaction was $1.20,resulting in net proceeds of this private financing, after deducting expensesof the financing, of $3.6 million. The net cash provided by operationsprimarily reflected an increase in deferred income from settlement and patentlicensing of $26.8 million as a result of the settlement and patentcross-license agreement signed with Polycom on November 12, 2004, offsetby a net loss of $8.7 million and an increase in deferred costs from settlementand patent licensing of $6.2 million.

We had cash and cash equivalents of $4.4 million as ofDecember 31, 2003. For 2003, we had a net cash outflow of $0.3 millionresulting primarily from net cash proceeds from issuance of common stock of$6.0 million and proceeds from net sales of short-term investments of$1.4 million, offset by net cash used in operations of $7.5 million. Thenet cash proceeds from issuance of common stock was primarily due to theprivate sale of 4,615,385 shares of our common stock toGerald J. Burnett, our Chairman, President and Chief ExecutiveOfficer, and other members of his family at a price per share of $1.30 in October 2003,resulting in net proceeds of this private financing, after deducting expensesof the financing, of $5.7 million. The net cash used in operationsprimarily reflected a net loss of $8.6 million and a decrease in deferredrevenue and customer deposits of $0.3 million, but was partially offset by anincrease in accounts payable of $0.4 million, an increase in accruedliabilities and other of $0.2 million, a decrease in inventories of $0.2million and a decrease in prepaid expenses and other current assets of $0.1million. The cash outflows associated with the net loss, along with the slightdecrease in inventories and prepaid expenses reflect the smaller scale of ourbusiness in 2003 relative to 2002. The increase in accounts payable and accruedliabilities and other reflect the timing of disbursements relative to 2002.

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Expenditures for property and equipment for 2005 wereapproximately $392,000. At December 31, 2005, we did not have any materialcommitments for future capital expenditures. We anticipate spendingapproximately $0.7 million in capital expenditures during the next 12 months.

Thefollowing table summarizes our known contractual obligations and commitments asof December 31, 2005 (in thousands) for the periods presented.

| ** **                  | ** ** | **Payments due by period** | ** ** |
|-----------------------------|------------|-------------------------------------------|------------|
| ** **                  | ** ** | **Total**                                 | ** ** | **Less than 1  Year** | ** ** | **1 – 3  Years** | ** ** | **3 – 5  Years** | ** ** | **More than   5 Years** | ** ** |
| *Contractual Obligations*   | * *   | * *                                  | * *   |   | * * | * * |   | * * | * * |   | * * | * * |   |   | * * | * * |   |
| Operating Lease Obligations |       | $                                         | 553        |   |   | $ | 465 | * * |   | $ | 88 |   |   | — | * * |   |   | — | * * |   |
| Purchase Obligations        |       | 416                                       |       |   | 354 | * * |   | 62 |   |   | — | * * |   |   | — | * * |   |
| Total                       |       | $                                         | 969        |   |   | $ | 819 | * * |   | $ | 150 |   |   | $ | — | * * |   |   | $ | — | * * |   |
|                             |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

On February 27, 2002, we entered into a Loan andSecurity Agreement with a financial institution to borrow up to $4.5 millionunder a revolving line of credit. On December 15, 2002, we entered into anamendment to the Loan and Security Agreement to increase the maximum funds availableunder the line of credit to $6.0 million and extend the term of the agreement.The amended Loan and Security Agreement, as further amended in March 2003,had an expiration date of February 27, 2004. The agreement, as amended,included a first priority security interest in all our assets, excludingintellectual property. Gerald Burnett, our Chairman and Chief ExecutiveOfficer, had provided a collateralized guarantee to the financial institution,assuring payment of our obligations under the agreement and as a consequence, anumber of restrictive covenants from the original Loan and Security Agreementwere deleted, except for quick ratio and loan to value covenants, allowing usgreater access to the full amount of the facility. On February 27, 2004, theLoan and Security Agreement was amended to change the maximum borrowings to$3.5 million, subject to certain quick ratio and loan to value covenants, andto extend the term of the Loan and Security Agreement to February 27,2005. In connection with this amendment, Dr. Burnett’s collateralizedguarantee was amended to reduce the amount of such guarantee to $3.5 million.In addition to the guarantee provided to the financial institution, Dr. Burnetthas also provided a personal guarantee to Avistar assuring the provision of upto $2.0 million to Avistar in the event that at least $2.0 million is notavailable to us under the line of credit, or an alternate financingarrangement, for any reason. During 2004, we borrowed $750,000 under the Loanand Security Agreement. These outstanding borrowings were repaid in November 2004using a portion of the proceeds from the settlement and patent cross-licenseagreement with Polycom, Inc. There were no outstanding borrowings underthe line of credit as of December 31, 2004. The Loan and SecurityAgreement expired by its terms on February 27, 2005, as which time thecollateralized guarantee of Dr. Burnett also expired.

On October 15, 2003, we completed the privatesale of 4,615,385 shares of our common stock to Dr. Burnett and othermembers of his family at a price per share of $1.30. The net proceeds of thisprivate financing, after deducting expenses of the financing, wereapproximately $5.7 million. Under the terms of the private placement, Dr. Burnettagreed to certain restrictions on 1,602,847 of the 3,661,539 shares purchasedby him. These restrictions require Dr. Burnett to vote such shares in thesame proportion as our outstanding common stock not beneficially owned by Dr. Burnett.

On March 26, 2004, we completed the private saleof a total of 3,000,000 shares of our common stock to Fuller & ThalerAvalanche Fund, L.P. and Fuller & Thaler Behavioral Finance Fund, Ltd.at a price per share of $1.20. The net proceeds of this private financing afterdeducting expenses of the financing were approximately $3.6 million. Theissuance of these additional shares reduced the number of Dr. Burnett’sshares subject to voting restrictions imposed in connection with his October 15,2003 purchase of common stock from 1,602,847 to 141,152 shares. As of December 31,2005, all voting restrictions of Dr. Burnett’s shares had lapsed.

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On November 12, 2004, we entered into settlementand patent cross-license agreement with Polycom, Inc. Under thisagreement, CPI agreed to dismiss, with prejudice, its infringement suit againstPolycom and both companies agreed to cross-license each other’s patentportfolios. The original litigation was initiated in September 2002, inthe Federal District Court for the Northern District of California and involvedthe following CPI patents: U.S. Patent Nos. 5,867,654; 5,896,500; 6,212,547;and 6,343,314. The agreement resulted in a payment, net of legal fees, to usfrom Polycom in the amount of $21.1 million.

We currently believe thatexisting cash and cash equivalents balances will provide us with sufficientfunds to finance our operations for the next 12 months. We intend to continueto invest in the development of new products and enhancements to our existingproducts. Our future liquidity and capital requirements will depend uponnumerous factors, including without limitation, general economic conditions andconditions in the financial services industry in particular, the level andtiming of product, services and licensing revenue, the costs and timing of our productdevelopment efforts and the success of these development efforts, the costs andtiming of our sales and marketing activities, the extent to which our existingand new products gain market acceptance, competing technological and marketdevelopments, the costs and proceeds involved in maintaining and enforcingpatent claims and other intellectual property rights, all of which may impactour ability to achieve and maintain profitability.

**Recent Accounting Pronouncements**

In March 2004, the Emerging Issues Task Force(EITF) reached a consensus on Issue No. 03-01, “The Meaning ofOther-Than-Temporary Impairment and Its Application to Certain Investments.”EITF 03-01 provides guidance on other-than-temporary impairment modelsfor marketable debt and equity securities accounted for under SFASNo. 115, “Accounting for Certain Investments in Debt and EquitySecurities,” and SFAS No. 124, “Accounting for Certain Investments Held byNot-for-Profit Organizations,” and non-marketable equity securities accountedfor under the cost method. The EITF developed a basic three-step model toevaluate whether an investment is other-than-temporarily impaired. InSeptember 2004, the Financial Accounting Standards Board (FASB) issuedEITF 03-01-1 which delayed the effective date of the recognitionand measurement provisions of EITF 03-01; however the disclosurerequirements remain effective for annual financial statements for fiscal yearsending after December 15, 2004. We will evaluate the effect, if any, ofthe adoption of EITF Issue No. 03-01 when final guidanceis released.

In December 2004, the FASB issued FASB StatementNo. 123 (revised 2004), “Share-Based Payment” (SFAS No. 123R), whichreplaced FASB Statement No. 123, “Accounting for Stock-BasedCompensation,” (SFAS No. 123) and superseded Accounting Principles BoardOpinion No. 25, “Accounting for Stock Issued to Employees” (APBNo. 25). SFAS No. 123R eliminates the alternative use of theintrinsic value method permitted under APB No. 25 and requires allshare-based payments to employees, including grants of employee stock options,to be recognized in the financial statements based on their grant date fairvalues. Under SFAS No. 123R, the pro forma disclosures previously permittedno longer will be an alternative to financial statement recognition. SFASNo. 123R was originally effective for all interim or annual periodsbeginning after June 15, 2005, with early adoption encouraged. InApril 2005, the Securities and Exchange Commission (the “SEC”) postponedthe effective date of SFAS No. 123R until the issuer’s first fiscal yearbeginning after June 15, 2005.

Avistar will adopt SFAS No. 123R in the firstquarter of 2006 using the modified prospective method. SFAS No. 123R requirescompanies that chose under SFAS No. 123 to recognize actual forfeitureswhen they occurred rather than estimate them at the grant date make a one-timecumulative adjustment at the adoption date for estimated forfeitures,regardless of the transition method. Avistar will apply theBlack-Scholes-Merton model to estimate the fair value of share-based paymentsto employees, which will then be amortized on a ratable basis over therequisite service period.

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In March 2005, the SEC issued Staff AccountingBulletin No. 107 (SAB No. 107) regarding the SEC’s interpretations ofSFAS No. 123R and the valuation of share-based payments for publiccompanies. Avistar is evaluating the requirements of SFAS No. 123R and SABNo. 107 and expects that the adoption of SFAS No. 123R on January 1,2006 will have a material impact on Avistar’ consolidated results of operationsand earnings per share beginning in the first quarter of 2006. Avistar’sassessment of the estimated compensation charges is affected by Avistar’s stockprice as well as assumptions regarding a number of complex and subjectivevariables and the related tax impact resulting in uncertainty as to whetherfuture stock-based compensation expense will be similar to the historical SFAS No. 123pro forma expense. These variables include, but are not limited to, thevolatility of our stock price and employee stock option exercise behavior.

In May 2005, the FASB issued SFAS No. 154, “AccountingChanges and Error Corrections—Replacement of APB Opinion No. 20 and FASBSFAS No. 3.” SFAS No. 154 requires retrospective application to priorperiod financial statements of changes in accounting principles, unless it isimpracticable to determine either the period-specific effects or the cumulativeeffect of the change. SFAS No. 154 also redefines “restatement” asthe revising of previously issued financial statements to reflect thecorrection of an error. This statement is effective for accounting changes andcorrection of errors made in fiscal years beginning after December 15,2005. It was determined during a review of our Form 10-K for fiscalyear 2004 by the SEC that an error was made in the classification of theproceeds of the settlement and patent cross-license agreement with Polycom, Inc.The corrections were made to prior period financial statements in this Form 10-Kas of December 31, 2005 under APB 20 and SFAS No. 3. See Note 2to the Notes to Consolidated Financial Statements. We do not expect theadoption of SFAS No. 154 to have a material effect on ourconsolidated financial position or results of operations.

In November 2005, the FASB issued FASB StaffPosition No. 123(R)-3 “Transition Election Related to Accounting forthe Tax Effects of Share-Based Payment Awards” (FSP No. 123(R)-3).FSP No. 123(R)-3 provides an alternative transition method ofaccounting for the tax effects of adopting SFAS No. 123(R). This FSPgrants one year from the later of the date of the FSP or the adoption of SFAS No. 123(R) bythe company for determination of the one-time election for purposes oftransition. Avistar is evaluating the alternative methods.

In November 2005, theFASB issued FSP FAS 115-1 and FAS 124-1, “The Meaning ofOther-Than-Temporary Impairment and Its Application to Certain Investments” (“FSP.. 115-1”), which provides guidance on determining when investments incertain debt and equity securities are considered impaired, whether thatimpairment is other-than-temporary, and on measuring such impairment loss. FSP115-1 also includes accounting considerations subsequent to therecognition of other-than temporary impairment and requires certain disclosuresabout unrealized losses that have not been recognized as other-than-temporaryimpairments. FSP 115-1 is required to be applied to fiscal yearsbeginning after December 15, 2005 and is required to be adopted by Avistarin the first quarter of 2006. Avistar is currently evaluating the effect thatthe adoption of FSP 115-1 will have on its consolidated results ofoperations and financial condition but does not expect it to have a materialimpact.

**Item 7a.   *Quantitative andQualitative Disclosures About Market Risk***

We develop products primarily inthe United States and sell those products primarily in North America, Europeand Asia. International revenue, which consists of sales to customers withoperations principally in Western Europe and Asia, comprised 63% of totalrevenue for the year ended 2005, 52% for the year ended December 31, 2004,and 58% for the year ended December 31, 2003. As a result, our financialcondition could be affected by factors such as changes in foreign currencyexchange rates or weak economic conditions in foreign markets. As all of oursales are currently made in United States dollars, a strengthening of theUnited States dollar could make our products less competitive in foreignmarkets. We 

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donot use derivative financial instruments for speculative or trading purposes,nor do we engage in any foreign currency hedging transactions.

Ourinterest income is sensitive to changes in the general level of United Statesinterest rates, particularly since the majority of our investments are inshort-term instruments.

**Cash and Cash Equivalents and Short and Long-Term Investments**

Cash equivalents consistprimarily of commercial paper and money market funds acquired with remainingmaturity periods of three months or less, and are stated at cost, plus accruedinterest that approximates market value. We would not expect our operatingresults or cash flow to be significantly impacted by the effect of suddenchanges in market interest rates given the nature of our short-terminvestments.

The following table provides information about ourinvestment portfolio. For investment securities, the table presents cash andcash equivalents and short and long-term investments and related weightedaverage interest rates by category at December 31, 2005.

| ** **                                                                                       | ** **   | **Amounts**             | ** **   | **Weighted Average  Interest Rate** | ** **   |
|--------------------------------------------------------------------------------------------------|--------------|-------------------------|--------------|-----------------------------------------------|--------------|
| ** **                                                                                       | ** **   | **(in thousands)** | ** **   | ** **                                    | ** **   |
| ***Description***                                                                                | *** *** |                    | *** *** | *** ***                                  |         |   | *** *** | *** *** |   |
| Cash  and cash equivalents and short-term investments:                                           |         |                    |         | *** ***                                  |         |   |   |   |   |
| Cash                                                                                             |         |                    | $            | 549                                           | *** *** |   |   | — |   |   |
| Commercial Paper                                                                                 |         |                    | 7,667        | *** ***                                  |         |   | 4.3 | % |   |
| Short-term investments  (average 60 remaining days to maturity)                                  |         |                    | 2,995        | *** ***                                  |         |   | 4.2 | % |   |
| Total cash and cash  equivalents and short term-investments at December 31, 2005            |         |                    | 11,211       | *** ***                                  |         |   |   |   |   |
| Long-term-investments (average 390 days to maturity)                                             |         |                    | 958          | *** ***                                  |         |   | 4.1 | % |   |
| Total cash, cash equivalents and short-term and long-term investments  at December 31, 2005 |         |                    | $            | 12,169                                        | *** *** |   |   | 4.3 | % |   |

 

**Item 8.   *Financial Statements andSupplementary Data***

Ourconsolidated financial statements and Reports of Independent Registered PublicAccounting Firms appear on pages F-1 through F-30 of thisReport.

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

On March 22, 2005, KPMG LLP (“KPMG”), our independent registered public accounting firmat the time, advised the Audit Committee of our Board of Directors that KPMGwas resigning effective upon the completion of its audit of Avistar’sconsolidated financial statements as of and for the year ended December 31,2004 and the issuance of their report thereon. On March 28, 2005, we filedour annual report on Form 10-K for the year ended December 31,2004. The client-auditor relationship between us and KPMG ceased as of thatdate.

In connection with the audits of the two fiscal yearsended December 31, 2004 and 2003 and through the date March 28, 2005,there were no disagreements with KPMG on any matter of accounting principles orpractices, financial statement disclosure, or auditing scope or procedure,which disagreements, if not resolved to the satisfaction of KPMG, would havecaused KPMG to make reference to the subject matter of the disagreements inconnection with its reports on Avistar’s financial statements for those twofiscal years. Nor were there any reportable events as defined in Item 304(a)(1)(v) ofRegulation S-K. In addition, KPMG’s reports on the consolidated financialstatements of Avistar for the fiscal years ended December 31, 2004 and2003 did not contain an adverse opinion or a disclaimer of opinion, and werenot 

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qualified or modified asto uncertainty, audit scope, or accounting principles, except as stated in thenext paragraph.

In connection with the restatement as described inNote 2 to the Consolidated Financial Statements included herein, KPMG’sreissued report on the Consolidated Financial Statements of Avistar for thefiscal years ended December 31, 2004 and 2003 included in this Form 10-Kcontains an explanatory paragraph regarding the restatement.

The Audit Committee of our Board of Directors selectedBurr, Pilger & Mayer LLP (“BPM”) as our independent registered publicaccounting firm for the fiscal year ending December 31, 2005 and BPMadvised us of its acceptance of this engagement effective April 18, 2005.

During fiscal years 2003and 2004 and through March 28, 2005, neither we nor anyone on our behalfhas consulted with BPM regarding either (i) the application of accountingprinciples to a specified transaction, either completed or proposed; or thetype of audit opinion that might be rendered on our financial statements, andneither a written report was provided to us nor oral advice was provided by BPMthat was an important factor considered by us in reaching a decision as to anyaccounting, auditing or financial reporting issue; or (ii) any matter thatwas the subject of a disagreement, as that term is defined in Item 304 (a)(1)(iv) ofRegulation S-K and the related instructions to Item 304 of Regulation S-K, or areportable event, as that term is defined in Item 304 (a)(1)(v) ofRegulation S-K.

**Item 9a.   *Controls and Procedures***

(a)   Evaluation of disclosure controls and procedures: Our managementevaluated, with the participation of our Chief Executive Officer and ChiefFinancial Officer, the effectiveness of our disclosure controls and proceduresas of the end of the period covered by this Annual Report on Form 10-K.Based on this evaluation, our Chief Executive Officer and Chief FinancialOfficer have concluded that our disclosure controls and procedures (as definedin Rules 13a-15(e) and 15d-15(e) under theSecurities Exchange Act of 1934 (the Exchange Act)) are effective to ensurethat information required to be disclosed by us in reports that we file orsubmit under the Exchange Act (i) is accumulated and communicated to ourmanagement, including our chief executive officer and chief financial officer,as appropriate to allow timely decisions regarding required disclosure, and (ii) isrecorded, processed, summarized and reported within the time periods specifiedin Securities and Exchange Commission rules and forms.

(b)   Changes in internal control over financialreporting: There was no change in our internal control over financial reportingthat occurred during the period covered by this Annual Report on Form 10-Kthat has materially affected, or is reasonably likely to materially affect, ourinternal control over financial reporting.

**Item 9b.   *Other Information***

On April 18,2006, we received a notice from the staff of The NASDAQ Stock Market statingthat Avistar is not in compliance with Marketplace Rule 4310(c)(14)because it had not filed its Annual Report on Form 10-K for the yearended December 31, 2005 on a timely basis. The notice is automaticallygenerated by NASDAQ, and indicated that due to such noncompliance, Avistar’scommon stock will be subject to potential delisting. On April 19, 2006, werequested a hearing before the NASDAQ Listing Qualifications Panel to appealthe NASDAQ staff’s determination. The hearing request automatically stayed thedelisting of Avistar’s common stock pending the Panel’s review and decision.There can be no assurance, however, that the Panel will grant Avistar’s requestfor continued listing.

47

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**PART III**

**Item 10.**   *Directors and Executive Officersof the Registrant*

The information required by thisitem concerning our directors is incorporated by reference to the sectionscaptioned “Election of Directors” and “Section 16(a) BeneficialOwnership Reporting Compliance” contained in our Proxy Statement related to the2006 Annual Meeting of Stockholders, to be filed by us with the Securities andExchange Commission within 120 days of the end of 2005 pursuant to GeneralInstruction G(3) of Form 10-K (the “Proxy Statement”). Certaininformation required by this item concerning executive officers is set forth inPart I of this Report in “Business—Executive Officers” and certain otherinformation required by this item is incorporated by reference from the sectioncaptioned “Principal Stockholders” contained in the Proxy Statement.

We have adopted a code of ethics that applies to ourprincipal 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 onour Internet website. The Internet address for our website ishttp://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 andEthics Policy.”*

Weintend to satisfy the disclosure requirement under Item 5.05 of Form 8-Kregarding an amendment to, or waiver from, a provision of this code of ethicsby posting such information on our website, at the address and locationspecified above.

**Item 11.**   *Executive Compensation*

Theinformation required by this item is incorporated by reference to the sectioncaptioned “Executive Compensation and Other Matters” contained in the ProxyStatement.

**Item 12.**   *Security Ownership of CertainBeneficial Owners and Management*

Theinformation required by this item is incorporated by reference to the sectionscaptioned “Principal Stockholders”,  “ExecutiveCorporation and Other Matters” contained in the Proxy Statement.

48

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**Equity CompensationPlan Information**

Thefollowing table provides information as of December 31, 2005 with respectto the shares of our Common Stock that may be issued under our existing equitycompensation plans.

| ** **                                                   | ** ** | **A**                                 | ** ** | **B**                           | ** ** | **C**                                 | ** ** |
|--------------------------------------------------------------|------------|---------------------------------------|------------|---------------------------------|------------|---------------------------------------|------------|
| ** **                                                   | ** ** | ** **                            | ** ** | ** **                      | ** ** | **Number of securities**    | ** ** |
| ** **                                                   | ** ** | ** **                            | ** ** | ** **                      | ** ** | **remaining available for** | ** ** |
| ** **                                                   | ** ** | ** **                            | ** ** | ** **                      | ** ** | **future issuance under**   | ** ** |
| ** **                                                   | ** ** | **Number of securities**    | ** ** | ** **                      | ** ** | **equity compensation**          | ** ** |
| ** **                                                   | ** ** | **to be issued upon**  | ** ** | **Weighted-average**            | ** ** | **plans (excluding**             | ** ** |
| ** **                                                   | ** ** | **exercise of outstanding** | ** ** | **exercise price of** | ** ** | **securities reflected in** | ** ** |
| **Plan Category**                                       | ** ** | ** **                            | ** ** | **options**                     | ** ** | **outstanding options**          | ** ** | **Column A)** | ** ** |
| Equity compensation  plans approved by security holders |       |                                  | 7,979,647  | (1)                             |       |                                  | $          | 3.06 |   |   |   | 3,544,233 | (2) |   |
| Equity compensation  plans not approved by security holders  |       |                                  | —     |                            |       |                                  | —     |   |   |   | — |   |   |
| Total                                                        |       |                                  | 7,979,647  |                            |       |                                  | $          | 3.06 |   |   |   | 3,544,233 |   |   |
|                                                              |            |                                       |            |                                 |            |                                       |            |  |  |  |  |  |  |  |  |  |

----

(1)          This number reflects thenumber of shares to be issued upon exercise of outstanding options under our2000 Director Option Plan (“Director Plan”), the 1997 Stock Option Plan (the “1997Plan”) and the 2000 Stock Option Plan (the “2000 Option Plan”). This numberexcludes purchase rights accruing under the Employee Stock Purchase Plan (“PurchasePlan”). The Purchase Plan authorizes the granting of stock purchase rights toeligible employees during two-year offering periods with exercise datesapproximately every six months. Shares are purchased through employee payrolldeductions at purchase prices equal to 85% of the lesser of the fair marketvalue of the our Common Stock at either the first day of each offering periodor the date of purchase.

(2)          Includes1,477,705 shares available for issuance under the 2000 Plan, 200,750 shares available for issuanceunder the Director Plan and 1,865,778 shares available for issuance under thePurchase Plan. No securities are available for future issuance under the 1997Plan. The 2000 Option Plan provides for an annual increase in the number ofshares of Common Stock reserved for issuance thereunder on the first day of ourfiscal year in an amount equal to the lesser of (x) 1,200,000 shares, (y) 4%of the outstanding shares of Avistar as of the last day of the prior fiscalyear or (z) such lesser amount as determined by the Board. The DirectorPlan currently provides for an annual increase to the number of shares reservedthereunder on the first day of Avistar’s fiscal year equal to the lesser of (x) 175,000shares, (y) 1% of the outstanding shares of our Common Stock on such dateor (z) such amount as determined by the Board. The Purchase Plan providesfor an annual increase in the number of shares of Common Stock reservedthereunder on the first day of our fiscal year in an amount equal to the lesserof (x) 900,000 shares, (y) 3% of our outstanding shares on the lastday of the prior fiscal year or (z) such amount as determined by theBoard. Under the terms of the Plans, on January 1, 2005, 1,200,000 and175,000 shares were added to the 2000 Option Plan and the Director Plan,respectively. No shares were added to the Purchase Plan on January 1,2005.

**Item 13.**   *Certain Relationships and RelatedTransactions*

Theinformation required by this item is incorporated by reference to the sectionscaptioned “Compensation Committee Interlocks and Insider Participation” and “CertainTransactions” contained in the Proxy Statement.

**Item 14.**   *Principal Accountant Fees andServices*

The information required by thissection is incorporated by reference from the information in the sectionentitled “Ratification of Appointment of Independent Accountants” in the ProxyStatement.

49

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**PART IV**

**Item 15.   *Exhibits, FinancialStatement Schedules***

(a)(1) *FinancialStatements*

The following financial statements are incorporated byreference in Item 8 of this Report:

|                                                                                                                                                                      | ** ** | **Page** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|
| Reports  of Independent Registered Public Accounting Firms                                                                                                           |       | F-2      |
| Consolidated  Balance Sheets as of December 31, 2005 and 2004                                                                                                   |       | F-4      |
| Consolidated  Statements of Operations for the years ended December 31, 2005, 2004 and  2003                                                                    |       | F-5      |
| Consolidated  Statements of Stockholders’ Equity (Deficit) for the years ended December 31,  2005, 2004 and 2003        |       | F-6      |
| Consolidated  Statements of Cash Flows for the years ended December 31, 2005, 2004 and  2003                                                                    |       | F-7      |
| Notes to the Consolidated  Financial Statements                                                                                                                      |       | F-8      |

 

(a)(2) *FinancialStatement Schedules*

Schedule II—Valuation andQualifying Accounts and Reserves (see page S-1)

Schedules not listed above havebeen omitted because the information required to be set forth therein is notapplicable or is shown in the financial statements or notes thereto.

(a)(3) *Exhibits*

| 3.2(1)          |   | Restated Certificate of  Incorporation                                                                                                             |
|-----------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.3(11)         |   | Bylaws  of Avistar Communications Corporation                                                                                                      |
| 4.1(1)          |   | Specimen  Certificate evidencing shares of Common Stock                                                                                            |
| 10.1(1)         |   | 1997  Stock Option Plan, as amended*                                                                                                               |
| 10.1.1(1)       |   | 1997  Stock Option Plan Form of Stock Option Agreement*                                                                                       |
| 10.2(1)         |   | 2000  Stock Option Plan, as amended*                                                                                                               |
| 10.3            |   | 2000  Director Option Plan, as amended*                                                                                                            |
| 10.4(1)         |   | Form of  Director Option Agreement*                                                                                                           |
| 10.5(4)         |   | 2000  Employee Stock Purchase Program, as amended*                                                                                                 |
| 10.6(1)         |   | Form of  Indemnification Agreement*                                                                                                           |
| 10.7(1)†   |   | Preferred  Supplier Agreement dated June 24, 1997 by and between Avistar and  Tandberg, Inc., including modifications Nos. 1, 2, 3 and 4 |
| 10.7.1(1)† |   | Modification  No. 5 to the Preferred Supplier Agreement dated June 27, 2000                                                              |
| 10.7.2(2)† |   | Modification  No. 6 to the Preferred Supplier Agreement dated November 27, 2000                                                          |
| 10.8(6)         |   | Settlement  Agreement and Release between the Registrant and R. Stephen Heinrichs dated April 26,  2001*                                      |
| 10.9(7)         |   | Master  Loan and Security Agreement between the Registrant and Comerica Bank—California  dated February 27, 2002                         |
| 10.9.1(7)† |   | First  Amendment dated December 17, 2002 to Master Loan and Security Agreement  between the Registrant and Comerica Bank—California      |
| 10.9.2(7)† |   | Unconditional  Guaranty of the Gerald J. Burnett and Marjorie J. Burnett Revocable Trust  dated December 17, 2002                             |

50

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| 10.9.3(7)† |   | Unconditional  Guaranty of Gerald J. Burnett dated December 17, 2002                                                                                                                      |
|-----------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.9.4(7)       |   | Second  Amendment dated March 10, 2003 to Master Loan and Security Agreement between  the Registrant and Comerica Bank—California                                                    |
| 10.9.5(9)       |   | Fourth Amendment dated February 27,  2004 to Master Loan and Security Agreement between the Registrant and  Comerica Bank—California                                                 |
| 10.9.6(9)       |   | Reaffirmation  of Unconditional Guaranty of the Gerald J. Burnett and Marjorie J. Burnett  Revocable Trust dated February 24, 2004                                                        |
| 10.10(8)        |   | Office  Lease Agreement between CA-Twin Dolphin Plaza Limited Partnership and the  Registrant dated July 30, 2003                                                                         |
| 10.11(8)        |   | 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 |
| 10.12(10)       |   | Stock Purchase Agreement  among the Registrant, Fuller & Thaler Behavioral Finance Fund, Ltd.  and Fuller & Thaler Avalanche Fund, L.P. dated March 23, 2004            |
| 10.13(11)       |   | Settlement Agreement  among the Registrant, Collaboration Properties, Inc. and Polycom, Inc.  dated November 12, 2004                                                           |
| 10.14†     |   | Patent Cross-License  Agreement Among the Company, Collaboration Properties, Inc. and Polycom, Inc.  dated November 12, 2004                                                    |
| 21.1(7)         |   | Subsidiaries  of the Company                                                                                                                                                                   |
| 23.1            |   | Consent  of Independent Registered Public Accounting Firm: Burr, Pilger &  Mayer LLP                                                                                                  |
| 23.2            |   | Consent  of Independent Registered Public Accounting Firm: KPMG LLP                                                                                                                            |
| 24.1            |   | Power  of Attorney (see page 47)                                                                                                                                                          |
| 31.1            |   | Rule 13a-14(a)/15d-14(a) Certification  by the Chief Executive Officer                                                                                                               |
| 31.2            |   | Rule 13a-14(a)/15d-14(a) Certification  by the Chief Financial Officer                                                                                                               |
| 32              |   | 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  |

----

*                    Indicatesmanagement contract or compensatory plan or arrangement required to be filed anexhibit pursuant to Item 14(c) of Form 10-K.

†                    Portionsof the exhibit have been omitted pursuant to a request for confidentialtreatment and the omitted portions have been separately filed with theCommission.

(1)          Filed asan exhibit to the Company’s Registration Statement on Form S-1 (FileNo. 333-39008) as declared effective by the Securities and ExchangeCommission on August 16, 2000.

(2)          Filed asan exhibit to the Registrant’s Annual Report on Form 10-K for theyear ended December 31, 2000 filed with the Securities and ExchangeCommission on March 9, 2001.

(3)          Reserved.

(4)          Filed asan exhibit to the Registrant’s Registration Statement on Form S-8filed with the Securities and Exchange Commission on August 16, 2000.

(5)          Filed asan exhibit to the Company’s Annual Report on Form 10-K for the yearended December 31, 2001 filed with the Securities and Exchange Commissionon March 21, 2002.

51

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(6)          Filed asan exhibit to the Registrant’s Current Report on Form 8-K filed withthe Securities and Exchange Commission on May 8, 2001.

(7)          Filed asan exhibit to the Company’s Annual Report on Form 10-K for the yearended December 31, 2002 with the Securities and Exchange Commission on March 25,2003.

(8)          Filed asan exhibit to the Registrant’s Quarterly Report on Form 10-Q for thethree months ended September 30, 2003 filed with the Securities andExchange Commission on October 23, 2003.

(9)          Filed asan exhibit to the Registrant’s Annual Report on Form 10-K for theyear ended December 31, 2003 filed with the Securities and ExchangeCommission on March 16, 2004.

(10)   Filed as an exhibit to the Registrant’s QuarterlyReport on Form 10-Q for the quarter ended March 31, 2004 filedwith the Securities and Exchange Commission on May 11, 2004.

(11)   Filed as an exhibit to the Registrant’s AnnualReport on Form 10-K for the year ended December 31, 2004 filedwith the Securities and Exchange Commission on March 28, 2005.

52

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**SIGNATURES**

Pursuant to the requirements of Section 13 or 15(d) ofthe Securities Exchange Act of 1934, as amended, the Registrant has duly causedthis annual report to be signed on its behalf by the undersigned, thereuntoduly authorized.
|                           |     | AVISTAR COMMUNICATIONS  CORPORATION |
|---------------------------|----------|-------------------------------------|
|                      |     | By:                                 | /s/   GERALD J. BURNETT |
|                      |     |                                | Gerald J. Burnett |
| * *                  | * * | * *                            | *Chief Executive* |
| * *                  | * * | * *                            | *Officer and Chairman* |
| Date: April 28, 2006 | * * | * *                            | * * |

 

**POWER OF ATTORNEY**

KNOW ALL PERSONS BY THESEPRESENTS, that each person whose signature appears below constitutes andappoints Gerald J. Burnett and Robert J. Habig, his true and lawfulattorney-in-fact and agent, with full power of substitution and resubstitution,to sign any and all amendments (including post- effective amendments) to thisAnnual Report on Form 10-K and to file the same, with all exhibitsthereto and other documents in connection therewith, with the Securities andExchange Commission, granting unto said attorney-in-fact and agent, full powerand authority to do and perform each and every act and thing requisite andnecessary to be done in connection therewith, as fully to all intents andpurposes as he or she might or could do in person, hereby ratifying andconfirming all that said attorney-in-fact and agent, or his substitute orsubstitutes, or any of them, shall do or cause to be done by virtue hereof.

Pursuant to the requirements of the Securities ExchangeAct of 1934, as amended, this report has been signed below by the followingpersons on behalf of the registrant and in the capacities and on the datesindicated:
|                                           | **Signature** | ** **                                 | ** ** |                     | **Title** | ** ** | ** ** |  | **Date** | ** ** |
|-------------------------------------------|---------------|--------------------------------------------|------------|---------------------|-----------|------------|------------|--|----------|------------|
| /s/   GERALD J. BURNETT    |          | Chief Executive Officer and  Chairman      |       | April 28, 2006 |
| Gerald J. Burnett                         |          | (Principal Executive Officer)              |       |                |
| /s/   ROBERT J. HABIG      |          | Chief Financial Officer  (Principal        |       | April 28, 2006 |
| Robert J. Habig                           |          | Financial and Accounting Officer)          |       |                |
| /s/   WILLIAM L. CAMPBELL  |          | Executive Vice President, Chief  Operating |       | April 28, 2006 |
| William L. Campbell                       |          | Officer and Director                       |       |                |
| /s/   CRAIG F. HEIMARK     |          | Director                                   |       | April 28, 2006 |
| Craig F. Heimark                          |          |                                       |       |                |
| /s/   R. STEPHEN HEINRICHS |          | Director                                   |       | April 28, 2006 |
| R. Stephen Heinrichs                      |          |                                       |       |                |
| /s/   ROBERT P. LATTA      |          | Director                                   |       | April 28, 2006 |
| Robert P. Latta                           |          |                                       |       |                |
| /s/   ROBERT M. METCALFE   |          | Director                                   |       | April 28, 2006 |
| Robert M. Metcalfe                        |          |                                       |       |                |
| /s/   JAMES W. ZEIGON      |          | Director                                   |       | April 28, 2006 |
| James W. Zeigon                           |          |                                       |       |                |

 

53

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**INDEXTO FINANCIAL STATEMENTS**

|                                                                                                                                 | ** ** | **Page** |
|---------------------------------------------------------------------------------------------------------------------------------|------------|----------|
| Reports of Independent  Registered Public Accounting Firms                                                                      |       |     | F-2 |
| Consolidated Balance Sheets as of  December 31, 2005 and 2004                                                              |       |     | F-4 |
| Consolidated Statements of  Operations for the years ended December 31, 2005, 2004 and 2003                                |       |     | F-5 |
| Consolidated Statements of  Stockholders’ Equity (Deficit) for the years ended December 31, 2005,  2004 and 2003 |       |     | F-6 |
| Consolidated Statements of  Cash Flows for the years ended December 31, 2005, 2004 and 2003                                |       |     | F-7 |
| Notes to the Consolidated Financial  Statements                                                                                 |       |     | F-8 |
|                                                                                                                            |       |     |   |

s

F-1

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**Report ofIndependent Registered Public Accounting Firm**

To the Board of Directors andStockholders ofAvistar Communications Corporation

We have audited the accompanyingconsolidated balance sheet of Avistar Communications Corporation and itssubsidiaries as of December 31, 2005, and the related consolidatedstatements of operations, stockholders’ equity (deficit), and cash flows forthe year then ended. Our audit also included the financial statement schedulelisted in Item 15(a)(2). These consolidated financial statements and financialstatement schedule are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these consolidated financialstatements and financial statement schedule based on our audit.

We conducted our audit inaccordance with the standards of the Public Company Accounting Oversight Board(United States). Those standards require that we plan and perform the audit toobtain reasonable assurance about whether the financial statements are free ofmaterial misstatement. An audit includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements. An auditalso includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financialstatement presentation. We believe that our audit provides a reasonable basisfor our opinion.

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, the financialposition of Avistar Communications Corporation and its subsidiaries as of December 31,2005, and the results of their operations and their cash flows for the yearthen ended, in conformity with accounting principles generally accepted in theUnited States of America. Also, in our opinion, the related financial statementschedule, when considered in relation to the consolidated financial statementstaken as a whole, presents fairly, in all material respects, the informationset forth therein.
|                                      | /s/ Burr, Pilger & Mayer LLP |
|--------------------------------------|---------------------------------------|
| Palo  Alto, California               |                                  |
| March 16, 2006, except  for the |                                  |
| second paragraph of Note 13,    |                                  |
| as to which the date is              |                                  |
| April 18, 2006                  |                                  |

 

F-2

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**Report ofIndependent Registered Public Accounting Firm**

The Board of Directors and StockholdersAvistar Communications Corporation:

We have audited the accompanying consolidated balancesheet of Avistar Communications Corporation and subsidiaries as of December 31,2004, and the related consolidated statements of operations, stockholders’equity, and cash flows for each of the years in the two-year period ended December 31,2004. In connection with our audits of the consolidated financial statements,we also have audited the financial statement schedule. These consolidatedfinancial statements and financial statement schedule are the responsibility ofthe Company’s management. Our responsibility is to express an opinion on thesefinancial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, 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 statementsreferred to above present fairly, in all material respects, the financialposition of Avistar Communications Corporation and subsidiaries as of December 31,2004, and the results of their operations and their cash flows for each of theyears in the two-year period ended December 31, 2004, in conformity withU.S. generally accepted accounting principles. Also in our opinion, the relatedfinancial statement schedule, when considered in relation to the consolidatedfinancial statements taken as a whole, presents fairly, in all materialrespects, the information set forth therein.

Asdiscussed in Note 2 to the accompanying consolidated financial statements, theconsolidated balance sheet of Avistar Communications Corporation and subsidiariesas of December 31, 2004, and the related consolidated statements ofoperations and cash flows for the year then ended have been restated.
|                                            | /s/ KPMG LLP |
|--------------------------------------------|--------------|
| Mountain View,  California                 |         |
| January 28, 2005, except as to        |         |
| Note 2, which is as of April 26, 2006 |         |

 

F-3

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**AVISTAR COMMUNICATIONS CORPORATION AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETSas of December 31, 2005 and 2004(in thousands, except share and per share data)**

| ** **                                                                                                                                                                                              | ** ** | **December 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                              | ** ** | ** **                  | ** ** | **Restated(1)**             | ** ** |
| **Assets:**                                                                                                                                                                                             |       |                        |       |                        |       |   |   |   |   |
| Current assets:                                                                                                                                                                                         |       |                        |       |                        |       |   |   |   |   |
| Cash and cash  equivalents                                                                                                                                                                              |       |                        | $          | 8,216                       |       |   |   | $ | 21,656 |   |   |
| Short-term investments                                                                                                                                                                                  |       |                        | 2,995      |                        |       |   | — |   |   |
| Accounts receivable, net  of allowance for doubtful accounts of $121 and $22 at December 31,  2005 and 2004, respectively                                                                     |       |                        | 1,428      |                        |       |   | 886 |   |   |
| Inventories, including  inventory shipped to customers’ sites, not yet installed of $28 and $34 at  December 31, 2005 and 2004, respectively                                                  |       |                        | 675        |                        |       |   | 737 |   |   |
| Deferred settlement and  patent licensing costs                                                                                                                                                         |       |                        | 1,256      |                        |       |   | 1,256 |   |   |
| Prepaid expenses and  other current assets                                                                                                                                                              |       |                        | 463        |                        |       |   | 454 |   |   |
| Total current assets                                                                                                                                                                                    |       |                        | 15,033     |                        |       |   | 24,989 |   |   |
| Long-term investments                                                                                                                                                                                   |       |                        | 958        |                        |       |   | — |   |   |
| Property and equipment,  net                                                                                                                                                                            |       |                        | 311        |                        |       |   | 192 |   |   |
| Long-term deferred  settlement and patent licensing costs                                                                                                                                               |       |                        | 3,685      |                        |       |   | 4,941 |   |   |
| Other assets                                                                                                                                                                                            |       |                        | 371        |                        |       |   | 286 |   |   |
| Total assets                                                                                                                                                                                            |       |                        | $          | 20,358                      |       |   |   | $ | 30,408 |   |   |
| **Liabilities and Stockholders’ Equity (Deficit):**                                                                                                                                                |       |                        |       |                        |       |   |   |   |   |
| Current liabilities:                                                                                                                                                                                    |       |                        |       |                        |       |   |   |   |   |
| Accounts payable                                                                                                                                                                                        |       |                        | $          | 1,004                       |       |   |   | $ | 1,105 |   |   |
| Deferred income from  settlement and patent licensing                                                                                                                                                   |       |                        | 5,520      |                        |       |   | 5,482 |   |   |
| Deferred services  revenue and customer deposits                                                                                                                                                        |       |                        | 712        |                        |       |   | 748 |   |   |
| Accrued liabilities and  other                                                                                                                                                                          |       |                        | 1,491      |                        |       |   | 1,287 |   |   |
| Total current  liabilities                                                                                                                                                                              |       |                        | 8,727      |                        |       |   | 8,622 |   |   |
| Long-term liabilities:                                                                                                                                                                                  |       |                        |       |                        |       |   |   |   |   |
| Long-term deferred  income from settlement and patent licensing                                                                                                                                         |       |                        | 15,789     |                        |       |   | 21,272 |   |   |
| Total liabilities                                                                                                                                                                                       |       |                        | 24,516     |                        |       |   | 29,894 |   |   |
| Commitments and contingencies (Notes 5 and 9)                                                                                                                                                           |       |                        |       |                        |       |   |   |   |   |
| Stockholders’ equity (deficit):                                                                                                                                                                    |       |                        |       |                        |       |   |   |   |   |
| Common stock, $0.001 par  value; 250,000,000 shares authorized at December 31, 2005 and 2004;  34,939,124 and 34,542,334 shares issued at December 31, 2005  and 2004, respectively |       |                        | 35         |                        |       |   | 35 |   |   |
| Less: treasury common  stock, 1,181,625 shares at December 31, 2005 and 2004, at cost                                                                                                         |       |                        | (53        | )                           |       |   | (53 | ) |   |
| Additional  paid-in-capital                                                                                                                                                                             |       |                        | 90,519     |                        |       |   | 90,005 |   |   |
| Other comprehensive loss                                                                                                                                                                                |       |                        | (12        | )                           |       |   | — |   |   |
| Accumulated deficit                                                                                                                                                                                     |       |                        | (94,647    | )                           |       |   | (89,473 | ) |   |
| Total stockholders’  equity (deficit)                                                                                                                                                              |       |                        | (4,158     | )                           |       |   | 514 |   |   |
| Total liabilities and stockholders’ equity (deficit)                                                                                                                                               |       |                        | $          | 20,358                      |       |   |   | $ | 30,408 |   |   |

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(1)          See Note2 “Correction of an Error” of the Notes to Consolidated Financial Statements

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

F-4

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**AVISTAR COMMUNICATIONS CORPORATION AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF OPERATIONSfor the years ended December 31, 2005, 2004 and 2003(in thousands, except per share data)**

| ** **                                                                           | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                           | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                           | ** ** | **Restated(1)**                            | ** ** |
| Revenue:                                                                             |       |                                       |       |   |   |   |   |
| Product                                                                              |       | $                                          | 3,503      |   | $ | 3,121 |   | $ | 2,817 |   |
| Services, maintenance and support                                                    |       | 3,408                                      |       | 3,200 |   | 3,775 |   |
| Total revenue                                                                        |       | 6,911                                      |       | 6,321 |   | 6,592 |   |
| Costs and expenses:                                                                  |       |                                       |       |   |   |   |   |
| Cost of product revenue                                                              |       | 1,892                                      |       | 1,435 |   | 1,410 |   |
| Cost of services, maintenance and support revenue                                    |       | 2,220                                      |       | 1,937 |   | 2,119 |   |
| Income from settlement and patent licensing                                          |       | (4,226                                     | )          | (575 | ) | — |   |
| Research and development                                                             |       | 3,544                                      |       | 2,588 |   | 2,420 |   |
| Sales and marketing                                                                  |       | 3,379                                      |       | 2,456 |   | 3,598 |   |
| General and administrative                                                           |       | 5,697                                      |       | 6,956 |   | 6,034 |   |
| Amortization of deferred stock compensation*                                         |       | —                                     |       | — |   | 135 |   |
| Total costs and expenses                                                             |       | 12,506                                     |       | 14,797 |   | 15,716 |   |
| Loss from operations                                                                 |       | (5,595                                     | )          | (8,476 | ) | (9,124 | ) |
| Other income (expense):                                                              |       |                                       |       |   |   |   |   |
| Interest income                                                                      |       | 537                                        |       | 118 |   | 44 |   |
| Other income (expense), net                                                          |       | (94                                        | )          | 15 |   | 481 |   |
| Total other income, net                                                              |       | 443                                        |       | 133 |   | 525 |   |
| Loss before  provision for income taxes                                              |       | (5,152                                     | )          | (8,343 | ) | (8,599 | ) |
| Provision for  income taxes                                                          |       | 22                                         |       | 363 |   | 20 |   |
| Net loss                                                                             |       | $                                          | (5,174     | ) | $ | (8,706 | ) | $ | (8,619 | ) |
| Net loss per  share—basic and diluted                                           |       | $                                          | (0.15      | ) | $ | (0.27 | ) | $ | (0.33 | ) |
| Weighted average  shares used in calculating basic and diluted net loss per share    |       | 33,600                                     |       | 32,610 |   | 26,368 |   |
|                                                                                      |       |                                       |       |   |   |   |   |
| * Amortization of  deferred stock compensation excluded from the following expenses: |       |                                       |       |   |   |   |   |
| Cost of revenue                                                                      |       | $                                          | —     |   | $ | — |   | $ | 15 |   |
| Research and development                                                             |       | —                                     |       | — |   | 12 |   |
| Sales and marketing                                                                  |       | —                                     |       | — |   | 104 |   |
| General and administrative                                                           |       | —                                     |       | — |   | 4 |   |
|                                                                                 |       | $                                          | —     |   | $ | — |   | $ | 135 |   |

 

(1)          See Note2 “Correction of an Error” of the Notes to Consolidated Financial Statements

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

F-5

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**AVISTAR COMMUNICATIONS CORPORATIONCONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)for the years ended December 31, 2005, 2004 and 2003(in thousands, except share amounts)**

| ** **                                                                       | ** ** | ** **            | ** ** | ** **              | ** ** | ** **  | ** ** | ** ** | ** ** | **Additional**    | ** ** | **Deferred**     | ** ** | **Other**              | ** ** | ** **  | ** ** | **Total**                 | ** ** |
|----------------------------------------------------------------------------------|------------|-----------------------|------------|-------------------------|------------|-------------|------------|------------|------------|-------------------|------------|------------------|------------|------------------------|------------|-------------|------------|---------------------------|------------|
| ** **                                                                       | ** ** | **Common Stock** | ** ** | **Treasury Stock** | ** ** | **Paid-In** | ** ** | **Stock**  | ** ** | **Comprehensive** | ** ** | **Accumulated**  | ** ** | **Stockholders’** | ** ** |
| ** **                                                                       | ** ** | **shares**            | ** ** | **amount**              | ** ** | **shares**  | ** ** | **amount** | ** ** | **Capital**       | ** ** | **Compensation** | ** ** | **Income (Loss)** | ** ** | **Deficit** | ** ** | **Equity (Deficit)** | ** ** |
| Balance at December 31, 2002                                                |       | 26,465,058            |       |                    | $          | 26          |       |       | 1,179,625  |              |       | $                | (51        | )                      |       |        | $          | 80,254                    |       |   |   | $ | (135 | ) |   |   | $ | 2 |   |   |   | $ | (72,148 | ) |   |   | $ | 7,948 |   |   |
| Issuance of common stock to employees pursuant to  employee stock purchase plan  |       | 87,191                |       |                    | —     |        |       | —     |       |              | —     |             |       |                   | 64         |        |       |                      | —     |   |   |   | — |   |   |   | — |   |   |   | 64 |   |   |
| Issuance of common stock to employees pursuant to  exercise of options      |       | 222,749               |       |                    | —     |        |       | —     |       |              | —     |             |       |                   | 219        |        |       |                      | —     |   |   |   | — |   |   |   | — |   |   |   | 219 |   |   |
| Issuance of common stock pursuant to private  placement (net of placement fees)  |       | 4,615,385             |       |                    | 5          |        |       | —     |       |              | —     |             |       |                   | 5,698      |        |       |                      | —     |   |   |   | — |   |   |   | — |   |   |   | 5,703 |   |   |
| Amortization of deferred stock compensation, net of  forfeitures                 |       | —                |       |                    | —     |        |       | —     |       |              | —     |             |       |                   | —     |        |       |                      | 135        |   |   |   | — |   |   |   | — |   |   |   | 135 |   |   |
| Non-employee stock-based compensation                                            |       | —                |       |                    | —     |        |       | —     |       |              | —     |             |       |                   | 43         |        |       |                      | —     |   |   |   | — |   |   |   | — |   |   |   | 43 |   |   |
| Unrealized loss on short-term investments                                        |       | —                |       |                    | —     |        |       | —     |       |              | —     |             |       |                   | —     |        |       |                      | —     |   |   |   | (2 | ) |   |   | — |   |   |   | (2 | ) |   |
| Net loss                                                                         |       | —                |       |                    | —     |        |       | —     |       |              | —     |             |       |                   | —     |        |       |                      | —     |   |   |   | — |   |   |   | (8,619 | ) |   |   | (8,619 | ) |   |
| Balance at December 31, 2003                                                |       | 31,390,383            |       |                    | 31         |        |       | 1,179,625  |       |              | (51        | )                |       |                   | 86,278     |        |       |                      | —     |   |   |   | — |   |   |   | (80,767 | ) |   |   | 5,491 |   |   |
| Issuance of common stock to employees pursuant to  employee stock purchase plan  |       | 118,139               |       |                    | 1          |        |       | —     |       |              | —     |             |       |                   | 85         |        |       |                      | —     |   |   |   | — |   |   |   | — |   |   |   | 86 |   |   |
| Issuance of common stock to employees pursuant to  exercise of options      |       | 33,812                |       |                    | —     |        |       | —     |       |              | —     |             |       |                   | 43         |        |       |                      | —     |   |   |   | — |   |   |   | — |   |   |   | 43 |   |   |
| Issuance of common stock pursuant to private  placement (net of placement fees)  |       | 3,000,000             |       |                    | 3          |        |       | —     |       |              | —     |             |       |                   | 3,575      |        |       |                      | —     |   |   |   | — |   |   |   | — |   |   |   | 3,578 |   |   |
| Non-employee stock-based compensation                                            |       | —                |       |                    | —     |        |       | —     |       |              | —     |             |       |                   | 24         |        |       |                      | —     |   |   |   | — |   |   |   | — |   |   |   | 24 |   |   |
| Purchase of common stock pursuant to stock repurchase  program                   |       | —                |       |                    | —     |        |       | 2,000      |       |              | (2         | )                |       |                   | —     |        |       |                      | —     |   |   |   | — |   |   |   | — |   |   |   | (2 | ) |   |
| Net loss                                                                         |       | —                |       |                    | —     |        |       | —     |       |              | —     |             |       |                   | —     |        |       |                      | —     |   |   |   | — |   |   |   | (8,706 | ) |   |   | (8,706 | ) |   |
| Balance at December 31, 2004                                                |       | 34,542,334            |       |                    | 35         |        |       | 1,181,625  |       |              | (53        | )                |       |                   | 90,005     |        |       |                      | —     |   |   |   | — |   |   |   | (89,473 | ) |   |   | 514 |   |   |
| Issuance of common stock to employees pursuant to  employee stock purchase  plan |       | 182,594               |       |                    | —     |        |       | —     |       |              | —     |             |       |                   | 143        |        |       |                      | —     |   |   |   | — |   |   |   | — |   |   |   | 143 |   |   |
| Issuance of common stock to employees pursuant to  exercise of options      |       | 214,196               |       |                    | —     |        |       | —     |       |              | —     |             |       |                   | 271        |        |       |                      | —     |   |   |   | — |   |   |   | — |   |   |   | 271 |   |   |
| Non-employee stock-based compensation                                            |       | —                |       |                    | —     |        |       | —     |       |              | —     |             |       |                   | 100        |        |       |                      | —     |   |   |   | — |   |   |   | — |   |   |   | 100 |   |   |
| Unrealized loss on short and long-term  investments                              |       | —                |       |                    | —     |        |       | —     |       |              | —     |             |       |                   | —     |        |       |                      | —     |   |   |   | (12 | ) |   |   | — |   |   |   | (12 | ) |   |
| Net loss                                                                         |       | —                |       |                    | —     |        |       | —     |       |              | —     |             |       |                   | —     |        |       |                      | —     |   |   |   | — |   |   |   | (5,174 | ) |   |   | (5,174 | ) |   |
| Balance at  December 31, 2005                                               |       | 34,939,124            |       |                    | $          | 35          |       |       | 1,181,625  |              |       | $                | (53        | )                      |       |        | $          | 90,519                    |       |   |   | $ | — |   |   |   | $ | (12 | ) |   |   | $ | (94,647 | ) |   |   | $ | (4,158 | ) |   |

 

The accompanying notes are an integral part ofthese financial statements.

F-6

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**AVISTAR COMMUNICATIONS CORPORATION AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWSfor the years ended December 31, 2005, 2004 and 2003(in thousands)**

| ** **                                                                                 | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                 | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                                 | ** ** | **Restated(1)**                            | ** ** |
| Cash Flows from  Operating Activities:                                                     |       |                                       |       |   |   |   |   |
| Net loss                                                                                   |       | $                                          | (5,174     | ) | $ | (8,706 | ) | $ | (8,619 | ) |
| Adjustments to reconcile net loss to net cash  provided by (used in) operating activities: |       |                                       |       |   |   |   |   |
| Depreciation                                                                               |       | 273                                        |       | 339 |   | 209 |   |
| Stock-based compensation                                                                   |       | —                                     |       | — |   | 135 |   |
| Compensation on options issued to consultants                                              |       | 100                                        |       | 24 |   | 43 |   |
| Provision for doubtful accounts                                                            |       | 99                                         |       | 77 |   | 125 |   |
| Changes in assets and liabilities:                                                         |       |                                       |       |   |   |   |   |
| Accounts receivable                                                                        |       | (641                                       | )          | (268 | ) | (80 | ) |
| Inventories                                                                                |       | 62                                         |       | 200 |   | 211 |   |
| Prepaid expenses and other current assets                                                  |       | (9                                         | )          | 61 |   | 114 |   |
| Deferred settlement and patent licensing costs                                             |       | 1,256                                      |       | (6,197 | ) | — |   |
| Other assets                                                                               |       | (85                                        | )          | 5 |   | 29 |   |
| Accounts payable                                                                           |       | (101                                       | )          | 164 |   | 383 |   |
| Deferred income from settlement and patent licensing                                       |       | (5,445                                     | )          | 26,754 |   | — |   |
| Deferred services revenue and customer deposits                                            |       | (36                                        | )          | 77 |   | (325 | ) |
| Accrued liabilities and other                                                              |       | 204                                        |       | 162 |   | 227 |   |
| Net cash (used in) provided by operating activities                                        |       | (9,497                                     | )          | 12,692 |   | (7,548 | ) |
| Cash Flows from  Investing Activities:                                                     |       |                                       |       |   |   |   |   |
| Purchase of short and long-term investments                                                |       | (3,965                                     | )          | — |   | (1,000 | ) |
| Sale of short-term investments                                                             |       | —                                     |       | 1,000 |   | 2,400 |   |
| Purchase of property and equipment                                                         |       | (392                                       | )          | (179 | ) | (183 | ) |
| Net cash (used in) provided by investing activities                                        |       | (4,357                                     | )          | 821 |   | 1,217 |   |
| Cash Flows from  Financing Activities:                                                     |       |                                       |       |   |   |   |   |
| Proceeds from issuance of common stock                                                     |       | 414                                        |       | 3,707 |   | 5,986 |   |
| Repurchases of common stock                                                                |       | —                                     |       | (2 | ) | — |   |
| Net cash provided by financing activities                                                  |       | 414                                        |       | 3,705 |   | 5,986 |   |
| Net (decrease) increase in cash and cash equivalents                                       |       | (13,440                                    | )          | 17,218 |   | (345 | ) |
| Cash and cash equivalents, beginning of year                                               |       | 21,656                                     |       | 4,438 |   | 4,783 |   |
| Cash and cash equivalents, end of year                                                     |       | $                                          | 8,216      |   | $ | 21,656 |   | $ | 4,438 |   |
| Supplemental Cash  Flow Information:                                                       |       |                                       |       |   |   |   |   |
| Cash paid for income taxes                                                                 |       | $                                          | 357        |   | $ | 60 |   | $ | 50 |   |
| Cash paid for  interest                                                                    |       | $                                          | 1          |   | $ | 6 |   | $ | 8 |   |

----

(1)   See Note 2 “Correction of an Error” of the Notes to ConsolidatedFinancial Statements

The accompanying notes are an integral part of these financialstatements.

F-7

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**AVISTAR COMMUNICATIONSCORPORATION AND SUBSIDIARIES**

**NOTESTO FINANCIAL STATEMENTS**

**1.**   Business,Organization, Reorganization, Initial Public Offering, Basis of Presentation,and Risks andUncertainties

**Business**

AvistarCommunications Corporation (“Avistar” or the “Company”) provides theAvistar vBusiness integrated suite of video-enabled applications, including networked video communications software andhardware products and services. Avistar’s products include applications forinteractive video calling, content creation and publishing, broadcast video andvideo-on-demand, as well as data sharing, directory services and networkmanagement. Avistar designs, develops, markets, sells, manufactures and/orassembles and installs and supports its products. Avistar’s real-time andnon-real-time products are based upon its architecture and Video OperatingSystem (AvistarVOS) platform, which facilitates distribution over local andwide area networks using telephony or Internet services as appropriate. Avistar’sservices include software development, consulting, implementation, training,maintenance and support. In addition, Avistar seeks to prosecute, maintain,support and license the intellectual property developed by the Company throughits wholly-owned subsidiary, Collaboration Properties, Inc., a Nevadacorporation (CPI).

**Organization**

The business was founded in 1993as a Nevada limited partnership, Avistar Systems, Limited Partnership (“ASLP”).In December 1997, ASLP entered into an acquisition agreement with a newlyformed corporation, Avistar Systems Corporation (“ASC”), to convey all of ASLP’sassets, and transfer all of ASLP’s liabilities, in exchange for 16,000,000shares of ASC’s Series A convertible preferred stock (see Note 6) and2,171,400 shares of common stock. Effective December 31, 1997, alloperations previously conducted by ASLP were thereafter undertaken by ASC.

CollaborationProperties, Inc. (“CPI”) and VCT, Inc. (“VCT”) were founded in 1997and 1998, respectively, to hold certain intellectual property, includingpatents, which underlie certain technology used by ASLP and subsequently byASC. Three of the stockholders of CPI and VCT owned approximately 95% of CPIand 100% of VCT and were also the partners of Collaborative Holdings L.P. (“CHLP”),which owned a controlling interest in ASLP. The remaining 5% ownership of CPIwas held by UBS (USA), Inc. (“UBS”) which also held a 5% ownershipinterest in ASC (see Note 6). Accordingly, the accounts of CPI and VCT havebeen combined at historical cost with those of ASC for all periods presentedsince their inception.

**Reorganization**

Effective March 31, 2000,ASC merged with and into a newly formed Delaware corporation, AvistarCommunications Corporation. The operating assets and liabilities of the businesswere then contributed to a wholly owned subsidiary, Avistar Systems Corporation(“Avistar Systems”), a Delaware corporation. At the same time, the owners ofCPI and VCT transferred all of their stock in those entities to Avistar as acapital contribution. As a result, CPI and VCT are recorded at their historicalcost basis and became wholly owned subsidiaries of Avistar as of March 31,2000. In April 2000, the operations of VCT were merged with and into CPI.

In June 2000, all of the Series Apreferred stock held by ASC was distributed to the Company’s three founders andseveral other individuals based on their respective ownership interests inASLP. In addition, all of the shares of Avistar’s common stock, held by ASLPwere distributed to the Company’s employees, 

F-8

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formeradvisors and officers. These common shares represent an amount equal to thoseshares of Class B units in ASLP that were owned by the respectiveindividuals before the acquisition.

In July 2001,the Board of Directors of Avistar and the board of directors of Avistar Systemsapproved the merger of Avistar Systems, the wholly owned subsidiary of Avistar,with and into Avistar. The merger was completed in July 2001. The assetsand liabilities of Avistar Systems were transferred to the Company athistorical cost on the date of the merger.

**Initial Public Offering**

In August 2000, the Companycompleted its initial public offering, selling three million shares of commonstock at $12 per share. The initial public offering resulted in net proceeds tothe Company of approximately $31.3 million after the payment of theunderwriters’ commission and deduction of offering expenses.

In August 2000,the Company used a portion of the net proceeds from the initial public offeringto repay the outstanding balances of notes payable and accrued interest duerelated parties of approximately $12.6 million. The remainder of the proceedshas been used to fund the Company’s working capital requirements.

**Basis of Presentation**

The accompanying financialstatements present the consolidated financial position, results of operations,and cash flows of Avistar and its two wholly-owned operating subsidiaries,Avistar Systems U.K. Limited (“ASUK”) and CPI after elimination of allintercompany accounts and transactions. The consolidated results are referredto, collectively, as those of Avistar or the Company in these notes.

The functional currency of ASUK is the United Statesdollar. Accordingly, all gains and losses resulting from transactionsdenominated in currencies other than the United States dollar are included inthe statements of operations.

TheCompany’s fiscal year end is December 31.

**Reclassifications**

Certain prior year amountshave been reclassified to conform with the current year’s presentation.

**Risks and Uncertainties**

The markets for the Company’s products and servicesare in the early stages of development. Some of the Company’s products utilizechanging 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 ofthe Company’s products, over time, is critical to the Company’s success. TheCompany’s prospects must be evaluated in light of difficulties encountered byit and its competitors in further developing this evolving marketplace. TheCompany has generated losses since inception and had an accumulated deficit of$94.6 million as of December 31, 2005. The Company’s operating results mayfluctuate significantly in the future as a result of a variety of factors,including, but not limited to, the economic environment, the adoption ofdifferent distribution channels, and the timing of new product announcements bythe Company or its competitors.

The Company’s futureliquidity and capital requirements will depend upon numerous factors,including, but not limited to, the costs and timing of its expansion of productdevelopment efforts and the success of these development efforts, the costs andtiming of its expansion of sales and marketing activities, the extent to whichits existing and new products gain market acceptance, competing technologicaland 

F-9

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marketdevelopments, the costs involved in maintaining, enforcing and defending patentclaims and other intellectual property rights, the level and timing of revenue,and other factors.

**2.**   Correction of anError

In September 2005, the Company received a commentletter from the U. S. Securities and Exchange Commission (“SEC”) relating tothe Company’s 2004 Form 10-K, which included a question regardingthe Company’s accounting for the November 2004 settlement and patentcross-license agreement with Polycom, Inc. (“Polycom”). The settlement andpatent cross-license agreement resulted in a $27.5 million one-time payment byPolycom to Avistar and a payment by Avistar to its own litigation counsel of$6.4 million in contingent legal fees. The Company’s Form 10-K forthe fiscal year ended December 31, 2004 and Form 10-Q for thethree, six and nine months ended March 31, 2005, June 30, 2005 and September 30,2005, respectively, reported the one time payment by Polycom as revenue,recognized ratably over a five-year period, net of contingent legal fees. As aresult of the SEC’s inquiry as to whether the Polycom transaction should becharacterized as revenue, and after discussions with the SEC, the Companyconcluded that a reclassification of license revenues from revenue to acomponent of operating expenses and reflected as “Income from settlement andpatent licensing” was necessary for previously filed financial reports. The restatementof the net proceeds and expenses from the Polycom settlement and patentcross-license agreement had no effect on reported net loss, loss per share,stockholders’ equity (deficit) or net cash flows from operating, investing orfinancing activities, but did have the effect of overstating revenues and operatingexpenses for previously issued interim and annual consolidated financialstatements, as of and for the quarters and year-to-date periods ended December 31,2004, March 31, 2005, June 30, 2005 and September 30, 2005. Inaddition, the balance sheet as of December 31, 2004 has been restated toreflect the gross effect of the $27.5 million payment by Polycom to Avistar,and the payment of $6.4 million of contingent legal fees by Avistar, which waspreviously reported on a net basis as deferred revenue. Notes 3, 12 and 14regarding significant concentrations,revenue recognition, segment reporting and the unaudited interim results have been restated to reclassify the Polycomproceeds from revenue to “Income from settlement and patent licensing,” to beconsistent with the presentation of the net proceeds from the Polycomsettlement and patent cross-license agreement in the 2005 Statement ofOperations. The presentation within operations is supported by a determinationthat the Polycom licensing transaction is central to the activities thatconstitute the Company’s ongoing major or central operations, but that thesettlement may also contain a gain element related to the settlement, which isnot considered revenue under the Financial Accounting Standards Board (“FASB”)Concepts Statement No. 6, *Elements of FinancialStatements.* The Company did not have sufficient historical evidenceto support a reasonable determination of value for purposes of segregating thetransaction into revenue related to the patent licensing and an operating ornon-operating gain upon settlement of litigation, resulting in thedetermination that the entire transaction is more appropriately classified as “Incomefrom settlement and patent licensing” within operations, as opposed to revenue.

F-10

----

Thefollowing table presents the impact of the adjustment to the consolidated balancesheet as of December 31, 2004 and the consolidated statement of operationsand cash flows for the fiscal year ended December 31, 2004 (in thousands):

| ** **                                                      | ** ** | **December 31, 2004** | ** ** |
|-----------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                      | ** ** | **As  Previously  Reported**    | ** ** | **Adjustment** | ** ** | **As  Restated** | ** ** |
| **Balance Sheet**                                          |       |                            |       |   |   |   |   |   |   |   |   |
| Current assets:                                                 |       |                            |       |   |   |   |   |   |   |   |   |
| Deferred settlement and patent  licensing costs                 |       |                            | $          | — |   |   |   | $ | 1,256 |   |   | $ | 1,256 |   |
| Total current assets                                            |       |                            | 23,733     |   |   |   | 1,256 |   |   | 24,989 |   |
| Long-term assets:                                               |       |                            |       |   |   |   |   |   |   |   |   |
| Long-term deferred settlement  and patent licensing costs       |       |                            | —     |   |   |   | 4,941 |   |   | 4,941 |   |
| Total assets                                                    |       |                            | 24,211     |   |   |   | 6,197 |   |   | 30,408 |   |
| Current liabilities:                                            |       |                            |       |   |   |   |   |   |   |   |   |
| Deferred license revenue                                        |       |                            | 4,226      |   |   |   | (4,226 | ) |   | — |   |
| Deferred income from  settlement and patent licensing           |       |                            | —     |   |   |   | 5,482 |   |   | 5,482 |   |
| Total current liabilities                                       |       |                            | 7,366      |   |   |   | 1,256 |   |   | 8,622 |   |
| Long-term liabilities:                                          |       |                            |       |   |   |   |   |   |   |   |   |
| Long-term deferred license  revenue                             |       |                            | 16,331     |   |   |   | (16,331 | ) |   | — |   |
| Long-term deferred income from  settlement and patent licensing |       |                            | —     |   |   |   | 21,272 |   |   | 21,272 |   |
| Total liabilities                                               |       |                            | 23,697     |   |   |   | 6,197 |   |   | 29,894 |   |
| Total liabilities and  stockholders’ equity                |       |                            | $          | 24,211 |   |   |   | $ | 6,197 |   |   | $ | 30,408 |   |

 

| ** **                                   | ** ** | **Year Ended December 31, 2004** | ** ** |
|----------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                   | ** ** | **As  Previously  Reported**               | ** ** | **Adjustment** | ** ** | **As  Restated** | ** ** |
| **Statement of Operations**                  |       |                                       |       |   |   |   |   |   |   |   |   |
| Revenues:                                    |       |                                       |       |   |   |   |   |   |   |   |   |
| Licensing revenue                            |       |                                       | $          | 575 |   |   |   | $ | (575 | ) |   | $ | — |   |
| Total revenues                               |       |                                       | 6,896      |   |   |   | (575 | ) |   | 6,321 |   |
| Costs and expenses:                          |       |                                       |       |   |   |   |   |   |   |   |   |
| Income from settlement and  patent licensing |       |                                       | $          | — |   |   |   | $ | (575 | ) |   | $ | (575 | ) |

 

| ** **                                           | ** ** | **Year Ended December 31, 2004** | ** ** |
|------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                           | ** ** | **As  Previously  Reported**               | ** ** | **Adjustment** | ** ** | **As  Restated** | ** ** |
| **Statement of Cash Flows**                          |       |                                       |       |   |   |   |   |   |   |   |   |
| Cash flows from Operating Activities:                |       |                                       |       |   |   |   |   |   |   |   |   |
| Deferred settlement and patent  licensing costs      |       |                                       | $          | — |   |   |   | $ | (6,197 | ) |   | $ | (6,197 | ) |
| Deferred license revenue                             |       |                                       | 20,557     |   |   |   | (20,557 | ) |   | — |   |
| Deferred income from settlement and patent licensing |       |                                       | $          | — |   |   |   | $ | 26,754 |   |   | $ | 26,754 |   |

 

The above adjustments correct anerror within the meaning of the Accounting Principles Board Opinion No. 20,*Accounting Changes.*

**3.**   Summary ofSignificant Accounting Policies and Balance Sheet Details

**Use of Estimates**

The preparation of financial statements in conformitywith generally accepted accounting principles requires management to makeestimates and assumptions that affect the reported amounts of assets and 

F-11

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liabilities and disclosure ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of revenues, income and expenses during the period. Actualresults could differ from those estimates.

**Cash and Cash Equivalents and Short and Long-term Investments**

The Company considers allinvestment instruments purchased with an original maturity of three monthsor less to be cash equivalents. Investment securities with original orremaining maturities of more than three months but less than one year areconsidered short-term investments. Auction rate securities with original orremaining maturities of more than three months are considered short-terminvestments even if they are subject to repricing within three months. Investmentsecurities with original or remaining maturities of one year or more areconsidered long-term investments. TheCompany’s cash equivalents at December 31, 2005 consisted of money marketfunds and short- term commercial paper with original maturities of three monthsor less and are therefore classified as cash and cash equivalents in theaccompanying balance sheet. The Company’s cash equivalents at December 31,2004 consisted of money market funds and short-term commercial paper.

The Company accounts forits short-term and long-term investments in accordance with Statement ofFinancial Accounting Standards (SFAS) No. 115, *Accounting for Certain Investments in Debt and Equity Securities*.The Company’sshort and long-term investments in securities are classified asavailable-for-sale and are reported at fair value, with unrealized gains andlosses, net of tax, recorded in other comprehensive income (loss). Realizedgains or losses and declines in value judged to be other than temporary, ifany, on available- for-sale securities are reported in other income, net. TheCompany reviews the securities for impairments considering current factorsincluding the economic environment, market conditions and the operationalperformance and other specific factors relating to the business underlying thesecurities. The Company records impairment charges equal to the amount that thecarrying value of its available-for-sale securities exceeds the estimated fairmarket value of the securities as of the evaluation date. The fair value forpublicly held securities is determined based on quoted market prices as of theevaluation date. In computing realized gains and losses on available-for-salesecurities, the Company determines cost based on amounts paid, including directcosts such as commissions, to acquire the security using the specificidentification method. The Company had net unrealized losses on its short andlong-term investment securities of $12,000 in 2005.

Cash,cash equivalents, short and long-term investments consisted of the following atDecember 31, 2005 and 2004 (in thousands):

| ** **                                                                   | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                   | ** ** | **2005**              | ** ** | **2004** | ** ** |
| ***Description***                                                            |       |                  |       |   |   |
| Cash and cash equivalents:                                                   |       |                  |       |   |   |
| Cash                                                                         |       | $                     | 549        |   | $ | 834 |   |
| Commercial paper cash  equivalents                                           |       | 7,667                 |       | 10,962 |   |
| Other cash equivalents                                                       |       | —                |       | 9,860 |   |
| Total cash and cash  equivalents                                             |       | 8,216                 |       | 21,656 |   |
| Short-term investments:                                                      |       |                  |       |   |   |
| Short-term investments  (average 60 remaining days to maturity in 2005) |       | 2,995                 |       | — |   |
| Total cash and cash  equivalents and short term-investments                  |       | 11,211                |       | 21,656 |   |
| Long-term-investments (average 390 days to maturity in 2005)                 |       | 958                   |       | — |   |
| Total cash, cash equivalents and short-term and long-term investments        |       | $                     | 12,169     |   | $ | 21,656 |   |

 

F-12

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**SignificantConcentrations**

Arelatively small number of customers have accounted for a significantpercentage of the Company’s net sales. Sales to major customers as a percentageof sales for each fiscal year are as follows:

| ** **  | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------|------------|----------|------------|----------|------------|----------|------------|
| Customer A  |       |     | 45         | %        |       |     | 16         | % |   |   | * | % |   |
| Customer  B |       |     | 39         | %        |       |     | 55         | % |   |   | 62 | % |   |

----

*                    Lessthan 10%

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

Financial instruments thatpotentially subject the Company to concentrations of credit risk consistprimarily of temporary cash investments and trade receivables. The Company hascash and investment policies that limit the amount of credit exposure to anyone financial institution or restrict placement of these investments tofinancial institutions evaluated as highly credit worthy. As of December 31,2005, the Company had cash and cash equivalents on deposit with a majorfinancial institution that were in excess of FDIC insured limits. Historically,the Company has not experienced any loss of its cash and cash equivalents dueto such concentration of credit risk. Concentrations of credit risk withrespect to trade receivables relate to those trade receivables from both UnitedStates and foreign entities, primarily in the financial services industry. Asof December 31, 2005, three customers represented 48%, 32% and 17% of ouraccounts receivable balance. As of December 31, 2004, approximately 81% ofaccounts receivable were concentrated with one customer.

**Allowance for Doubtful Accounts**

The Company uses estimatesin determining the allowance for doubtful accounts based on historicalcollection experience, historical write-offs, current trends and the creditquality of the Company’s customer base, and the characteristics of accountsreceivable by aging category. If the allowance for doubtful accounts wasunderstated, operating income could be significantly reduced. The impact of anysuch change or deviation may be increased by the Company’s reliance on arelatively small number of customers for a large portion of total revenue.

**Fair Value ofFinancial Instruments**

Thecarrying amounts of the Company’s financial assets and liabilities, includingcash and cash equivalents, short-term investments, accounts receivable andaccounts payable at December 31, 2005 and 2004, approximate fair valuebecause of the short maturity of these instruments.

**Inventories**

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

| ** **                                             | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------|------------|-----------------------|------------|
| ** **                                             | ** ** | **2005**              | ** ** | **2004** | ** ** |
| Raw materials and sub-assemblies                       |       | $                     | 43         |   | $ | 35 |   |
| Finished goods                                         |       | 604                   |       | 668 |   |
| Inventory shipped to customer sites, not yet installed |       | 28                    |       | 34 |   |
|                                                   |       | $                     | 675        |   | $ | 737 |   |

 

F-13

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Inventory shipped tocustomer sites, not yet installed, represents product shipped to customer sitespending completion of the installation process by the Company. As of December 31,2005 and December 31, 2004, the Company had billed approximately $28,000and $25,000, respectively, to customers related to these shipments, but did notrecord the revenue, as the installations had not been completed and confirmedby the customer. Although customers are billed in accordance with customeragreements, these deferred revenue amounts are netted against accountsreceivable until the customer confirms installation.

**Property and Equipment**

Property and equipment are stated at cost and aredepreciated using the double declining balance method over the estimated usefullives (three or five years) of the assets. Repairs and maintenance are expensedas incurred. Property and equipment consisted of the following (in thousands):

| ** **                        | ** ** | **December 31,** | ** ** |
|-----------------------------------|------------|-----------------------|------------|
| ** **                        | ** ** | **2005**              | ** ** | **2004** | ** ** |
| Computer equipment                |       | $                     | 876        |   | $ | 716 |   |
| Computer software                 |       | 364                   |       | 216 |   |
| Furniture, fixtures and equipment |       | 346                   |       | 258 |   |
|                              |       | 1,586                 |       | 1,190 |   |
| Less: Accumulated depreciation    |       | (1,275                | )          | (998 | ) |
|                              |       | $                     | 311        |   | $ | 192 |   |

 

**Accrued Liabilities and Other**

Accruedliabilities and other consisted of the following (in thousands):

| ** **                               | ** ** | **December 31,** | ** ** |
|------------------------------------------|------------|-----------------------|------------|
| ** **                               | ** ** | **2005**              | ** ** | **2004** | ** ** |
| Accrued consulting and professional fees |       | $                     | 570        |   | $ | 168 |   |
| Accrued payroll and related benefits     |       | 522                   |       | 368 |   |
| Accrued income taxes                     |       | —                |       | 301 |   |
| Accrued commissions and bonuses          |       | 116                   |       | 42 |   |
| Other                                    |       | 283                   |       | 408 |   |
|                                     |       | $                     | 1,491      |   | $ | 1,287 |   |

 

**Patent Costs**

Dueto uncertainties about the estimated future economic benefits and lives of theCompany’s patents and patent applications, all related outside patent costshave been expensed as incurred. Outside patent costs were approximately $0.4million, $0.1 million and $0.1 million for 2005, 2004 and 2003, respectively,and are reflected in general and administrative expenses in the accompanyingstatements of operations.

F-14

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**Revenue Recognition and Deferred Revenue**

The Company recognizes productand 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 Respectto Certain Transactions (SOP 98-9). The Company derives product revenuefrom the sale and licensing of a set of desktop (endpoint) products (hardwareand software) and infrastructure products (hardware and software) that combineto form an Avistar video-enabled collaboration solution. Services revenueincludes revenue from installation services, post-contract customer support,training and software development. The installation services that the Companyoffers to customers relate to the physical set-up and configuration of desktopand infrastructure components of the Company’s solution. The fair value of allproduct, installation services, post-contract customer support and trainingoffered to customers is determined based on the price charged when suchproducts or services are sold separately.

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

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

·       *Delivery has occurred*. The Companydelivers software and hardware to customers physically. The standard deliveryterms are FOB shipping point.

·       *The fee is fixed or determinable*. TheCompany’s determination that an arrangement fee is fixed or determinabledepends principally on the arrangement’s payment terms. The Company’s standardpayment terms generally require the arrangement fee to be paid within 30 daysof the date of invoice. Where these terms apply, the Company regards the fee asfixed or determinable, and recognizes revenue upon delivery (assuming otherrevenue recognition criteria are met). If the payment terms do not meet thisstandard, referred to as “extended payment terms,” the fee may not beconsidered to be fixed or determinable and the revenue would then be recognizedwhen customer installments are due and payable.

·       *Collectibility is probable*. To recognizerevenue, the Company judges collectibility of the arrangement fees on acustomer-by-customer basis pursuant to a credit review policy. The Companytypically sells to customers with a history of successful collection. For newcustomers, the Company evaluates the customer’s financial position and abilityto pay. If the Company determines that collectibility is not probable basedupon the credit review process or the customer’s payment history, revenue isrecognized when cash is collected.

If there are any undeliveredelements, the Company defers revenue for those elements, as long as VendorSpecific Objective Evidence (VSOE) exists for the undelivered elements.Additionally, per paragraph 14 of SOP 97-2, when the Company providesinstallation services, the product and installation revenue is recognized uponcompletion of the installation process and receipt of customer confirmation,subject to the satisfaction of the revenue recognition criteria describedabove, as the Company believes that the fee associated with the deliveredproduct elements does not meet the definition of collectibility if theinstallation services have not been completed. Customer confirmation isobtained and documented by means of a standard form indicating the installationservices have been provided and the hardware and 

F-15

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softwarecomponents installed. When the customer or a third party provides installationservices, the product revenue is recognized upon shipment, subject tosatisfaction of the revenue recognition criteria described above.

Payment for product is due uponshipment, subject to specific payment terms. Payment for installation andprofessional services are due upon providing the services, subject to specificpayment terms. Reimbursements received for out-of-pocket expenses incurredduring installation and support services, which have not been significant todate, are recognized as revenue in accordance with Emerging Issues Task Force(EITF) Issue No. 01-14 (EITF 01-14), “Income StatementCharacterization of Reimbursements Received for “Out of Pocket” ExpensesIncurred.”

The price charged formaintenance and/or support is defined in the contract, and is based on a fixedprice for both hardware and software components as stipulated in the customeragreement. Customers have the option to renew the maintenance and/or supportarrangement in subsequent periods at the same rate as paid in the initial year.Revenue from maintenance and support services is deferred and recognizedpro-rata over the maintenance and/or support term, which is typically one yearin length. Payments for services made in advance of the provision of servicesare recorded as deferred revenue and customer deposits in the accompanyingbalance sheets. Training services are offered independently of the purchase ofproduct. The value of these training services is determined based on the pricecharged when such services are sold separately, and training revenue isrecognized upon performance of the service.

The Company recognizes servicerevenue from software development contracts in accordance with SOP 81-1, “Accountingfor Performance of Construction-Type and Certain Production-Type Contracts.”Revenue related to contracts for software development is recognized using thepercentage of completion method, when all of the following conditions are met:a contract exists with the customer at a fixed price, the Company has fulfilledall of its material contractual obligations to the customer for eachdeliverable of the contract, verification of completion of the deliverable hasbeen received, and collection of the receivable is probable. The amounts billedto customers in excess of revenues recognized to date are deferred and recordedas deferred revenue and customer deposits in the accompanying balance sheets.Assumptions used for recording revenue and earnings are adjusted in the periodof change to reflect revisions in contract value and estimated costs tocomplete the contract. Any anticipated losses on contracts in progress arecharged to earnings when identified.

TheCompany recognizes revenue from the licensing of its intellectual propertyportfolio based on the terms of the royalty, partnership and cross-licensingagreements involved.

**Income from Settlement and Patent Licensing**

The Company recognizes theproceeds from settlement and patent licensing agreements based on the termsinvolved. When litigation has been filed prior to a settlement and patentlicensing agreement, and insufficient historical evidence exists of fair valueof the patents licensed to support the segregation of the proceeds between again on litigation settlement and patent license revenues, the Company reportsall proceeds in income from settlement and patent licensing within operatingcosts and expenses. When litigation has been filed prior to a settlement andpatent licensing agreement, and sufficient historical evidence exists of fairvalue of the patents licensed to support the segregation of the proceedsbetween a gain on litigation settlement and patent license revenues, theCompany reports as license revenue, consistent with Financial AccountingStandards Board (“FASB”) Concepts Statement No. 6, *Elements ofFinancial Statements*. The gain portion of the proceeds, whensufficient historical evidence exists to segregate the proceeds, is reported inother income according to SFAS No. 5, *Accounting forContingencies*.

F-16

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**Warranty**

TheCompany accrues the estimated costs of fulfilling the warranty provisions ofits contracts over the warranty period, which is typically 90 days. Thewarranty accrual was approximately $1,000 as of December 31, 2005 and$14,000 as of December 31, 2004, and was included in accrued liabilitiesin the accompanying balance sheets.

**Stock-Based Compensation**

The Company applies the intrinsic-value-basedmethod of accounting prescribed by Accounting Principles Board (APB) Opinion No. 25,Accounting for Stock Issued to Employees, and related interpretations includingFASB Interpretation No. 44, Accounting for Certain Transactions involvingStock Compensation, an interpretation of APB Opinion No. 25, to account forits fixed-plan stock options. Under this method, compensation expense isrecorded on the date of grant only if the current market price of theunderlying stock exceeded the exercise price. SFAS No. 123, Accounting forStock-Based Compensation as amended by SFAS No. 148, Accounting forStock-Based Compensation Transition and Disclosure, established accounting and disclosurerequirements using a fair-value-based method of accounting forstock-based employee compensation plans. As allowed by SFAS No. 123,the Company has elected to continue to apply the intrinsic-value-basedmethod of accounting described above, and has adopted only the disclosurerequirements of SFAS No. 123 (see Note 8). The following table illustratesthe effect on net loss if the fair-value-based method had beenapplied to all outstanding and unvested awards in each period.

| ** **                                                                                                                   | ** ** | **Year Ended December 31,  (in thousands)** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                                                                                                                   | ** ** | **2005**                                                        | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net loss, as reported                                                                                                        |       | $                                                               | (5,174     | ) | $ | (8,706 | ) | $ | (8,619 | ) |
| Add stock-based employee compensation expense  included in reported net loss, net of tax                           |       | —                                                          |       | — |   | 135 |   |
| Deduct total stock-based employee compensation expense determined  under fair-value-based method for all  awards, net of tax |       | (1,886                                                          | )          | (2,206 | ) | (4,135 | ) |
| Pro forma net loss                                                                                                           |       | $                                                               | (7,060     | ) | $ | (10,912 | ) | $ | (12,619 | ) |
| Basic and diluted net loss per  share                                                                                        |       |                                                            |       |   |   |   |   |
| As reported                                                                                                                  |       | $                                                               | (0.15      | ) | $ | (0.27 | ) | $ | (0.33 | ) |
| Pro forma                                                                                                                    |       | $                                                               | (0.21      | ) | $ | (0.33 | ) | $ | (0.48 | ) |

 

F-17

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TheCompany has adopted SFAS 123 for disclosure purposes. The weighted average fairvalue of options granted during 2005, 2004, and 2003, estimated on the date ofgrant using the Black-Scholes-Merton option pricing model was $2.40, $1.10 and$0.82, respectively. The Black-Scholes-Merton option-pricing model wasdeveloped for use in estimating the fair value of traded options that havevesting restrictions and are fully transferable. In addition, option-pricingmodels require the input of highly subjective assumptions, including a factorto represent expected stock price volatility. Because the Company’s employeestock options have characteristics significantly different from those of tradedoptions, and because changes in the subjective input assumptions can materiallyaffect the fair value estimate, in management’s opinion, the existing models donot necessarily provide a reliable single measure of the fair value of theCompany’s options. The fair value of 2005, 2004, and 2003 options granted isestimated on the date of grant using the following assumptions:

| ** **                      | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------|------------|--------------------------------------------|------------|
| ** **                      | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Employee Stock Option Plan**  | ** ** | ** **                                 | ** ** |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Expected dividend               |       | 0                                          | %          |   | 0 | % |   |   | 0 | % |   |
| Average risk-free interest rate |       | 4.38                                       | %          |   | 3.5 | % |   |   | 2.9 | % |   |
| Expected volatility             |       | 152                                        | %          |   | 230 | % |   |   | 156 | % |   |
| Expected  term (years)          |       | 4                                          |       |   | 4 |   |   |   | 4 |   |   |

 

| ** **                        | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------|------------|--------------------------------------------|------------|
| ** **                        | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Employee  Stock Purchase Plan** | ** ** |                                       | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Expected dividend                 |       |                                       | 0          | % |   |   | 0 | % |   |   | 0 | % |   |
| Average risk-free interest rate   |       |                                       | 3.3        | % |   |   | 3.3 | % |   |   | 3.2 | % |   |
| Expected volatility               |       |                                       | 96         | % |   |   | 479 | % |   |   | 109 | % |   |
| Expected  term (months)           |       |                                       | 6          |   |   |   | 6 |   |   |   | 6 |   |   |

 

**Recent Accounting Pronouncements**

In March 2004, the Emerging Issues Task Force(EITF) reached a consensus on Issue No. 03-01, “The Meaning ofOther-Than-Temporary Impairment and Its Application to Certain Investments.”EITF No. 03-01 provides guidance on other-than-temporary impairmentmodels for marketable debt and equity securities accounted for under SFAS No. 115,“Accounting for Certain Investments in Debt and Equity Securities,” and SFAS No. 124,“Accounting for Certain Investments Held by Not-for-Profit Organizations,” andnon-marketable equity securities accounted for under the cost method. The EITFdeveloped a basic three-step model to evaluate whether an investment isother-than-temporarily impaired. In September 2004, the FinancialAccounting Standards Board (FASB) issued EITF No. 03-01-1which delayed the effective date of the recognition and measurement provisionsof EITF No. 03-01; however the disclosure requirements remaineffective for annual financial statements for fiscal years ending after December 15,2004. Avistar will evaluate the effect, if any, of the adoption of EITF No. 03-01when final guidance is released.

In December 2004, the FASB issued FASB Statement No. 123(revised 2004), “Share-Based Payment” (SFAS No. 123R), which replaced FASBStatement No. 123, “Accounting for Stock-Based Compensation,” (SFAS No. 123)and superseded Accounting Principles Board Opinion No. 25, “Accounting forStock Issued to Employees” (APB No. 25). SFAS No. 123R eliminates thealternative use of the intrinsic value method permitted under APB No. 25and requires all share-based payments to employees, including grants ofemployee stock options, to be recognized in the financial statements based ontheir grant date fair values. Under SFAS No. 123R, the pro formadisclosures previously permitted no longer will be an alternative to financialstatement recognition. SFAS No. 123R was originally effective for allinterim or annual periods beginning after June 15, 2005, with earlyadoption encouraged. In April 2005, 

F-18

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the SEC postponed theeffective date of SFAS No. 123R until the issuer’s first fiscal yearbeginning after June 15, 2005.

The Company will adopt SFAS No. 123R in the firstquarter of 2006 using the modified prospective method. SFAS No.123R requirescompanies that chose under SFAS No. 123 to recognize actual forfeitureswhen they occurred rather than estimate them at the grant date to make aone-time cumulative effect adjustment at the adoption date for estimatedforfeitures, regardless of the transition method. Avistar is currently analyzingthe estimated forfeiture adjustment amount for outstanding awards at adoption.The Company will apply the Black-Scholes-Merton model to estimate the fairvalue of share-based payments to employees, which will then be amortized on aratable basis over the requisite service period.

In March 2005, the SEC issued Staff AccountingBulletin No. 107 (SAB No. 107) regarding the SEC’s interpretations ofSFAS No. 123R and the valuation of share-based payments for publiccompanies. The Company is evaluating the requirements of SFAS No. 123R andSAB No. 107 and expects that the adoption of SFAS No. 123R on January 1,2006 will have a material impact on the Company’s consolidated results ofoperations and earnings per share beginning in the first quarter of 2006. TheCompany’s assessment of the estimated compensation charges is affected by theCompany’s stock price as well as assumptions regarding a number of complex andsubjective variables and the related tax impact resulting in uncertainty as towhether future stock-based compensation expense will be similar to thehistorical SFAS No. 123 pro forma expense. These variables include,but are not limited to, the volatility of our stock price and employee stockoption exercise behaviors.

In May 2005, the FASB issued SFAS No. 154, “AccountingChanges and Error Corrections—Replacement of APB Opinion No. 20 and FASBSFAS No. 3.” SFAS No. 154 requires retrospective application to priorperiod financial statements of changes in accounting principles, unless it isimpracticable to determine either the period-specific effects, or thecumulative effect of the change. SFAS No. 154 also redefines “restatement”as the revising of previously issued financial statements to reflect thecorrection of an error. This statment is effective for accounting changes andcorrection of errors made in fiscal years beginning after December 15,2005. It was determined during a review of Avistar’s Form 10-K forfiscal year 2004 by the SEC that an error was made in the classification ofrevenues. The corrections were made to this Form 10-K for the fiscalyear ending December 31, 2005 under APB 20 and SFAS No. 3. See Note 2“Correction of an Error.” The Company does not expect the adoption of SFAS No. 154to have a material effect on the Company’s consolidated financial position orresults of operations

In November 2005, the FASB issued FASB StaffPosition (FSP) No. 123R-3 “Transition Election Related to Accountingfor the Tax Effects of Share-Based Payment Awards” (FSP No. 123(R)-3).FSP 123(R)-3 provides an alternative transition method of accountingfor the tax effects of adopting SFAS No. 123(R). This FSP grants oneyear from the later of the date of the FSP or the adoption of SFAS No. 123Rby the Company for determination of the one-time election for purposes oftransition. The Company is evaluating the alternative methods.

In November 2005, theFASB issued FSP FAS 115-1 and FAS 124-1, “The Meaning ofOther-Than-Temporary Impairment and Its Application to Certain Investments” (“FSP115-1”), which provides guidance on determining when investments incertain debt and equity securities are considered impaired, whether thatimpairment is other-than-temporary, and on measuring such impairment loss. FSP115-1 also includes accounting considerations subsequent to therecognition of other-than temporary impairment and requires certain disclosuresabout unrealized losses that have not been recognized as other-than-temporaryimpairments. FSP 115-1 is required to be applied to fiscal yearsbeginning after December 15, 2005 and is required to be adopted by theCompany in the first quarter of 2006. The Company is currently evaluating theeffect that the adoption of FSP 115-1 will have on its consolidatedresults of operations and financial condition but does not expect it to have amaterial impact.

F-19

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**Other Comprehensive Income**

SFAS No. 130 (“SFAS 130”), “ReportingComprehensive Income,” establishes standards for the reporting and the displayof comprehensive income (loss) and its components. This standard defines comprehensiveincome as the changes in equity of an enterprise, except those resulting fromstockholder transactions. Accordingly, comprehensive income includes certainchanges in equity that are excluded from the net income or loss. Thecomprehensive loss was $5.2 million, $8.7 million and $8.6 million for theyears ended 2005, 2004 and 2003, respectively.

The components of comprehensive loss are as follows:

| ** **                                                      | ** ** | **Year Ending December 31,** | ** ** |
|-----------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                      | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net loss                                                        |       | $                                           | (5,174     | ) | $ | (8,706 | ) | $ | (8,619 | ) |
| Other comprehensive income (loss):                              |       |                                        |       |   |   |   |   |
| Change in net unrealized gains  and losses on  investments |       | (12                                         | )          | — |   | (2 | ) |
| Total  comprehensive loss                                       |       | $                                           | (5,186     | ) | $ | (8,706 | ) | $ | (8,621 | ) |

 

**4.**   Line of Credit

On February 27,2002, the Company entered into a Loan and Security Agreement with a financialinstitution to borrow up to $4.5 million under a revolving line of credit. On December 15,2002, the Company entered into an amendment to the Loan and Security Agreementto increase the maximum funds available under the line of credit to $6.0million and extend the term of the agreement. The amended Loan and SecurityAgreement, as further amended in March 2003, had an expiration date of February 27,2004. The agreement, as amended, included a first priority security interest inall the Company’s assets, excluding intellectual property. Gerald Burnett, theCompany’s Chairman and Chief Executive Officer, provided a collateralizedguarantee to the financial institution, assuring payment of the Company’sobligations under the agreement and as a consequence, a number of restrictivecovenants from the original Loan and Security Agreement had been deleted,except for quick ratio and loan to value covenants, allowing the Companygreater access to the full amount of the facility. On February 27, 2004,the Loan and Security Agreement was amended to change the maximum borrowings to$3.5 million, subject to certain quick ratio and loan to value covenants, andto extend the term of the Loan and Security Agreement to February 27,2005. In connection with this amendment, Dr. Burnett’s collateralizedguarantee was amended to reduce the amount of such guarantee to $3.5 million.In addition to the guarantee provided to the financial institution, Dr. Burnetthas also provided a personal guarantee to Avistar assuring the provision of upto $2.0 million to Avistar in the event that at least $2.0 million is notavailable to the Company under the line of credit, or an alternate financingarrangement, for any reason. There were no outstanding borrowings under theline of credit as of December 31, 2004. The Loan and Security Agreement,and Dr. Burnetts’ guarantee expired by their terms on February 27,2005.

**5.**   Commitments

At December 31, 2005, the Company had openpurchase orders and other contractual obligations of approximately $416,000,primarily related to inventory purchases. These purchase order commitments andcontractual obligations will be reflected in the Company’s financial statementsonce goods or services have been received, or payments related to theobligations become due.

F-20

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The Company leases its facilities under operating leasesthat expire through March 2007. As of December 31, 2005, the futureminimum lease commitments under all leases were as follows (in thousands):

| **Year Ending December 31,** | ** ** | ** ** | ** ** | **Amount** | ** ** |
|---------------------------------------------|------------|------------|------------|------------|------------|
| 2006                                        |       |       | $          | 465        |       |   |
| 2007                                        |       |       | 88         |       |       |
| Total  minimum lease payments               |       |       | $          | 553        |       |   |

 

Rentexpense under all operating leases for 2005, 2004 and 2003 was approximately$0.7 million, $0.6 million and $1.2 million, respectively.

**6.**   Related Party Transactions

Certaindirectors with controlling interests in the Company are also the majorityowners of one entity that conducted business with the Company, Vicor Inc. (“Vicor”).Descriptions of certain transactions between the Company and this relatedentity follow.

**Revenue from a Related Party**

UBS Warburg LLC, which is anaffiliate of UBS AG, is a stockholder of the Company and is also a customer ofthe Company. As of December 31, 2005 and 2004, UBS Warburg LLC held lessthan 5% of the Company’s stock. Revenue from UBS Warburg LLC and its affiliatesrepresented 45% and 16% of total revenue for 2005 and 2004, respectively andless than 10% for 2003. Management believes the transactions with UBS WarburgLLC and its affiliates are at terms comparable to those provided to unrelatedthird parties. As of December 31, 2005 and 2004, the Company had accountsreceivable outstanding from UBS Warburg LLC and its affiliates of approximately$749,000 and $61,000, respectively.

Revenuefrom Vicor represented less than 10% of total revenue for 2005 and 2004. TheCompany did not recognize revenue from, or contracted for sales made to Vicor,during 2003. Management believes the transactions with Vicor are at termscomparable to those provided to unrelated third parties. As of December 31,2005 and 2004, the Company did not have any accounts receivable outstandingfrom Vicor.

**Fees to Related Parties**

Robert P. Latta, a member of the law firm WilsonSonsini Goodrich & Rosati, a Professional Corporation (“WSGR”), hasserved as a director of the Company since February 2001. Mr. Lattaand WSGR have represented the Company and its predecessors as corporate counselsince 1997. During 2005, 2004 and 2003, payments of $119,000, $114,000 and$303,000, respectively, were made to WSGR for legal services provided to theCompany.

During2003, payments totaling $110,000 were madeto R. Stephen Heinrichs, a former officer of the Company, who is also a memberof the Board of Directors, pursuant to a Separation Agreement between Mr. Heinrichsand the Company dated April 26, 2001. No payments other than director feeswere made to Mr. Heinrichs during 2005 and 2004.

**Private Placement of Common Stock**

On October 15, 2003,the Company completed the private sale of 4,615,385 shares of common stock to Dr. Burnettand other members of his family at a price per share of $1.30. The net proceedsof this private financing, after deducting expenses of the financing, wereapproximately $5.7 million. Under the terms of the private placement, Dr. Burnettagreed to certain restrictions on 1,602,847 of the 3,661,539 shares 

F-21

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purchasedby him. These restrictions require Dr. Burnett to vote such shares in thesame proportion as outstanding common stock not beneficially owned by Dr. Burnett.

**7.**   Stockholders’ Equity

**Private Placement of Common Stock**

On March 26, 2004,the Company completed the private sale of a total of 3,000,000 shares of commonstock to Fuller & Thaler Avalanche Fund, L.P. and Fuller &Thaler Behavioral Finance Fund, Ltd. at a price per share of $1.20. The netproceeds of this private financing after deducting expenses of the financingwere approximately $3.6 million. The issuance of these additional sharesreduced the number of Dr. Burnett’s shares subject to voting restrictionsimposed in connection with his October 15, 2003 purchase of common stockfrom 1,602,847 to 141,152 shares. Due to subsequent increases in the totalnumber of outstanding shares, the number of shares owned by Dr. Burnettwith voting restrictions dropped to zero by December 31, 2005. Also as aresult of this private equity financing, the personal guarantee of Dr. Burnettto provide the Company with up to $2.0 million in the event that at least $2.0million is not available to the Company under the Loan and Security Agreementwas terminated by its terms.

**Stock Repurchase Plan**

On March 22,2001, the Company announced that its Board of Directors authorized therepurchase of up to $2.0 million of its common stock in the open market. During2004, the Company repurchased 2,000 shares at an aggregate cost of $2,000.No shares of common stock were repurchased by the Company during 2005 and 2003.

**Preferred Stock**

In April 2000,the stockholders of the Company authorized 10,000,000 shares of convertiblepreferred stock, effective upon completion of its initial public offering in August 2000.As of December 31, 2005, the Company had 10,000,000 shares of convertiblepreferred stock authorized, at $0.001 per share par value. No shares ofconvertible preferred stock were issued or outstanding as of December 31,2005.

**Deferred Stock Compensation**

In connection with thegrant of stock options to purchase shares of common stock to employees during2000, the Company recorded deferred compensation of approximately $1.7 million,representing the difference between the estimated fair value of the commonstock and the aggregate option exercise price of such options at the date ofgrant. This amount was presented as a reduction of stockholders’ equity and wasbeing amortized ratably over the service period of the applicable options(generally four years). The Company did not record any amortization of deferredstock compensation in 2005 or 2004 due to the completion of the pre-IPO optionaward amortization and the forfeitures of stock options by employees no longerwith our company. Amortization expense, net of forfeitures related to deferredstock compensation was approximately $0.1 million in 2003.

**8.**   Stock Option Plans

**1997 Stock Option Plan**

In December 1997, the Board established the 1997Stock Option Plan (the “1997 Plan”) and authorized the issuance of 1,828,602shares of common stock thereunder. In December 1999 and May 2000,respectively, the Board authorized an additional 1,065,625 shares and 100,000shares to be issued under the Plan. In connection with the initial publicoffering in August 2000, the Board terminated the 1997 Plan as to futuregrants effective August 17, 2000. Under the 1997 Plan, incentive stockoptions to purchase shares of common stock were granted only to employees atnot less than 100% of the fair market 

F-22

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value at the grant date asdetermined by the Board. Additionally, nonqualified stock options to purchaseshares of common stock were granted to employees and consultants at not lessthan 85% of the fair market value at the grant date. Options granted generallyhad a life of ten years.

Optionsgranted under the plan vested over a four-year period, with 25% vesting afterone year and the remaining balance vesting 6.25% per quarter. Under the 1997Plan, the Company granted options to purchase approximately 1.2 million commonshares in 2000. In 2005, 2004 and 2003, the Company made no grants under thisplan. At December 31, 2005, options to purchase a total of 810,200 shareswere outstanding under the 1997 Plan, and no options were available for grant.

**2000 Stock Option Plan**

In April 2000, theBoard established the 2000 Stock Option Plan (the “2000 Plan”). Initially, atotal of 3,000,000 shares of common stock were approved by the Board forissuance under the 2000 Plan, together with annual increases in the number ofshares of common stock reserved under the plan beginning on the first day ofthe Company’s fiscal year, commencing January 1, 2001. In January 2001,the Board approved an increase of 1,004,936 shares. In January 2002, theBoard approved an increase of 1,007,858 shares. In January 2003, the Boardapproved an increase of 1,011,957 shares. In January 2004, the Boardapproved an increase of 1,200,000 shares. In January 2005, the Boardapproved and increase of 1,200,000 shares. As of December 31, 2005, atotal of 8,424,751 shares had been reserved for issuance under the 2000 Plan.The term of the options granted under this plan may not exceed 10 years and inthe case of the grantees who own more than 10% of the Company’s outstandingstock at the time of grant, the term of the option may not exceed five years.Options granted under the 2000 Plan vest and become exercisable as set forth ineach option agreement, generally one quarter vest after one year andone-twelfth vest quarterly thereafter. In the event of a merger or sale ofsubstantially all assets, these options must be assumed by the successor and ifnot assumed, will fully vest. The 2000 Plan will terminate in 2010. As a resultof past and future increases, a maximum of 15,000,000 shares of common stockcould be issued under the 2000 Plan. The Company granted options to purchaseapproximately 2.0 million, 1.3 million, and 1.8 million shares under the planin 2005, 2004 and 2003, respectively. At December 31, 2005 options topurchase a total of 6,618,697 shares were outstanding under the 2000 Plan and1,477,705 options were available for future grant.

**2000 Director Option Plan**

In April 2000, the Companyadopted the 2000 Director Option Plan (the “Director Plan”). Initially, a totalof 90,000 shares of common stock were approved by the Board for issuance underthe plan, together with an annual increase in the number of shares of commonstock reserved thereunder as provided in the plan beginning on the first day ofthe Company’s fiscal year, commencing January 1, 2001. In January 2001,the Board approved an annual increase of 12,000 shares. In May 2001, theBoard approved an additional 198,000 shares under this plan. In January 2002,the Board approved the annual increase of 30,000 shares. In January 2003,the Board approved the annual increase of 30,000 shares. In April 2003,the Board approved an additional 104,000 shares under this plan. In January 2004,the Board approved the annual increase of 175,000 shares. In January 2005,the Board approved the annual increase of 175,000 shares. As of December 31,2005, the Company has authorized a total of 814,000 shares for issuance underthis plan. As a result of past and future annual increases, a maximum of1,689,000 shares of common stock could be issued over the 10-year life ofthe plan. The Company granted options to purchase 170,000, 170,000 and 120,000shares under this plan in 2005, 2004 and 2003 respectively. At December 31,2005 options to purchase a total of 552,000 shares were outstanding under theDirector Plan and 200,750 options were available for future grant.

In April 2005, the board of directors authorizedfurther amendments to the Director Plan, subject to stockholder approval, to: (i) providethat annual grants under the plan shall take place on January 1 of 

F-23

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each year starting in2006, (ii) provide that, after the first year, options granted under theplan vest at a rate of 1¤48per month rather than 1¤4per year, (iii) provide that options granted under the plan shall continueto vest and be exercisable for so long as the option holder remains a directoror consultant to the Company, subject to the term of the option; (iv) extendthe time period for optionees to exercise options following the date on whichthey are no longer a director or consultant to the Company, and (v) toprovide the board of directors with the authority to make amendments to theDirector Plan applicable to all options granted under the Director Plan,including options granted prior to the effective date of the amendment. Theproposed amendments were approved by stockholders in June 2005 but did notaffect options already granted under the Director Plan prior to the effectivedate of the amendments.

A summary of the 1997 Plan, the 2000 Plan, and theDirector Plan activity and related information for the years ended December 31,2005, 2004 and 2003 follows:

| ** **                       | ** ** | ** **                                        | ** ** | **Options Outstanding** | ** ** |
|----------------------------------|------------|---------------------------------------------------|------------|------------------------------|------------|
| ** **                       | ** ** | **Shares  Available for  Option Grant** | ** ** | **Shares**                   | ** ** | **Weighted  Average  Exercise Price** | ** ** |
| Balance, December 31, 2002  |       |                                              | 1,630,845  |                         |       | 5,180,730 |   |   | $ | 4.42 |   |   |
| Authorized                       |       |                                              | 1,145,957  |                         |       | — |   |   | — |   |   |
| Granted                          |       |                                              | (1,956,000 | )                            |       | 1,956,000 |   |   | 1.13 |   |   |
| Exercised                        |       |                                              | —     |                         |       | (222,749 | ) |   | 1.01 |   |   |
| Canceled/repurchased             |       |                                              | 847,903    |                         |       | (1,383,627 | ) |   | 3.17 |   |   |
| Balance, December 31, 2003  |       |                                              | 1,668,705  |                         |       | 5,530,354 |   |   | $ | 3.70 |   |   |
| Authorized                       |       |                                              | 1,375,000  |                         |       | — |   |   | — |   |   |
| Granted                          |       |                                              | (1,484,500 | )                            |       | 1,484,500 |   |   | 1.14 |   |   |
| Exercised                        |       |                                              | —     |                         |       | (33,812 | ) |   | 1.09 |   |   |
| Canceled/repurchased             |       |                                              | 314,030    |                         |       | (332,979 | ) |   | 2.60 |   |   |
| Balance, December 31, 2004  |       |                                              | 1,873,235  |                         |       | 6,648,063 |   |   | $ | 3.20 |   |   |
| Authorized                       |       |                                              | 1,375,000  |                         |       | — |   |   | — |   |   |
| Granted                          |       |                                              | (2,180,500 | )                            |       | 2,180,500 |   |   | 2.71 |   |   |
| Exercised                        |       |                                              | —     |                         |       | (214,196 | ) |   | 1.27 |   |   |
| Expired                          |       |                                              | 150,000    |                         |       | (150,000 | ) |   | 9.35 |   |   |
| Canceled                         |       |                                              | 460,720    |                         |       | (484,720 | ) |   | 1.69 |   |   |
| Balance,  December 31, 2005 |       |                                              | 1,678,455  |                         |       | 7,979,647 |   |   | $ | 3.06 |   |   |

 

| ** **   | **Options Outstanding**            | ** ** | ** ** | ** **                                                   | **Options Exercisable** | ** **                                |
|--------------|-----------------------------------------|------------|------------|--------------------------------------------------------------|------------------------------|-------------------------------------------|
| ** **   | **Range of  Exercise Prices** | ** ** | ** ** | **Number  Outstanding at  December 31, 2005** | ** **                   | **Weighted-Average  Remaining Life** | ** ** | **Weighted-Average  Exercise Price** | ** ** | **Number  Exercisable at  December 31, 2005** | ** ** | **Weighted-Average  Exercise Price** | ** ** |   |
| $0.25 - 0.90 |                                    |       | 1,441,534  |                                                         |                         |                                      | 7.04 |   |   |   | $ | 0.83 |   |   |   | 880,060 |   |   |   | $ | 0.80 |   |   |   |
| $0.92 - 1.21 |                                    |       | 1,778,338  |                                                         |                         |                                      | 7.07 |   |   |   | 1.15 |   |   |   | 1,092,397 |   |   |   | 1.14 |   |   |   |
| $1.27 - 1.85 |                                    |       | 905,825    |                                                         |                         |                                      | 5.28 |   |   |   | 1.50 |   |   |   | 773,575 |   |   |   | 1.48 |   |   |   |
| $2.09 - 2.65 |                                    |       | 1,358,000  |                                                         |                         |                                      | 7.61 |   |   |   | 2.26 |   |   |   | 684,875 |   |   |   | 2.23 |   |   |   |
| $2.91        |                                    |       | 1,497,000  |                                                         |                         |                                      | 8.63 |   |   |   | 2.91 |   |   |   | 145,000 |   |   |   | 2.91 |   |   |   |
| $3.95 - 5.31 |                                    |       | 83,300     |                                                         |                         |                                      | 4.91 |   |   |   | 4.84 |   |   |   | 83,300 |   |   |   | 4.84 |   |   |   |
| $8.50        |                                    |       | 437,700    |                                                         |                         |                                      | 4.74 |   |   |   | 8.50 |   |   |   | 437,700 |   |   |   | 8.50 |   |   |   |
| $17.25       |                                    |       | 477,950    |                                                         |                         |                                      | 4.25 |   |   |   | 17.25 |   |   |   | 477,950 |   |   |   | 17.25 |   |   |   |
|         |                                    |       | 7,979,647  |                                                         |                         |                                      | 6.92 |   |   |   | $ | 3.06 |   |   |   | 4,574,857 |   |   |   | $ | 3.80 |   |   |   |
|              |                                         |            |            |                                                              |                              |                                           |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

F-24

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**2000 Employee Stock Purchase Plan**

In April 2000, theCompany adopted the 2000 Employee Stock Purchase Plan (“Employee Stock PurchasePlan”). Initially, a total of 1,500,000 shares of common stock were approved bythe Board for issuance under the plan, together with an annual increase in thenumber of shares of common stock reserved thereunder as provided in the planbeginning 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, 2005, the Company has authorized a total of 2,253,702shares for issuance under this plan. As a result of past and future annualincreases, a maximum of 10,500,000 shares could be sold over the 10-yearlife of the plan. The Employee Stock Purchase Plan permits employees topurchase common stock through payroll deductions, which may not exceed 15% ofan employee’s compensation, at 85% of the lower of the fair market value of theCompany’s common stock on the first or the last day of each offering period. Atotal of 182,594, 118,139, and 87,191 shares were sold under this plan during2005, 2004 and 2003, respectively.

**Common StockReserved for Future Issuance**

As of December 31, 2005, the Company had reservedthe following shares of common stock for issuance in connection with:

| Stock options under stock option plans |   | 10,048,951 |   |
|----------------------------------------|--------|------------|--------|
| Employee stock purchase plan           |   | 2,253,702  |   |
| Total                                  |   | 12,302,653 |   |

 

**9.**   LegalProceedings

On May 11, 2005, CPI,Avistar’s wholly-owned patent prosecution and licensing subsidiary, commenced apatent infringement lawsuit against Tandberg ASA and Tandberg, Inc, allegingthat several Tandberg videoconferencing products infringe three patents held byCPI. The suit was filed in the United States District Court for the NorthernDistrict of California. The three patents involved are U.S. Patent Nos.5,867,654; 5,896,500; and 6,212,547. These patents cover technologies relatingto video and data conferencing over unshielded twisted pair (UTP) networks,distributed call-state management and separate monitors for simultaneouscomputer-based data sharing and videoconferencing. These technologies are corecomponents of the AvistarVOS video operating system. In this action, CPI hasrequested injunctive relief, damages to compensate for past and presentinfringement, treble damages, costs associated with the litigation and suchfurther relief as the Court deems just and proper. Both of the Tandbergentities answered the complaint on July 15, 2005, at which time theyasserted that they did not infringe the patents and that the patents wereinvalid and unenforceable. On January 30, 2006, Tandberg Telecom AS, awholly-owned manufacturing and patent holding subsidiary of Tandberg ASA, fileda patent infringement lawsuit against Avistar in the United States DistrictCourt for the Eastern District of Texas. The suit alleges that Avistarvideoconferencing products infringe one patent purchased by Tandberg Telecom AS.The patent involved is U.S. Patent No. 6,621,515, which claims a methodand system for routing video calls. In the Texas litigation, Tandberg TelecomAS has requested injunctive relief, monetary damages to compensate for itsactual damages, costs associated with the litigation and such further relief asthe Court deems just and proper. The Company responded to the complaint on March 23,2006, at which time we asserted that Avistar did not infringe the patent, thatthe patent was invalid, and that the claim was without merit. Tandberg ASA andTandberg, Inc. sought to add two defenses, and provisionally filed twomotions for summary judgment in the California litigation on January 13,2006 and February 24, 2006, respectively. Each proposed defense assertsthat the Company is subject to a different contractual provision that eithertotally precludes or limits CPI’s remedies in the California litigation. Specifically,Tandberg alleged that (1) it had a license to the subject patents and (2) thatAvistar had released its claims 

F-25

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againstTandberg with respect to the subject patents. Both motions for summary judgmentwere determined to be procedurally defective in that Tandberg had notpreviously pled the contractual provisions as defenses to CPI’s claims. In thefirst case, on January 13, 2006, Tandberg voluntarily filed a motion toamend its complaint to add a license defense. That motion to amend has beenfully briefed and argued and is pending. If the court permits Tandberg to amendits complaint, the briefing on Tandberg’s motion for summary judgment will becompleted and the issue will be submitted to the court for resolution. During ahearing on March 20, 2006 concerning the “release” defense, the courtrefused to permit Tandberg to amend its complaint, holding that Tandberg couldnot prevail on that defense, and thereby prohibiting Tandberg from pursuingthis defense in the California case. The Markman hearing for the CPI claims, apivotal stage of the litigation process at which time definitions aredetermined for the following proceeding, is currently scheduled for May 22,2006. The prosecution of this lawsuit and the defense of the Tandberg TelecomAS claim may require Avistar and CPI to expend significant financial andmanagerial resources, and therefore may have a material negative impact on theCompany’s business, financial condition and results of operations. The durationand ultimate outcome of this litigation are uncertain.

**10.**   Income Taxes

The Company accounts for income taxes in accordancewith SFAS No. 109, “Accounting for Income Taxes” (“SFAS 109”). SFAS 109provides for an asset and liability approach to account for income taxes underwhich deferred tax assets and liabilities are recognized for the future taxconsequences attributable to differences between the financial statementcarrying amounts of existing assets and liabilities, and their respective taxbases. Deferred tax assets and liabilities are measured using enacted tax ratesexpected to apply to taxable income in the years in which those temporarydifferences are expected to be recovered or settled. Deferred tax assets arereduced by a valuation allowance when, in the opinion of management, it is morelikely 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 isrecognized in income in the period of enactment.

The provision for income taxes relates to Federal,State and Foreign tax. The Company provided for income taxes for its subsidiaryin the United Kingdom (ASUK) of approximately $22,000, $60,000 and $20,000 in2005, 2004 and 2003, respectively.

The provision for income taxes consisted of thefollowing (in thousands):

| ** **           | ** ** | **Year Ended December 31,** | ** ** |
|----------------------|------------|--------------------------------------------|------------|
| ** **           | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| Current:             |       |                                       |       |   |   |   |   |
| Federal              |       | $                                          | —     |   | $ | 237 |   | $ | — |   |
| State                |       | —                                     |       | 66 |   | — |   |
| Foreign              |       | 22                                         |       | 60 |   | 20 |   |
|                 |       | 22                                         |       | 363 |   | 20 |   |
| Deferred benefits:   |       |                                       |       |   |   |   |   |
| Federal              |       | (2,262                                     | )          | (2,691 | ) | (2,985 | ) |
| State                |       | (460                                       | )          | (335 | ) | (490 | ) |
|                 |       | (2,722                                     | )          | (3,026 | ) | (3,475 | ) |
| Valuation  allowance |       | 2,722                                      |       | 3,026 |   | 3,475 |   |
|                 |       | $                                          | 22         |   | $ | 363 |   | $ | 20 |   |

 

F-26

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

| ** **                              | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------|------------|--------------------------------------------|------------|
| ** **                              | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| Domestic                                |       | $                                          | (4,839     | ) | $ | (8,668 | ) | $ | (8,813 | ) |
| Foreign                                 |       | (313                                       | )          | 325 |   | 214 |   |
| Loss before provision for  income taxes |       | $                                          | (5,152     | ) | $ | (8,343 | ) | $ | (8,599 | ) |

 

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

| ** **                                                                                            | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                            | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| Expected tax benefit at federal statutory rate                                                        |       | $                                          | (1,652     | ) | $ | (2,837 | ) | $ | (2,985 | ) |
| Foreign and state taxes, net                                                                          |       | 22                                         |       | 126 |   | 20 |   |
| Permanent non-deductible                                                                              |       | 17                                         |       | — |   | 57 |   |
| Utilization of net operating losses                                                                   |       | —                                     |       | (3,786 | ) | — |   |
| Current year operating losses and temporary  differences for which no tax benefit is  recognized |       | 1,635                                      |       | 6,860 |   | 2,928 |   |
| Provision  for income taxes                                                                           |       | $                                          | 22         |   | $ | 363 |   | $ | 20 |   |

 

Permanent non-deductible isprimarily composed of the non-deductible portion of the deferred stockcompensation expense.

The net deferred income tax asset consisted of thefollowing as of December 31, 2005 and 2004 (in thousands):

| ** **                                     | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------|------------|----------|------------|----------|------------|
| Deferred  income tax assets:                   |       |     |       |     |       |
| Federal net operating loss  carryforwards      |       | $        | 11,514     |     | $          | 8,244 |   |
| State net operating loss  carryforwards        |       | 694      |       | —   |       |
| Tax credit carry forward                       |       | 2,312    |       | 2,246    |       |
| Deferred settlement and patent  licensing, net |       | 6,507    |       | 8,172    |       |
| Reserves                                       |       | 294      |       | 57       |       |
| Property and Equipment                         |       | 195      |       | 75       |       |
|                                           |       | 21,516   |       | 18,794   |       |
| Valuation allowance                            |       | (21,516  | )          | (18,794  | )          |
| Net  deferred income tax asset                 |       | $        | —     |     | $          | — |   |

 

Net operating loss carryforwardsat December 31, 2005 were approximately $34 million and $12 million, forFederal and state income tax purposes, respectively. The Federal net operatingloss carryforwards expire on various dates through the year 2024.

F-27

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As of December 31, 2005,unused research and development tax credits of approximately $1.0 million and$1.1 million are available to reduce future Federal and California incometaxes, respectively. Federal credit carryforwards expire beginning in year 2013.California credits will carry forward indefinitely.

TheInternal Revenue Code of 1986, as amended, contains provisions that may limitthe net operating loss carryforwards to be used in any given year upon theoccurrence of certain events, including a significant change in ownershipinterest. The Company believes significant uncertainty exists regarding therealizability of the net operating loss and tax credit carryforwards and othertiming differences. Accordingly, a valuation allowance has been provided forthe entire net deferred tax asset.

**11.**   Net Loss Per Share

Basic and diluted net loss pershare of common stock is presented in conformity with SFAS No. 128 (“SFAS128”), “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 ofshares of common stock outstanding during the period, less shares subject torepurchase. Diluted net loss per share is computed on the basis of the weightedaverage number of shares and potential common shares outstanding during theperiod. Potential common shares result from the assumed exercise of outstandingstock options that have a dilutive effect when applying the treasury stockmethod. The Company has excluded all convertible preferred stock, outstandingstock options and shares subject to repurchase from the calculation of dilutednet loss per share for 2005, 2004, and 2003, because all such securities areantidilutive (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 sharefor all years presented.

The total number of potential common shares excludedfrom the calculations of diluted net loss per share was 1,668,006, 1,873,782and 1,556,292 for 2005, 2004, and 2003, respectively.

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

| ** **                                                                         | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                         | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net loss                                                                           |       | $                                          | (5,174     | ) | $ | (8,706 | ) | $ | (8,619 | ) |
| Weighted average shares of common stock used in  computing net loss per share |       | 33,600                                     |       | 32,610 |   | 26,368 |   |
| Net  loss per share basic and diluted                                              |       | $                                          | (0.15      | ) | $ | (0.27 | ) | $ | (0.33 | ) |

 

**12.**   SegmentReporting

Disclosure of segments ispresented in accordance with SFAS No. 131 (“SFAS 131”), “Disclosures AboutSegments of an Enterprise and Related Information.” SFAS 131 establishesstandards for disclosures regarding operating segments, products and services,geographic areas and major customers. TheCompany is organized and operates as two operating segments: (1) thedesign, development, manufacturing, sale and marketing of networked videocommunications products (Avistar) and (2) the prosecution,maintenance, support and licensing of the intellectual property used in theCompany’s products (CPI). CPI Servicerevenue relates mainly to the maintenance, support, training, softwaredevelopment and installation of products, and is included in Avistar forpurposes of reporting and decision-making. Avistar also engages incorporate functions, and provides financing and services to its subsidiaries.The Company’s chief operating decision maker, its Chief Executive Officer,monitors the Company’s operations based upon the information reflected in thefollowing table (in thousands). The table includes a reconciliation of therevenue and expense classification used by the Company’s CEO with 

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theclassification of revenue, other income and expenses as set forth in theCompany’s audited financial statements included elsewhere herein. 

| ** **                                           | ** ** | **CPI** | ** ** | **Avistar** | ** ** | **Reconciliation** | ** ** | **Total** | ** ** |
|------------------------------------------------------|------------|---------|------------|-------------|------------|--------------------|------------|-----------|------------|
| **Year  Ended December 31, 2005**               |       |    |       |        |       |               |       |      |       |   |   |
| Revenue                                              |       | $       | 4,226      |        | $          | 6,911              |       |      | (4,226     | ) |   | $ | 6,911 |   |
| Depreciation expense                                 |       | —  |       | (273        | )          |               | —     |      |       | (273 | ) |
| Total costs and expenses                             |       | (2,535  | )          | (14,197     | )          |               | 4,226      |      |       | (12,506 | ) |
| Interest income                                      |       | —  |       | 537         |       |               | —     |      |       | 537 |   |
| Interest expense                                     |       | —  |       | 1           |       |               | —     |      |       | 1 |   |
| Net income (loss)                                    |       | 1,691   |       | (6,865      | )          |               | —     |      |       | (5,174 | ) |
| Assets                                               |       | 5,081   |       | 15,277      |       |               | —     |      |       | 20,358 |   |
| **Year  Ended December 31, 2004 (as restated)** |       |    |       |        |       |               |       |      |       |   |   |
| Revenue                                              |       | $       | 575        |        | $          | 6,321              |       |      | $          | (575 | ) |   | $ | 6,321 |   |
| Depreciation expense                                 |       | —  |       | (339        | )          |               | —     |      |       | (339 | ) |
| Total costs and expenses                             |       | (3,898  | )          | (11,474     | )          |               | 575        |      |       | (14,797 | ) |
| Interest income                                      |       | —  |       | 118         |       |               | —     |      |       | 118 |   |
| Interest expense                                     |       | —  |       | 6           |       |               | —     |      |       | 6 |   |
| Net loss                                             |       | (3,322  | )          | (5,384      | )          |               | —     |      |       | (8,706 | ) |
| Assets                                               |       | 6,330   |       | 24,078      |       |               | —     |      |       | 30,408 |   |
| **Year  Ended December 31, 2003**               |       |    |       |        |       |               |       |      |       |   |   |
| Revenue                                              |       | $       | —     |        | $          | 6,592              |       |      | —     |   |   | $ | 6,592 |   |
| Depreciation expense                                 |       | (6      | )          | (203        | )          |               | —     |      |       | (209 | ) |
| Total costs and expenses                             |       | (2,446  | )          | (13,270     | )          |               | —     |      |       | (15,716 | ) |
| Interest income                                      |       | —  |       | 44          |       |               | —     |      |       | 44 |   |
| Interest expense                                     |       | —  |       | 8           |       |               | —     |      |       | 8 |   |
| Net loss                                             |       | (2,446  | )          | (6,173      | )          |               | —     |      |       | (8,619 | ) |
| Assets                                               |       | 22      |       | 8,206       |       |               | —     |      |       | 8,228 |   |
|                                                      |            |         |            |             |            |                    |            |           |            |  |  |  |  |  |  |

 

Internationalrevenue, which consists of sales to customers with operations principally inWestern Europe and Asia,  comprised63%, 52% and 58% of total revenue for 2005, 2004, and 2003, respectively. For2005, 2004, and 2003, respectively, international revenues to customers in theUnited Kingdom accounted for 23%, 31% and 40%, respectively, of total revenue.The Company had no significant long-lived assets in any country otherthan the United States for any period presented.

**13.**   Subsequent Events

On March 15, 2006, Avistar signed a new lease fora 2,500 square foot office space in London, United Kingdom to house sales andoperational staff. The new office space replaces similar facilities vacated in March 2006.The new lease requires minimum payments of approximately $112,000, $144,000,$144,000 and $80,000 for fiscal years 2006, 2007, 2008 and 2009, respectively.

On April 18, 2006, the Company received a notice fromthe staff of The NASDAQ Stock Market stating that Avistar is not in compliancewith Marketplace Rule 4310(c)(14) because it had not filed its AnnualReport on Form 10-K for the year ended December 31, 2005 (the “2005Form 10-K”) on a timely basis. The notice is automatically generatedby NASDAQ, and indicated that due to such noncompliance, Avistar’s common stockwill be subject to potential delisting. On April 19, 2006, Avistarrequested a hearing before the NASDAQ Listing Qualifications Panel (the “Panel”)to appeal the NASDAQ staff’s determination. The hearing request automaticallystayed the delisting of Avistar’s common stock pending the Panel’s review anddecision. There can be no assurance, however, that the Panel will grant Avistar’s

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request for continued listing.Until compliance with NASDAQ’s Marketplace Rules is re-established, thetrading symbol for Avistar may be changed from AVSR to AVSRE by the NASDAQCapital Market.

**14.**   Selected Quarterly Results of Operations(unaudited)

The following tables set forth, for the periodsindicated, the Company’s unaudited financial information for the last eightquarters. The Company believes that the financial statements used to preparethis information include all adjustments, consisting only of normal recurringadjustments, necessary for a fair presentation of this information when read inconjunction with the Company’s financial statements and notes to financialstatements. The operating results for any quarter do not necessarily indicatethe results expected for any future period. As described in the Summaryof Significant Accounting Policies, Income from Settlement and PatentLicensing, we expect to recognize the payment received from Polycom, Inc.and the associated deferred contingent legal costs paid in income from settlementand patent licensing in equal installments over a five-year period starting November 12,2004. The payment from Polycom and its recognition in income from settlementand patent licensing may affect the comparability of our financial statementsfor periods before and after the payment was received.

| ** **                                                | ** ** | **Quarter Ended**                                            | ** ** |
|-----------------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                                                | ** ** | **December 31,  2005**                                       | ** ** | **September 30,  2005** | ** ** | **June 30,  2005** | ** ** | **March 31,  2005** | ** ** |
| ** **                                                | ** ** | **(In thousands except per share data)** | ** ** |
| Total revenue (As Previously Reported)                    |       |                                                              | $          | 1,808 |   |   |   | $ | 2,891 |   |   | $ | 2,403 |   |   | $ | 2,979 |   |   |
| Total revenue (Adjustment)                                |       |                                                              | —     |   |   |   | (1,057 | ) |   | (1,056 | ) |   | (1,057 | ) |   |
| Total revenue (As Restated)                               |       |                                                              | 1,808      |   |   |   | 1,834 |   |   | 1,347 |   |   | 1,922 |   |   |
| Cost of product  revenue                                  |       |                                                              | 593        |   |   |   | 531 |   |   | 318 |   |   | 450 |   |   |
| Cost of services,  maintenance and support costs revenues |       |                                                              | 632        |   |   |   | 616 |   |   | 525 |   |   | 447 |   |   |
| Net loss                                                  |       |                                                              | $          | (2,102 | ) |   |   | $ | (1,425 | ) |   | $ | (1,260 | ) |   | $ | (387 | ) |   |
| Net loss per share—Basic/Diluted                     |       |                                                              | $          | (0.06 | ) |   |   | $ | (0.04 | ) |   | $ | (0.04 | ) |   | $ | (0.01 | ) |   |
| Weighted  average shares                                  |       |                                                              | 33,738     |   |   |   | 33,687 |   |   | 33,547 |   |   | 33,420 |   |   |

 

| ** **                                                | ** ** | **Quarter Ended**                                            | ** ** |
|-----------------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                                                | ** ** | **December 31,  2004**                                       | ** ** | **September 30,  2004** | ** ** | **June 30,  2004** | ** ** | **March 31,  2004** | ** ** |
| ** **                                                | ** ** | **(In thousands except per share data)** | ** ** |
| Total revenue (As Previously Reported)                    |       |                                                              | $          | 2,304 |   |   |   | $ | 1,512 |   |   | $ | 1,676 |   |   | $ | 1,404 |   |   |
| Total revenue (Adjustment)                                |       |                                                              | (575       | ) |   |   | — |   |   | — |   |   | — |   |   |
| Total revenue (As Restated)                               |       |                                                              | 1,729      |   |   |   | 1,512 |   |   | 1,676 |   |   | 1,404 |   |   |
| Cost of product  revenue                                  |       |                                                              | 435        |   |   |   | 344 |   |   | 364 |   |   | 292 |   |   |
| Cost of services,  maintenance and support costs revenues |       |                                                              | 468        |   |   |   | 526 |   |   | 461 |   |   | 482 |   |   |
| Net loss                                                  |       |                                                              | $          | (2,096 | ) |   |   | $ | (2,289 | ) |   | $ | (2,233 | ) |   | $ | (2,088 | ) |   |
| Net loss per share—Basic/Diluted                     |       |                                                              | $          | (0.06 | ) |   |   | $ | (0.07 | ) |   | $ | (0.07 | ) |   | $ | (0.07 | ) |   |
| Weighted  average shares                                  |       |                                                              | 33,361     |   |   |   | 33,335 |   |   | 33,277 |   |   | 30,450 |   |   |

 

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**Item 15(a)**

**AVISTARCOMMUNICATIONS CORPORATION AND SUBSIDIARIES**

**SCHEDULEII—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 Accounts** |       |                                         |       |                                       |       |           |       |                                       |       |   |   |   |   |   |   |   |   |
| Period  Ended:                      |       |                                         |       |                                       |       |           |       |                                       |       |   |   |   |   |   |   |   |   |
| December 31, 2005              |       |                                         | $          | 22                                         |       |           |       | $                                          | 120        |   |   |   | $ | (21 | ) |   |   | $ | 121 |   |   |
| December 31, 2004              |       |                                         | $          | 44                                         |       |           |       | $                                          | 77         |   |   |   | $ | (99 | ) |   |   | $ | 22 |   |   |
| December 31, 2003              |       |                                         | $          | 69                                         |       |           |       | $                                          | 125        |   |   |   | $ | (150 | ) |   |   | $ | 44 |   |   |

 

S-1

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**INDEX TO EXHIBITS**
| Exhibits | ** ** | ** ** | ** **                                                                                                                                                                                    | ** ** | ** ** | ** ** |
|----------|------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|
| 3.2      | (1)        |       | Restated Certificate of Incorporation                                                                                                                                                         |       |       |
| 3.3      | (11)       |       | Bylaws of Avistar Communications Corporation                                                                                                                                                  |       |       |
| 4.1      | (1)        |       | Specimen Certificate evidencing shares of Common Stock                                                                                                                                        |       |       |
| 10.1     | (1)        |       | 1997 Stock Option Plan, as amended*                                                                                                                                                           |       |       |
| 10.1.1   | (1)        |       | 1997 Stock Option Plan Form of Stock Option Agreement*                                                                                                                                   |       |       |
| 10.2     | (1)        |       | 2000 Stock Option Plan, as amended*                                                                                                                                                           |       |       |
| 10.3     |       |       | 2000 Director Option Plan, as amended*                                                                                                                                                        |       |       |
| 10.4     | (1)        |       | Form of Director Option Agreement*                                                                                                                                                       |       |       |
| 10.5     | (4)        |       | 2000 Employee Stock Purchase Program, as amended*                                                                                                                                             |       |       |
| 10.6     | (1)        |       | Form of Indemnification Agreement*                                                                                                                                                       |       |       |
| 10.7     | (1)†  |       | Preferred Supplier Agreement dated June 24, 1997 by and between  Avistar and Tandberg, Inc., including modifications Nos. 1, 2, 3 and 4                                             |       |       |
| 10.7.1   | (1)†  |       | Modification No. 5 to the Preferred Supplier Agreement dated  June 27, 2000                                                                                                         |       |       |
| 10.7.2   | (2)†  |       | Modification No. 6 to the Preferred Supplier Agreement dated  November 27, 2000                                                                                                     |       |       |
| 10.8     | (6)        |       | Settlement Agreement and Release between the Registrant and R. Stephen  Heinrichs dated April 26, 2001*                                                                                  |       |       |
| 10.9     | (7)        |       | Master Loan and Security Agreement between the Registrant and Comerica  Bank—California dated February 27, 2002                                                                     |       |       |
| 10.9.1   | (7)†  |       | First Amendment dated December 17, 2002 to Master Loan and  Security Agreement between the Registrant and Comerica Bank—California                                                  |       |       |
| 10.9.2   | (7)†  |       | Unconditional Guaranty of the Gerald J. Burnett and Marjorie J. Burnett  Revocable Trust dated December 17, 2002                                                                         |       |       |
| 10.9.3   | (7)†  |       | Unconditional Guaranty of Gerald J. Burnett dated December 17,  2002                                                                                                                     |       |       |
| 10.9.4   | (7)        |       | Second Amendment dated March 10, 2003 to Master Loan and Security  Agreement between the Registrant and Comerica Bank—California                                                    |       |       |
| 10.9.5   | (9)        |       | Fourth Amendment dated February 27, 2004 to Master Loan and  Security Agreement between the Registrant and Comerica Bank—California                                                 |       |       |
| 10.9.6   | (9)        |       | Reaffirmation of Unconditional Guaranty of the Gerald J. Burnett and  Marjorie J. Burnett Revocable Trust dated February 24, 2004                                                        |       |       |
| 10.10    | (8)        |       | Office Lease Agreement between CA-Twin Dolphin Plaza Limited  Partnership and the Registrant dated July 30, 2003                                                                         |       |       |
| 10.11    | (8)        |       | 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 |       |       |
| 10.12    | (10)       |       | Stock Purchase  Agreement among the Registrant, Fuller & Thaler Behavioral Finance  Fund, Ltd. and Fuller & Thaler Avalanche Fund, L.P. dated  March 23, 2004          |       |       |
| 10.13    | (11)       |       | Settlement  Agreement among the Registrant, Collaboration Properties, Inc. and  Polycom, Inc. dated November 12, 2004                                                          |       |       |
| 10.14    | †     |       | Patent  Cross-License Agreement Among the Company, Collaboration  Properties, Inc. and Polycom, Inc. dated November 12, 2004                                                   |       |       |
| 21.1     | (7)        |       | Subsidiaries of the Company                                                                                                                                                                   |       |       |
|          |            |            |                                                                                                                                                                                               |            |            |            |  |

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| 23.1 |   |   | Consent of Independent Registered Public Accounting Firm: Burr,  Pilger & Mayer LLP                                                                                                  |   |   |
|------|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|
| 23.2 |   |   | Consent of Independent Registered Public Accounting Firm: KPMG LLP                                                                                                                                 |   |   |
| 24.1 |   |   | Power of Attorney (see page 47)                                                                                                                                                               |   |   |
| 31.1 |   |   | Rule 13a-14(a)/15d-14(a) Certification by the  Chief Executive Officer                                                                                                                   |   |   |
| 31.2 |   |   | Rule 13a-14(a)/15d-14(a) Certification by the  Chief Financial Officer                                                                                                                   |   |   |
| 32   |   |   | 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 |   |   |

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*                    Indicatesmanagement contract or compensatory plan or arrangement required to be filed anexhibit pursuant to Item 14(c) of Form 10-K.

†                    Portionsof the exhibit have been omitted pursuant to a request for confidential treatmentand the omitted portions have been separately filed with the Commission.

(1)          Filed asan exhibit to the Company’s Registration Statement on Form S-1 (FileNo. 333-39008) as declared effective by the Securities and ExchangeCommission on August 16, 2000.

(2)          Filed asan exhibit to the Registrant’s Annual Report on Form 10-K for theyear ended December 31, 2000 filed with the Securities and ExchangeCommission on March 9, 2001.

(3)          Reserved.

(4)          Filed asan exhibit to the Registrant’s Registration Statement on Form S-8filed with the Securities and Exchange Commission on August 16, 2000.

(5)          Filed asan exhibit to the Company’s Annual Report on Form 10-K for the yearended December 31, 2001 filed with the Securities and Exchange Commissionon March 21, 2002.

(6)          Filed asan exhibit to the Registrant’s Current Report on Form 8-K filed withthe Securities and Exchange Commission on May 8, 2001.

(7)          Filed asan exhibit to the Company’s Annual Report on Form 10-K for the yearended December 31, 2002 with the Securities and Exchange Commission on March 25,2003.

(8)          Filed asan exhibit to the Registrant’s Quarterly Report on Form 10-Q for thethree months ended September 30, 2003 filed with the Securities andExchange Commission on October 23, 2003.

(9)          Filed asan exhibit to the Registrant’s Annual Report on Form 10-K for theyear ended December 31, 2003 filed with the Securities and ExchangeCommission on March 16, 2004.

(10)   Filed as an exhibit to the Registrant’s QuarterlyReport on Form 10-Q for the quarter ended March 31, 2004 filedwith the Securities and Exchange Commission on May 11, 2004.

(11)   Filed as an exhibit to the Registrant’s AnnualReport on Form 10-K for the year ended December 31, 2004 filedwith the Securities and Exchange Commission on March 28, 2005.

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