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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q



|[X] |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2001
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------



|[   ] |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES AND EXCHANGE ACT OF 1934
|----- |  | --------------------------------------------------------------------------------------------

Commission file number: 000  31121

AVISTAR COMMUNICATIONS CORPORATION
(Exact name of registrant as specified in its charter)

|                                                                        |  |                                                   
|----------------------------------------------------------------------- |  | --------------------------------------------------
|DELAWARE
(State or other jurisdiction
of incorporation or organization) |  | 88-0463156
(I.R.S. Employer Identification Number)

555 TWIN DOLPHIN DRIVE, SUITE 360, REDWOOD SHORES, CA 94065
(Address of Principal Executive Offices) (Zip Code)

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

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities and Exchange Act
of 1934 during the preceding 12 months (or for shorter period that the
registrant was required to file such reports); and (2) has been subject to such
filing requirements for the past 90 days.

Yes   [X]     No   [   ]

At September 30, 2001, 25,196,478 shares of common stock of the Registrant were
outstanding.





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TABLE OF CONTENTS



|                               |                                                                                               |                                             |  |  |  |  |  | 
|------------------------------ | --------------------------------------------------------------------------------------------- | ------------------------------------------- |  |  |  |  |  | 
|PART I  FINANCIAL INFORMATION
|                               | Item 1. Financial Statements                                                                 
|                               |                                                                                               | CONDENSED CONSOLIDATED BALANCE SHEETS      
|                               |                                                                                               | CONDENSED COMBINED STATEMENTS OF OPERATIONS
|                               |                                                                                               | CONDENSED COMBINED STATEMENT OF CASH FLOWS 
|                               |                                                                                               | NOTES TO CONDENSED FINANCIAL STATEMENTS    
|                               | Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
|                               | Item 3. Quantitative and Qualitative Disclosures About Market Risk                           
|PART II  OTHER INFORMATION   
|SIGNATURES                    



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AVISTAR COMMUNICATIONS CORPORATION

INDEX

|           |  |                                                                                       |  |         
|---------- |  | ------------------------------------------------------------------------------------- |  | --------
|           |  |                                                                                       |  | PAGE NO.
|           |  |                                                                                       |  |         
|PART I     |  | FINANCIAL INFORMATION                                                                 |  |         
|Item 1.    |  | Financial Statements                                                                  |  | 3       
|           |  | Condensed Consolidated Balance Sheets                                                 |  | 3       
|           |  | Condensed Combined and Consolidated Statements of Operations                          |  | 4       
|           |  | Condensed Combined and Consolidated Statements of Cash Flows                          |  | 5       
|           |  | Notes to Condensed Financial Statements                                               |  | 6       
|Item 2.    |  | Managements Discussion and Analysis of Financial Condition and Results of Operations |  | 11      
|Item 3.    |  | Quantitative and Qualitative Disclosures About Market Risk                            |  | 22      
|PART II    |  | OTHER INFORMATION                                                                     |  |         
|None       |  |                                                                                       |  |         
|SIGNATURES |  |                                                                                       |  | 23      

2



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PART I  FINANCIAL INFORMATION




Item 1.Financial Statements




AVISTAR COMMUNICATIONS CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 2000 AND SEPTEMBER 30, 2001
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

|                                      |                             |                                                                                                                                                                                                              |                                            |     |              |        |               |     |             |        | 
|------------------------------------- | --------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | ------------------------------------------ | --- | ------------ | ------ | ------------- | --- | ----------- | ------ | 
|                                      |                             |                                                                                                                                                                                                              |                                            |     | DECEMBER 31, |        | SEPTEMBER 30,
|                                      |                             |                                                                                                                                                                                                              |                                            |     | 2000         |        | 2001         
|                                      |                             |                                                                                                                                                                                                              |                                            |     |              |        |              
|                                      |                             |                                                                                                                                                                                                              |                                            |     |              |        |               |     | (UNAUDITED)
|ASSETS:                               |                             |                                                                                                                                                                                                              |                                            |     |              |        |               |    
|                                      | Current assets:             |                                                                                                                                                                                                              |                                            |     |              |        |               |     |            
|                                      |                             | Cash and cash equivalents                                                                                                                                                                                    |                                            | $   | 21,660       |        |               | $   | 10,176      |       
|                                      |                             | Short-term investments                                                                                                                                                                                       |                                            |     |             |        |               |     | 5,225       |       
|                                      |                             | Accounts receivable, net of allowances for doubtful
accounts of $312 and $252, respectively                                                                                                                  |                                            |     | 3,712        |        |               |     | 2,974       |       
|                                      |                             | Inventories, including inventory shipped to customer
sites, not yet installed of $854 and $231, respectively                                                                                                 |                                            |     | 2,156        |        |               |     | 1,644       |       
|                                      |                             | Prepaid expenses and other current assets                                                                                                                                                                    |                                            |     | 434          |        |               |     | 402         |       
|                                      |                             |                                                                                                                                                                                                              |                                            |     |              |        |               |    
|                                      |                             |                                                                                                                                                                                                              | Total current assets                       |     |              | 27,962 |               |     |             | 20,421 | 
|                                      | Property and equipment, net |                                                                                                                                                                                                              |                                            | 83  |              |        |               | 460 |            
|                                      | Other assets                |                                                                                                                                                                                                              |                                            | 258 |              |        |               | 431 |            
|                                      |                             |                                                                                                                                                                                                              |                                            |     |              |        |               |    
|                                      |                             |                                                                                                                                                                                                              | Total assets                               |     | $            | 28,303 |               |     | $           | 21,312 | 
|                                      |                             |                                                                                                                                                                                                              |                                            |     |              |        |               |    
|LIABILITIES AND STOCKHOLDERS EQUITY: |                             |                                                                                                                                                                                                              |                                            |     |              |        |               |    
|                                      | Current liabilities:        |                                                                                                                                                                                                              |                                            |     |              |        |               |     |            
|                                      |                             | Accounts payable                                                                                                                                                                                             |                                            | $   | 2,006        |        |               | $   | 1,104       |       
|                                      |                             | Deferred revenue and deposits                                                                                                                                                                                |                                            |     | 2,126        |        |               |     | 1,691       |       
|                                      |                             | Accrued liabilities and other                                                                                                                                                                                |                                            |     | 2,407        |        |               |     | 2,007       |       
|                                      |                             |                                                                                                                                                                                                              |                                            |     |              |        |               |    
|                                      |                             |                                                                                                                                                                                                              | Total current liabilities                  |     |              | 6,539  |               |     |             | 4,802  | 
|                                      |                             |                                                                                                                                                                                                              |                                            |     |              |        |               |    
|                                      | Stockholders equity:       |                                                                                                                                                                                                              |                                            |     |              |        |               |     |            
|                                      |                             | Convertible preferred stock, $0.001 per share par value;
10,000,000 authorized at December 31, 2000 and September 30, 2001,
no shares issued and outstanding at December 31, 2000 and September 30, 2001     |                                            |     |             |        |               |     |            |       
|                                      |                             | Common stock, $0.001 par value; 250,000,000 shares
authorized at December 31, 2000 and September 30, 2001,
26,266,990 and 26,362,603 shares issued at December 31, 2000
and September 30, 2001, respectively |                                            |     | 26           |        |               |     | 26          |       
|                                      |                             | Treasury common stock, 1,143,625 and 1,166,125
shares at December 31, 2000 and September 30, 2001,
respectively                                                                                              |                                            |     | (1           | )      |               |     | (1          | )     
|                                      |                             | Additional paid-in-capital                                                                                                                                                                                   |                                            |     | 80,145       |        |               |     | 80,000      |       
|                                      |                             | Deferred stock compensation                                                                                                                                                                                  |                                            |     | (1,755       | )      |               |     | (685        | )     
|                                      |                             | Accumulated deficit                                                                                                                                                                                          |                                            |     | (56,651      | )      |               |     | (62,830     | )     
|                                      |                             |                                                                                                                                                                                                              |                                            |     |              |        |               |    
|                                      |                             |                                                                                                                                                                                                              | Total stockholders equity                 |     |              | 21,764 |               |     |             | 16,510 | 
|                                      |                             |                                                                                                                                                                                                              |                                            |     |              |        |               |    
|                                      |                             |                                                                                                                                                                                                              | Total liabilities and stockholders equity |     | $            | 28,303 |               |     | $           | 21,312 | 
|                                      |                             |                                                                                                                                                                                                              |                                            |     |              |        |               |    

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

3



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AVISTAR COMMUNICATIONS CORPORATION AND SUBSIDIARIES

CONDENSED COMBINED STATEMENTS OF OPERATIONS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2000 AND
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2001
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

|                                                                                     |                                                  |                            |                                   |       |                    |        |                   |       |      |        |         |        |       |        |        |       |     |        |  
|------------------------------------------------------------------------------------ | ------------------------------------------------ | -------------------------- | --------------------------------- | ----- | ------------------ | ------ | ----------------- | ----- | ---- | ------ | ------- | ------ | ----- | ------ | ------ | ----- | --- | ------ | -
|                                                                                     |                                                  |                            |                                   |       | THREE MONTHS ENDED |        | NINE MONTHS ENDED
|                                                                                     |                                                  |                            |                                   |       | SEPTEMBER 30,      |        | SEPTEMBER 30,    
|                                                                                     |                                                  |                            |                                   |       |                    |        |                  
|                                                                                     |                                                  |                            |                                   |       | 2000               |        | 2001              |       | 2000 |        | 2001   
|                                                                                     |                                                  |                            |                                   |       |                    |        |                   |       |      |        |        
|                                                                                     |                                                  |                            |                                   |       | (UNAUDITED)       
|Revenue:                                                                             |                                                  |                            |                                   |       |                    |        |                   |       |      |        |         |        |       |        |        |      
|                                                                                     | Products                                         |                            | $                                 | 4,492 |                    |        | $                 | 1,719 |      |        | $       | 11,573 |       |        | $      | 8,854 |    
|                                                                                     | Services, maintenance and support                |                            |                                   | 1,040 |                    |        |                   | 1,310 |      |        |         | 3,210  |       |        |        | 3,800 |    
|                                                                                     |                                                  |                            |                                   |       |                    |        |                   |       |      |        |         |        |       |        |        |      
|                                                                                     |                                                  |                            | Total revenue                     |       |                    | 5,532  |                   |       |      | 3,029  |         |        |       | 14,783 |        |       |     | 12,654 |  
|                                                                                     |                                                  |                            |                                   |       |                    |        |                   |       |      |        |         |        |       |        |        |      
|Cost of revenue:                                                                     |                                                  |                            |                                   |       |                    |        |                   |       |      |        |         |        |       |        |        |      
|                                                                                     | Products                                         |                            |                                   | 1,816 |                    |        |                   | 857   |      |        |         | 5,088  |       |        |        | 3,745 |    
|                                                                                     | Services, maintenance and support                |                            |                                   | 466   |                    |        |                   | 578   |      |        |         | 1,520  |       |        |        | 2,113 |    
|                                                                                     |                                                  |                            |                                   |       |                    |        |                   |       |      |        |         |        |       |        |        |      
|                                                                                     |                                                  |                            | Total cost of revenue             |       |                    | 2,282  |                   |       |      | 1,435  |         |        |       | 6,608  |        |       |     | 5,858  |  
|                                                                                     |                                                  |                            |                                   |       |                    |        |                   |       |      |        |         |        |       |        |        |      
|                                                                                     |                                                  |                            | Gross margin                      |       |                    | 3,250  |                   |       |      | 1,594  |         |        |       | 8,175  |        |       |     | 6,796  |  
|                                                                                     |                                                  |                            |                                   |       |                    |        |                   |       |      |        |         |        |       |        |        |      
|Operating expenses:                                                                  |                                                  |                            |                                   |       |                    |        |                   |       |      |        |         |        |       |        |        |      
|                                                                                     | Research and development                         |                            |                                   | 1,129 |                    |        |                   | 1,146 |      |        |         | 2,920  |       |        |        | 4,073 |    
|                                                                                     | Sales and marketing                              |                            |                                   | 1,660 |                    |        |                   | 1,278 |      |        |         | 4,009  |       |        |        | 4,791 |    
|                                                                                     | General and administrative                       |                            |                                   | 1,154 |                    |        |                   | 1,105 |      |        |         | 2,933  |       |        |        | 4,069 |    
|                                                                                     | Amortization of deferred stock
compensation, net |                            |                                   | 447   |                    |        |                   | 155   |      |        |         | 1,615  |       |        |        | 706   |    
|                                                                                     |                                                  |                            |                                   |       |                    |        |                   |       |      |        |         |        |       |        |        |      
|                                                                                     |                                                  |                            | Total operating expenses          |       |                    | 4,390  |                   |       |      | 3,684  |         |        |       | 11,477 |        |       |     | 13,639 |  
|                                                                                     |                                                  |                            |                                   |       |                    |        |                   |       |      |        |         |        |       |        |        |      
|                                                                                     |                                                  |                            | Loss from operations              |       |                    | (1,140 | )                 |       |      | (2,090 | )       |        |       | (3,302 | )      |       |     | (6,843 | )
|                                                                                     |                                                  |                            |                                   |       |                    |        |                   |       |      |        |         |        |       |        |        |      
|Other income (expenses)                                                              |                                                  |                            |                                   |       |                    |        |                   |       |      |        |         |        |       |        |        |      
|                                                                                     | Interest expense                                 |                            |                                   | (247  | )                  |        |                   |      |      |        |         | (977   | )     |        |        | (2    | )  
|                                                                                     | Interest income                                  |                            |                                   | 192   |                    |        |                   | 157   |      |        |         | 311    |       |        |        | 643   |    
|                                                                                     | Other, net                                       |                            |                                   | (5    | )                  |        |                   | (4    | )    |        |         | (10    | )     |        |        | 23    |    
|                                                                                     |                                                  |                            |                                   |       |                    |        |                   |       |      |        |         |        |       |        |        |      
|                                                                                     |                                                  |                            | Total other income (expense), net |       |                    | (60    | )                 |       |      | 153    |         |        |       | (676   | )      |       |     | 664    |  
|                                                                                     |                                                  |                            |                                   |       |                    |        |                   |       |      |        |         |        |       |        |        |      
|                                                                                     |                                                  |                            | Net loss                          |       | $                  | (1,200 | )                 |       | $    | (1,937 | )       |        | $     | (3,978 | )      |       | $   | (6,179 | )
|                                                                                     |                                                  |                            |                                   |       |                    |        |                   |       |      |        |         |        |       |        |        |      
|Beneficial conversion related to convertible
preferred stock                         |                                                  |                            | (37,783                           | )     |                    |        |                  |       |      |        | (37,783 | )      |       |        |       |      
|                                                                                     |                                                  |                            |                                   |       |                    |        |                   |       |      |        |         |        |       |        |        |      
|Net loss attributable to common stockholders                                         |                                                  | $                          | (38,983                           | )     |                    | $      | (1,937            | )     |      | $      | (41,761 | )      |       | $      | (6,179 | )    
|                                                                                     |                                                  |                            |                                   |       |                    |        |                   |       |      |        |         |        |       |        |        |      
|Net loss per share  basic and diluted                                               |                                                  | $                          | (3.21                             | )     |                    | $      | (0.08             | )     |      | $      | (9.95   | )      |       | $      | (0.25  | )    
|                                                                                     |                                                  |                            |                                   |       |                    |        |                   |       |      |        |         |        |       |        |        |      
|Weighted Average shares used in calculating
basic and diluted net loss per share     |                                                  |                            | 12,136                            |       |                    |        | 25,181            |       |      |        | 4,195   |        |       |        | 25,159 |      
|                                                                                     |                                                  |                            |                                   |       |                    |        |                   |       |      |        |         |        |       |        |        |      
|Pro forma net loss per share  basic & diluted                                       |                                                  | $                          | (1.56                             | )     |                    |        |                   |       |      | $      | (1.67   | )      |       |        |        |      
|                                                                                     |                                                  |                            |                                   |       |                    |        |                   |       |      |        |         |        |       |        |        |      
|Pro forma weighted average shares used in
calculating basic & diluted loss per share |                                                  |                            | 25,067                            |       |                    |        |                   |       |      |        | 25,012  |        |       |        |        |      
|                                                                                     |                                                  |                            |                                   |       |                    |        |                   |       |      |        |         |        |       |        |        |      
|* Amortization of deferred stock compensation
excluded from the following expenses:  |                                                  |                            |                                   |       |                    |        |                   |       |      |        |         |        |       |        |        |      
|                                                                                     |                                                  | Cost of revenue            |                                   | $     | 49                 |        |                   | $     | 18   |        |         | $      | 214   |        |        | $     | 98  |       
|                                                                                     |                                                  | Research and development   |                                   |       | 39                 |        |                   |       | 14   |        |         |        | 184   |        |        |       | 83  |       
|                                                                                     |                                                  | Sales and marketing        |                                   |       | 350                |        |                   |       | 120  |        |         |        | 1,178 |        |        |       | 508 |       
|                                                                                     |                                                  | General and administrative |                                   |       | 9                  |        |                   |       | 3    |        |         |        | 39    |        |        |       | 17  |       
|                                                                                     |                                                  |                            |                                   |       |                    |        |                   |       |      |        |         |        |       |        |        |      
|                                                                                     |                                                  | $                          | 447                               |       |                    | $      | 155               |       |      | $      | 1,615   |        |       | $      | 706    |      
|                                                                                     |                                                  |                            |                                   |       |                    |        |                   |       |      |        |         |        |       |        |        |      

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

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AVISTAR COMMUNICATIONS CORPORATION AND SUBSIDIARIES

CONDENSED COMBINED STATEMENT OF
CASH FLOWSFOR THE NINE MONTHS ENDED SEPTEMBER 30, 2000 AND CONDENSED CONSOLIDATED STATEMENT OF
CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2001
(IN THOUSANDS)

|                                      |                                                                             |                                            |                                           |         |                   |       |               |         |     |      |  
|------------------------------------- | --------------------------------------------------------------------------- | ------------------------------------------ | ----------------------------------------- | ------- | ----------------- | ----- | ------------- | ------- | --- | ---- | -
|                                      |                                                                             |                                            |                                           |         | NINE MONTHS ENDED
|                                      |                                                                             |                                            |                                           |         |                  
|                                      |                                                                             |                                            |                                           |         | SEPTEMBER 30,     |       | SEPTEMBER 30,
|                                      |                                                                             |                                            |                                           |         | 2000              |       | 2001         
|                                      |                                                                             |                                            |                                           |         |                   |       |              
|                                      |                                                                             |                                            |                                           |         | (UNAUDITED)      
|Cash Flows from Operating Activities: |                                                                             |                                            |                                           |         |                   |       |               |        
|                                      | Net loss                                                                    |                                            | $                                         | (3,978  | )                 |       | $             | (6,179  | )  
|                                      | Adjustments to reconcile net loss to net cash used in operating activities: |                                            |                                           |         |                   |       |               |         |    
|                                      |                                                                             | Depreciation                               |                                           |         | 110               |       |               |         | 130 |     
|                                      |                                                                             | Stock compensation expense, net            |                                           |         | 1,615             |       |               |         | 706 |     
|                                      |                                                                             | Provision for doubtful accounts            |                                           |         | (11               | )     |               |         | 50  |     
|                                      |                                                                             | Changes in current assets and liabilities: |                                           |         |                   |       |               |         |     |     
|                                      |                                                                             |                                            | Accounts receivable                       |         |                   | (558  | )             |         |     | 688  |  
|                                      |                                                                             |                                            | Inventories                               |         |                   | (984  | )             |         |     | 512  |  
|                                      |                                                                             |                                            | Prepaid expenses and other current assets |         |                   | (429  | )             |         |     | 32   |  
|                                      |                                                                             |                                            | Other assets                              |         |                   | 60    |               |         |     | (173 | )
|                                      |                                                                             |                                            | Accounts payable                          |         |                   | 348   |               |         |     | (902 | )
|                                      |                                                                             |                                            | Deferred revenue and deposits             |         |                   | 1,319 |               |         |     | (435 | )
|                                      |                                                                             |                                            | Accrued liabilities and other             |         |                   | 639   |               |         |     | (400 | )
|                                      |                                                                             |                                            |                                           |         |                   |       |               |        
|                                      | Net cash used in operating activities                                       |                                            |                                           | (1,869  | )                 |       |               | (5,971  | )  
|                                      |                                                                             |                                            |                                           |         |                   |       |               |        
|Cash Flows from Investing Activities: |                                                                             |                                            |                                           |         |                   |       |               |        
|                                      | Purchase of short-term investments                                          |                                            |                                           |        |                   |       |               | (5,225  | )  
|                                      | Purchase of property and equipment                                          |                                            |                                           |        |                   |       |               | (507    | )  
|                                      |                                                                             |                                            |                                           |         |                   |       |               |        
|                                      | Net cash used in investing activities                                       |                                            |                                           |        |                   |       |               | (5,732  | )  
|                                      |                                                                             |                                            |                                           |         |                   |       |               |        
|Cash Flows from Financing Activities: |                                                                             |                                            |                                           |         |                   |       |               |        
|                                      | Net borrowings under line of credit                                         |                                            |                                           | 817     |                   |       |               |        |    
|                                      | Payments on notes payable to related parties                                |                                            |                                           | (12,623 | )                 |       |               |        |    
|                                      | Borrowings from related parties                                             |                                            |                                           | 900     |                   |       |               |        |    
|                                      | Proceeds from issuance of common stock                                      |                                            |                                           | 31,410  |                   |       |               | 253     |    
|                                      | Repurchases of common stock                                                 |                                            |                                           |        |                   |       |               | (34     | )  
|                                      |                                                                             |                                            |                                           |         |                   |       |               |        
|                                      | Net cash provided by financing activities                                   |                                            |                                           | 20,504  |                   |       |               | 219     |    
|                                      |                                                                             |                                            |                                           |         |                   |       |               |        
|                                      | Net increase (decrease) in cash and cash equivalents                        |                                            |                                           | 18,635  |                   |       |               | (11,484 | )  
|                                      | Cash and cash equivalents, beginning of period                              |                                            |                                           | 6,232   |                   |       |               | 21,660  |    
|                                      |                                                                             |                                            |                                           |         |                   |       |               |        
|                                      | Cash and cash equivalents, end of period                                    |                                            | $                                         | 24,867  |                   |       | $             | 10,176  |    
|                                      |                                                                             |                                            |                                           |         |                   |       |               |        
|Supplemental Cash Flow Information:   |                                                                             |                                            |                                           |         |                   |       |               |        
|                                      | Cash paid for income taxes                                                  |                                            | $                                         | 5       |                   |       | $             |        |    
|                                      | Cash paid for interest                                                      |                                            | $                                         | 1,201   |                   |       | $             |        |    
|                                      | Beneficial conversion related to convertible preferred stock                |                                            | $                                         | 37,783  |                   |       | $             |        |    

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

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AVISTAR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)

1. Business, Basis of Presentation, Use of Estimates, and Risks and
Uncertainties

Business

Avistar Communications Corporation (Avistar or the Company) provides
networked video communications software and hardware products and services.
Avistars products include applications for interactive video calling, content
creation and publishing, broadcast video and video-on-demand, as well as data
sharing, directory services and network management. Avistar designs, markets,
sells, manufactures and/or assembles and installs and supports its products.
Avistars real-time and non-real-time products are based upon its architecture
and Video Operating System platform, which facilitate distribution over local
and wide area networks using telephony or internet services as appropriate. In
addition, Avistar develops, prosecutes, maintains and supports intellectual
property used in the Companys products. Avistars services include
consulting, implementation, training, maintenance and support.

Basis of Presentation

The unaudited balance sheet as of September 30, 2001 presents the
consolidated financial position of Avistar and its two wholly-owned
subsidiaries, Avistar Systems Corporation UK (ASC UK) and Collaboration
Properties, Inc. (CPI). In July of 2001, the Boards of Directors of Avistar
Communications Corporation (ACC) and Avistar Systems Corporation (ASC)
approved the merger of ASC, the wholly owned subsidiary of ACC, with and into
ACC. The merger was completed in July 2001. The consolidated results are
referred to, collectively, as those of Avistar or the Company in these notes.

The functional currency of ASC UK is the U.S. dollar. Accordingly, all
gains and losses resulting from transactions denominated in currencies other
than the U.S. dollar are included in the statements of operations. All amounts
included herein are unaudited unless otherwise specified.

Use Of Estimates

The preparation of financial statements requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and to disclose contingent liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reported
period. Actual results could differ from those estimates.

Risks and Uncertainties

The markets for the Companys products and services have only recently
begun to develop. Some of the Companys products utilize changing and emerging
technologies. As is typical in industries of this nature, demand and market
acceptance are subject to a high level of uncertainty, particularly when there
are adverse conditions in the economy. Acceptance of the Companys products,
over time, is critical to the Companys success. The Companys prospects must
be evaluated in light of difficulties encountered by it and its competitors in
further developing this evolving marketplace. The Company has generated losses
since inception and had an accumulated deficit of $63 million as of September
30, 2001. The Companys operating results may fluctuate significantly in the
future as a result of a variety of factors, including, but not limited to, the
current challenging economic environment, the use of differing distribution
channels, and the timing of the new product announcements by the Company or its
competitors.

2. Summary of Significant Accounting Policies

Unaudited Interim Financial Information

In the opinion of management, the unaudited financial statements furnished
in this report reflect all adjustments (consisting of normal recurring
adjustments) necessary for a fair presentation of the results of operations for
the interim periods covered and of the Companys financial position as of the
interim balance sheet date. The results of operations for the interim periods
are not necessarily indicative of the results for the entire year. These
financial statements should be read in conjunction with the Companys audited
consolidated financial statements and the accompanying notes for the year ended
December 31, 2000 included in the Companys annual report on Form 10-K filed
with the Securities and Exchange Commission.

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Cash and Cash Equivalents and Short Term Investments

The Company considers all investment instruments purchased with an
original maturity of three months or less to be cash equivalents. The Companys
cash equivalents at December 31, 2000 and September 30, 2001 consisted of money
market funds and short-term securities.

The Company classifies its short-term investments as available for sale
with unrealized gains or losses reported as a separate component of
stockholders equity. At September 30, 2001, the Companys investments
approximated fair value, and, as such, unrealized holding gains and losses were
insignificant. The fair value of the Companys investments was determined
based on quoted market prices at the reporting date for those instruments.

Significant Concentrations

A relatively small number of customers accounted for a significant
percentage of the Companys net sales. Sales to these customers as a percentage
of sales were as follows for the three months and nine months ended September
30, 2000 and 2001:

|           |  |                    |    |                   |  |      |    |      |  |  |    |   |  |  |    |  
|---------- |  | ------------------ | -- | ----------------- |  | ---- | -- | ---- |  |  | -- | - |  |  | -- | -
|           |  | THREE MONTHS ENDED |    | NINE MONTHS ENDED
|           |  | SEPTEMBER 30,      |    | SEPTEMBER 30,    
|           |  |                    |    |                  
|           |  | 2000               |    | 2001              |  | 2000 |    | 2001
|           |  |                    |    |                   |  |      |    |     
|           |  | (UNAUDITED)       
|Customer A |  |                    | 38 | %                 |  |      | 32 | %    |  |  | 29 | % |  |  | 33 | %
|Customer B |  |                    | 33 | %                 |  |      | 21 | %    |  |  | 25 | % |  |  | 25 | %
|Customer C |  |                    | 11 | %                 |  |      | *  |      |  |  | 12 | % |  |  | *  |  
|Customer D |  |                    | *  |                   |  |      | 15 | %    |  |  | 15 | % |  |  | *  |  



---

|* |  | Less than 10%
|- |  | -------------

Any change in the relationship with these customers could have a
potentially adverse effect on the Companys financial position and/or results
of operations.

Financial instruments that potentially subject the Company to
concentrations of credit risk consist primarily of trade receivables from U.S.
and foreign entities. As of December 31, 2000, approximately 80% of accounts
receivable was concentrated with four customers. As of September 30, 2001,
approximately 74 % of accounts receivable was concentrated with four customers.

Inventories

Inventories are stated at the lower of cost (first-in, first-out method)
or market and comprised the following (in thousands):

|                                                       |             |              |       |               |  |   |       | 
|------------------------------------------------------ | ----------- | ------------ | ----- | ------------- |  | - | ----- | 
|                                                       |             | DECEMBER 31, |       | SEPTEMBER 30,
|                                                       |             | 2000         |       | 2001         
|                                                       |             |              |       |              
|                                                       | (UNAUDITED)
|Raw materials                                          |             | $            | 216   |               |  | $ | 166   | 
|Work-in-progress                                       |             |              | 88    |               |  |   | 327   | 
|Finished goods                                         |             |              | 998   |               |  |   | 1,137 | 
|Inventory shipped to customer sites, not yet installed |             |              | 854   |               |  |   | 231   | 
|                                                       |             |              |       |               |  |   |       | 
|                                                       |             | $            | 2,156 |               |  | $ | 1,861 | 
|                                                       |             |              |       |               |  |   |       | 

Inventory shipped to customer sites, not yet installed, represents product
shipped to customer sites pending completion of the installation process by the
Company. As of December 31, 2000 and September 30, 2001, the Company had billed
approximately $2.4 million and $600,000 to their customers related to these
shipments, but had fully reserved the receivable, and had not recognized the
revenue, as the installations had not been completed.

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Research and Development

Research and development expenditures are charged to operations as
incurred. Statement of Financial Accounting Standards (SFAS) No. 86 (SFAS
86), Accounting for Costs of Computer Software to be Sold, Leased, or
Otherwise Marketed, requires the capitalization of certain software
development costs subsequent to the establishment of technological feasibility.
Based on the Companys product development process, technological feasibility
is established upon completion of a working model. Costs incurred by the
Company between completion of a working model and the point at which the
product is ready for general release have been insignificant. Through September
30, 2001, all research and development costs have been expensed.

Patent Costs

Due to uncertainties about the estimated future economic benefits and
lives of the Companys patents and patent applications, all related outside
patent costs have been expensed as incurred, and the Company plans to continue
with this policy in the future. Outside patent costs were approximately
$300,000 and $344,000 for the nine months ended September 30, 2000 and 2001,
respectively, and were reflected in general and administrative expenses in the
accompanying statements of operations.

Revenue Recognition and Deferred Revenue

The Company recognizes revenue pursuant to the Statement of Position
(SOP) SOP 97-2, Software Revenue Recognition (SOP 97-2), SOP 98-9,
Modification of SOP 97-2, Software Revenue Recognition, with Respect to
Certain Transactions (SOP 98-9) and Staff Accounting Bulletin No. 101 (SAB
101), Revenue Recognition in Financial Statements. Accordingly, the Company
recognizes revenues from product sales when all of the following conditions are
met: the product has been shipped, an arrangement exists with the customer at a
fixed price and the Company has the right to invoice the customer, collection
of the receivable is probable and the Company has fulfilled all of its material
contractual obligations to the customer.

The price charged for maintenance is stipulated in the contract and is
based on a percentage of product revenue. Customers have the option to
initially acquire and subsequently renew the maintenance in subsequent periods
at the rate established in the original agreement. Training services are
offered independently from the purchase of products or maintenance.

When the Company provides installation services, the Company recognizes
product and installation revenues upon completion of installation and customer
acceptance. When the customer or a third party provides installation services,
the Company recognizes product revenue upon shipment. Product sales are
invoiced upon shipment, subject to specific payment terms. Installation and
training services are payable upon provision of services, subject to specific
payment terms. If payments for systems are received in advance of the
completion of installation, such amounts are recorded as deferred revenue in
the accompanying balance sheets until installation has occurred and the
customer has accepted the product. Revenue from the provision of services,
including training, is recognized as the work is performed. Revenue from
maintenance is offered based on a percentage of product sales and is recognized
pro-rata over the maintenance term, which is typically one year in length.
Payments for services and maintenance made in advance of the provision of
services and maintenance are recorded as deferred revenue.

Recent Accounting Pronouncements

In July 2001, the Financial Accounting Standards Board (FASB) issued
SFAS No. 141 (SFAS 141), Business Combinations, which supersedes Accounting
Principles Board (APB) Opinion No. 16, Business Combinations. SFAS 141
eliminates the pooling-of-interests method of accounting for business
combinations and modifies the application of the purchase accounting method.
The elimination of the pooling-of-interests method is effective for
transactions initiated after September 30, 2001. The remaining provisions of
SFAS 141 will be effective for transactions accounted for using the purchase
method that are completed after September 30, 2001. The Company believes that
the adoption of this Statement will not have a material impact on the financial
position or the results of operations of the Company.

In July 2001, the FASB also issued SFAS No. 142, (SFAS 142), Goodwill
and Intangible Assets, which supersedes APB Opinion No. 17, Intangible
Assets. SFAS 142 eliminates the current requirement to amortize goodwill and
indefinite-lived intangible assets, addresses the amortization of intangible
assets with a defined life and addresses the impairment testing and recognition
for goodwill and intangible assets. SFAS 142 will apply to goodwill and
intangible assets arising from transactions completed before and after the
Statements effective date. SFAS 142 is effective for 2002. The Company
believes that the adoption of this Statement will not have a material impact on
the financial position or the results of operations of the Company.

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In June 2001, the FASB issued SFAS No. 143 (SFAS 143), Accounting for
Asset Retirement Obligations. SFAS 143 addresses financial accounting and
reporting for obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. SFAS 143 is required for
adoption for fiscal years beginning after June 15, 2002. Management has
reviewed the provisions of SFAS 143, and believes that upon adoption, the
Statement will not have a significant effect on the Companys financial
statements.

In August 2001, the FASB issued SFAS No. 144 (SFAS 144), Accounting for
the Impairment or Disposal of Long-Lived Assets. SFAS 144 establishes a single
accounting model for long-lived assets to be disposed off and replaces SFAS No.
121 and APB Opinion No. 30. The provisions of this statement are effective
beginning with fiscal years starting after December 15, 2001. Management
believes the adoption of SFAS 144 will not have a material effect on the
Companys financial statements.

3. Related Party Transactions

Certain directors with controlling interests in the Company are also the
majority owners of two entities that conducted business with the Company,
Vicor, Inc. (Vicor) and Western Data Systems of Nevada, Inc. (WDS).
Descriptions of certain transactions between the Company and these entities
follow.

Support Services

Prior to January 1, 2001, the Company maintained a support center to
handle first level support calls for WDS. The support center also handled
calls for the Company. Pursuant to an agreement between the Company and WDS
dated July 1, 1996, the Company charged WDS for its share of support center
costs. For the nine months ended September 30, 2000, the Company received fees
of approximately $100,000 under the agreement. The subsequent reimbursement
from WDS was recorded as a reduction in the costs incurred for the support
center. This agreement was terminated in December 2000. The Company did not
receive any fees from WDS for the nine months ended September 30, 2001.

Lease

The Company began subleasing office space to Vicor in September 1999. The
Company received approximately $68,000 and $34,000 during the nine months
ended September 30, 2000 and 2001, respectively, from Vicor pursuant to the
sublease agreement. As of March 31, 2001, the Company is no longer subleasing
office space to Vicor.

Revenue From a Related Party

UBS Warburg LLC, which is an affiliate of UBS (an approximate 5%
stockholder during 2000), is also a customer of the Company. Revenue from UBS
Warburg LLC and its affiliates represented approximately 25% of total revenue
for the nine months ended September 30, 2000. Management believes the
transactions with UBS Warburg LLC and its affiliates are at terms comparable to
those provided to unrelated third parties. Since December 31, 2000, the
Company does not have any information to suggest that UBS Warburg holds 5% or
more of outstanding shares of common stock of the Company.

4. Stock Repurchase Plan

On March 22, 2001 the Company announced that its Board authorized the
repurchase of up to $2.0 million of its common stock in the open market.
During the nine months ended September 30, 2001, the Company repurchased 22,500
shares at an aggregate cost of approximately $34,000.

5. Net Loss Per Share

Basic and diluted net loss per share of common stock are presented in
conformity with SFAS No. 128 (SFAS 128), Earnings Per Share, for all
periods presented. Pursuant to SEC Staff Accounting Bulletin No. 98, common
stock and convertible preferred stock issued or granted for nominal
consideration prior to an initial public offering must be included in the
calculation of basic and diluted net loss per share as if such stock had been
outstanding for the period ended September 30, 2000. To date, the Company has
had no issuances or grants for nominal consideration.

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In accordance with SFAS 128, basic net loss per share has been computed
using the weighted average number of shares of common stock outstanding during
the period, less shares subject to repurchase. Diluted net loss per share is
computed on the basis of the weighted average number of shares and common
equivalent shares outstanding during the period. Common equivalent shares
result from the assumed exercise of outstanding stock options that have a
dilutive effect when applying the treasury stock method. The Company has
excluded all convertible preferred stock, outstanding stock options and shares
subject to repurchase from the calculation of diluted net loss per share for
the nine months ended September 30, 2000 and 2001 because all such securities
are anti-dilutive. Accordingly, diluted net loss per share approximates basic
net loss per share for all periods presented.

The total number of shares excluded from the calculations of diluted net
loss per share were 892,177 and 531,170 for the three months ended September
30, 2000 and 2001, respectively, and 1,124,571 and 824,871 for the nine months
ended September 30, 2000 and 2001, respectively. Basic and diluted pro forma
net loss per share have been computed as described above and also give effect,
under SEC guidance, to the conversion of the convertible preferred stock (using
the if-converted method) from the original date of issuance and the effect of
the beneficial conversion related to the Series A convertible preferred stock.

6. Segment Reporting

Disclosure of segments is presented in accordance with SFAS No. 131 (SFAS
131), Disclosures About Segments of an Enterprise and Related Information.
SFAS 131 was adopted by the Company in January 1998. SFAS 131 establishes
standards for disclosures regarding operating segments, products and services,
geographic areas and major customers. The Company is organized and operates in
two operating segments: (1) the design, development, manufacturing, sale and
marketing of networked video communications products (ACC) and (2) the
development, prosecution, maintenance and support of the intellectual property
used in the Companys products (CPI). The parent company (ACC) also engages in
the corporate functions and provides financing and services to the
subsidiaries. The Companys chief decision maker monitors the Companys
operations based upon the information reflected in the following table:

|                                     |                          |  |     |         |     |  |       |        |   |  |   |         |  
|------------------------------------ | ------------------------ |  | --- | ------- | --- |  | ----- | ------ | - |  | - | ------- | -
|                                     |                          |  | ACC |         | CPI |  | Total
|                                     |                          |  |     |         |     |  |      
|Nine Months Ended September 30, 2001 |                          |  |     |         |     |  |       |        |   |  |   |        
|                                     | Revenue                  |  | $   | 12,654  |     |  | $     |       |   |  | $ | 12,654  |  
|                                     | Gross margin             |  |     | 6,796   |     |  |       |       |   |  |   | 6,796   |  
|                                     | Depreciation expense     |  |     | (121    | )   |  |       | (9     | ) |  |   | (130    | )
|                                     | Total operating expenses |  |     | (12,771 | )   |  |       | (868   | ) |  |   | (13,639 | )
|                                     | Interest income          |  |     | 643     |     |  |       |       |   |  |   | 643     |  
|                                     | Interest expense         |  |     | (2      | )   |  |       |       |   |  |   | (2      | )
|                                     | Net loss                 |  |     | (5,311  | )   |  |       | (868   | ) |  |   | (6,179  | )
|                                     | Assets                   |  |     | 21,301  |     |  |       | 11     |   |  |   | 21,312  |  
|Nine Months Ended September 30, 2000 |                          |  |     |         |     |  |       |        |   |  |   |        
|                                     | Revenue                  |  | $   | 14,783  |     |  | $     |       |   |  | $ | 14,783  |  
|                                     | Gross margin             |  |     | 8,175   |     |  |       |       |   |  |   | 8,175   |  
|                                     | Depreciation expense     |  |     | (99     | )   |  |       | (11    | ) |  |   | (110    | )
|                                     | Total operating expenses |  |     | (10,511 | )   |  |       | (966   | ) |  |   | (11,477 | )
|                                     | Interest income          |  |     | 277     |     |  |       | 34     |   |  |   | 311     |  
|                                     | Interest expense         |  |     | (810    | )   |  |       | (167   | ) |  |   | (977    | )
|                                     | Net loss                 |  |     | (2,878  | )   |  |       | (1,100 | ) |  |   | (3,978  | )
|                                     | Assets                   |  |     | 30,277  |     |  |       | 693    |   |  |   | 30,970  |  

International revenue, which consists of domestic sales to customers with
operations principally in Western Europe, and more specifically, a significant
concentration in the United Kingdom, comprised 43%, and 47% of total revenue
for the nine months ended September 30, 2000, and 2001, respectively. The
Company had no significant long-lived assets in any country other than in the
United States for any period presented.

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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with the Unaudited
Condensed Consolidated Interim Financial Statements and the Notes thereto
included elsewhere herein, and the audited consolidated financial statements
contained in the Companys Annual Report on Form 10-K for the year ended
December 31, 2000, as filed with the Securities and Exchange Commission.

Certain statements in this Managements Discussion and Analysis of
Financial Condition and Results of Operations are forward looking statements.
These statements relate to future events or our future financial performance
and involve known and unknown risks, uncertainties and other factors that may
cause our or our industrys actual results, levels of activity, performance or
achievements to be materially different from any future results, levels of
activity, performance or achievements expressed or implied by the forward
looking statements. These risks and other factors include those listed under
Factors Affecting Future Operating Results and elsewhere in this report on
Form 10-Q. In some cases, you can identify forward-looking statements by
terminology such as may, will, should, expects, plans, anticipates,
believes, estimates, predicts, potential, continue or the negative of
these terms or other comparable terminology. These statements are only
predictions. Actual events or results may differ materially. In evaluating
these statements, you should specifically consider various factors, including
the risks outlined under Risk Factors. These factors may cause our actual
results to differ materially from any forward-looking statement.

Although we believe that the expectations reflected in the forward looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements. Moreover, neither we nor any other
person assumes responsibility for the accuracy and completeness of these
forward-looking statements. We are under no duty to update any of the
forward-looking statements after the date of this report on Form 10-Q to
conform our prior statements to actual results.

Overview

We engage in the design, development, manufacturing, sale and marketing of
networked video communications products, and associated support services, and
Collaboration Properties, Inc., our wholly owned subsidiary, engages in the
development, prosecution, maintenance, support and licensing of the
intellectual property used in our system.

Revenue

We derive product revenue principally from the sale and licensing of our
video-enabled networked communications system consisting of a suite of
Avistar-designed software and hardware products, including third party
components. In addition, we derive revenue from fees for installation,
maintenance, support and training services. As a percentage of total revenue,
product revenue was 78% in the nine months ended September 30, 2000 and 70% in
the nine months ended September 30, 2001.

Revenue from customers outside the United States accounted for 43% of our
revenue in the nine months ended September 30, 2000 and 47% of our revenue in
the nine months ended September 30, 2001. To date, a significant portion of our
revenue resulted from sales to a limited number of customers. In the nine
months ended September 30, 2000, we recorded revenue of approximately $12.0
million, or 81% of total revenue, from our four largest customers and their
affiliates. In the nine months ended September 30, 2001, we recorded revenue of
approximately $7.3 million, or 58% of total revenue, from our two largest
customers and their affiliates. We anticipate that our revenue and, therefore,
our operating results for any given period, will continue to depend to a
significant extent on a limited number of customers. As a result, the loss or a
reduction in sales to any one of these customers would have a significant
adverse impact on our operations and financial performance.

Cost of Revenue

Our cost of revenue consists primarily of the cost of software and
hardware, including compensation and third party components, the cost of
compensation for installation, maintenance, support and training personnel and
other costs related to facilities and office equipment for professional
services, technical support and training personnel. We recognize product costs
as revenue is recorded, and costs of installation, maintenance, support and
training services as we incur those expenses.

Operating Expenses

We generally recognize our operating expenses as we incur them in six
operational categories: research and development, sales and marketing and
general and administrative. Our operating expenses also include amortization of
our deferred stock compensation charges related to stock options. These charges
are amortized over the vesting period of the options, generally four years. Our
research

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and development expenses consist primarily of compensation expenses for
our personnel, patent and licensing costs and, to a minor extent, independent
contractors. We expense all patent and licensing costs. Our sales and marketing
expenses consist primarily of compensation, commissions and travel expenses,
along with other marketing expenses. Our general and administrative expenses
consist primarily of compensation for our administrative, financial, and
contractual personnel, and a number of non-allocable costs, including
professional fees, legal fees, accounting fees and provision for doubtful
accounts.

We allocate the total cost of overhead and facilities to each of the
functional areas that use overhead and facilities, based upon the number of
employees assigned to each of these areas. These allocated charges include
facilities rent, utilities and depreciation/amortization expense for property
and equipment.

The non-cash deferred stock compensation charge relates to stock options,
and represents the difference between the exercise price of options granted to
acquire our shares of common stock during the period, and the deemed fair value
for financial reporting purposes of our shares of common stock on the
measurement date, which is the same as the date of grant of those options.
Based on the outstanding options at December 31, 2000, we anticipate recording
charges of approximately $900,000 in 2001, $400,000 in 2002 and $100,000 in
2003 to record the remainder of the costs associated with these grants.

Interest Income and Expenses

We generate interest income by investing our cash balances. At September
30, 2001, we had no short-term or long-term debt.

Income Taxes

We have made no provision for and have received no benefit from U.S.
federal income taxes for any period due to our operating losses. As of December
31, 2000, we had $3.9 million of net operating loss carry-forwards for U.S.
federal income tax purposes, which expire beginning on various dates through
the year 2020. Our use of these net operating losses may be limited in future
periods. We have recorded no tax benefits for these losses.

Results of Operations

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

|                        |                                             |                              |       |                             |       |                   |       |      |       |      |       |      |       |   |       |      |       | 
|----------------------- | ------------------------------------------- | ---------------------------- | ----- | --------------------------- | ----- | ----------------- | ----- | ---- | ----- | ---- | ----- | ---- | ----- | - | ----- | ---- | ----- | 
|                        |                                             |                              |       | PERCENTAGE OF TOTAL REVENUE
|                        |                                             |                              |       |                            
|                        |                                             |                              |       | THREE MONTHS ENDED          |       | NINE MONTHS ENDED
|                        |                                             |                              |       | SEPTEMBER 30,               |       | SEPTEMBER 30,    
|                        |                                             |                              |       |                             |       |                  
|                        |                                             |                              |       | 2000                        |       | 2001              |       | 2000 |       | 2001
|                        |                                             |                              |       |                             |       |                   |       |      |       |     
|Revenue:                |                                             |                              |       |                             |       |                   |       |      |       |      |       |      |       |   |       |     
|                        | Product                                     |                              |       | 81.2                        | %     |                   |       | 56.8 | %     |      |       | 78.3 | %     |   |       | 70.0 | %    
|                        | Services, maintenance and support           |                              |       | 18.8                        |       |                   |       | 43.2 |       |      |       | 21.7 |       |   |       | 30.0 |      
|                        |                                             | Total revenue                |       |                             | 100.0 |                   |       |      | 100.0 |      |       |      | 100.0 |   |       |      | 100.0 | 
|Cost of revenue:        |                                             |                              |       |                             |       |                   |       |      |       |      |       |      |       |   |       |     
|                        | Product                                     |                              |       | 32.8                        |       |                   |       | 28.3 |       |      |       | 34.4 |       |   |       | 29.6 |      
|                        | Services, maintenance and support           |                              |       | 8.4                         |       |                   |       | 19.1 |       |      |       | 10.3 |       |   |       | 16.7 |      
|                        |                                             | Total cost of revenue        |       |                             | 41.2  |                   |       |      | 47.4  |      |       |      | 44.7  |   |       |      | 46.3  | 
|Gross margin            |                                             |                              | 58.8  |                             |       |                   | 52.6  |      |       |      | 55.3  |      |       |   | 53.7  |     
|Operating expenses:     |                                             |                              |       |                             |       |                   |       |      |       |      |       |      |       |   |       |     
|                        | Research and development                    |                              |       | 20.4                        |       |                   |       | 37.8 |       |      |       | 19.8 |       |   |       | 32.2 |      
|                        | Sales and marketing                         |                              |       | 30.0                        |       |                   |       | 42.2 |       |      |       | 27.1 |       |   |       | 37.9 |      
|                        | General and administrative                  |                              |       | 20.9                        |       |                   |       | 36.5 |       |      |       | 19.8 |       |   |       | 32.2 |      
|                        | Amortization of deferred stock compensation |                              |       | 8.1                         |       |                   |       | 5.1  |       |      |       | 10.9 |       |   |       | 5.6  |      
|                        |                                             | Total operating expenses     |       |                             | 79.4  |                   |       |      | 121.6 |      |       |      | 77.6  |   |       |      | 107.9 | 
|Loss from operations    |                                             |                              | (20.6 | )                           |       |                   | (69.0 | )    |       |      | (22.3 | )    |       |   | (54.2 | )   
|Other (expense) income: |                                             |                              |       |                             |       |                   |       |      |       |      |       |      |       |   |       |     
|                        | Interest expense                            |                              |       | (4.5                        | )     |                   |       | 0.0  |       |      |       | (6.6 | )     |   |       | 0.0  |      
|                        | Interest income                             |                              |       | 3.5                         |       |                   |       | 5.2  |       |      |       | 2.1  |       |   |       | 5.1  |      
|                        | Other                                       |                              |       | (0.1                        | )     |                   |       | (0.1 | )     |      |       | (0.1 | )     |   |       | 0.2  |      
|                        |                                             | Total other (expense) income |       |                             | (1.1  | )                 |       |      | 5.1   |      |       |      | (4.6  | ) |       |      | 5.3   | 
|Net loss                |                                             |                              | (21.7 | )%                          |       |                   | (63.9 | )%   |       |      | (26.9 | )%   |       |   | (48.9 | )%  

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COMPARISON OF THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2000 AND 2001

Revenue

Total revenue decreased by 45% from $5.5 million for the three months
ended September 30, 2000 to $3.0 million for the three months ended September
30, 2001, and decreased by 14% from $14.8 million for the nine months ended
September 30, 2000 to $12.7 million for the nine months ended September 30,
2001. The decrease during the three months ended September 30, 2001 relative to
the prior year was due to lower product sales. Those lower product sales were
due predominantly to delayed procurement decisions in our customers
organizations. The decrease in revenue for the nine months ended September 30,
2001, relative to the prior year, reflected a decrease in product revenue and
an increase in service revenue. For the nine months ended September 30, 2001,
revenue from two customers accounted for 58% of total revenue. The comparable
concentration figure for the same period in 2000 was 81% for the top four
customers. The level of sales to any customer may vary from quarter to
quarter. We expect that there will be significant customer concentration in
future quarters. The loss of any one of those customers would have a material
adverse impact on our financial condition or operating results.

Cost of Revenue

The cost of revenue declined by 37% from $2.3 million for the three months
ended September 30, 2000 to $1.4 million for the three months ended September
30, 2001, and decreased by 11% from $6.6 million for the nine months ended
September 30, 2000 to $5.9 million for the nine months ended September 30,
2001. Cost of revenue decreased during the three months ended September 30,
2001 relative to the prior year due to a reduction in product revenue, offset
partially by increased costs associated with service revenue. The same factors
influenced the decrease for the nine months ended September 30, 2001 relative
to the prior year.

Gross Margin

The gross margin as a percentage of revenue decreased from 59% for the
three months ended September 30, 2000 to 53% for the three months ended
September 30, 2001, and decreased slightly from 55% for the nine months ended
September 30, 2000 to 54% for the nine months ended September 30, 2001. The
decrease in the three months ended September 30, 2001 relative to the prior
year was due to a higher percentage of service revenue, which generally carries
a lower margin than product revenue, as well as the lower overall revenue base,
which provided more limited coverage of the fixed components of the cost of
sales.

Operating expenses

In July of 2001, a reduction of approximately 17% of the overall staffing
level at June 30, 2001 was completed, as one of several cost management
initiatives.

Research and development. Research and development expenses increased by
2% from $1.1 million in the three months ended September 30, 2000 to $1.1
million for the three months ended September 30, 2001, and by 39% from $2.9
million for the nine months ended September 30, 2000 to $4.1 million for the
nine months ended September 30, 2001. The increases in the three and nine month
periods ended September 30, 2001 relative to the prior year were due to the
addition of personnel and personnel related expenses, and increased prototype
and development expenses, reflecting increased costs for new product
development and enhancements to existing products.

Sales and marketing. Sales and marketing expenses decreased by 23% from
$1.7 million in the three months ended September 30, 2000 to $1.3 million in
the three months ended September 30, 2001, and increased by 20% from $4.0
million for the nine months ended September 30, 2000 to $4.8 million for the
nine months ended September 30, 2001. The decrease in the three month period
ended September 30, 2001 relative to the prior year was due to a reduction in
travel expenses and commissions, as well as reduced staffing and related costs.
The increase in the nine month period ended September 30, 2001 relative to the
prior year was due to increased personnel and personnel related costs due to
the hiring of additional sales and marketing staff in the first two quarters of
2001, and higher marketing program costs and related expenses.

General and administrative. General and administrative expenses decreased
by 4% from $1.2 million in the three months ended September 30, 2000 to $1.1
million for the three months ended September 30, 2001, and increased by 39%
from $2.9 million in the nine months ended September 30, 2000 to $4.1 million
for the nine months ended September 30, 2001. The decrease in the three month
period ended September 30, 2001 relative to the prior year was due to a
reduction in staffing. The increase in the nine month

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period ended September 30, 2001 relative to the prior year was a result of
hiring additional personnel earlier in the year, increased outside professional
services expenses and other expenses required of a public company.

Amortization of deferred stock compensation. Amortization of deferred
stock compensation decreased by 65% from $447,000 in the three months ended
September 30, 2000 to $155,000 in the three months ended September 30, 2001.
Amortization of deferred stock compensation decreased by 56% from $1.6 million
in the nine months ended September 30, 2000 to $706,000 in the nine months
ended September 30, 2001. The decreases in the three and nine month periods
ended September 30, 2001 were due to the achievement of full vesting for a
number of option grants.

Other expenses, net. Other expenses, net changed from an expense of
$60,000 in the three months ended September 30, 2000 to income of $153,000 in
the three months ended September 30, 2001. The change from the three months
ended September 30, 2000 to the three months ended September 30, 2001 was due
to lower interest expenses due to the retirement of debt. Other expenses, net
changed from an expense of $676,000 for the nine months ended September 30,
2000 to income of $664,000 for the nine months ended September 30, 2001. The
change from the nine month period ended September 30, 2000 to the nine month
period ended September 30, 2001 was due to lower interest expenses due to the
retirement of debt, and higher interest income due to an increased balance of
cash, cash equivalents, and short term investments resulting from our initial
public offering in August 2000.

LIQUIDITY AND CAPITAL RESOURCES

We had cash and cash equivalents and short-term investments of $21.7
million as of December 31, 2000 and $15.4 million as of September 30, 2001.
There were net cash inflows of $18.6 million for the nine months ended
September 30, 2000 and net cash outflows of $6.3 million for the nine months
ending September 30, 2001. For the nine months ended September 30, 2001, the
net cash outflow of $6.3 million resulted primarily from the net cash used in
operations of $6.0 million, which reflected a net loss of $6.2 million.

Expenditures for property and equipment for the nine months ended
September 30, 2001 were $507,000. At September 30, 2001, we did not have any
material commitments for future capital expenditures.

We had no outstanding borrowings at September 30, 2001 from our previous
line of credit. We incurred $82,000 of interest expense on this line of credit
for the nine months ended September 30, 2000 at an average interest rate of
10%. This line of credit was retired using the proceeds from a portion of a
$4.0 million one-year line of credit with another financial institution in
September 2000. This replacement line was subsequently retired in December
2000, and no interest expense was incurred during the nine months ended
September 30, 2001.

We currently believe that existing cash and cash equivalents balances and
short-term investments, will provide us with sufficient funds to finance our
operations for at least the next 12 months. We intend to continue to invest
heavily in the development of new products and enhancements to our existing
products. Our future liquidity and capital requirements will depend upon
numerous factors, including the costs and timing of our expansion of product
development efforts and the success of these development efforts, the costs and
timing of our expansion of sales and marketing activities, the extent to which
our existing and new products gain market acceptance, competing technological
and market developments, the costs involved in maintaining and enforcing patent
claims and other intellectual property rights, the level and timing of revenue,
and other factors. We may need to raise additional funds, and additional
financing may not be available on favorable terms, if at all. If we cannot
raise funds, if needed, on acceptable terms, we may not be able to develop or
enhance our products, take advantage of future opportunities, or respond to
competitive pressures or unanticipated requirements, which could seriously harm
our business, financial condition, and results of operations. If additional
funds are raised through the issuance of equity securities, our net tangible
book value per share may decrease, the percentage ownership of then current
stockholders may be diluted, and such equity securities may have rights,
preferences or privileges senior to those of the holders of our common stock.

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Recent Accounting Pronouncements

In July 2001, the Financial Accounting Standards Board (FASB) issued
SFAS No. 141 (SFAS 141), Business Combinations, which supersedes Accounting
Principles Board (APB) Opinion No. 16, Business Combinations. SFAS 141
eliminates the pooling-of-interests method of accounting for business
combinations and modifies the application of the purchase accounting method.
The elimination of the pooling-of-interests method is effective for
transactions initiated after September 30, 2001. The remaining provisions of
SFAS 141 will be effective for transactions accounted for using the purchase
method that are completed after September 30, 2001. The Company believes that
the adoption of this Statement will not have a material impact on the financial
position or the results of operations of the Company.

In July 2001, the FASB also issued SFAS No. 142, (SFAS 142), Goodwill
and Intangible Assets, which supersedes APB Opinion No. 17, Intangible
Assets. SFAS 142 eliminates the current requirement to amortize goodwill and
indefinite-lived intangible assets, addresses the amortization of intangible
assets with a defined life and addresses the impairment testing and recognition
for goodwill and intangible assets. SFAS 142 will apply to goodwill and
intangible assets arising from transactions completed before and after the
Statements effective date. SFAS 142 is effective for 2002. The Company
believes that the adoption of this Statement will not have a material impact on
the financial position or the results of operations of the Company.

In June 2001, the FASB issued SFAS No. 143 (SFAS 143), Accounting for
Asset Retirement Obligations. SFAS 143 addresses financial accounting and
reporting for obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. SFAS 143 is required for
adoption for fiscal years beginning after June 15, 2002. Management has
reviewed the provisions of SFAS 143, and believes that upon adoption, the
Statement will not have a significant effect on the Companys financial
statements.

In August 2001, the FASB issued SFAS No. 144 (SFAS 144), Accounting for
the Impairment or Disposal of Long-Lived Assets. SFAS 144 establishes a
single accounting model for long-lived assets to be disposed off and replaces
SFAS No. 121 and APB Opinion No. 30. The provisions of this statement are
effective beginning with fiscal years starting after December 15, 2001.
Management believes the adoption of SFAS 144 will not have a material effect on
the Companys financial statements.

Factors Affecting Future Operating Results

You may have difficulty evaluating our business and operating results because
we are still in the early stages of development.

Although we commenced operations in November 1993, the first two and a
half years of our operations were primarily dedicated to research and
development. We did not begin delivering our initial two-way video calling and
data sharing applications until mid-1996, and we did not release our full
product suite, including video-publishing, one-way broadcast viewing and
video-on-demand, until the third quarter of 1998. Because we have only recently
begun to offer our full system and services, it may be difficult for you to
evaluate our historical performance and project our future operating results.

In addition, as an early stage company in an industry with rapidly
changing technology, we face numerous risks and uncertainties associated with
our need to grow and develop, as discussed in more detail below. If we are
unsuccessful in addressing these risks, sales of our system and services, as
well as our ability to maintain or increase our customer base, will be
substantially diminished.

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

We incurred net losses of $6.2 million for the nine months ended September
30, 2001, $4.7 million for 2000 and $6.4 million for 1999. As of September 30,
2001, our accumulated deficit was $62.8 million. Our revenue may not increase,
or even remain at its current level. In addition, we expect our operating
expenses may increase significantly as we develop and expand our business in
the future. As a result, to become profitable, we will need to increase our
revenue by increasing sales to existing customers and by attracting additional
customers. If our expenses increase more rapidly than our revenue, we may never
become profitable. Furthermore, we will record additional amortization of
deferred stock compensation in connection with options that we granted in 1999
and 2000. This amortization, although declining, will further decrease our
ability to become profitable.

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We cannot predict whether or when we will become profitable. If we do
become profitable, we may not be able to sustain or increase profitability on a
quarterly or annual basis. In addition, if we fail to reach profitability or to
sustain or grow our profits within the time frame expected by investors, the
market price of our common stock may fall.

General economic conditions may reduce our revenues and harm our business.

Recently, economic growth in the United States has slowed to the point
where industries are delaying or reducing technology purchases. This tendency
may be further aggravated by the events of September 11, 2001. If our
customers delay ordering our products, we will fall short of our revenue
expectations for the balance of 2001 and/or beyond. These conditions have
negatively affected our business in the first nine months of 2001 and will in
the future if these conditions persist. The outlook for the video
communications industry is uncertain and it is very difficult to predict how
long the current slowdown will last, or whether we will be materially adversely
affected by such continued slowdown. Slower growth among our end-user
customers, tightening of customers operating budgets, retrenchment in the
capital markets and other general economic factors all could have a material
adverse effect on our capital resources, financial condition and results of
operations.

If our customers delay ordering our products, we will fall short of our
revenue expectations for any given quarter in 2001 or for the entire year and
beyond. These conditions have negatively affected our business in the first
nine months of 2001 and will in the future if these conditions persist. For
example, we experienced a decline in revenues during the nine months ended
September 30, 2001 relative to the same periods of 2000.

Our lengthy sales cycle to acquire new customers or large follow-on orders may
cause our quarterly operating results to vary significantly and make it more
difficult to forecast our revenue.

We have generally experienced a product sales cycle of four to nine months
for new customers or large follow-on orders due to the time needed to educate
potential customers about the uses and benefits of our system, and the
significant investment decisions that our prospective customers must make when
they decide to buy our system. Many of our prospective customers have neither
budgeted expenses for networked video communications systems nor personnel
specifically dedicated to the procurement, installation or support of these
systems. As a result, our customers spend a substantial amount of time before
purchasing our system performing internal reviews and obtaining capital
expenditure approvals. Current economic conditions have contributed to
additional deliberation, and consequent delay in the sales cycle.

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

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

Our customers typically place limited initial orders for our networked
video communications system, which allows them to evaluate its usefulness and
value. Our strategy is to pursue additional and larger follow-on orders after
these initial orders. Revenue generated from follow-on orders accounted for
approximately 91% and 89% of our revenue in the nine months ended September 30,
2000 and 2001, respectively. Current economic conditions have led to decreases
in our clients capital spending, and we have experienced a decrease in the
size of follow-on orders. Our future financial performance depends on
successful initial installations of our system, which in turn lead to follow-on
orders. If our system does not meet the needs and expectations of customers who
order our system, we may not be able to generate follow-on orders, or they may
be of smaller magnitude.

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

We have historically derived the majority of our revenue from a limited
number of customers, particularly Deutsche Bank and UBS Warburg LLC and their
affiliates. Collectively, these customers accounted for 58% of our revenue in
the nine months ended September 30, 2001. We expect to continue to depend upon
a limited number of customers for a substantial portion of our revenue.

The loss of a major customer or the reduction, delay or cancellation of
orders from one or more of our significant customers could cause our revenue
and, therefore, any profits we may make to decline, or our losses to increase.
Because we currently depend on a limited number of customers with lengthy
budgeting cycles and unpredictable buying patterns, our revenue from quarter to
quarter

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may be volatile. Adverse changes in our revenue or operating results as a
result of these budgeting cycles, or any other reduction in capital
expenditures by our large customers, could substantially reduce the trading
price of our common stock.

We may not be able to modify our products in a timely and cost effective manner
to respond to technological change, or to shifts away from the Microsoft
operating system.

Future hardware and software platforms embodying new technologies and the
emergence of new industry standards could render our system non-competitive or
even obsolete. The market for our system is characterized by:



| |  |  | rapid technological change;                                                     
| | - |  | --------------------------------------------------------------------------------
|
| |  |  | significant development costs;                                                  
|
| |  |  | frequent new stand-alone introductions;                                         
|
| |  |  | changes in the requirements of our customers and their communities of users; and
|
| |  |  | evolving industry standards.                                                    

Our system is designed to work with a variety of hardware and software
configurations and data networking infrastructures used by our customers. The
majority of these customer networks rely on Microsoft Windows NT servers.
However, our software may not operate correctly on other hardware and software
platforms and programming languages, database environments and systems that our
customers use. Also, we must constantly modify and improve our system to keep
pace with changes made to our customers platforms, data networking
infrastructures and their evolving ability to transport video and other
applications. This may result in uncertainty relating to the timing and nature
of our new release announcements, introductions or modifications, which in turn
may cause confusion in the market, with a potentially harmful effect on our
business. If we fail to promptly modify or improve our system in response to
evolving industry standards or customers demands, our system could become
obsolete, which would harm our financial condition and reputation.

If our networked video communications system cannot be deployed effectively on
a large scale to many users across an enterprise, we may lose orders and suffer
decreased revenue.

Our strategy requires that our video-enabled communications network be
highly scalable, or able to accommodate substantial increases in the number of
individuals simultaneously using our system. We are only beginning to deploy
large-scale implementations within organizations, and none of these
installations has yet been operating at any customer site for an extended
period of time. If our system does not perform adequately when deployed on an
increasingly larger scale, we may lose orders and our revenue may decrease.

Difficulties in installing our products could harm our revenue and margins.

We recognize revenue upon the installation of our system in those cases
where we are responsible for installation, which often entails working with
sophisticated software and computing and communications systems. If we
experience difficulties with installation, or do not meet deadlines due to
delays caused by our customers or ourselves, we could be required to devote
more customer support, technical and other resources to a particular
installation. If new or existing customers have difficulty installing our
products or require significant amounts of our professional services support,
our revenue recognition could be delayed, our costs could increase, and our
margins could suffer.

Competition could reduce our market share and decrease our revenue.

Currently, our competition comes from many other kinds of companies,
including communication equipment providers, integrated solution providers,
broadcast video providers and stand-alone point solution providers. The market
in which we operate is highly competitive and fragmented, and we expect
competition to increase significantly in the future. In addition, because our
industry is new and one which is characterized by rapid technological change,
evolving user needs, developing industry standards and protocols, and the
frequent introduction of new products and services, it is difficult for us to
predict whether or when new competing technologies or new competitors will
enter our market.

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

Infringement of our proprietary rights could affect our competitive position,
harm our reputation or cost us money.

We regard our system as open but proprietary. In an effort to protect our
proprietary rights, we rely primarily on a combination of patent, copyright,
trademark and trade secret laws, as well as licensing, non-disclosure and other
agreements with our consultants, suppliers, customers and employees. However,
these laws and agreements provide only limited protection of our proprietary
rights. In addition, we may not have signed agreements in every case, and the
contractual provisions that are in place and the protection they produce may
not provide us with adequate protection in all circumstances. Although we hold
patents and have filed patent applications covering some of the inventions
embodied in our systems, our means of protecting our proprietary rights may not
be adequate. It may be possible for a third party to copy or otherwise obtain
and use our technology without authorization and without our detection. A third
party may also develop similar technology independently, without infringing our
patents and copyrights. In addition, the laws of some countries in which we
sell our system may not protect our software and intellectual property rights
to the same extent as the laws of the United States. Unauthorized copying, use
or reverse engineering of our system could harm our business, financial
condition or results of operations.

Infringement claims could require us to expend significant financial and
managerial resources.

A third party could claim that our technology infringes upon its
proprietary rights. As the number of software systems in our target market
increases and the functionality of these systems overlap, we believe that the
number of infringement suits filed by software developers will increase.
Although we have no knowledge that our system infringes the proprietary rights
of any third parties, we could nevertheless be sued in the future for
infringement. Claims of infringement against us, if successful, could harm us.
Defending against any infringement claims, even those that are not meritorious
could result in the expenditure of significant financial and managerial
resources. In addition, if we are found liable for infringement, we may have to
pay damages or royalties to a third party and may not be able to continue
offering that portion of our system that is found to be infringing. Redesigning
our system components to avoid any alleged or actual infringement could result
in the expenditure of significant financial and managerial resources and
diminish the value of our system, which could harm our business, financial
condition or results of operations.

Our system could have defects for which we could be held liable for, and which
could result in lost revenue, increased costs, loss of our credibility or delay
in the further acceptance of our system in the market.

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

In addition, we have warranted to some of our customers that our software
is free of viruses. If a virus infects a customers computer software, the
customer could assert claims against us, which, regardless of their merits,
could be costly to defend and could require us to pay damages and potentially
harm our reputation.

Our license agreements with our customers typically contain provisions
designed to limit our exposure to potential product liability and certain
contract claims. Our license agreements also typically limit a customers
entire remedy to either a refund of the price paid or modification of our
system to satisfy our warranty. However, these provisions vary as to their
terms and may not be effective under the laws of some jurisdictions. Although
we maintain product liability insurance coverage, we cannot assure you that
such coverage will be adequate. A product liability, warranty or other claim
could harm our business, financial condition and/or results of operations.
Performance interruptions at a customers site could negatively affect demand
for our system, or give rise to claims against us.

The third party software we license with our system may also contain
errors or defects for which we do not maintain insurance. Typically, our
license agreements transfer any warranty from the third party to our customers
to the extent permitted. Product liability,

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warranty or other claims brought against us with respect to such
warranties could, regardless of their merits, harm our business, financial
condition or results of operations.

We rely on a continuous power supply to conduct our operations, and
Californias current energy crisis could disrupt our operations and increase
our expenses.

California is in the midst of an energy crisis that could disrupt our
operations and increase our expenses. In the event of an acute power shortage,
that is, when power reserves for the State of California fall below one and
one-half percent, the State of California has on some occasions implemented,
and may in the future continue to implement, rolling blackouts throughout the
state. We currently do not have backup generators or alternate sources of power
in the event of a blackout, and our current insurance does not provide coverage
for any damages we or our customers may suffer as a result of any interruption
in our power supply.

Furthermore, the deregulation of the energy industry instituted in 1996 by
the California state government has caused power prices to increase. If
wholesale prices continue to increase, our operating expenses will likely
increase, as our primary North American facility is located in California. Some
of our component suppliers are also located in California. While our orders
from our suppliers have not been affected by power failure to date, the
continuance of blackouts may affect our suppliers ability to manufacture our
products and meet scheduled delivery needs.

The loss of any of our outside contract manufacturers or third party equipment
suppliers that produce key components of our system could significantly disrupt
our manufacturing process.

We depend on outside contract manufacturers to produce components of our
systems. Most of our compression and decompression product, or gateway, is
currently supplied by a single source, Tandberg, Inc. In addition, we depend on
various third party suppliers for the cameras, microphones, speakers and
monitors that we install at desktops and in conference rooms as a part of each
video communications network system. Our reliance on these third parties
involves a number of risks, including:



| |  |  | the possible unavailability of critical services and components on a
timely basis, on commercially reasonable terms, or at all;                                                                                         
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | if the components necessary for our system were to become
unavailable, the need to qualify new or alternative components for our
use or reconfigure our system and manufacturing process could be lengthy
and expensive;
|
| |  |  | the likelihood that, if particular components were not available, we
would suffer an interruption in the manufacture and shipment of our
systems until these components or alternatives become available;               
|
| |  |  | reduced control by us over the quality and cost of our system and
over our ability to respond to unanticipated changes and increases in
customer orders; and                                                            
|
| |  |  | the possible unavailability of, or interruption in, access to some
technologies.                                                                                                                                        

If these manufacturers or suppliers cease to provide us with the assistance or
the components necessary for the operation of our business, we may not be able
to identify alternate sources in a timely fashion. Any transition to alternate
manufacturers or suppliers would likely result in operational problems and
increased expenses, and could cause delays in the shipment of, or otherwise
limit our ability to provide our products. In the case of the gateway
component, we believe a delay could be several months or more. We cannot assure
you that we would be able to enter into agreements with new manufacturers or
suppliers on commercially reasonable terms or at all. Any disruption in product
flow may limit our revenue, seriously harm our competitive position, or result
in additional costs, or cancellation of orders by our customers.

Our market is in an early stage of development, and our system may not be
adopted.

Our ability to achieve profitability depends in large part on the
widespread adoption by end users of networked video communications systems. If
the market for our system fails to grow or grows more slowly than we
anticipate, we may not be able to increase revenue or achieve profitability.
The market for our system is relatively new and rapidly evolving. We will have
to devote substantial resources to educating prospective customers about the
uses and benefits of our system. Our efforts to educate potential customers may
not result in our system achieving market acceptance. In addition, businesses
that have invested substantial resources in video products may be reluctant or
slow to adopt our system. Similarly, customers using existing information
systems in which they have made significant investments may refuse to adopt our
system if they perceive that our offerings will not complement their

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existing systems. Consequently, the conversion from dependence on
traditional methods of communication to the extensive use of video networking
may not occur as rapidly as we wish.

If we do not maintain and improve our current networked video communications
system and develop new systems, applications and features, our future business
prospects may suffer.

We believe that our future business prospects depend in large part on our
ability to maintain and improve our current system, and to develop new systems,
applications and features on a timely basis. Our system will have to achieve
additional market acceptance, maintain technological competitiveness and meet
an expanding range of customer requirements. As a result of the complexities
inherent in our system, major new releases, applications and system features
require long development and testing periods. We may not be successful in
developing and marketing, on a timely and cost effective basis, new releases,
applications or features that respond to technological change, evolving
industry standards and protocols or customer requirements. Significant delays
or problems in the installation or implementation of new releases of our system
could harm our business, financial condition and results of operations.

If we are unable to expand our direct sales force and distribution channels,
our business will suffer.

To increase our revenue, we must increase the size of our direct sales
force and add indirect distribution channels, such as systems integrators or
value-added resellers, or effect sales through our customers. An inability to
increase our direct sales force and to add indirect distribution channels may
limit our future revenue growth and harm our future operating results. As of
September 30, 2001, our sales force consisted of 15 professionals. We expect to
increase the size of our sales force over the next twelve months. However,
there is intense competition for sales personnel in the communications
marketplace and we cannot assure you that we will be successful in attracting,
integrating, motivating and retaining new sales personnel. Furthermore, it can
take several months before a new hire becomes a productive member of our sales
force. The failure of new salespeople to develop the necessary skills in a
timely manner could reduce our revenue growth.

We may not be able to retain our existing key personnel, or hire and retain the
additional personnel that we need to sustain and grow our business.

We depend on the continued services of our executive officers and other
key personnel. We do not carry any key man life insurance. The loss of the
services of any of our executive officers or key personnel could harm our
business, financial condition and results of operations.

As of September 30, 2001, we had 78 employees, down from 91 employees as
of September 30, 2000. We expect to hire a number of new employees in the
future to support our business. If we are unable to manage our growth
effectively, our business, financial condition and results of operations could
be harmed.

In addition, we need to attract and retain highly skilled technical and
managerial personnel for whom there is intense competition. If we are unable to
attract and retain qualified technical and managerial personnel, our results of
operations could suffer and we may never achieve profitability.

Our plans call for growth in our business, and our inability to manage this
growth could harm our business.

Failure to manage future, anticipated growth effectively will harm our
business, financial condition and operating results. Furthermore, in order to
remain competitive or to expand our business, we may find it necessary or
desirable to acquire other businesses, products or technologies. If we identify
an appropriate acquisition candidate, we may not be able to negotiate the terms
of the acquisition successfully, to finance the acquisition or to integrate the
acquired businesses, products or technologies into our existing business and
operations. In addition, completing a potential acquisition and integrating an
acquired business may strain our resources and require significant management
time.

Our international operations expose us to potential tariffs and other trade
barriers, unexpected changes in foreign regulatory requirements and laws, and
economic and political instability, as well as other risks that could adversely
affect our results of operations.

We intend to expand our international business in Western Europe and enter
additional international markets. Expansion will require significant management
attention and financial resources as we establish additional foreign
operations, hire additional

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personnel and establish indirect distribution channels. Revenue from this
international expansion may be inadequate to cover the related expenses.

Other risks we may encounter in conducting international business
activities generally could include the following:



| |  |  | tariffs and other trade barriers;                                                                                                                            
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | unexpected changes in foreign regulatory requirements and laws;                                                                                              
|
| |  |  | economic and political instability;                                                                                                                          
|
| |  |  | increased risk of infringement claims;                                                                                                                       
|
| |  |  | restrictions on the repatriation of funds;                                                                                                                   
|
| |  |  | potentially adverse tax consequences;                                                                                                                        
|
| |  |  | timing, cost and potential difficulty of adapting our system to the
local language standards in those foreign countries that do not use the
English alphabet;
|
| |  |  | fluctuations in foreign currencies; and                                                                                                                      
|
| |  |  | limitations in communications infrastructures in some foreign countries.                                                                                     

If our customers do not perceive our system or services to be effective or of
high quality, our brand and name recognition would suffer.

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

Our stock has been and will likely continue to be subject to substantial price
and volume fluctuations due to a number of factors, many of which will be
beyond our control, that may prevent our stockholders from reselling our common
stock at a profit.

The securities markets have recently experienced significant price and
volume fluctuations, and the market prices of the securities of technology
companies have been especially volatile. This market volatility, as well as
general economic, market or political conditions could reduce the market price
of our common stock in spite of our operating performance. In addition, our
operating results could be below the expectations of public market analysts and
investors, and in response the market price of our common stock could decrease
significantly. The market price of our common stock ranged from a low of $0.875
to a high of $8.0625 during the period from September 30, 2000 to September 30,
2001. Investors may be unable to resell their shares of our common stock for a
profit.

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

In the past, following periods of market volatility in the price of a
companys securities, security holders have often instituted class action
litigation. Many technology companies have been subject to this type of
litigation. If the market value of our common stock experiences adverse
fluctuations and we become involved in this type of litigation, regardless of
the merits or outcome, we could incur substantial legal costs and our
managements attention could be diverted, causing our business, financial
condition and operating results to suffer.

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

Our certificate of incorporation, our bylaws and Delaware law contain
provisions that may inhibit changes in our control that are not approved by our
Board of Directors. For example, the Board of Directors has the authority to
issue up to 10,000,000 shares of preferred stock and to determine the terms of
this preferred stock, without any further vote or action on the part of the
stockholders.

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

Our principal stockholders can exercise a controlling influence over our
business affairs and they may make business decisions with which you disagree
that will affect the value of your investment.

Our executive officers, directors and entities affiliated with them, in
the aggregate, beneficially own approximately 73% of our common stock. If they
were to act together, these stockholders would be able to exercise control over
most matters requiring approval by our stockholders, including the election of
directors and approval of significant corporate transactions. This
concentration of ownership may also have the effect of delaying or preventing a
change in control of our company, which could cause our stock price to drop.
These actions may be taken even if they are opposed by the other investors.




Item 3.Quantitative and Qualitative Disclosures About Market Risk

We are exposed to market risk related to changes in interest rates. We do
not use derivative financial instruments for speculative or trading purposes.
We do not engage in any foreign currency hedging transactions and therefore, do
not believe we are subject to any significant exchange rate risk. There has
not been a material change in our exposure to interest rate and foreign
currency risks since the date of our annual report on Form 10-K.

Cash and Cash Equivalents and Short Term Investments

Cash equivalents consist primarily of commercial paper and money market
and municipal bond funds acquired with remaining maturity periods of six months
or less and are stated at cost, plus accrued interest that approximates market
value. Short-term investments consist of corporate notes that are classified
as available for sale and are stated at fair value. We would not expect our
operating results or cash flow to be affected to any significant degree by the
effect of a sudden change in market interest rates on our investment portfolio.

The following table provides information about the Companys investment
portfolio. For investment securities, the table presents cash and cash
equivalents and short-term investments and related weighted average interest
rates by category.

|                                                      |                                  |  |                |        |               |  |                  |      |  
|----------------------------------------------------- | -------------------------------- |  | -------------- | ------ | ------------- |  | ---------------- | ---- | -
|                                                      |                                  |  |                |        |               |  | Weighted Average
|                                                      |                                  |  | Amounts        |        | Interest Rate
|                                                      |                                  |  |                |        |              
|                                                      |                                  |  | (in thousands) |        |               |  |                 
|Description                                           |                                  |  |                |        |               |  |                  |     
|Cash and cash equivalents and short-term investments: |                                  |  |                |        |               |  |                  |     
|                                                      | Cash                             |  | $              | 904    |               |  |                  |      |  
|                                                      | Commercial paper                 |  |                | 9,259  |               |  |                  | 2.93 | %
|                                                      | Other cash equivalents           |  |                | 13     |               |  |                  | 3.39 | %
|                                                      | Short-term investments           |  |                | 5,225  |               |  |                  | 4.72 | %
|                                                      |                                  |  |                |        |               |  |                  |     
|                                                      | Fair Value at September 30, 2001 |  | $              | 15,401 |               |  |                  |      |  
|                                                      |                                  |  |                |        |               |  |                  |     




PART II  OTHER INFORMATION

None

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SIGNATURES

Pursuant to the requirements of the Securities and Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized, on this 31st day of October 2001.

| |  |                                    |  |                                                                                                
| |  | ---------------------------------- |  | -----------------------------------------------------------------------------------------------
| |  | AVISTAR COMMUNICATIONS CORPORATION
|
| |  | By:                                |  | /s/   GERALD J. BURNETT                                                                        
| |  |                                    |  |                                                                                                
| |  |                                    |  | Gerald J. Burnett
Chief Executive Officer, President and
Chairman (Principal Executive Officer)
|
| |  | By:                                |  | /s/   ROBERT
J. HABIG                                                                          
| |  |                                    |  |                                                                                                
| |  |                                    |  | Robert J. Habig
Chief Financial Officer
(Principal Financial and Accounting
Officer)           

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