**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

**FORM 10-Q**

**ý**                                 QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES AND EXCHANGE ACT OF 1934

**Forthe quarterly period ended March 31, 2007**

**OR**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES AND EXCHANGE ACT OF 1934

**Forthe transition period from           to          **

**Commissionfile number:  000-31121**

**AVISTAR COMMUNICATIONS CORPORATION**

(Exact name of registrant as specified in itscharter)
|                                                                        | **DELAWARE**                      | ** ** | **88-0463156**                          |
|-----------------------------------------------------------------------------|-----------------------------------|------------|-----------------------------------------|
|                                                                        | (State or other jurisdiction      |       | (I.R.S. Employer Identification Number) |
|                                                                        | of incorporation or organization) |       |                                    |
| ** **                                                                  |                              |
| **1875 SOUTH GRANT STREET, 10****TH FLOOR, SAN MATEO, CA 94402**       |                              |
| (Address of  Principal Executive Offices) (Zip Code)                        |                              |
|                                                                        |                              |
| Registrant’s  telephone number, including area code:**(650) 525-3300** |                              |
|                                                                             |                                   |            |                                         |  |

**Indicate by check mark whether theregistrant (1) has filed all reports required to be filed by Section 13 or15(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 ****o**

**Indicateby check mark whether the registrant is a large accelerated filer, an acceleratedfiler or a non-accelerated filer. See definition of “accelerated filer andlarge accelerated filer” in Rule 12b-2 of the Exchange Act. (check one):**

| **Large accelerated filer    ****o** | ** ** | **Accelerated  filer   ****o** | ** ** | **Non-accelerated  filer   ****x** |
|-----------------------------------------------------|------------|-----------------------------------------------|------------|---------------------------------------------------|

 

**Indicateby check mark whether the registrant is a shell company (as defined inRule 12b-2 of the Exchange Act).**

**Yes ****o      No ****x**

**AtMay 7, 2007, 35,431,842 shares of common stock of the Registrant wereoutstanding.**

 

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**AVISTAR COMMUNICATIONS CORPORATION**

**INDEX**

 
| PART I.    | FINANCIAL  INFORMATION                                                                      | 3      |
|------------|---------------------------------------------------------------------------------------------|--------|
|       |                                                                                        |   |
| Item 1.    | Financial  Statements (unaudited)                                                           | 3      |
|       | Condensed  Consolidated Balance Sheets                                                      | 3      |
|       | Condensed  Consolidated Statements of Operations                                            | 4      |
|       | Condensed  Consolidated Statements of Cash Flows                                            | 5      |
|       | Notes  to Condensed Consolidated Financial Statements                                       | 6      |
| Item  2.   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations | 14     |
| Item  3.   | Quantitative  and Qualitative Disclosures About Market Risk                                 | 19     |
| Item 4T.   | Controls  and Procedures                                                                    | 20     |
|       |                                                                                        |   |
| PART II.   | OTHER  INFORMATION                                                                          | 20     |
|       |                                                                                        |   |
| Item 1.    | Legal  Proceedings                                                                          | 20     |
| Item 1a.   | Risk Factors                                                                                | 21     |
| Item 6.    | Exhibits                                                                                    | 29     |
|       |                                                                                        |   |
| SIGNATURES | 30                                                                                          |

 

 

2

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**PART I - FINANCIAL INFORMATION**

**Item 1. *FinancialStatements***

**AVISTAR COMMUNICATIONS CORPORATION ANDSUBSIDIARIES**

**CONDENSEDCONSOLIDATED BALANCE SHEETSas of March 31, 2007 and December 31, 2006(in thousands, except share and per share data)**

 
| ** **                                                                                                                                                                                                             | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                             | ** ** | **2007**           | ** ** | **2006**              | ** ** |
| ** **                                                                                                                                                                                                             | ** ** | **(unaudited)**    | ** ** |
| **Assets:**                                                                                                                                                                                                            | ** ** | ** **         | ** ** | ** **            | ** ** |
| Current assets:                                                                                                                                                                                                        |       |               |       |                  |       |
| Cash and cash  equivalents                                                                                                                                                                                             |       | $                  | 12,339     |                  | $          | 7,854 |   |
| Accounts  receivable, net of allowance for doubtful accounts of $48 and $51 at  March 31, 2007 and December 31, 2006, respectively                                                                           |       | 1,350              |       | 1,409                 |       |
| Inventories,  including inventory shipped to customers’ sites, not yet installed of $3 and  $70 at March 31, 2007 and December 31, 2006, respectively                                                   |       | 634                |       | 712                   |       |
| Deferred  settlement and patent licensing costs                                                                                                                                                                        |       | 1,256              |       | 1,256                 |       |
| Prepaid expenses  and other current assets                                                                                                                                                                             |       | 469                |       | 534                   |       |
| Total current  assets                                                                                                                                                                                                  |       | 16,048             |       | 11,765                |       |
| Property and  equipment, net                                                                                                                                                                                           |       | 520                |       | 256                   |       |
| Long-term  deferred settlement and patent licensing costs                                                                                                                                                              |       | 2,073              |       | 2,391                 |       |
| Other assets                                                                                                                                                                                                           |       | 289                |       | 287                   |       |
| Total assets                                                                                                                                                                                                           |       | $                  | 18,930     |                  | $          | 14,699 |   |
|                                                                                                                                                                                                                   |       |               |       |                  |       |
| **Liabilities and Stockholders’  Equity (Deficit):**                                                                                                                                                              |       |               |       |                  |       |
| Current  liabilities:                                                                                                                                                                                                  |       |               |       |                  |       |
| Line of credit                                                                                                                                                                                                         |       | $                  | 3,000      |                  | $          | 3,000 |   |
| Accounts payable                                                                                                                                                                                                       |       | 1,205              |       | 1,578                 |       |
| Deferred income  from settlement and patent licensing                                                                                                                                                                  |       | 5,520              |       | 5,520                 |       |
| Deferred  services revenue and customer deposits                                                                                                                                                                       |       | 1,405              |       | 1,979                 |       |
| Accrued  liabilities and other                                                                                                                                                                                         |       | 3,512              |       | 2,263                 |       |
| Total current  liabilities                                                                                                                                                                                             |       | 14,642             |       | 14,340                |       |
| Long-term  liabilities:                                                                                                                                                                                                |       |               |       |                  |       |
| Long-term  deferred income from settlement and patent licensing                                                                                                                                                        |       | 8,933              |       | 10,308                |       |
| Total  liabilities                                                                                                                                                                                                     |       | 23,575             |       | 24,648                |       |
| Commitments and  contingencies (Note 7)                                                                                                                                                                                |       |               |       |                  |       |
| Stockholders’  equity (deficit):                                                                                                                                                                                  |       |               |       |                  |       |
| Common stock,  $0.001 par value; 250,000,000 shares authorized at March 31, 2007 and  December 31, 2006; 35,318,092 and 35,219,768 shares issued at  March 31, 2007 and December 31, 2006, respectively |       | 35                 |       | 35                    |       |
| Less: treasury  common stock, 1,181,625 shares at March 31, 2007 and December 31,  2006, at cost                                                                                                             |       | (53                | )          | (53                   | )          |
| Additional  paid-in-capital                                                                                                                                                                                            |       | 93,676             |       | 92,865                |       |
| Accumulated  deficit                                                                                                                                                                                                   |       | (98,303            | )          | (102,796              | )          |
| Total  stockholders’ equity (deficit)                                                                                                                                                                             |       | (4,645             | )          | (9,949                | )          |
| Total liabilities and  stockholders’ equity (deficit)                                                                                                                                                             |       | $                  | 18,930     |                  | $          | 14,699 |   |

 

The accompanying notes are anintegral part of these financial statements.

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**AVISTARCOMMUNICATIONS CORPORATION AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTS OF OPERATIONSfor the three months ended March 31, 2007 and 2006(in thousands, except per share data)**

 
| ** **                                                                         | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                         | ** ** | **March 31,  2007**         | ** ** | **March 31,  2006** | ** ** |
| ** **                                                                         | ** ** | **(unaudited)**                  | ** ** |
| Revenue:                                                                           |       |                             |       |   |   |
| Product                                                                            |       | $                                | 1,258      |   | $ | 877 |   |
| Licensing                                                                          |       | 232                              |       | 32 |   |
| Services, maintenance and support                                                  |       | 902                              |       | 949 |   |
| Total revenue                                                                      |       | 2,392                            |       | 1,858 |   |
| Costs and  expenses:                                                               |       |                             |       |   |   |
| Cost of product revenue*                                                           |       | 729                              |       | 632 |   |
| Cost of services, maintenance and support revenue*                                 |       | 676                              |       | 607 |   |
| Income from settlement and patent licensing                                        |       | (13,057                          | )          | (1,057 | ) |
| Research and development*                                                          |       | 1,657                            |       | 1,272 |   |
| Sales and marketing*                                                               |       | 1,489                            |       | 1,300 |   |
| General and administrative*                                                        |       | 6,463                            |       | 2,256 |   |
| Total (income) costs and expenses                                                  |       | (2,043                           | )          | 5,010 |   |
| Income (loss) from operations                                                      |       | 4,435                            |       | (3,152 | ) |
| Other income (expense):                                                            |       |                             |       |   |   |
| Interest income                                                                    |       | 113                              |       | 103 |   |
| Other expense, net                                                                 |       | (55                              | )          | (7 | ) |
| Total other income, net                                                            |       | 58                               |       | 96 |   |
| Net income  (loss)                                                                 |       | $                                | 4,493      |   | $ | (3,056 | ) |
|                                                                               |       |                             |       |   |   |
| Net income  (loss) per share - basic and diluted                                   |       | $                                | 0.13       |   | $ | (0.09 | ) |
|                                                                               |       |                             |       |   |   |
| Weighted average  shares used in calculating basic and diluted net loss per share. |       |                             |       |   |   |
| Basic net income (loss) per share                                                  |       | 34,101                           |       | 33,834 |   |
| Diluted net income (loss) per share                                                |       | 35,146                           |       | 33,834 |   |
| *Including stock  based compensation of:                                           |       |                             |       |   |   |
| Cost of products, services, maintenance and support  revenue                       |       | $                                | 60         |   | $ | 36 |   |
| Research and development                                                           |       | 204                              |       | 147 |   |
| Sales and marketing                                                                |       | 185                              |       | 112 |   |
| General and administrative                                                         |       | 233                              |       | 180 |   |
|                                                                               |       | $                                | 682        |   | $ | 475 |   |

 

The accompanying notes are anintegral part of these financial statements.

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**AVISTARCOMMUNICATIONS CORPORATION AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWSfor the three months ended March 31, 2007 and 2006(in thousands)**

 
| ** **                                                                                          | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                          | ** ** | **March 31,**               | ** ** | **March 31,** | ** ** |
| ** **                                                                                          | ** ** | **2007**                         | ** ** | **2006** | ** ** |
| ** **                                                                                          | ** ** | **(unaudited)**                  | ** ** |
| Cash Flows from  Operating Activities:                                                              |       |                             |       |   |   |
| Net income (loss)                                                                                   |       | $                                | 4,493      |   | $ | (3,056 | ) |
| Adjustments to reconcile net income (loss) to net  cash provided by (used in) operating activities: |       |                             |       |   |   |
| Depreciation                                                                                        |       | 50                               |       | 114 |   |
| Compensation on options issued to consultants and  employees                                        |       | 682                              |       | 475 |   |
| Provision for doubtful accounts                                                                     |       | (3                               | )          | (19 | ) |
| Changes in assets and liabilities:                                                                  |       |                             |       |   |   |
| Accounts receivable                                                                                 |       | 62                               |       | (231 | ) |
| Inventories                                                                                         |       | 78                               |       | (7 | ) |
| Prepaid expenses and other current assets                                                           |       | 65                               |       | 162 |   |
| Deferred settlement and patent licensing costs                                                      |       | 318                              |       | 340 |   |
| Other assets                                                                                        |       | (2                               | )          | (16 | ) |
| Accounts payable                                                                                    |       | (373                             | )          | (17 | ) |
| Deferred income from settlement and patent licensing                                                |       | (1,375                           | )          | (1,325 | ) |
| Deferred services revenue and customer deposits                                                     |       | (574                             | )          | 706 |   |
| Accrued liabilities and other                                                                       |       | 1,249                            |       | 188 |   |
| Net cash provided by (used in) operating activities                                                 |       | 4,670                            |       | (2,686 | ) |
|                                                                                                |       |                             |       |   |   |
| Cash Flows from  Investing Activities:                                                              |       |                             |       |   |   |
| Maturities of short-term investments                                                                |       | —                           |       | 1,525 |   |
| Purchase of property and equipment                                                                  |       | (314                             | )          | (109 | ) |
| Net cash (used in) provided by investing activities                                                 |       | (314                             | )          | 1,416 |   |
|                                                                                                |       |                             |       |   |   |
| Cash Flows from  Financing Activities:                                                              |       |                             |       |   |   |
| Proceeds from issuance of common stock                                                              |       | 129                              |       | 128 |   |
| Net cash provided by financing activities                                                           |       | 129                              |       | 128 |   |
| Net increase (decrease) in cash and cash equivalents                                                |       | 4,485                            |       | (1,142 | ) |
| Cash and cash equivalents, beginning of period                                                      |       | 7,854                            |       | 8,216 |   |
| Cash and cash  equivalents, end of period                                                           |       | $                                | 12,339     |   | $ | 7,074 |   |

 

The accompanying notes are anintegral part of these financial statements.

 

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** **

**AVISTAR COMMUNICATIONS CORPORATION AND SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)**

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

# **Business**

AvistarCommunications Corporation (“Avistar” or the “Company”) provides theAvistar vBusiness integrated suite of video-enabled applications, including networked video communications software andhardware products and services. Avistar’s products include applications forinteractive video calling, content creation and publishing, broadcast video andvideo-on-demand, as well as data sharing, directory services and networkmanagement. Avistar designs, develops, markets, sells, manufactures and/orassembles and installs and supports its products. Avistar’s real-time and non-real-timeproducts are based upon its architecture and AvistarVOS software platform,which facilitates distribution over local and wide area networks using Internetor telephony services as appropriate. Avistar’s services include softwaredevelopment, consulting, implementation, training, maintenance and support. Inaddition, Avistar seeks to prosecute, maintain, support and license theintellectual property developed by the Company through its wholly-ownedsubsidiary, Collaboration Properties, Inc., a Nevada corporation (CPI).

# **Basis of Presentation**

The unauditedcondensed consolidated balance sheet as of March 31, 2007 presents theconsolidated financial position of Avistar and its two wholly-owned operatingsubsidiaries, Avistar Systems U.K. Limited (“ASUK”) and CPI, after theelimination of all intercompany accounts and transactions. The unauditedcondensed consolidated balance sheet of Avistar as of December 31, 2006 wasderived from audited financial statements, but does not contain all disclosuresrequired by accounting principles generally accepted in the United States ofAmerica, and certain information and footnote disclosures normally included hasbeen condensed, or omitted, pursuant to the rules and regulations of theSecurities and Exchange Commission (“SEC”). The consolidated results are referred to, collectively, as those ofAvistar or the Company in these notes.

The functional currencyof ASUK is the United States dollar. Accordingly, all gains and lossesresulting from transactions denominated in currencies other than the UnitedStates dollar are included in the statements of operations and have not beenmaterial.

TheCompany’s fiscal year end is December 31.

# **Risks and Uncertainties**

The markets for theCompany’s products and services are in the early stages of development. Some ofthe Company’s products utilize changing and emerging technologies. As istypical in industries of this nature, demand and market acceptance are subjectto a high level of uncertainty, particularly when there are adverse conditionsin the economy. Acceptance of the Company’s products, over time, is critical tothe Company’s success. The Company’s prospects must be evaluated in light ofdifficulties encountered by it and its competitors in further developing thisevolving marketplace. The Company has generated losses since inception and hadan accumulated deficit of $98.3 million as of March 31, 2007. The Company’soperating results may fluctuate significantly in the future as a result of avariety of factors, including, but not limited to, the economic environment,the adoption of different distribution channels, and the timing of new productannouncements by the Company or its competitors.

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

**2. Summary of Significant AccountingPolicies**

# **Unaudited Interim Financial Information**

The financialstatements filed in this report have been prepared by the Company, withoutaudit, pursuant to the rules and regulations of the SEC. Certain informationand footnote disclosures normally included in financial statements prepared inaccordance with accounting principles generally accepted in the United Statesof America have been condensed or omitted pursuant to such rules andregulations.

6

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In the opinion of management, the unaudited financial statementsfurnished in this report reflect all adjustments (consisting of normalrecurring adjustments) necessary for a fair presentation of the results ofoperations for the interim periods covered and of the Company’s financialposition as of the interim balance sheet date. The results of operations forthe interim periods are not necessarily indicative of the results for theentire year. These financial statements should be read in conjunction with theCompany’s audited consolidated financial statements and the accompanying notesfor the year ended December 31, 2006, included in the Company’s annualreport on Form 10-K filed with the Securities and Exchange Commission on March22, 2007.

**Use of Estimates**

The preparation of financial statements in conformity with generallyaccepted accounting principles requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities, anddisclosure of contingent assets and liabilities at the date of the financialstatements, and the reported amounts of revenues and expenses during theperiod. Actual results could differ from those estimates.

# **Cash and Cash Equivalents and Short and Long-termInvestments**

The Companyconsiders all investment instruments purchased with an original maturityof three months or less to be cash equivalents. Investment securities withoriginal or remaining maturities of more than three months but less than oneyear are considered short-term investments. Auction rate securities withoriginal or remaining maturities of more than three months are consideredshort-term investments even if they are subject to re-pricing within threemonths. Investment securities held with intent to reinvest or hold for longerthan a year or with remaining maturities of one year or more are consideredlong-term investments. The Company’s cash equivalents at December 31, 2006 andMarch 31, 2007 consisted of money market funds and short-term commercial paperwith original maturities of three months or less, and are therefore classifiedas cash and cash equivalents in the accompanying balance sheets.

TheCompany accounts for its short-term and long-term investments in accordancewith Statement of Financial Accounting Standards (SFAS) No. 115, *Accounting for Certain Investments in Debt and Equity Securities*.The Company’s short and long-term investments in securities are classified asavailable-for-sale and are reported at fair value, with unrealized gains andlosses, net of tax, recorded in other comprehensive income (loss). Realizedgains or losses and declines in value judged to be other than temporary, ifany, on available-for-sale securities are reported in other income, net. TheCompany reviews the securities for impairments considering current factorsincluding the economic environment, market conditions, and the operationalperformance and other specific factors relating to the business underlying thesecurities. The Company records impairment charges equal to the amount that thecarrying value of its available-for-sale securities exceeds the estimated fairmarket value of the securities as of the evaluation date. The fair value forpublicly held securities is determined based on quoted market prices as of theevaluation date. In computing realized gains and losses on available-for-salesecurities, the Company determines cost based on amounts paid, including directcosts such as commissions, to acquire the security using the specificidentification method. The Company did not have any short or long-terminvestments at March 31, 2007 or December 31, 2006.

Cashand cash equivalents consisted of the following at March 31, 2007 and December31, 2006 (in thousands):

|                                    | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                         | ** ** | **2007**           | ** ** | **2006**              | ** ** |
| ** **                         | ** ** | **(Unaudited)**    | ** ** |
| *Description*                      | ** ** | ** **         | ** ** | ** **            | ** ** |
| Cash and cash equivalents:         |       |               |       |                  |       |
| Cash                               |       | $                  | 1,424      |                  | $          | 4,224 |   |
| Commercial paper cash  equivalents |       | 10,915             |       | 3,630                 |       |
| Total cash and cash equivalents    |       | $                  | 12,339     |                  | $          | 7,854 |   |

# **SignificantConcentrations**

A relatively small number of customers accounted for a significantpercentage of the Company’s revenues for the three months ended March 31, 2007and March 31, 2006. Revenues to these customers as a percentage of total revenueswere as follows for the three months ended March 31, 2007 and 2006:

|            | ** ** | **Three Months Ended  March 31,** | ** ** |
|------------|------------|--------------------------------------------------|------------|
| ** ** | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
| ** ** | ** ** | **(Unaudited)**                                  | ** ** |
| Customer A |       | 30                                               | %          | 40 | % |
| Customer B |       | 29                                               | %          | 37 | % |
| Customer C |       | 10                                               | %          | 13 | % |

 

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

Financialinstruments that potentially subject the Company to concentrations of creditrisk consist primarily of temporary cash investments and trade receivables. TheCompany has cash and investment policies that limit the amount of creditexposure to any one financial institution or restrict placement of theseinvestments to financial institutions evaluated as highly credit worthy. As ofMarch 31, 2007, the Company had cash and cash equivalents on deposit with amajor financial institution that were in excess of FDIC insured limits.Historically, the Company has not experienced any loss of its cash and cashequivalents due to such concentration of credit risk. Concentrations of creditrisk with respect to trade receivables relate to those trade receivables fromboth United States and foreign entities, primarily in the financial servicesindustry. As of March 31, 2007, approximately 64% of gross accountsreceivable were concentrated with three customers, each of whom representedmore than 10% of the Company’s total gross accounts receivable balance. As ofDecember 31, 2006, approximately 84% of accounts receivable wereconcentrated with three customers, each of whom represented more than 10% ofthe Company’s total gross accounts receivable balance. No other customersindividually accounted for greater than 10% of total accounts receivable as ofMarch 31, 2007 and December 31, 2006.

# **Inventories**

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

|                                                         | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                              | ** ** | **2007**           | ** ** | **2006**              | ** ** |
| ** **                                              | ** ** | **(Unaudited)**    | ** ** |
| Raw materials and subassemblies                         |       | $                  | 41         |                  | $          | 59 |   |
| Finished goods                                          |       | 590                |       | 583                   |       |
| Inventory  shipped to customer sites, not yet installed |       | 3                  |       | 70                    |       |
|                                                    |       | $                  | 634        |                  | $          | 712 |   |

 

Inventory shippedto customer sites, not yet installed, represents product shipped to customersites pending completion of the installation process by the Company. As ofMarch 31, 2007 and December 31, 2006, the Company had billed approximately$13,000 and $202,000, respectively, to customers related to these shipments,but did not record the revenue, as the installations had not been completed andconfirmed by the customer. Although customers are billed in accordance withcustomer agreements, these deferred revenue amounts are netted against accountsreceivable until the customer confirms installation.

**Revenue Recognition and Deferred Revenue**

The Companyrecognizes product and services revenue in accordance with Statement ofPosition (“SOP”) 97-2, SoftwareRevenue Recognition (“SOP 97-2”), as amended by SOP 98-9, Modification of SOP 97-2, SoftwareRevenue Recognition, With Respect to Certain Transactions**(“SOP 98-9”). The Companyderives product revenue from the sale and licensing of a set of desktop(endpoint) products (hardware and software) and infrastructure products(hardware and software) that combine to form an Avistar video-enabledcollaboration solution. Services revenue includes revenue from installationservices, post-contract customer support, training and software development.The installation services that the Company offers to customers relate to thephysical set-up and configuration of desktop and infrastructure components ofthe Company’s solution. The fair value of all product, installation services,post-contract customer support and training offered to customers is determinedbased on the price charged when such products or services are sold separately.

Arrangements thatinclude multiple product and service elements may include software and hardwareproducts, as well as installation services, post-contract customer support andtraining. Pursuant to SOP 97-2, the Company recognizes revenue whenall of the following criteria are met: (i) persuasive evidence of anarrangement exists, (ii) delivery has occurred, (iii) the fee isfixed or determinable, and (iv) collectibility is probable. The Companyapplies these criteria as discussed below:

·                  *Persuasive evidence of an arrangement exists*. The Companyrequires a written contract, signed by both the customer and the Company, or apurchase order from those customers that have previously negotiated a standardend-user license arrangement or volume purchase agreement, prior to recognizingrevenue on an arrangement.

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

·                  *The fee is fixed or determinable*. The Company’sdetermination that an arrangement fee is fixed or determinable dependsprincipally on the arrangement’s payment terms. The Company’s standard termsgenerally require payment within 30 to 90 days of the date of invoice. Wherethese terms apply, the Company regards the fee as fixed or determinable, andrecognizes revenue upon delivery (assuming other revenue recognition criteriaare met). If the payment terms do not meet this standard, but rather, involve “extendedpayment terms,” the fee may not be considered to be fixed or determinable andthe revenue would then be recognized when customer installments are due andpayable.

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·                  *Collectibility is probable*. To recognize revenue, theCompany judges collectibility of the arrangement fees on a customer-by-customerbasis pursuant to a credit review policy. The Company typically sells tocustomers with which it has had a history of successful collections. For newcustomers, the Company evaluates the customer’s financial position and abilityto pay. If the Company determines that collectibility is not probable basedupon the credit review process or the customer’s payment history, revenue isrecognized when cash is collected.

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

Payment forproduct is due upon shipment, subject to specific payment terms. Payment forinstallation and professional services is due upon providing the services,subject to specific payment terms. Reimbursements received for out-of-pocketexpenses and shipping costs incurred during installation and support services,which have not been significant to date, are recognized as revenue inaccordance with Emerging Issues Task Force (“EITF”) Issue No. 01-14 (“EITF01-14”), *Income StatementCharacterization of Reimbursements Received for “Out of Pocket” ExpensesIncurred*.

The price chargedfor maintenance and/or support is defined in the contract, and is based on afixed price for both hardware and software components as stipulated in thecustomer agreement. Customers have the option to renew the maintenance and/orsupport arrangement in subsequent periods at the same or similar rate as paidin the initial year subject to contractual adjustments for inflation in somecases. Revenue from maintenance and support services is deferred and recognizedpro-rata over the maintenance and/or support term, which is typically one yearin length. Payments for services made in advance of the provision of servicesare recorded as deferred revenue and customer deposits in the accompanyingbalance sheets. Training services are offered independently of the purchase ofproduct. The value of these training services is determined based on the pricecharged when such services are sold separately. Training revenue is recognizedupon performance of the service.

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

The Company alsorecognizes revenue from the licensing of its intellectual property portfolio,according to SOP 97-2, based on the terms of the royalty,partnership and cross-licensing agreements involved. In the event that alicense to the Company’s intellectual property is granted after thecommencement of litigation proceedings between the Company and the licensee,the proceeds of such transaction are recognized as licensing revenue by theCompany only if sufficient historical evidence exists for the determination offair value of the licensed patents to support the segregation of the proceedsbetween a gain on litigation settlement and patent license revenues, consistentwith Financial Accounting Standards Board (“FASB”) Concepts StatementNo. 6, *Elements of Financial Statements*(“CON No. 6”). As ofMarch 31, 2007, these criteria for recognizing license revenue followingthe commencement of litigation had not been met, and proceeds have thereforebeen recorded in “income from settlement and licensing” activities.

**Income from Settlement and Patent Licensing**

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

9

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On November 12, 2004, the Company entered into a settlement and apatent cross-license agreement with Polycom, thus ending litigation againstPolycom for patent infringement. As part of the settlement and patentcross-license agreement with Polycom, Avistar granted Polycom a non-exclusive,fully paid-up license to its entire patent portfolio. The settlement and patentcross-license agreement includes a five year capture period from the date ofthe settlement, adding all new patents with a priority date extending up tofive years from the date of execution of the agreement. Polycom, as partof the settlement and patent cross-licensing agreement, made a one time paymentto the Company of $27.5 million and Avistar paid $6.4 million in contingentlegal fees to Avistar’s litigation counsel upon completion of the settlementand patent cross-licensing agreement. The contingent legal fees were payableonly in the event of a favorable outcome from the litigation with Polycom. The Company expects to recognize the grossproceeds of $27.5 million from the settlement and patent cross-licenseagreement as income from settlement and patent licensing within operations overthe five-year capture period, due to a lack of evidence necessary to apportionthe proceeds between an implied punitive gain element in the settlement of thelitigation, and software license revenues from the cross-licensing of Avistar’spatented technologies for prior and future use by Polycom. Additionally,the $6.4 million in contingent legal fees was deferred and is expected to beamortized to income from settlement and patent licensing over the five yearcapture period, resulting in a net of $21.1million being recognized as income within operations over the five year captureperiod.

On February 15, 2007, the Company entered into a patent license agreementwith Tandberg ASA, Tandberg Telecom AS and Tandberg, Inc.  Under this agreement, CPI dismissed itsinfringement suit against Tandberg, Tandberg dismissed its infringement suitagainst CPI and Avistar, and the companies cross-licensed each other’s patentportfolios.  The agreement resulted in apayment of $12.0 million to the Company from Tandberg**. **The Company recognized the grossproceeds of $12.0 million from the patent license agreement as income fromsettlement and patent licensing within operations in the three months endedMarch 31, 2007.  To recognize theproceeds as revenue, the Company would have required sufficient history oftransactions in order to isolate the aspect of the settlement attributable tothe gain associated with the process of litigation, separate from commercialcompensation for the use of the Company’s intellectual property.  Sufficient evidence was not available toallow this distinction.   The patentlicense agreement with Tandberg includes a ten year capture period, extendingfrom the date of the agreement, during which patents filed with a  priority date within the capture period wouldbe licensed in addition to exsiting patents on the agreement date.  However, such additional patents would belicensed under the agreement solely for purposes of the manufacture, sale,license or other transfer of existing products of Tandberg and products thatare closely related enhancements of such products based primarily andsubstantially on the existing products. The Company reviewed the existing products of Tandberg and consideredthe likelihood that future patent filings by Avistar or CPI would relate to orotherwise affect existing Tandberg products and closely related enhancementsthereto.  The Company concluded that  the filing for such additional patents wasunlikely, and therefore concluded that the ten year capture period was notmaterial from an accounting perspective related to recognition.

The presentation within operating expenses of the Polycom and Tandbergtransactions is supported by a determination that the transactions are centralto the activities that constitute Avistar’s ongoing major or centraloperations, but may contain a gain element related to the settlement, which isnot considered as revenue under FASB CONNo. 6*.* The Company did not have sufficienthistorical evidence to support a reasonable determination of value for thepurposes of segregating the transaction into revenue related to the patentlicensing and an operating or non-operating gain upon settlement of litigation,resulting in the determination that the entire transaction is moreappropriately classified as “income from settlement and patent licensing”within operations, as opposed to revenue.

**Stock-Based Compensation**

Effective January 1, 2006, the Company adopted the provisions ofSFAS No. 123 (R), *Share-Based Payment*.SFAS No. 123R establishes accounting for stock-based awards exchangedfor employee services. Accordingly, stock-based compensation cost is measuredat grant date, based on the fair value of the award, and is recognized asexpense over the employee’s service period. The effect of recordingstock-based compensation for the three months ended March 31, 2007 and2006 was as follows (in thousands, except per share data):

|                                                     | ** ** | **Three Months Ended March 31,** | ** ** |
|-----------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                          | ** ** | **2007**                                             | ** ** | **2006** | ** ** |
| ** **                                          | ** ** | **(unaudited)**                                      | ** ** |
| Stock-based compensation expense by type of award:  |       |                                                 |       |   |   |
| Employee stock options                              |       | $                                                    | 636        |   | $ | 413 |   |
| Non-employee stock options                          |       | 16                                                   |       | 18 |   |
| Employee stock purchase plan                        |       | 30                                                   |       | 44 |   |
| Total stock-based compensation                      |       | 682                                                  |       | 475 |   |
| Tax effect on stock-based compensation              |       | —                                               |       | — |   |
| Net  effect of stock-based compensation on net loss |       | $                                                    | 682        |   | $ | 475 |   |

 

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As ofMarch 31, 2007, the Company had an unrecognized deferred stock-basedcompensation balance related to stock options of approximately$4.5 million before estimated forfeitures. SFASNo. 123R requires forfeitures to be estimated at the time of grantand revised if necessary in subsequent periods if actual forfeitures differfrom those estimates. Based on the Company’s historical experience of optionpre-vesting cancellations, the Company has assumed an annualized forfeiturerate of 3% for its executive options and 20% for non-executive options.Accordingly, as of March 31, 2007, the Company estimated that the stock-basedcompensation for the awards not expected to vest was approximately $802,000,and therefore, the unrecognized deferred stock-based compensation balancerelated to stock options was adjusted to approximately $3.7 million afterestimated forfeitures and will be recognized over an estimated weighted averageamortization period of 1.7 years. During the three months ended March 31, 2007,the Company granted 288,000 stock options, with an estimated total grant-datefair value of $464,000.

**Valuation Assumptions**

The Companyestimated the fair value of stock options granted during the three months endedMarch 31, 2007 and 2006, using a Black-Scholes-Merton valuation model,consistent with the provisions of SFAS No. 123R, SEC Staff AccountingBulletin (SAB) No. 107. The fair value of each option grant is estimatedon the date of grant using the Black-Scholes-Merton option valuation model andthe straight-line attribution approach with the following weighted-averageassumptions:

Employee Stock Option Plan

|                                 | ** ** | **Three Months Ended  March 31,** | ** ** |     |
|---------------------------------|------------|--------------------------------------------------|------------|----------|
| ** **                      | ** ** | **2007**                                         | ** ** | **2006** | ** ** |   |
| Expected dividend               |       | —                                           | %          | —   | % |
| Average risk-free interest rate |       | 4.7                                              | %          | 4.3      | % |
| Expected volatility             |       | 138                                              | %          | 146      | % |
| Expected term (years)           |       | 6.1                                              |       | 6.1      |   |
|                                 |            |                                                  |            |          |  |  |  |  |  |  |

 

**Employee Stock Purchase Plan**

|                                 | ** ** | **Three Months Ended  March 31,** | ** ** |
|---------------------------------|------------|--------------------------------------------------|------------|
| ** **                      | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
| Expected dividend               |       | —                                           | %          | — | % |
| Average risk-free interest rate |       | 5.1                                              | %          | 2.8 | % |
| Expected volatility             |       | 96                                               | %          | 113 | % |
| Expected  term (months)         |       | 6.0                                              |       | 6.0 |   |

 

The dividend yieldof zero is based on the fact that the Company has never paid cash dividends andhas no present intention to pay cash dividends. The risk-free interest ratesare taken from the Daily Federal Yield Curve Rates as of the grant dates aspublished by the Federal Reserve, and represent the yields on actively tradedTreasury securities for terms that approximate the expected term of theoptions. Expected volatility is based on the historical volatility of theCompany’s common stock over a period consistent with the expected term of thestock-option. The expected term calculation is based on an average prescribedby SAB No. 107, based on the weighted average of the vesting periods, which isgenerally one quarter vesting after one year and one sixteenth vestingquarterly for 12 quarters, and adding the term of the option, which isgenerally 10 years, and dividing by 2.

**3. Related Party Transactions**

Robert P. Latta, a member of the law firm Wilson Sonsini Goodrich &Rosati, Professional Corporation (WSGR), has served as a director of theCompany since February 2001. Mr. Latta and WSGR have represented theCompany and its predecessors as corporate counsel since 1997. During the threemonths ended March 31, 2007 and 2006, payments of approximately $57,000and $11,000, respectively, were made to WSGR for legal services provided to theCompany.

**4. Net Income (Loss) Per Share**

Basic and diluted net loss per share of common stock is presented inconformity with SFAS No. 128 (“SFAS No. 128”), *Earnings PerShare*, for all periods presented.

In accordance with SFAS No. 128, basic net loss per share has beencomputed using the weighted average number of shares of common stockoutstanding during the period, less shares subject to repurchase. Diluted netloss per share is computed on the basis of the weighted average number ofshares and potential common shares outstanding during the period. Potentialcommon shares result from the assumed exercise of outstanding stock optionsthat have a dilutive effect when applying the treasury stock method. For thethree months ended March 31, 2007, due to the Company’s net income for theperiod, the Company included the net effect of the weighted average number ofshares and potential common shares outstanding during the period in thecalculation of diluted net income per share.  The Company excluded all outstanding stock options and shares subject torepurchase from the calculation of diluted net loss per share for the threemonths ended March 31, 2006, because all such securities are antidilutive(owing to the fact that the Company is in a loss position). Accordingly,diluted net loss per share is equal to basic net loss per share for the threemonths ended March 31, 2006.

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The followingtable set forth the computation of basic and diluted net income (loss) pershare (in thousands, except per share data):

|                                                      | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                           | ** ** | **2007**                                             | ** ** | **2006** | ** ** |
| ** **                                           | ** ** | **(Unaudited)**                                      | ** ** |
| Numerator:                                           |       |                                                 |       |   |   |
| Net income (loss)                                    |       | $                                                    | 4,493      |   | $ | (3,056 | ) |
| Denominator:                                         |       |                                                 |       |   |   |
| Basic weighted  average shares outstanding           |       | 34,101                                               |       | 33,834 |   |
| Add: dilutive employee and non employeestock options |       | 1,045                                                |       | — |   |
| Diluted weighted  average shares outstanding         |       | 35,146                                               |       | 33,834 |   |
| Basic and diluted net  income (loss) per share       |       | $                                                    | 0.13       |   | $ | (0.09 | ) |

 

The total numberof potential common shares excluded from the calculations of diluted net lossper share was 2,975,573 for the three months ended March 31, 2006.

**5. Income Taxes**

Income taxes are accounted for using an asset and liability approach inaccordance with Statement of Financial Accounting Standards No. 109, *Accounting for Income Taxes*, which requires the recognitionof taxes payable or refundable for the current year and deferred taxliabilities and assets for the future tax consequences of events that have beenrecognized in the Company’s financial statements or tax returns. The measurementof current and deferred tax liabilities and assets are based on the provisionsof enacted tax law; the effects of future changes in tax laws or rates are notanticipated. The measurement of deferred tax assets is reduced, if necessary,by the amount of any tax benefits that, based on available evidence, are notexpected to be realized.

Deferred tax assets and liabilities are determined based on thedifference between the financial statement and tax basis of assets andliabilities using enacted tax rates in effect for the year in which thedifferences are expected to affect taxable income. Valuation allowances areprovided if, based upon the weight of available evidence, it is considered morelikely than not that some or all of the deferred tax assets will not berealized.

Effective January 1, 2007, we adopted the provisions of FASB FinancialAccounting Standards Interpretation No. 48, *Accounting for Uncertaintyin Income Taxes*, or FIN No. 48. FIN No. 48 contains a two-stepapproach to recognizing and measuring uncertain tax positions accounted for inaccordance with SFAS No. 109. Tax positions are evaluated for recognition bydetermining if the weight of available evidence indicates it probable that theposition will be sustained on audit, including resolution of related appeals orlitigation. Tax benefits are then measured as the largest amount which is morethan 50% likely of being realized upon ultimate settlement. The Companyconsiders many factors when evaluating and estimating tax positions and tax benefits,which may require periodic adjustments and which may not accurately anticipateactual outcomes.

As of December 31, 2006, the Company’s unrecognized tax benefits totaled$24.6 million. The adoption of FIN 48 resulted in no change to the reserve for unrecognizedtax benefits that existed at December 31, 2006. As such, there is no changerecorded to retained earnings as a result of the adoption.

**6. Segment Reporting**

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

 

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| ** **                                              | ** ** | **CPI**    | ** ** | **Avistar** | ** ** | **Reconciliation** | ** ** | **Total** | ** ** |
|---------------------------------------------------------|------------|------------|------------|-------------|------------|--------------------|------------|-----------|------------|
| **Three  Months Ended March 31, 2007 (unaudited)** |       |       |       |        |       |               |       |      |       |
| Revenue                                                 |       | $          | 13,289     |        | $          | 2,160              |       | $         | (13,057    | ) | $ | 2,392 |   |
| Depreciation expense                                    |       | —     |       | (50         | )          | —             |       | (50       | )          |
| Total (costs and expenses) income                       |       | (5,155     | )          | (5,859      | )          | 13,057             |       | 2,043     |       |
| Interest income                                         |       | —     |       | 113         |       | —             |       | 113       |       |
| Net income (loss)                                       |       | 8,134      |       | (3,641      | )          | —             |       | 4,493     |       |
| Assets                                                  |       | 4,165      |       | 14,765      |       | —             |       | 18,930    |       |
| **Three  Months Ended March 31, 2006 (unaudited)** | ** ** | ** ** |       |        |       |               |       |      |       |
| Revenue                                                 |       | $          | 1,089      |        | $          | 1,826              |       | $         | (1,057     | ) | $ | 1,858 |   |
| Depreciation expense                                    |       | —     |       | (114        | )          | —             |       | (114      | )          |
| Total costs and expenses                                |       | (1,213     | )          | (4,854      | )          | 1,057              |       | (5,010    | )          |
| Interest income                                         |       | —     |       | 103         |       | —             |       | 103       |       |
| Net loss                                                |       | (124       | )          | (2,932      | )          | —             |       | (3,056    | )          |
| Assets                                                  |       | 4,658      |       | 12,804      |       | —             |       | 17,462    |       |

 

International revenue, which consists of sales tocustomers with operations principally in Western Europe and Asia, comprised 52%and 49% of total product and services revenue for the three months endedMarch 31, 2007 and 2006, respectively. For the three months endedMarch 31, 2007 and 2006, international revenues from customers in theUnited Kingdom accounted for 7% and 10%, of total product and services revenue,respectively. The Company had no significant long-lived assets in any countryother than in the United States for any period presented.

**7.****              Legal Proceedings**

On May 11, 2005, CPI, Avistar’s wholly-ownedpatent prosecution and licensing subsidiary, commenced a patent infringementlawsuit against Tandberg ASA and Tandberg, Inc., alleging that numerousTandberg videoconferencing products infringe three patents held by CPI. The suitwas filed in the United States District Court for the Northern District ofCalifornia. Both of the Tandberg entities answered the complaint onJuly 15, 2005, at which time they asserted that they did not infringe thepatents and that the patents were invalid and unenforceable.

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

On February 15, 2007, CPI entered into a patentlicense agreement with Tandberg ASA, Tandberg Telecom AS andTandberg, Inc. Under this agreement, CPI agreed to dismiss itsinfringement suit against Tandberg, Tandberg agreed to dismiss its infringementsuit against Avistar and CPI, and the companies agreed to cross-licenseeach other’s patent portfolios. The agreement resulted in a payment to CPI fromTandberg in the amount of $12.0 million.

**SoftwareIndemnifications**

Avistar entersinto standard indemnification agreements in the ordinary course of business.Pursuant to these agreements, Avistar indemnifies, holds harmless, and agreesto reimburse the indemnified party for losses suffered or incurred by theindemnified party, generally Avistar’s business partners or customers, inconnection with any patent, copyright or other intellectual propertyinfringement claim by any third party with respect to its products. The term ofthese indemnification agreements is generally perpetual. The maximum potentialamount of future payments Avistar could be required to make under theseindemnification agreements is  generallylimited to the cost of products purchased per customer, but may be unlimitedwhen customer purchases are considered in aggregate. Avistar has never incurredcosts to defend lawsuits or settle claims related to these indemnificationagreements. Accordingly, Avistar has no liabilities recorded for theseagreements as of March 31, 2007.

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**8.****              Recently AccountingPronouncements**

In September 2006, the FASB issued StatementNo. 157, *Fair Value Measurements* (“SFAS No.157”). The standard provides guidance for using fair value to measure assetsand liabilities and responds to investors’ requests for expanded informationabout the extent to which companies measure assets and liabilities at fairvalue, the information used to measure fair value, and the effect of fair valuemeasurements on earnings. The standard applies whenever other standards requireor permit assets or liabilities to be measured at fair value. The standard doesnot expand the use of fair value in any new circumstances. SFAS 157 mustbe adopted prospectively as of the beginning of the year it is initially applied.SFAS 157 is effective for financial statements issued for fiscal yearsbeginning after November 15, 2007, and interim periods within those fiscalyears. The Company is evaluating the impact this standard will have on itsfinancial position or results of operations.

**9.****              SubsequentEvent**

In May 2007, Avistar added 7,900 square foot of officespace to its existing lease at its headquarters in San Mateo, California tohouse operational staff.  The newfacilities require minimum payments of approximately $114,000, $281,000,$288,000, $296,000, $303,000 and $76,000 for fiscal years 2007, 2008, 2009,2010, 2011 and 2012, respectively.

**Item 2. *Management’s Discussion and Analysis of Financial Condition and Resultsof Operations***

The following discussion should be read in conjunctionwith the unaudited Condensed Consolidated Financial Statements and the Notes toCondensed Consolidated Financial Statements elsewhere herein, and the AuditedConsolidated Financial Statements and the Notes thereto contained in our AnnualReport on Form 10-K for the year ended December 31, 2006, as filed withthe Securities and Exchange Commission on March 22, 2007.

Certain statements in this “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” areforward looking statements. These statements relate to future events or ourfuture financial performance and involve known and unknown risks, uncertaintiesand other factors that may cause our or our industry’s actual results, levelsof activity, performance or achievements to be materially different from anyfuture results, levels of activity, performance or achievements expressed orimplied by the forward looking statements. These risks and other factorsinclude those listed under “Risk Factors” elsewhere in this Quarterly Report onForm 10-Q. In some cases, you can identify forward looking statements byterminology such as “may”, “will”, “should”, “expects”, “intends”, “plans”, “anticipates”,“believes”, “estimates”, “predicts”, “potential”, “continue” or the negative ofthese terms, or other comparable terminology. These statements are onlypredictions. Actual events or results may differ materially. In evaluatingthese statements, you should specifically consider various factors, includingthe risks outlined under “Risk Factors.” These factors may cause our actualresults to differ materially from any forward-looking statement.  Althoughwe believe that the expectations reflected in the forward-looking statementsare reasonable, we cannot guarantee future results, levels of activity,performance or achievements. We are under no duty to update any of theforward-looking statements after the date of this Quarterly Report on Form 10-Qto conform our prior statements to actual results.

**Overview**

We develop, market and support an integrated suite ofvBusiness—video-enabled eBusiness—applications, all powered by the AvistarVOSTMsoftware. From the desktop, we deliver business-quality interactive videocalling, content creation and publishing, broadcast origination and distribution,video-on-demand, and integrated data sharing. The Avistar video and datacollaboration applications are all managed by the AvistarVOS video operatingsystem. By integrating video tightly into the way they work, our customers canuse our system to save costs and improve productivity and communication withinthe enterprise and between enterprises, and to enhance relationships withcustomers, suppliers and partners. Using AvistarVOS software and leveragingvideo, telephony and Internet networking standards, Avistar applications aredesigned to be scalable, reliable, cost effective, easy to use, and capable ofevolving with communications networks as bandwidth increases and as newstandards and protocols emerge. We currently sell our system directly toenterprises in selected strategic vertical markets, and have focused initiallyon the financial services industry. Additionally, we have licensed ourtechnology and patents to companies in the video conferencing market. Ourobjective is to establish our technology as the standard for networked videothrough direct sales, indirect channel sales/partnerships and the licensing ofour technology to others.

We operate in two segments. Avistar CommunicationsCorporation engages in the design, development, manufacture, sale and marketingof networked video communications products and associated support services.Collaboration Properties, Inc., or CPI, our wholly owned subsidiary, engages inthe prosecution, maintenance, support and licensing of the intellectualproperty that we have developed, some of which is used in our products.

Since inception, we have recognized the innovativevalue of our research and development efforts, and have invested in securingprotection for these innovations through domestic and foreign patentapplication and issuance. As of March 31, 2007, we hold 75 U.S. and foreignpatents, which have been licensed to third parties. We continue to pursueopportunities to license these patents to others in the collaborationtechnology marketplace.

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**CriticalAccounting Policies**

The preparation of our Consolidated FinancialStatements in accordance with accounting principles generally accepted in theUnited States requires us to make estimates and judgments that affect thereported amounts of assets, liabilities, revenues and expenses, and relateddisclosure of contingent assets and liabilities.  We base our estimates on historicalexperience and assumptions that we believe to be reasonable under thecircumstances, the results of which form the basis for making judgments aboutthe carrying values of assets and liabilities that are not readily apparentfrom other sources.  Actual results maydiffer from these estimates.

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

·                  Revenuerecognition;

·                  Income fromsettlement and patent licensing;

·                  Valuation ofaccounts receivable;

·                  Valuation ofinventories; and

·                  Stock based compensation.

**RevenueRecognition**

We derive product revenue from the sale and licensingof our video-enabled networked communications system, consisting of a suite ofAvistar-designed software and hardware products, including third partycomponents. We also derive revenue from fees for installation, maintenance,support, training services and software development. In addition, we deriverevenue from the licensing of our intellectual property portfolio. Productrevenue as a percentage of total revenue was 52% and 47% for the three monthsended March 31, 2007 and 2006, respectively. We recognize product and services revenue in accordance with Statementof Position (“SOP”)  97-2, *Software Revenue Recognition*(“SOP 97-2”),as amended by SOP 98-9, Modification of SOP 97-2, *Software Revenue Recognition, With Respect to CertainTransactions*(“SOP 98-9”). We derive product revenue fromthe sale and licensing of a set of desktop (endpoint) products (hardware andsoftware) and infrastructure products (hardware and software) that combine toform an Avistar video-enabled collaboration solution. Services revenue includesrevenue from installation services, post-contract customer support, training,out of pocket expenses, freight and software development. The installation servicesthat we offer to customers relate to the physical set-up and configuration ofdesktop and infrastructure components of our solution. The fair value of allproduct, installation services, post-contract customer support and trainingoffered to customers is determined based on the price charged when suchproducts or services are sold separately.

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

·       *Persuasiveevidence of an arrangement exists.* We require a written contract,signed by both the customer and us, or a purchase order from those customersthat have previously negotiated a standard end-user license arrangement orvolume purchase agreement with us prior to recognizing revenue on anarrangement.

·       *Delivery hasoccurred.* We deliver software and hardware to our customersphysically. Our standard delivery terms are FOB shipping point.

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

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

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If there are any undelivered elements, we deferrevenue for those elements, as long as Vendor Specific Objective Evidence (“VSOE”)exists for the undelivered elements. Additionally, when we provide installationservices, the product and installation revenue is recognized upon completion ofthe installation process and receipt of customer confirmation, subject to thesatisfaction of the revenue recognition criteria described above. We believethat the fee associated with the delivered product elements does not meet thecollectibility criteria if the installation services have not been completed.Customer confirmation is obtained and documented by means of a standard formindicating the installation services were provided and the hardware andsoftware components were installed. When the customer or a third party providesinstallation services, the product revenue is recognized upon shipment, subjectto satisfaction of the revenue recognition criteria described above.

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

The price charged for maintenance and/or support isdefined in the product sale contract, and is based on a fixed price for bothhardware and software components as stipulated in the customer agreement.Customers have the option to renew the maintenance and/or support services insubsequent periods at the same or similar rate as paid in the initial yearsubject to contractual adjustments for inflation in some cases. Revenue frommaintenance and support is recognized pro-rata over the maintenance and/orsupport term, which is typically one year in length. Payments for services madein advance of the provision of services are recorded as deferred revenue andcustomer deposits in the accompanying balance sheets. Training services areoffered independently of the purchase of product. The value of these trainingservices is determined based on the price charged when such services are soldseparately. Training revenue is recognized upon performance of the service.

We recognize service revenue from software developmentcontracts in accordance with SOP 81-1, *Accounting for Performance of Construction-Type and CertainProduction-Type Contracts.*Revenue related to contracts for softwaredevelopment is recognized using the percentage of completion method, when allof the following conditions are met: a contract exists with the customer at afixed price, we have fulfilled all of our material contractual obligations tothe customer for each deliverable of the contract, verification of completionof the deliverable has been received, and collection of the receivable isprobable. Amounts billed to customers in excess of revenues recognized to dateare deferred and recorded as deferred revenue and customer deposits in theaccompanying balance sheets. Assumptions used for recording revenue andearnings are adjusted in the period of change to reflect revisions in contractvalue and estimated costs to complete the contract. Any anticipated losses oncontracts in progress are charged to earnings when identified.

We also recognize revenue from the licensing of ourintellectual property portfolio, according to SOP 97-2, based on theterms of the royalty, partnership and cross-licensing agreements involved. Inthe event that a license to our intellectual property is granted after thecommencement of litigation proceedings between us and the licensee, theproceeds of such transaction are recognized as licensing revenue by us only ifsufficient historical evidence exists for the determination of fair value ofthe licensed patents to support the segregation of the proceeds between a gainon litigation settlement and patent license revenues, consistent with FinancialAccounting Standards Board (“FASB”) Concepts Statement No. 6, *Elements of Financial Statements*. As ofMarch 31, 2007, these criteria for recognizing license revenue following thecommencement of litigation have not been met, and proceeds have therefore beenrecorded in “income from settlement and licensing” activities.

To date, a significant portion of our revenue hasresulted from sales to a limited number of customers, particularly DeutscheBank AG and UBS AG and their affiliates. Collectively, Deutsche Bank AG and UBSAG and their affiliates accounted for approximately 59% and 77% of totalrevenue for the three month periods ended March 31, 2007 and 2006,respectively. As of March 31, 2007, approximately 64% of our grossaccounts receivable was concentrated with three customers, each of whomrepresented more than 10% of our gross accounts receivable. As ofMarch 31, 2006, approximately 95% of our gross accounts receivable wasconcentrated with two customers, each of whom represented more than 10% of ourgross accounts receivable.

International revenue, which consists of sales tocustomers with operations principally in Western Europe and Asia, comprised 52%and 49% of total revenue for the three months ended March 31, 2007 and 2006,respectively.

**Incomefrom Settlement and Patent Licensing**

We recognize the proceedsfrom settlement and patent licensing agreements based on the terms involved.When litigation has been filed prior to a settlement and patent licensingagreement, and insufficient historical evidence exists for the determination offair value of the patents licensed to support the segregation of the proceedsbetween a gain on litigation settlement and patent license revenues, we reportall proceeds in “income from settlement and patent licensing” within operatingcosts and expenses. The gain portion of the proceeds, when sufficienthistorical evidence exists to segregate the proceeds, would be reported inother income according to Statements ofFinancial Accounting Standards (“SFAS”) No. 5, *Accountingfor Contingencies*. To date, all proceeds from settlement and patentlicensing agreements entered into following the commencement of litigation havebeen reported as income from settlement and patent licensing. When a patentlicense agreement is entered into prior to the commencement of litigation, wereport the proceeds of such transaction as licensing revenue in the period inwhich such proceeds are received, subject to the revenue recognition criteria describedabove.

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On February 15, 2007, the weentered into a patent license agreement with Tandberg ASA, Tandberg Telecom ASand Tandberg, Inc.  Under this agreement,CPI dismissed its infringement suit against Tandberg, Tandberg dismissed itsinfringement suit against us, and the we cross-licensed each other’s patentportfolios.  The agreement resulted in apayment of $12.0 million to the us from Tandberg**. **We recognized the gross proceedsof $12.0 million from the patent license agreement as income from settlementand patent licensing within operations in the three months ended March 31,2007.  To recognize the proceeds asrevenue, we would have required sufficient history of transactions in order toisolate the aspect of the settlement attributable to the gain associated withthe process of litigation, separate from commercial compensation for the use ofthe our intellectual property. Sufficient evidence was not available to allow this distinction.   The patent license agreement with Tandbergincludes a ten year capture period, extending from the date of the agreement,during which patents filed with a priority date within the capture period would be licensed in addition toexsiting patents on the agreement date. However, such additional patents would be licensed under the agreementsolely for purposes of the manufacture, sale, license or other transfer ofexisting products of Tandberg and products that are closely relatedenhancements of such products based primarily and substantially on the existingproducts.  We reviewed the existingproducts of Tandberg and considered the likelihood that future patent filingsby us would relate to or otherwise affect existing Tandberg products andclosely related enhancements thereto.  Weconcluded that the filing for such additional patents was unlikely, andtherefore concluded that the ten year capture period was not material from anaccounting perspective related to recognition.

**Valuationof Accounts Receivable**

Estimates are used in determining our allowance fordoubtful accounts and are based on our historical collection experience,historical write-offs, current trends, the credit quality of our customer baseand the characteristics of our accounts receivable by aging category. If theallowance for doubtful accounts were to be understated, our operating resultswould be negatively affected by the correction. The impact of any such changeor deviation may be increased by our reliance on a relatively small number ofcustomers for a large portion of our total revenue. As of March 31, 2007,three customers represented 27%, 21% and 16% of our accounts receivablebalance, each of whom represented more than 10% of our gross accountsreceivable. As of December 31, 2006, three customers represented 44%, 20% and20% of our accounts receivable balance, each of whom represented more than 10%of our gross accounts receivable.

**Valuationof Inventories**

We record a provision for obsolete or excess inventoryfor systems and components that are no longer manufactured or are at risk of beingreplaced with new versions of our product. In determining the allowance forobsolete or excess inventory, we look at our forecasted demand, versusquantities on hand and commitments. Any significant unanticipated changes indemand or technological developments could have a significant impact on thevalue of our inventory, commitments, and our reported results. If actual marketconditions are less favorable than those projected, additional inventorywrite-downs, provision for purchase commitments and charges against earningsmay be required, which would negatively affect our operating results for thatperiod.

**Stock Compensation**

We account for stock based compensation to employeeand non-employees according to the FASBSFAS No. (R), *Share-Based Payment*(SFAS No. 123R), which is a very complex accounting standard, theapplication of which requires significant judgment and the use of estimates,particularly surrounding Black-Scholes-Merton assumptions such as stock pricevolatility and expected option terms, as well as expected option forfeiturerates to value equity-based compensation. There is little experience orguidance with respect to developing these assumptions and models. SFAS No. 123Rrequires the recognition of the fair value of stock compensation in net income(loss). Refer to Note 2 — Stock-Based Compensation in the Notes to ourUnaudited Condensed Consolidated Financial Statements included elsewhere inthis Quarterly Report of Form 10-Q for more information.

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**Results of Operations**

The following table sets forth data expressed as apercentage of total revenue for the periods indicated.
| ** **                                         | ** ** | **Percentage of Total Revenue**       | ** ** |
|----------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                         | ** ** | **Three Months Ended March 31,** | ** ** |
| ** **                                         | ** ** | **2007**                                             | ** ** | **2006** | ** ** |
| Revenue:                                           |       |                                                 |       |   |   |
| Product                                            |       | 52                                                   | %          | 47 | % |
| Licensing                                          |       | 10                                                   |       | 2 |   |
| Services, maintenance and support                  |       | 38                                                   |       | 51 |   |
| Total revenue                                      |       | 100                                                  |       | 100 |   |
| Costs and Expenses:                                |       |                                                 |       |   |   |
| Cost of product revenue                            |       | 31                                                   |       | 34 |   |
| Cost of services, maintenance  and support revenue |       | 28                                                   |       | 33 |   |
| Income from settlement and  patent licensing       |       | (546                                                 | )          | (57 | ) |
| Research and development                           |       | 69                                                   |       | 69 |   |
| Sales and marketing                                |       | 62                                                   |       | 70 |   |
| General and administrative                         |       | 270                                                  |       | 121 |   |
| Total (income) costs and  expenses                 |       | (86                                                  | )          | 270 |   |
| Income (loss) from operations                      |       | 186                                                  |       | (170 | ) |
| Other income (expense):                            |       |                                                 |       |   |   |
| Interest income                                    |       | 4                                                    |       | 5 |   |
| Other income (expense), net                        |       | (2                                                   | )          | — |   |
| Total other income, net                            |       | 2                                                    |       | 5 |   |
| Net  income (loss)                                 |       | 188                                                  | %          | (165 | )% |

 

**COMPARISON OF THE THREE MONTHS ENDED MARCH 31, 2007AND 2006**

***Revenue***

Total revenue increased by $534,000 or 29%, to $2.4million for the three month period ended March 31, 2007, from $1.9 million forthe three months ended March 31, 2006. This increase was due primarily to a$381,000 increase in product revenue and a $200,000 increase in licensingrevenue, partially offset by a $47,000 decrease in services, maintenance andsupport revenue.

For the three months endedMarch 31, 2007, revenue from three customers accounted for 69% of totalrevenue, each of whom accounted for greater than 10% of total revenue. For thethree months ended March 31, 2006, revenue from three customers accountedfor 91% of total revenue, each of whom accounted for greater than 10% of totalrevenue. The level of sales to any customer may vary from quarter to quarter.We expect that there will be significant customer concentration in futurequarters. The loss of any one of those customers would have a material adverseimpact on our financial condition and operating results.

***Costs and Expenses***

*Cost ofproduct revenue.*****Cost of product revenue increased by $97,000, or 15%, to $729,000 for thethree months ended March 31, 2007, from $632,000 for the three months endedMarch 31, 2006. This increase in cost of product revenue was due to theincrease in product sales.

*Cost ofservices, maintenance and support revenue.*****Cost of services,maintenance and support revenue increased by $69,000, or 11%, to $676,000 forthe three months ended March 31, 2007, from $607,000 for the three months endedMarch 31, 2006. The increase was due primarily to the allocation of labor coststo a funded software project during the quarter ended March 31, 2007.  We expect cost of services, maintenance andsupport revenue to vary in the future due to labor costs associated with fundedsoftware projects.

*Income fromsettlement and patent licensing.*****Incomefrom settlement and patent licensing increased by $12.0 million, or 1,135% to$13.1 million for the three month period ended March 31, 2007, from $1.1million for the three month period ended March 31, 2006. The increase was due to the settlement and  patent license agreement entered intowith Tandberg ASA and its subsidiaries in February 2007, which resulted in a cash payment to us of $12.0 million. Income from settlement andpatent licensing for the three months ended March 31, 2007 and 2006 also reflects the amortization in each period of $1.1million of the $21.1 million in net proceeds from our November 2004  settlement and cross-license agreement withPolycom, Inc., which is being recognized over a five year period beginning inNovember 2004 and ending in November 2009.

*Research anddevelopment.*****Research and developmentexpenses increased by $385,000, or 30%,to $1.7 million for the three months ended March 31, 2007 from $1.3 million forthe three months ended March 31, 2006. This increase was due primarily toincreased recruiting and labor expenses, and to a lesser extent, an increase in stock based compensation of $57,000,partially offset by the allocation of engineering employee expenses to cost ofservices associated with a funded software project during the quarter endedMarch 31, 2007.

*Sales andmarketing.* Sales andmarketing expenses increased by $189,000, or 15%, to $1.5 million for the threemonths ended March 31, 2007, from $1.3 million for the three months endedMarch 31, 2006. The increase was due primarily to increased personnel andpersonnel related expenses, and to alesser extent, an increase in stock based compensation of $73,000.

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*General andadministrative.* Generaland administrative expenses increased by $4.2 million, or 186%, to $6.5 millionfor the three months ended March 31, 2007, from $2.3 million for the threemonths ended March 31, 2006. The increase was due primarily to the legalexpenses, including $3.8 million of contingent legal expenses associated withthe settlement of our litigation against Tandberg ASA and its subsidiaries forpatent infringement, and to a lesser extent, an increase in our patent filing expense.

***Other Income***

Other income, net decreased by $38,000, or 40%, to$58,000 for the three months ended March 31, 2007, from $96,000 for thethree months ended March 31, 2006. The decrease was due to interestexpense on our line of credit advance partially offset by increased interestincome from our marketable securities classified as cash equivalents and shortand long-term investments.

**Liquidity and Capital Resources**

We had cash and cash equivalents of $12.3 million asof March 31, 2007, and $7.9 million as of December 31, 2006. For the threemonths ended March 31, 2007, we had an increase in cash and cash equivalentsand short and long-term investments of $4.5 million. The net cash provided byoperations of $4.7 million resulted primarily from net income of $4.5 million,an increase in accrued liabilities and other of $1.2 million and non-cashexpenses of $729,000, which included $682,000 in non-cash stock based compensation,and a decrease in deferred settlement and patent licensing costs of $318,000offset by a decrease in deferred income from settlement and patent licensing of$1.3 million, and a decrease in deferred services revenue of $574,000.  The net cash used in investing activities of$314,000 was due to the purchases of property and equipment.  The net cash inflow from financing activitieswas $129,000, due to the proceeds from the issuance of common stock through ouremployee stock option and purchase plans.

At March 31, 2007, we had open purchase ordersand other contractual obligations of approximately $744,000, primarily relatedto inventory purchase commitments. We also have commitments that consist ofobligations under our operating leases. These purchase order commitments andcontractual obligations are reflected in our financial statements once goods orservices have been received or payments related to the obligations become due.

In May 2007, we added 7,900 square foot of officespace to our existing lease at our headquarters in San Mateo, California tohouse operational staff.  The newfacilities require minimum payments of approximately $114,000, $281,000,$288,000, $296,000, $303,000 and $76,000 for fiscal years 2007, 2008, 2009,2010, 2011 and 2012, respectively.

We currently believe that our existing cash and cashequivalents balance and line of credit will provide us with sufficient funds tofinance our operations for the next 12 months. We intend to continue to investin the development of new products and enhancements to our existing products.Our future liquidity and capital requirements will depend upon numerousfactors, including without limitation, general economic conditions andconditions in the financial services industry in particular, the level andtiming of product, services and patent licensing revenues and income, the costsand timing of our product development efforts and the success of thesedevelopment efforts, the costs and timing of our sales and marketingactivities, the extent to which our existing and new products gain marketacceptance, competing technological and market developments, and the costsinvolved in maintaining and enforcing patent claims and other intellectualproperty rights, all of which may impact our ability to achieve and maintainprofitability or generate positive cash flows.

**RecentlyAccounting Pronouncements**

In September 2006, the FASB issued FASB StatementNo. 157, *Fair Value Measurements* (“SFAS No.157”). The standard provides guidance for using fair value to measure assetsand liabilities and responds to investors’ requests for expanded informationabout the extent to which companies measure assets and liabilities at fairvalue, the information used to measure fair value, and the effect of fair valuemeasurements on earnings. The standard applies whenever other standards requireor permit assets or liabilities to be measured at fair value. The standard doesnot expand the use of fair value in any new circumstances. SFAS 157 mustbe adopted prospectively as of the beginning of the year it is initiallyapplied. SFAS 157 is effective for financial statements issued for fiscalyears beginning after November 15, 2007, and interim periods within thosefiscal years. We are evaluating the impact this standard will have on ourfinancial position or results of operations.

**Item 3. *Quantitativeand Qualitative Disclosures About Market Risk***

We develop products primarily in the United States and sell those products primarily in North America, Europe and Asia. International revenue, which consists of sales to customers with operations principally in Western Europe and Asia, comprised 52% of total product and services revenue for the three months ended March 31, 2007 and 49% for the three months ended March 31, 2006. Our financial condition could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. As all of our sales are currently transacted in United States dollars, a strengthening of the United States dollar could make our products less competitive in foreign markets. We do not use derivative financial instruments for speculative or trading purposes, nor do we engage in any foreign currency hedging transactions.

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Our interest income is sensitive to changes in the general level of United States interest rates, particularly since the majority of our investments are in short-term instruments. There has not been a material change in our exposure to interest rate and foreign currency risk since the date of our annual report on Form 10-K for the year ended December 31, 2006 filed with the Securities and Exchange Commission on March 22, 2007.

**Cash, 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 three months or less, and are stated at cost, plus accrued interest that approximates market value. We would not expect our operating results or cash flow to be significantly impacted by the effect of sudden changes in market interest rates given the nature of our short-term investments.

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

|                                                 | ** ** | **Amounts**             | ** ** | **Weighted Average  Interest Rate** | ** ** |
|-------------------------------------------------|------------|-------------------------|------------|-----------------------------------------------|------------|
| ** **                                      | ** ** | **(in thousands)** | ** ** | ** **                                    | ** ** |
| **Description**                                 | ** ** | ** **              | ** ** | ** **                                    | ** ** |
| Cash  and cash equivalents:                     |       |                    |       |                                          |       |
| Cash                                            |       | $                       | 1,424      |                                          | —     |   |
| Commercial Paper and US Government Agency Notes |       | 10,915                  |       | 5.3                                           | %          |
| Fair Value at March 31, 2007               |       | $                       | 12,339     |                                          |       |   |

 

# **Item 4T.*****Controlsand Procedures***

(a) Evaluation of disclosure controls and procedures: Our management evaluated, with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the Exchange Act)) were  effective to provide reasonable assurance  that information required to be disclosed by us in reports that we file or submit under the Exchange Act (i) is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure, and (ii) is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.  In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives.  In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.

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

**PART II - OTHER INFORMATION**

**Item 1. *Legal Proceedings***

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

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

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On February 15, 2007, we entered into a patent license agreement with Tandberg ASA, Tandberg Telecom AS and Tandberg, Inc. Under this agreement, CPI agreed to dismiss its infringement suit against Tandberg, Tandberg agreed to dismiss its infringement suit against us and CPI, and the companies agreed to cross-license each other’s patent portfolios. The agreement resulted in a payment to us from Tandberg in the amount of $12.0 million.

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

**Factors Affecting Future Operating Results**

**Wehave incurred substantial losses in the past and may not be profitable in thefuture.**

Werecorded  net income of $4.5 million forthe three months ended March 31, 2007, a net loss of $8.1 million forfiscal year 2006, and a net loss of $5.2 million for fiscal year 2005. As of March 31, 2007, our accumulated deficit was $98.3million.  Our net income for the threemonths ended March 31, 2007 was primarily due to the $12.0 million in incomefrom settlement and patent licensing we received from Tandberg ASA insettlement of our litigation with Tandberg.  Our revenue and income from settlement and patent licensing maynot increase, or even remain at its current level. In addition, our operatingexpenses may increase as we continue to develop our business and pursuelicensing opportunities. As a result, to become profitable, we will need toincrease our revenue and income from settlement and patent licensing byincreasing sales to existing customers and by attracting additional customersand licensees. If our expenses increase more rapidly than our revenue, or ifrevenue and expense levels remain the same, we may never become profitable. Inthe quarter ended March 31, 2007 we attained a profit, as we did during thethird quarter of 2006, but we may not be able to sustain or increaseprofitability on a quarterly or annual basis. In addition, if we fail to reachprofitability or to sustain or grow our profits within the time frame expectedby investors, the market price of our common stock may be adversely impacted.

**Ourmarket is in the early stages of development, and our system may not be widelyaccepted.**

Ourability to achieve profitability depends in part on the widespread adoption ofnetworked video communications systems and the sale and adoption of our videosystem in particular. If the market for our system fails to grow or grows moreslowly than we anticipate, we may not be able to increase revenue or achieveprofitability. The market for our system is relatively new and evolving. Wehave to devote substantial resources to educate prospective customers about theuses and benefits of our system. Our efforts to educate potential customers maynot result in our system achieving broad market acceptance. In addition,businesses that have invested or may invest substantial resources in othervideo products may be reluctant or slow to adopt our system. Consequently, theconversion from traditional methods of communication to the extensive use ofnetworked video may not occur as rapidly as we wish.

**Ourlengthy sales cycle to acquire new customers or large follow-on orders maycause our operating results to vary significantly and make it more difficult toforecast our revenue.**

We have generallyexperienced a product sales cycle of four to nine months for new customers orlarge follow-on orders from existing customers.   This sales cycle is due to the time neededto educate customers about the uses and benefits of our system, and theinvestment decisions that our prospective customers must make when they decideto buy our system. Many of our prospective customers have neither budgetedexpenses for networked video communications systems, or for personnelspecifically dedicated to the procurement, installation or support of thesesystems. As a result, our customers spend a substantial amount of time beforepurchasing our system in performing internal reviews and obtaining capitalexpenditure approvals. Economic conditions over the last several years havecontributed to additional deliberation and an associated delay in the salescycle.

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

**General economicconditions have and may impact our revenues and harm our business in thefuture.**

Theinternational economic slowdown and the downturn in the investment bankingindustry that began in 2000 negatively affected our business, and areoccurrence of a difficult economic environment may do so in the future.During this most recent economic downturn, the investment banking industrysuffered a sharp decline, which caused many of our existing and potentialcustomers to cancel or delay orders for our products. Although the U.S. economyhas improved, our customers and potential customers may continue to delayordering our products, and we could fall short of our revenue expectations for2007 and beyond. Slower growth among our customers, tightening of customers’operating budgets, retrenchment in the capital markets and other generaleconomic factors all have had, and could in the future have, a materiallyadverse effect on our revenue, capital resources, financial condition andresults of operations.

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**Futurerevenues and income from settlement and licensing activities are difficult topredict for several reasons, including our lengthy and costly licensing cycle.Our failure to predict revenues and income accurately may cause us to missanalysts’ estimates and result in our stock price declining.**

Becauseour licensing cycle is a lengthy process, the accurate prediction of futurerevenues and income from settlement and patent licensing from new licensees isdifficult. The process of persuading companies to adopt our technologies orconvincing them that their products infringe upon our intellectual propertyrights can be lengthy. The proceeds of our intellectual property licensing andenforcement efforts tend to be sporadic and difficult to predict. There is alsoa tendency in the technology industry to close business deals at the end of aquarter, thereby increasing the likelihood that a possible material deal wouldnot be concluded in a current quarter, but slip into a subsequent reportingperiod. This kind of delay may result in a given quarter’s performance beingbelow analyst or shareholder expectations.

**Sincea majority of our product revenue has come from follow-on orders, our financialperformance could be harmed if we fail to obtain follow-on orders in thefuture.**

Ourcustomers typically place limited initial orders for our networked videocommunications system, as they seek to evaluate its utilization and resultantvalue. Our strategy is to pursue additional and larger follow-on orders afterthese initial orders. Excluding licensing and services revenue, product revenuegenerated from follow-on orders accounted for approximately 95%, 95% and 99% ofour product revenue for the three months ended March 31, 2007, and the yearsended December 31, 2006 and 2005, respectively. Our future financialperformance depends on successful initial installations of our system, andsuccessful generation of follow-on orders as the Avistar network expands withina customer’s organization. If our system does not meet the needs andexpectations of customers, we may not be able to generate follow-on orders.

**Becausewe depend on a few customers for a majority of our product revenue, servicesrevenue, and income from settlement and patent licensing, the loss of one ormore of them could cause a significant decrease in our operating results.**

To date, a significant portion of our revenue andincome from settlement and patent licensing has resulted from sales or licensesto a limited number of customers, particularly Deutsche Bank AG, UBS AG,Polycom, Inc., Tandberg ASA and their affiliates.  Prior to the three month period ended March31, 2007, income from settlement and patent licensing had come solely from oursettlement and patent licensing agreements with Polycom. Collectively,Tandberg, Polycom, Deutsche Bank AG and UBS AG and their affiliates accountedfor approximately 94% and 85% of total revenues and income from settlement andpatent licensing for the three month periods ended March 31, 2007 and2006, respectively.  As of March 31,2007, approximately 64% of our gross accounts receivable was concentrated withthree customers, each of whom represented more than 10% of our gross accountsreceivable. As of December 31, 2006, approximately 84% of our grossaccounts receivable was concentrated with three customers, each of whomrepresented more than 10% of our gross accounts receivable.

Theloss of a major customer or the reduction, delay or cancellation of orders fromone or more of our significant customers could cause our revenue to decline andour losses to increase.  Income fromsettlement and licensing activities from Tandberg, which was $12.0 million inthe first quarter of 2007, was a one time payment from Tandberg and we expectto complete the amortization of the Polycom proceeds in 2009. If we are unableto license our patent portfolio to additional parties on terms equal to orbetter than our agreements with Polycom and Tandberg, our income fromsettlement and licensing will decline, which could cause our losses toincrease. We currently depend on a limited number of customers with lengthy budgetingcycles and unpredictable buying patterns, and as a result, our revenue fromquarter-to-quarter or year-to-year may be volatile. Adverse changes in ourrevenue or operating results as a result of these budgeting cycles or any otherreduction in capital expenditures by our large customers could substantiallyreduce the trading price of our common stock.

**Ourexpected future working capital needs may require that we seek additional debtor equity funding which, if not available on acceptable terms, could cause ourbusiness to suffer.**

Asof March 31, 2007, ouraccumulated deficit was $98.3 million. Our revenue and income fromsettlement and patent licensing may not increase, or even remain at its currentlevel. In addition, our operating expenses may increase as we continue todevelop our business and pursue licensing opportunities. As a result, we mayneed to arrange for the availability of additional funding in addition to ourexisting line of credit in order to meet our future business requirements. If weare unable to obtain additional funding when needed on acceptable terms, we maynot be able to develop or enhance our products, take advantage of futureopportunities, respond to competitive pressures or unanticipated requirements,or finance our efforts to protect and enforce our intellectual property rights,which could seriously harm our business, financial condition, results ofoperations and ability to continue operations.

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**Wemay not be able to modify and improve our products in a timely and cost effectivemanner to respond to technological change and customer demands.**

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

·       rapid technological change;

·       the emergence of newcompetitors;

·       significant development costs;

·       changes in the requirements of our customers andtheir communities of users;

·       evolving industry standards; and

·       transition to Internet protocol connectivity forvideo at the desktop, with increasing availability of bandwidth and improvingquality of service.

Oursystem is designed to work with a variety of hardware and softwareconfigurations and data networking infrastructures used by our customers. Themajority of these customer networks rely on Microsoft Windows servers. However,our software may not operate correctly on other hardware and software platformsor with other programming languages, database environments and systems that ourcustomers use. Also, we must constantly modify and improve our system to keeppace with changes made to our customers’ platforms, data networkinginfrastructures, and their evolving ability to integrate video with otherapplications. This may result in uncertainty relating to the timing and natureof our new release announcements, introductions or modifications, which in turnmay cause confusion in the market, with a potentially harmful effect on ourbusiness. If we fail to promptly modify or improve our system in response toevolving industry standards or customers’ demands, our system could become lesscompetitive, which would harm our financial condition and reputation.

**Difficultiesor delays in installing our products could harm our revenue and margins.**

Werecognize product and installation revenue upon the installation of our systemin those cases where we are responsible for installation, which often entailsworking with sophisticated software, computing and communications systems. Ifwe experience difficulties with installation or do not meet deadlines due todelays caused by our customers or ourselves, we could be required to devotemore customer support, technical and other resources to a particularinstallation. If we encounter delays in installing our products for new orexisting customers, or installation requires significant amounts of ourprofessional services support, our revenue recognition could be delayed, ourcosts could increase and our margins could suffer.

**Competitioncould reduce our market share and decrease our revenue.**

The market in which weoperate is highly competitive. In addition, because our industry is relativelynew and is characterized by rapid technological change, evolving user needs,developing industry standards and protocols and the introduction of newproducts and services, it is difficult for us to predict whether or when newcompeting technologies or new competitors will enter our market. Currently, ourcompetition comes from many other kinds of companies, including communicationequipment, integrated solution, broadcast video and stand-alone “point solution”providers. Within the video-enabled network communications market, we competeprimarily against Polycom, Tandberg ASA, Sony Corporation, Apple Inc.,Radvision, Ltd. and Emblaze-VCON Ltd. Withincreasing interest in the power of video collaboration and the establishmentof communities of users, we believe we face increasing competition fromalternative video communications solutions that employ new technologies or newcombinations of technologies from companies such as Cisco Systems, Inc.,Avaya, Inc., Microsoft Corporation, Nortel Networks Corporation and WebExCommunications, Inc. (in the process of being acquired by Cisco Systems,Inc.) that enable web-based or network-based video communications with low-costdigital camera systems.

We expect competition toincrease in the future from existing competitors, partnerships of competitors,and from new market entrants with products that may be less expensive thanours, or that may provide better performance or additional features notcurrently provided by our products. Many of our current and potentialcompetitors have substantially greater financial, technical, manufacturing,marketing, distribution and other resources, greater name recognition andmarket presence, longer operating histories, lower cost structures and largercustomer bases than we do. As a result, they may be able to adapt more quicklyto new or emerging technologies and changes in customer requirements.

We may be required toreduce prices or increase spending in response to competition in order toretain or attract customers, pursue new market opportunities or invest inadditional research and development efforts. As a result, our revenue, marginsand market share may be harmed. We cannot assure you that we will be able to compete successfully against current andfuture competitors and partnerships of our competitors, or that competitivepressures faced by us will not harm our business, financial condition andresults of operations.

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

Weregard our system as open but proprietary. In an effort to protect our proprietaryrights, we rely primarily on a combination of patent, copyright, trademark andtrade secret laws, as well as licensing, non-disclosure and other agreementswith our consultants, suppliers, customers and employees. However, these lawsand agreements provide only limited protection of our proprietary rights. Inaddition, we may not have signed agreements in every case, and the contractualprovisions that are in place and the protection they produce may not provide uswith adequate protection in all circumstances. Although CPI holds patents andhas filed patent applications covering some of the inventions embodied in oursystems, our means of protecting our proprietary rights may not be adequate. Itmay be possible for a third party to copy or otherwise obtain and use ourtechnology without authorization and without our detection. In the eventthat we believe a third party is infringing our intellectual property rights,an infringement claim brought by us could, regardless of the outcome, result insubstantial cost to us, divert our management’s attention and resources, betime consuming to prosecute and result in unpredictable damage awards. A third party may also develop similar technologyindependently, without infringing upon our patents and copyrights. In addition,the laws of some countries in which we sell our system may not protect oursoftware and intellectual property rights to the same extent as the laws of theUnited States or other countries where we hold patents. As we move to more of asoftware based system, inadequate licensing controls, unauthorized copying, anduse, or reverse engineering of our system could harm our business, financialcondition or results of operations.

**Othersmay bring infringement claims against us, which could be time-consuming andexpensive to defend.**

Inrecent years, there has been significant litigation in the United Statesinvolving patents and other intellectual property rights, and we have been aparty to such litigation. The prosecution and defense of these lawsuits wherewe are involved may require us and CPI to expend significant financial andmanagerial resources, and therefore may have a material negative impact on ourfinancial position and results of operations. The duration and ultimate outcomeof these proceedings are uncertain. We may be a party to additional litigationin the future, to protect our intellectual property or as a result of analleged infringement of the intellectual property of others. These claims andany resulting lawsuit could subject us to significant liability for damages andinvalidation of our proprietary rights. These lawsuits, regardless of theirmerit or success, would likely be time-consuming and expensive to resolve andwould divert management’s time and attention. Any potential intellectualproperty litigation also could force us to do one or more of the following:

·       stop selling, incorporating or using products orservices that use the challenged intellectual property;

·       obtain from the owner of the infringedintellectual property a license to the relevant intellectual property, whichmay require us to license our intellectual property to such owner, or may notbe made available on reasonable terms or at all; and

·       redesign those products or services that usetechnology that is the subject of an infringement claim.

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

**Ourinability to protect the intellectual property created by us would cause ourbusiness to suffer.**

We rely on a combinationof license, development and nondisclosure agreements, trademark, trade secretand copyright law, and contractual provisions to protect our other,non-patentable intellectual property rights. If we fail to protect theseintellectual property rights, our licensees, potential licensees and others mayseek to use our technology without the payment of license fees and royalties,which could weaken our competitive position, reduce our operating results andincrease the likelihood of costly litigation. The growth of our businessdepends in part on the applicability of our intellectual property to theproducts of third parties, and our ability to enforce intellectual propertyrights against them. In addition, effective trade secret protection may beunavailable or limited in certain foreign countries. Although we intend toprotect our rights vigorously, if we fail to do so, our business will suffer.

**Oursystem could have defects for which we could be held liable for, and whichcould result in lost revenue, increased costs, and loss of our credibility ordelay in the further acceptance of our system in the market.**

Oursystem may contain errors or defects, especially when new products are introducedor when new versions are released. Despite internal system testing, we have inthe past discovered software errors in some of the versions of our system aftertheir introduction. Errors in new systems or versions could be found aftercommencement of commercial shipments, and this could result in additionaldevelopment costs, diversion of technical and other resources from our otherdevelopment efforts or the loss of credibility with current or futurecustomers. Any of these events could result in a loss of revenue or a delay inmarket acceptance of our system and could harm our reputation.

Inaddition, we have warranted to some of our customers that our software is freeof viruses. If a virus infects a customer’s computer software, the customercould assert claims against us, which, regardless of their merits, could becostly to defend and could require us to pay damages and potentially harm ourreputation.

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Ourlicense agreements with our customers typically contain provisions designed tolimit our exposure to potential product liability and certain contract claimsand typically limit a customer’s entire remedy to either a refund of the pricepaid or modification of our system. However, these provisions vary as to theirterms and may not be effective under the laws of some jurisdictions. Althoughwe maintain product liability (“errors and omissions”) insurance coverage, wecannot assure you that such coverage will be adequate. A product liability,warranty or other claim could harm our business, financial condition and/orresults of operations. Performance interruptions at a customer’s site couldnegatively affect the demand for our system or give rise to claims against us.

Thethird party software we license with our system may also contain errors ordefects for which we do not maintain insurance. Typically, our licenseagreements transfer any warranty from the third party to our customers to theextent permitted. Product liability, warranty or other claims brought againstus with respect to such warranties could, regardless of their merits, harm ourbusiness, financial condition or results of operations.

**Theloss of any of our outside contract manufacturers or third party equipmentsuppliers that produce key components of our system could significantly disruptour manufacturing and new product development process.**

We depend on outside contract manufacturers to producecomponents of our systems, such as cameras, microphones, gateway, speakers andmonitors that we install at desktops and in conference rooms. One supplier,Pacific Corporation, is a single source supplier for a key component of ourproduct. Another supplier, Pixelworks Inc., is our only current source of acomponent used in our IP gateway product. In addition, during 2006, we beganusing an offshore contract resource in China for product development work. Ourreliance on these third parties involves a number of risks, including:

·       the possible unavailability of critical servicesand components on a timely basis, on commercially reasonable terms or at all;

·       if the components necessary for our system wereto become unavailable, the need to qualify new or alternative components forour use or reconfigure our system and manufacturing process could be lengthyand expensive;

·       the likelihood that, if particular components orhuman resources were not available, we would suffer an interruption in themanufacture and shipment of our systems until these components or alternativesbecome available;

·       reduced control by us over the quality and costof our system and over our ability to respond to unanticipated changes andincreases in customer orders, and conversely, price changes from suppliers ifcommitted volumes are not met;

·       the possible unavailability of, or interruptionin, access to some technologies due to infringement claims, production/supplyissues or other hindrances; and

·       the possible misappropriation of our source codethrough reverse engineering or other means by contract developers or otherparties.

Ifthese manufacturers or suppliers cease to provide us with the assistance or thecomponents necessary for the operation of our business, we may not be able toidentify alternate sources in a timely fashion. Any transition to alternatemanufacturers or suppliers would likely result in operational problems andincreased expenses, and could cause delays in the shipment of or otherwiselimit our ability to provide our products. We cannot assure you that we wouldbe able to enter into agreements with new manufacturers or suppliers oncommercially reasonable terms, or at all. Any disruption in product flow maylimit our revenue, delay our product development, seriously harm ourcompetitive position and/or result in additional costs or cancellation oforders by our customers.

**Ifwe are unable to expand our direct sales force and/or add distributionchannels, our business will suffer.**

Toincrease our revenue, we must increase the size of our direct sales force andadd indirect distribution channels, such as systems integrators, productpartners and/or value-added resellers, and/or effect sales through ourcustomers. If we are unable to maintain or increase our direct sales force oradd indirect distribution channels due to our own cost constraints, limitedavailability of qualified personnel or other reasons, our future revenue growthmay be limited and our future operating results may suffer. We cannot assureyou that we will be successful in attracting, integrating, motivating andretaining sales personnel. Furthermore, it can take several months before a newhire becomes a productive member of our sales force. The loss of existingsalespeople, or the failure of new salespeople and/or indirect sales partnersto develop the necessary skills in a timely manner, could impact our revenuegrowth.

**Wemay not be able to retain our existing key personnel, or hire and retain theadditional personnel that we need to sustain and grow our business.**

We depend on thecontinued services of our executive officers and other key personnel. We do nothave long-term employment agreements with our executive officers or other keypersonnel and we do not carry any “key man” life insurance. The loss of theservices of any of our executive officers or key personnel could harm ourbusiness, financial condition and results of operations.

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Our products andtechnologies are complex, and to successfully implement our business strategyand manage our business, an in-depth understanding of video communication andcollaboration technologies and their potential uses is required. We need toattract and retain highly skilled technical and managerial personnel for whomthere is intense competition. If we are unable to attract and retain qualifiedtechnical and managerial personnel due to our own cost constraints, limitedavailability of qualified personnel or other reasons, our results of operationscould suffer and we may never achieve profitability. The failure of newpersonnel to develop the necessary skills in a timely manner could harm ourbusiness.

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

Failureto achieve or effectively manage growth will harm our business, financialcondition and operating results. Furthermore, in order to remain competitive orto expand our business, we may find it necessary or desirable in the future toacquire other businesses, products or technologies. If we identify anappropriate acquisition candidate, we may not be able to negotiate the terms ofthe acquisition successfully, to finance the acquisition or to integrate theacquired businesses, products or technologies into our existing business andoperations. In addition, completing a potential acquisition and integrating anacquired business may strain our resources and require significant managementtime.

**Ourinternational operations expose us to potential tariffs and other tradebarriers, unexpected changes in foreign regulatory requirements and laws andeconomic and political instability, as well as other risks that could adverselyaffect our results of operations.**

International revenue, which consists of sales tocustomers with operations principally in Western Europe and Asia,  comprised 52% of total revenue for the threemonths ended March 31, 2007, 75% for the year end December 31, 2006 and 63% foryear end December 31, 2005. Some of the risks we may encounter in conductinginternational business activities include the following:

·       tariffs and other trade barriers;

·       unexpected changes in foreign regulatoryrequirements and laws;

·       economic and political instability;

·       increased risk of infringement claims;

·       protection of our intellectual property;

·       restrictions on the repatriation of funds;

·       potentially adverse tax consequences;

·       timing, cost and potential difficulty of adaptingour system to the local language standards in those foreign countries that donot use the English language;

·       fluctuations in foreign currencies; and

·       limitations in communications infrastructures insome foreign countries.

Someof our products are subject to various federal, state and international lawsgoverning substances and materials in products, including those restricting thepresence of certain substances in electronics products. We could incursubstantial costs, including fines and sanctions, or our products could beenjoined from entering certain jurisdictions, if we were to violateenvironmental laws or if our products become non-compliant with environmentallaws. We also face increasing complexity in our product design and procurementoperations as we adjust to new and future requirements relating to thematerials composition of our products, including the restrictions on lead andcertain other substances that apply to specified electronics products sold inthe European Union as of July 1, 2006 (Restriction of Hazardous SubstancesDirective). The ultimate costs under environmental laws and the timing of thesecosts are difficult to predict. Similar legislation has been or may be enactedin other regions, including in the United States, the cumulative impact of whichcould be significant.

**Internationalpolitical instability may increase our cost of doing business and disrupt ourbusiness.**

Increased internationalpolitical instability, evidenced by the threat or occurrence of terroristattacks, enhanced national security measures and/or sustained military actionmay halt or hinder our ability to do business, may increase our costs and mayadversely affect our stock price. This increased instability has had and maycontinue to have negative effects on financial markets, including significantprice and volume fluctuations in securities markets. If this internationalpolitical instability continues or escalates, our business and results ofoperations could be harmed and the market price of our common stock could decline.

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**Ifour customers do not perceive our system or services to be effective or of highquality, our brand and name recognition would suffer.**

We believe thatestablishing and maintaining brand and name recognition is critical forattracting and expanding our targeted customer base. We also believe that theimportance of reputation and name recognition will increase as competition inour market increases. Promotion and enhancement of our name will depend on thesuccess of our marketing efforts, and on our ability to continue to providehigh quality systems and services, neither of which can be assured. If ourcustomers do not perceive our system or services to be effective or of highquality, our brand and name recognition will suffer, which would harm our business.

**Wemay not meet the continued listing criteria for The NASDAQ Capital Market,which could materially and adversely affect the price and liquidity of ourstock, our business and our financial condition.**

For continued listing ofour common stock on The NASDAQ Capital Market, we are required to, among otherthings (i) maintain stockholders’ equity of at least $2.5 million, or amarket value of listed securities of at least $35 million, or annual net incomefrom continuing operations of at least $500,000, and (ii) maintain aminimum closing bid price of our common stock of at least $1.00. If we do notmeet the continued listing requirements, our common stock could be subject todelisting from trading on The NASDAQ Capital Market. There can be no assurancethat we will continue to meet all requirements for continued listing on TheNASDAQ Capital Market.

If we are unable tocontinue to list our common stock for trading on The NASDAQ Capital Market,there may be adverse impact on the market price and liquidity of our commonstock, and our stock may be subject to the “penny stock rules” contained inSection 15(g) of the Securities Exchange Act of 1934, as amended, andthe rules promulgated thereunder. Delisting of our common stock from TheNASDAQ Capital Market could also have a materially adverse effect on ourbusiness, including, among other things: our ability to raise additionalfinancing to fund our operations; our ability to attract and retain customers;and our ability to attract and retain personnel, including managementpersonnel. In addition, if we were unable to list our common stock for tradingon NASDAQ, many institutional investors would no longer be able to retain theirinterests in and/or make further investments in our common stock because of theirinternal rules and protocols.

**Ourcommon stock has been and will likely continue to be subject to substantialprice and volume fluctuations due to a number of factors, many of which will bebeyond our control, which may prevent our stockholders from reselling ourcommon stock at a profit.**

Thetrading price of our common stock has in the past been and could in the futurebe subject to significant fluctuations in response to:

·       general trends in the equities market, and/ortrends in the technology sector;

·       quarterly variations in our results ofoperations;

·       announcements regarding our product developments;

·       the size and timing of agreements to license ourpatent portfolio;

·       announcements of technological innovations or newproducts by us, our customers or competitors;

·       announcements of competitive productintroductions by our competitors;

·       sales, or the perception in the market ofpossible sales, of a large number of shares of our common stock by ourdirectors, officers, employees or principal stockholders; and

·       developments or disputes concerning patents orproprietary rights, or other events.

If our revenue andresults of operations are below the expectations of public market securitiesanalysts or investors, then significant fluctuations in the market price of ourcommon stock could occur. In addition, the securities markets have, from timeto time, experienced significant price and volume fluctuations, which haveparticularly affected the market prices for high technology companies, andwhich often are unrelated and disproportionate to the operating performance ofparticular companies. These broad market fluctuations, as well as generaleconomic, political and market conditions, may negatively affect the marketprice of our common stock.

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

Inthe past, following periods of market volatility in the price of a company’ssecurities, security holders have often instituted class action litigation.Many technology companies have been subject to this type of litigation. Ourshare price has, in the past, experienced price volatility, and may continue todo so in the future. If the market value of our common stock experiencesadverse fluctuations and we become involved in this type of litigation,regardless of the merits or outcome, we could incur substantial legal costs andour management’s attention could be diverted, causing our business, financialcondition and operating results to suffer.

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**Provisionsof our certificate of incorporation, our bylaws and Delaware law may make itdifficult for a third party to acquire us, despite the possible benefits to ourstockholders.**

Ourcertificate of incorporation, our bylaws, and Delaware law contain provisionsthat may inhibit changes in our control that are not approved by our Board ofDirectors. For example, the Board of Directors has the authority to issue up to10,000,000 shares of preferred stock and to determine the terms of thispreferred stock, without any further vote or action on the part of thestockholders.

Theseprovisions may have the effect of delaying, deferring or preventing a change inthe control of Avistar despite possible benefits to our stockholders, maydiscourage bids at a premium over the market price of our common stock, and mayadversely affect the market price of our common stock and the voting and otherrights of our stockholders.

**Our principalstockholders can exercise a controlling influence over our business affairs andthey may make business decisions with which you disagree that will affect thevalue of your investment.**

Ourexecutive officers, directors and entities affiliated with them, in theaggregate, beneficially owned approximately 63% of our common stock as of March 31, 2007. If they were to act together, thesestockholders would be able to exercise control over most matters requiringapproval by our stockholders, including the election of directors and approvalof significant corporate transactions. These actions may be taken even if theyare opposed by other investors. This concentration of ownership may also havethe effect of delaying or preventing a change in control of Avistar, whichcould cause the market price of our common stock to decline.

**Changes in stock optionaccounting rules enacted have and will continue to adversely impact ourreported operating results prepared in accordance with generally acceptedaccounting principles, which may in turn adversely impact our stock price andour ability to attract and retain employees.**

InDecember 2004, the FASB issued SFAS No. 123R, which  requires employee stock options and rights topurchase shares under stock participation plans to be accounted for under thefair value method, and eliminates the ability to account for these instrumentsunder the intrinsic value method prescribed by Accounting Principles Board  Opinion No. 25, and allowed under theoriginal provisions of SFAS No. 123. SFAS No. 123R requires the useof an option pricing model for estimating fair value, which is amortized toexpense over the service periods.

We expect to continue togrant stock options to employees. The impact of SFAS No. 123R had amaterial impact on our results of operations.

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**Item 6. *Exhibits***
| Exhibit No. | ** ** | **Description**                                                                                                                                                                            |
|------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|             |       |                                                                                                                                                                                       |
| 10.20+           |       | Patent License Agreement dated February 15, 2007 by  and among the Registrant, Collaboration Properties, Inc., Tandberg ASA,  Tandberg Telecom AS, and Tandberg, Inc.                      |
|             |       |                                                                                                                                                                                       |
| 31.1             |       | Rule 13a-14(a)/15d-14(a) Certification by the  Chief Executive Officer.                                                                                                               |
|             |       |                                                                                                                                                                                       |
| 31.2             |       | Rule 13a-14(a)/15d-14(a) Certification by the  Chief Financial Officer.                                                                                                               |
|             |       |                                                                                                                                                                                       |
| 32.1             |       | Certification of Chief Executive Officer and Chief  Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |

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+ Portions of this exhibit have been omitted pursuant toa request for confidential treatment and the omitted portions have beenseparately filed with the Commission.

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**SIGNATURES**

Pursuant to the requirements ofthe Securities and Exchange Act of 1934, the registrant has duly caused thisreport to be signed on its behalf by the undersigned thereunto duly authorized,on this 14th day of May 2007.

 
|        | 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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**EXHIBITINDEX**
| Exhibit No. | ** ** | **Description**                                                                                                                                                                            |
|------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|             |       |                                                                                                                                                                                       |
| 10.20+           |       | Patent License Agreement dated February 15, 2007 by  and among the Registrant, Collaboration Properties, Inc., Tandberg ASA,  Tandberg Telecom AS, and Tandberg, Inc.                      |
|             |       |                                                                                                                                                                                       |
| 31.1             |       | Rule 13a-14(a)/15d-14(a) Certification by the  Chief Executive Officer.                                                                                                               |
|             |       |                                                                                                                                                                                       |
| 31.2             |       | Rule 13a-14(a)/15d-14(a) Certification by the  Chief Financial Officer.                                                                                                               |
|             |       |                                                                                                                                                                                       |
| 32.1             |       | Certification of Chief Executive Officer and Chief  Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |

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+ Portions of this exhibit have been omitted pursuant toa request for confidential treatment and the omitted portions have beenseparately filed with the Commission.

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