UNITED
STATES




SECURITIES
AND EXCHANGE COMMISSION




WASHINGTON,
D.C. 20549




FORM
10-Q





x
            
            QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
              SECURITIES
      AND EXCHANGE ACT OF 1934For
      the quarterly period ended March 31, 2008ORo
            
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
              SECURITIES
      AND EXCHANGE ACT OF 1934For
      the transition period from
                
      toCommission
      file number: 000-31121






AVISTAR
COMMUNICATIONS CORPORATION




(Exact
name of registrant as specified in its charter)





DELAWARE
            
            88-0463156(State
      or other jurisdiction
            
            (I.R.S.
      Employer Identification Number)of
      incorporation or organization)1875 SOUTH GRANT STREET,
      10 THFLOOR, 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 the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934
during the preceding 12 months (or for shorter period that the registrant was
required to file such reports); and (2) has been subject to such filing
requirements for the past 90 days.




Yes xNo o




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





Large accelerated filer o
            
            Accelerated
      filer o




Non-accelerated
      filer o
            
            Smaller reporting
      company x




Indicate
by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).




Yes oNo x




At
May 5, 2008, 34,547,139 shares of common stock of the Registrant were
outstanding.












AVISTAR
COMMUNICATIONS CORPORATION




INDEX





PART
      I.
              FINANCIAL
      INFORMATION
              3Item
      1.
              Financial
      Statements (unaudited)
              3Condensed
      Consolidated Balance Sheets
              3Condensed
      Consolidated Statements of Operations
              4Condensed
      Consolidated Statements of Cash Flows
              5Notes
      to Condensed Consolidated Financial Statements
              6Item
      2.
              Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
              15Item
      3.
              Inttentionally
      OmittedItem
      4T.
              Controls
      and Procedures
              22PART
      II.
              OTHER
      INFORMATION
              23Item
      1A.
              Risk
      Factors
              23Item
      2.
              Unregistered
      sales of Equity Securities and Use of Proceeds
              31Item
      3.
              Defaults
      Upon Senior Securities
              31Item
      4.
              Submissions
      of Matters to a Vote of Security Holders
              31Item
      5.
              Other
      Information
              31Item
      6.
              Exhibits
              32SIGNATURES
              
              33







2





PART I - FINANCIAL INFORMATION




Item 1.Financial
Statements







AVISTAR
COMMUNICATIONS CORPORATION AND SUBSIDIARY




CONDENSED
CONSOLIDATED BALANCE SHEETS




as
of March 31, 2008 and December 31, 2007




(in
thousands, except share and per share data)





March 31,
      2008
            
            
            
            December 31,
      2007(unaudited)Assets:Current
      assets:Cash
      and cash equivalents
            
            $
            5,975
            
            
            $
            4,077Short-term
      investments
            
            
            —
            
            
            
            799Total
      cash, cash equivalents and short-term investments
            
            
            5,975
            
            
            
            4,876Accounts
      receivable, net of allowance for doubtful accounts of $34 and $24 at March
      31, 2008 and December 31, 2007, respectively
            
            
            1,570
            
            
            
            1,385Inventories
            
            
            492
            
            
            
            428Deferred
      settlement and patent licensing costs
            
            
            1,256
            
            
            
            1,256Prepaid
      expenses and other current assets
            
            
            451
            
            
            
            462Total
      current assets
            
            
            9,744
            
            
            
            8,407Property
      and equipment, net
            
            
            671
            
            
            
            767Long-term
      deferred settlement and patent licensing costs
            
            
            799
            
            
            
            1,117Other
      assets
            
            
            288
            
            
            
            286Total
      assets
            
            $
            11,502
            
            
            $
            10,577Liabilities
      and Stockholders’ Equity (Deficit):Current
      liabilities:Line
      of credit
            
            $
            4,000
            
            
            $
            5,100Accounts
      payable
            
            
            962
            
            
            
            1,287Deferred
      income from settlement and patent licensing
            
            
            5,520
            
            
            
            5,520Deferred
      services revenue and customer deposits
            
            
            2,071
            
            
            
            2,231Accrued
      liabilities and other
            
            
            1,901
            
            
            
            1,451Total
      current liabilities
            
            
            14,454
            
            
            
            15,589Long-term
      liabilities:Long-term
      convertible debt
            
            
            7,000
            
            
            
            —Long-term
      deferred income from settlement and patent licensing
            
            
            3,438
            
            
            
            4,814Total
      liabilities
            
            
            24,892
            
            
            
            20,403Commitments
      and contingencies (Note 9)Stockholders’
      equity (deficit):Common
      stock, $0.001 par value; 250,000,000 shares authorized at March 31,
      2008 and December 31, 2007; 35,730,014 and 35,678,807 shares issued
      including treasury shares at March 31, 2008 and December 31, 2007,
      respectively
            
            
            36
            
            
            
            36Less:
      treasury common stock, 1,182,875 shares at March 31, 2008 and
      December 31, 2007, at cost
            
            
            (53
            )
            
            
            (53
            )Additional
      paid-in-capital
            
            
            96,128
            
            
            
            95,925Accumulated
      deficit
            
            
            (109,501
            )
            
            
            (105,734
            )Total
      stockholders’ equity (deficit)
            
            
            (13,390
            )
            
            
            (9,826
            )Total
      liabilities and stockholders’ equity (deficit)
            
            $
            11,502
            
            
            $
            10,577






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


3





AVISTAR
COMMUNICATIONS CORPORATION AND SUBSIDIARY




CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS




for
the three months ended March 31, 2008 and 2007




(in
thousands, except per share data)





Three Months EndedMarch 31,
      2008
            
            
            March 31,
      2007(unaudited)Revenue:Product
            
            $
            249
            
            
            $
            1,258Licensing
            
            
            154
            
            
            
            232Services,
      maintenance and support
            
            
            748
            
            
            
            902Total
      revenue
            
            
            1,151
            
            
            
            2,392Costs
      and Expenses:Cost
      of product revenue*
            
            
            359
            
            
            
            729Cost
      of services, maintenance and support revenue*
            
            
            519
            
            
            
            676Income
      from settlement and patent licensing
            
            
            (1,057
            )
            
            
            (13,057
            )Research
      and development*
            
            
            1,851
            
            
            
            1,657Sales
      and marketing*
            
            
            1,329
            
            
            
            1,489General
      and administrative*
            
            
            1,878
            
            
            
            6,463Total
      costs and expenses
            
            
            4,879
            
            
            
            (2,043
            )(Loss)
      income from operations
            
            
            (3,728
            )
            
            
            4,435Other
      (Expense) Income:Interest
      income
            
            
            46
            
            
            
            113Other
      expense, net
            
            
            (85
            )
            
            
            (55
            )Total
      other (expense) income, net
            
            
            (39
            )
            
            
            58Net
      (loss) income
            
            $
            (3,767
            )
            
            $
            4,493Net
      (loss) income per share - basic and diluted
            
            $
            (0.11
            )
            
            $
            0.13Weighted
      Average Shares Used in Calculating:Basic
      net (loss) income per share
            
            
            34,532
            
            
            
            34,101Diluted
      net (loss) income per share
            
            
            34,532
            
            
            
            35,146*Including
      Stock-Based Compensation of:Cost of product, services, maintenance and
      support revenue
            
            $
            7
            
            
            $
            60Research
      and development
            
            
            63
            
            
            
            204Sales
      and marketing
            
            
            (36
            )
            
            
            185General
      and administrative
            
            
            113
            
            
            
            233






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


4





AVISTAR
COMMUNICATIONS CORPORATION AND SUBSIDIARY




CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS




for
the three months ended March 31, 2008 and 2007




(in
thousands)







Three Months EndedMarch 31,
      2008
            
            March 31,
      2007(unaudited)Cash
      Flows from Operating Activities:Net
      (loss) income
            
            $
            (3,767
            )
            $
            4,493Adjustments
      to reconcile net (loss) income to net cash (used in) provided by operating
      activities:Depreciation
            
            131
            
            50Stock-based
      compensation for options issued to consultants and
    employees
            
            147
            
            682Provision
      for doubtful accounts
            
            10
            
            (3
            )Changes
      in assets and liabilities:Accounts
      receivable
            
            (195
            )
            62Inventories
            
            (64
            )
            78Prepaid
      expenses and other current assets
            
            11
            
            65Deferred
      settlement and patent licensing costs
            
            318
            
            318Other
      assets
            
            (2
            )
            (2
            )Accounts
      payable
            
            (325
            )
            (373
            )Deferred
      income from settlement and patent licensing
            
            (1,376
            )
            (1,375
            )Deferred
      services revenue and customer deposits
            
            (160
            )
            (574
            )Accrued
      liabilities and other
            
            450
            
            1,249Net
      cash (used in) provided by operating activities
            
            (4,822
            )
            4,670Cash
      Flows from Investing Activities:Maturities
      of short-term investments
            
            799
            
            —Purchase
      of property and equipment
            
            (35
            )
            (314
            )Net
      cash provided by (used in) investing activities
            
            764
            
            (314
            )Cash
      Flows from Financing Activities:Line
      of credit payments
            
            (1,100
            )
            —Proceeds
      of debt issuance
            
            7,000
            
            —Net
      proceeds from stock options and stock purchase plans
            
            56
            
            129Net
      cash provided by financing activities
            
            5,956
            
            129Net
      increase in cash and cash equivalents
            
            1,898
            
            4,485Cash
      and cash equivalents, beginning of period
            
            4,077
            
            7,854Cash
      and cash equivalents, end of period
            
            $
            5,975
            
            $
            12,339






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


5





AVISTAR
COMMUNICATIONS CORPORATION AND SUBSIDIARY


NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)




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




Business




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




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




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




Basis
of Presentation




The unaudited condensed consolidated
balance sheet as of March 31, 2008 and the unaudited condensed consolidated
results of operations, and unaudited condensed consolidated cash flows for the
three months ended March 31, 2008 and 2007 presents the consolidated financial
position of Avistar and ASUK after the elimination of all intercompany accounts
and transactions. The unaudited condensed consolidated balance sheet of Avistar
as of December 31, 2007 was derived from audited financial statements, but does
not contain all disclosures required by accounting principles generally accepted
in the United States of America, and certain information and footnote
disclosures normally included have been condensed or omitted pursuant to the
rules and regulations of the SEC.  The consolidated results are referred
to, collectively, as those of Avistar or the Company in these
notes.




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




The
Company’s fiscal year end is December 31.




Risks
and Uncertainties




The
markets for the Company’s products and services are in the early stages of
development. Some of the Company’s products utilize changing and emerging
technologies. As is typical in industries of this nature, demand and market
acceptance are subject to a high level of uncertainty, particularly when there
are adverse conditions in the economy. Acceptance of the Company’s products,
over time, is critical to the Company’s success. The Company’s prospects must be
evaluated in light of difficulties encountered by it and its competitors in
further developing this evolving marketplace. The Company has generated annual
losses since inception and had an accumulated deficit of $110 million as of
March 31, 2008. The Company’s operating results may fluctuate significantly
in the future as a result of a variety of factors, including, but not limited
to, the economic environment, the adoption of different distribution channels,
the timing of new product announcements by the Company or its competitors, and
the timing of the Company’s licensing and settlement activities.




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




6


2.
Summary of Significant Accounting Policies




Unaudited
Interim Financial Information




The
financial statements filed in this report have been prepared by the Company,
without audit, pursuant to the rules and regulations of the SEC. Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with accounting principles generally accepted in the
United States of America have been condensed or omitted pursuant to such rules
and regulations.




In the
opinion of management, the unaudited financial statements furnished in this
report reflect all adjustments (consisting of normal recurring adjustments)
necessary for a fair presentation of the results of operations for the interim
periods covered and of the Company’s financial position as of the interim
balance sheet date. The results of operations for the interim periods are not
necessarily indicative of the results for the entire year. These financial
statements should be read in conjunction with the Company’s audited consolidated
financial statements and the accompanying notes for the year ended
December 31, 2007, included in the Company’s annual report on Form 10-K
filed with the SEC on March 31, 2008.




Use
of Estimates




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




Cash
and Cash Equivalents and Short and Long-term Investments




The
Company considers all investment instruments purchased with an
original maturity of three months or less to be cash equivalents.
Investment securities with original or remaining maturities of more than three
months but less than one year are considered short-term investments. Auction
rate securities with original or remaining maturities of more than three months
are considered short-term investments even if they are subject to re-pricing
within three months. The
Company was not invested in any auction rate securities as of  March
31, 2008.Investment securities held with intent to reinvest or hold for
longer than a year, or with remaining maturities of one year or more, are
considered long-term investments. The Company’s cash equivalents at March 31,
2008 and December 31, 2007 consisted of money market funds and short-term
commercial paper with original maturities of three months or less, and are
therefore classified as cash and cash equivalents in the accompanying balance
sheets.




The
Company accounts for its short-term and long-term investments in accordance with
Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for Certain Investments
in Debt and Equity Securities. The Company’s short and long-term
investments in securities are classified as available-for-sale and are reported
at fair value, with unrealized gains and losses, net of tax, recorded in other
comprehensive income (loss). Realized gains or losses and declines in value
judged to be other than temporary, if any, on available-for-sale securities are
reported in other income, net. The Company reviews the securities for
impairments, considering current factors including the economic environment,
market conditions, and the operational performance and other specific factors
relating to the businesses underlying the securities. The Company records
impairment charges equal to the amount that the carrying value of its
available-for-sale securities exceeds the estimated fair market value of the
securities as of the evaluation date. The fair value for publicly held
securities is determined based on quoted market prices as of the evaluation
date. In computing realized gains and losses on available-for-sale securities,
the Company determines cost based on amounts paid, including direct costs such
as commissions, to acquire the security using the specific identification
method. The Company did not have any short or long-term investments at March 31,
2008. The Company had no net unrealized losses on its short-term investment
securities at March 31, 2008 and December 31, 2007.




See Note
3 for further information on fair value.




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




March
      31, 2008
            
            
            December 31,
      2007(Unaudited)Cash
      and cash equivalents:Cash
      and money market funds
            
            $
            4,885
            
            
            $
            740Commercial
      paper cash equivalents
            
            
            1,090
            
            
            
            3,337Total
      cash and cash equivalents
            
            
            5,975
            
            
            
            4,077Short-term
      investments:Short-term
      investments (average 27 remaining days to maturity on December 31,
      2007)
            
            
            —
            
            
            
            799Total
      cash, cash equivalents and short-term investments
            
            $
            5,975
            
            
            $
            4,876







7


Significant
Concentrations




A
relatively small number of customers accounted for a significant percentage of
the Company’s revenues for the three months ended March 31, 2008 and 2007.
Revenues to these customers as a percentage of total revenues were as follows
for the three months ended March 31, 2008 and 2007:




Three Months Ended March 31,2008
            
            2007(Unaudited)Customer
      A
            
            54
            %
            30
            %Customer
      B
            
            20
            %
            29
            %Customer
      C
            
            13
            %
            10
            %





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




Financial
instruments that potentially subject the Company to concentrations of credit
risk consist primarily of temporary cash investments and trade receivables. The
Company has cash and investment policies that limit the amount of credit
exposure to any one financial institution or restrict placement of these
investments to financial institutions evaluated as highly credit worthy. As of
March 31, 2008, the Company had cash and cash equivalents on deposit with a
major financial institution that were in excess of FDIC insured limits.
Historically, the Company has not experienced any loss of its cash and cash
equivalents due to such concentration of credit risk. Concentrations of credit
risk with respect to trade receivables relate to those trade receivables from
both United States and foreign entities, primarily in the financial services
industry. As of March 31, 2008, approximately 83% of gross accounts
receivable were concentrated with two customers, each of whom represented more
than 10% of the Company’s total gross accounts receivable balance. As of
December 31, 2007, approximately 78% of accounts receivable were
concentrated with three customers, each of whom represented more than 10% of the
Company’s total gross accounts receivable balance. No other customer
individually accounted for greater than 10% of total accounts receivable as of
March 31, 2008 and December 31, 2007.




Inventories




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







March
      31, 2008
              
              December 31,
      2007(Unaudited)Raw
      materials and subassemblies
              
              $
              21
              
              $
              25Finished
      goods
              
              471
              
              403Total
      Inventories
              
              $
              492
              
              $
              428




Revenue
Recognition and Deferred Revenue




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




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




8


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




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




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




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




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




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




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




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




The
Company derives revenue from the licensing of its intellectual property
portfolio. The Company recognizes revenue from the licensing of its intellectual
property portfolio according to SOP 97-2, based on the terms of the
royalty, partnership and cross-licensing agreements involved. In the event that
a license to the Company’s intellectual property is granted after the
commencement of litigation proceedings between the Company and the licensee, the
proceeds of such transaction are recognized as licensing revenue by us only if
sufficient historical evidence exists for the determination of fair value of the
licensed patents to support the segregation of the proceeds between a gain on
litigation settlement and patent license revenues consistent with Financial
Accounting Standards Board (FASB) Concepts Statement No. 6, Elements of Financial
Statements (CON 6). As of March 31, 2008, these criteria for
recognizing license revenue following the commencement of litigation had not
been met.




9


In
July 2006, Avistar entered into a Patent License Agreement with Sony
Corporation (Sony) and Sony Computer Entertainment, Inc. (SCEI). Under the
license agreement, Avistar granted Sony and its subsidiaries, including SCEI a
license to all of the Company’s patents with a filing date on or before
January 1, 2006 for a specific field of use relating to video conferencing.
The license covers Sony’s video conferencing apparatus as well as other
products, including video-enabled personal computer products and certain SCEI
PlayStation products. Future royalties under this license are being recognized
as estimated royalty-based sales occur in accordance with
SOP 97-2.  The Company uses historical and forward looking sales
forecasts provided by SCEI and third party sources, in conjunction with actual
royalty reports provided periodically by SCEI directly to the Company, to
develop an estimate of royalties recognized for each quarterly reporting
period.  The royalty reporting directly from SCEI to the Company is
delayed beyond the period in which the actual royalties are generated, and thus
the estimate of current period royalties requires significant management
judgment and is subject to corrections in a future period once actual royalties
become known.




Income
from Settlement and Patent Licensing




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




On
November 12, 2004, the Company entered into a settlement and a patent
cross-license agreement with Polycom Inc., thus ending litigation against
Polycom, Inc. for patent infringement. As part of the settlement and patent
cross-license agreement with Polycom, Inc, Avistar granted Polycom, Inc. a
non-exclusive, fully paid-up license to its entire patent portfolio. The
settlement and patent cross-license agreement includes a five-year capture
period from the date of the settlement, adding all new patents with a priority
date extending up to five years from the date of execution of the agreement.
Polycom, Inc, as part of the settlement and patent cross-licensing agreement,
made a one time payment to the Company of $27.5 million and Avistar paid $6.4
million in contingent legal fees to Avistar’s litigation counsel upon completion
of the settlement and patent cross-licensing agreement. The contingent legal
fees were payable only in the event of a favorable outcome from the litigation
with Polycom, Inc. The Company is recognizing the gross proceeds of $27.5
million from the settlement and patent cross-license agreement as income from
settlement and patent licensing within operations over the five-year capture
period, due to a lack of evidence necessary to apportion the proceeds between an
implied punitive gain element in the settlement of the litigation, and software
license revenues from the cross-licensing of Avistar’s patented technologies for
prior and future use by Polycom, Inc. Additionally, the $6.4 million in
contingent legal fees was deferred and is being amortized to income from
settlement and patent licensing over the five year capture period, resulting in
a net of $21.1 million being recognized as income within operations over the
five year capture period.




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




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




10


Stock-Based
Compensation




Effective
January 1, 2006, the Company adopted the provisions of SFAS No. 123
(R), Share-Based
Payment (SFAS 123R), which establishes accounting for
stock-based awards exchanged for employee services. Accordingly, stock-based
compensation cost is measured at grant date, based on the fair value of the
award, and is recognized as expense over the employee’s service period. The
effect of recording stock-based compensation for the three months ended March
31, 2008 and 2007 was as follows (in thousands, except per share
data):







Three Months EndedMarch 31,
      2008
            
            
            March 31,
      2007(Unaudited)Stock-based
      compensation expense by type of award:Employee
      stock options
            
            $
            154
            
            
            $
            636Non-employee
      stock options
            
            
            3
            
            
            
            16Employee
      stock purchase plan
            
            
            (10
            )
            
            
            30Total
      stock-based compensation
            
            
            147
            
            
            
            682Tax
      effect on stock-based compensation
            
            
            —
            
            
            
            —Net
      effect of stock-based compensation on net (loss) income
            
            $
            147
            
            
            $
            682







As of
March 31, 2008, the Company had an unrecognized stock-based compensation
balance related to stock options of approximately $6.4 million before
estimated forfeitures. SFAS 123R requires forfeitures to be estimated
at the time of grant and revised if necessary in subsequent periods if actual
forfeitures differ from those estimates. Based on the Company’s historical
experience of option pre-vesting cancellations, the Company has assumed an
annualized forfeiture rate of 10% for its executive options and 29% for
non-executive options. Accordingly, as of March 31, 2008, the Company estimated
that the stock-based compensation for the awards not expected to vest was
approximately $1.6 million, and therefore, the unrecognized stock-based
compensation balance related to stock options was adjusted to approximately $4.8
million after estimated forfeitures.  This net amount will be
recognized over an estimated weighted average amortization period of 2.7 years.
During the three months ended March 31, 2008 and 2007, the Company granted
499,000 and 288,000 stock options with an estimated total grant-date fair value
of $335,000 and $464,000, respectively.




Valuation
Assumptions




The
Company estimated the fair value of stock options granted during the three
months ended March 31, 2008 and 2007 using a Black-Scholes-Merton valuation
model, consistent with the provisions of SFAS 123R and SEC Staff Accounting
Bulletin (SAB) No. 107 (SAB 107). The fair value of each option grant is
estimated on the date of grant using the Black-Scholes-Merton option valuation
model and the straight-line attribution approach with the following
weighted-average of the assumptions of both the three month periods ended March
31, 2008 and 2007:




Employee Stock Option Plan




Three Months EndedMarch
      31, 2008
            
            March
      31, 2007Expected
      dividend
            
            —
            %
            —
            %Average
      risk-free interest rate
            
            3.0
            %
            4.7
            %Expected
      volatility
            
            131
            %
            138
            %Expected
      term (years)
            
            6.1
            
            6.1






Employee Stock Purchase Plan





Three Months EndedMarch
      31, 2008
            
            March
      31, 2007Expected
      dividend
            
            —
            %
            —
            %Average
      risk-free interest rate
            
            2.2
            %
            5.1
            %Expected
      volatility
            
            176
            %
            96
            %Expected
      term (months)
            
            6.0
            
            6.0




The
dividend yield of zero is based on the fact that the Company has never paid cash
dividends and has no present intention to pay cash dividends. The risk-free
interest rates are taken from the Daily Federal Yield Curve Rates as of the
grant dates as published by the Federal Reserve, and represent the yields on
actively traded treasury securities for terms that approximate the expected term
of the options. Expected volatility is based on the historical volatility of the
Company’s common stock over a period consistent with the expected term of the
stock-option. The expected term calculation is based on an average prescribed by
SAB 107, based on the weighted average of the vesting periods, which is
generally one quarter vesting after one year and one sixteenth vesting quarterly
for twelve quarters, and adding the term of the option, which is
generally ten years, and dividing by two.  The Company uses this
method because it does not have sufficient historical exercise data to provide a
reasonable basis upon which to estimate expected term due to the limited number
of exercises that have occurred over the previous six years during which its
equity shares have been publicly traded.






11


3.
Fair Value Measurement




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




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




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




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




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





Fair
      Value
            
            
            Level
      1
            
            
            Level
      2
            
            
            Level
      3Cash
      Equivalents:Money
      market funds
            
            $
            4,571
            
            
            $
            4,571
            
            
            $
            —
            
            
            $
            —Commercial
      paper
            
            
            1,090
            
            
            
            —
            
            
            
            1,090
            
            
            
            —Total
      cash equivalents
            
            $
            5,661
            
            
            $
            4,571
            
            
            $
            1,090
            
            
            $
            —





4.
Related Party Transactions




Robert P.
Latta, a member of the law firm Wilson Sonsini Goodrich & Rosati,
Professional Corporation (WSGR), served as a director of the Company from
February 2001 until June 2007. Mr. Latta and WSGR have represented the
Company andits
predecessors as corporate counsel since 1997. During the three months ended
March 31, 2007, payments of approximately $57,000 were made to WSGR for
legal services provided to the Company.




On
January 4, 2008, Avistar issued $7,000,000 of 4.5% Convertible Subordinated
Secured Notes, which are due in 2010 (the Notes). The Notes were sold pursuant
to a Convertible Note Purchase Agreement to Baldwin Enterprises, Inc., a
subsidiary of Leucadia National Corporation, directors Gerald Burnett, R.
Stephen Heinrichs, William Campbell, and Craig Heimark, officers Simon Moss and
Darren Innes, and WS Investment Company, a fund
associated with Wilson Sonsini Goodrich & Rosati, Professional
Corporation.




5.
      Net (Loss) Income Per Share




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




In
accordance with SFAS 128, basic net (loss) income per share has been computed
using the weighted average number of shares of common stock outstanding during
the period, less shares subject to repurchase. Diluted net (loss) income per
share is computed on the basis of the weighted average number of shares and
potential common shares outstanding during the period. Potential common shares
result from the assumed exercise of outstanding stock options that have a
dilutive effect when applying the treasury stock method. The Company excluded
all outstanding stock options from the calculation of diluted net loss per share
for the three months ended March 31, 2008, because all such securities are
anti-dilutive (owing to the fact that the Company was in a loss position during
the time period). Accordingly, diluted net loss per share is equal to basic net
loss per share for the three months ended March 31, 2008. For the three months
ended March 31, 2007, due to the Company’s net income for the period, the
Company included the net effect of the weighted average number of shares and
dilutive potential common shares outstanding during the period in the
calculation of diluted net income per share.




12


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







Three Months EndedMarch 31,
      2008
            
            
            March 31,
      2007(Unaudited)Numerator:Net
      income (loss)
            
            $
            (3,767
            )
            
            $
            4,493Denominator:Basic
      weighted average shares outstanding
            
            
            34,532
            
            
            
            34,101Add:
      dilutive employee and non employee stock options
            
            
            —
            
            
            
            1,045Diluted
      weighted average shares outstanding
            
            
            34,532
            
            
            
            35,146Basic
      and diluted net income (loss) per share
            
            $
            (0.11
            )
            
            $
            0.13









Due to
the net loss position in the three months ended March 31, 2008, the total number
of potential common shares excluded from the calculation of diluted net loss per
share was 298,471 for the period.




6.
Income Taxes




Income
taxes are accounted for using an asset and liability approach in accordance with
SFAS No. 109, Accounting for
Income Taxes(SFAS 109), which requires the recognition of taxes payable
or refundable for the current year and deferred tax liabilities and assets for
the future tax consequences of events that have been recognized in the Company’s
financial statements. The measurement of current and deferred tax liabilities
and assets are based on the provisions of enacted tax law. The effects of future
changes in tax laws or rates are not anticipated. The measurement of deferred
tax assets is reduced, if necessary, by the amount of any tax benefits that,
based on available evidence, are not expected to be realized.




Deferred
tax assets and liabilities are determined based on the difference between the
financial statement, and the tax basis of assets and liabilities using enacted
tax rates in effect for the year in which the differences are expected to affect
taxable income. Valuation allowances are provided if, based upon the weight of
available evidence, it is considered more likely than not that some or all of
the deferred tax assets will not be realized.




The Company accounts for uncertain tax
positions according to the provisions of FASB Financial Accounting Standards
Interpretation No. 48,Accounting for
Uncertainty in Income Taxes(FIN 48).   FIN 48
contains a two-step approach for recognizing and measuring uncertain tax
positions accounted for in accordance with SFAS 109. Tax positions are evaluated
for recognition by determining if the weight of available evidence indicates
that it’s probable that the position will be sustained on audit, including
resolution of related appeals or litigation. Tax benefits are then measured as
the largest amount which is more than 50% likely of being realized upon ultimate
settlement. The Company considers many factors when evaluating and estimating tax positions and tax
benefits, which may require periodic adjustments and which may not accurately
anticipate actual outcomes.  No material changes have occurred in the
Company’s tax positions taken as of December 31, 2007 during the three months
ended March 31, 2008.




As of
December 31, 2007, the Company’s unrecognized tax benefits totaled $24.8
million.




7.
Segment Reporting




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




13


Intellectual
      Property Division
            
            
            Products
      Division
            
            
            Reconciliation
            
            
            TotalThree
      Months Ended March 31, 2008 (unaudited)Revenue
            
            $
            1,211
            
            
            $
            997
            
            
            $
            (1,057
            )
            
            $
            1,151Depreciation
      expense
            
            
            —
            
            
            
            (131
            )
            
            
            —
            
            
            
            (131
            )Total
      costs and expenses
            
            
            (771
            )
            
            
            (5,165
            )
            
            
            1,057
            
            
            
            (4,879
            )Interest
      income
            
            
            —
            
            
            
            46
            
            
            
            —
            
            
            
            46Interest
      expense
            
            
            —
            
            
            
            (80
            )
            
            
            —
            
            
            
            (80
            )Net
      income (loss)
            
            
            440
            
            
            
            (4,207
            )
            
            
            —
            
            
            
            (3,767
            )Total
      Assets
            
            
            2,646
            
            
            
            8,856
            
            
            
            —
            
            
            
            11,502Three
      Months Ended March 31, 2007 (unaudited)Revenue
            
            $
            13,289
            
            
            $
            2,160
            
            
            $
            (13,057
            )
            
            $
            2,392Depreciation
      expense
            
            
            —
            
            
            
            (50
            )
            
            
            —
            
            
            
            (50
            )Total
      costs and expenses
            
            
            (5,155
            )
            
            
            (5,859
            )
            
            
            13,057
            
            
            
            2,043Interest
      income
            
            
            —
            
            
            
            113
            
            
            
            —
            
            
            
            113Interest Expense
            
            
            —
            
            
            
            (50
            )
            
            
            —
            
            
            
            (50
            )Net
      income (loss)
            
            
            8,134
            
            
            
            (3,641
            )
            
            
            —
            
            
            
            4,493Total
      Assets
            
            
            4,165
            
            
            
            14,765
            
            
            
            —
            
            
            
            18,930




International
revenue, which consists of sales to customers with operations principally in
Western Europe and Asia, comprised 52% of total revenues for the three months
ended March 31, 2008 and 2007. For the three months ended March 31,
2008 and 2007, international revenues from customers in the United Kingdom
accounted for 11% and 7% of total product and services revenue, respectively.
The Company had no significant long-lived assets in any country other than in
the United States for any period presented.




8.  Notes
      Payable




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




9.
      Commitments and Contingencies




Software
Indemnifications




Avistar
enters into standard indemnification agreements in the ordinary course of
business. Pursuant to these agreements, Avistar indemnifies, holds harmless, and
agrees to reimburse the indemnified party for losses suffered or incurred by the
indemnified party, generally Avistar’s business partners or customers, in
connection with any patent, copyright or other intellectual property
infringement claim by any third party with respect to its products. The term of
these indemnification agreements is generally perpetual. The maximum potential
amount of future payments Avistar could be required to make under these
indemnification agreements is generally limited to the cost of products
purchased per customer, but may be material when customer purchases since
inception are considered in aggregate. Avistar has never incurred costs to
defend lawsuits or settle claims related to these indemnification agreements.
Accordingly, Avistar has no liabilities recorded for these agreements as of
March 31, 2008.




10.
      Recent Accounting Pronouncements




In
September 2006, the FASB issued SFAS 157. The standard provides guidance for
using fair value to measure assets and liabilities and responds to investors’
requests for expanded information about the extent to which companies’ measure
assets and liabilities at fair value, the information used to measure fair
value, and the effect of fair value measurements on earnings. The standard
applies whenever other standards require or permit assets or liabilities to be
measured at fair value. The standard does not expand the use of fair value in
any new circumstances. The Company adopted SFAS 157 prospectively on
January 1, 2008.  The adoption of SFAS 157 did not have any impact on
the Company’s financial position or results of operations.




14


In
February 2007, the FASB issued Statement No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities, including an amendment of FASB Statement
No. 115 (SFAS 159). The standard provides an entity with the
irrevocable option to elect fair value for the initial and subsequent
measurement for certain financial assets and liabilities under an
instrument-by-instrument election. Subsequent measurements for the financial
assets and liabilities an entity elects to fair value will be recognized in
earnings. SFAS 159 also establishes additional disclosure
requirements.  The Company adopted SFAS 159 prospectively on
January 1, 2008.  The Company did not make any elections for fair
value accounting and therefore, it did not record a cumulative adjustment to its
opening accumulated deficit balance.




In
February 2008, the FASB issued FASB Staff Position No. FAS 157-2, Effective Date of FASB Statement No.
157 (FSP 157-2), to partially defer SFAS 157. FSP 157-2 defers the
effective date of SFAS 157 for nonfinancial assets and nonfinancial liabilities,
except those that are recognized or disclosed at fair value in the financial
statements on a recurring basis (at least annually), to fiscal years, and
interim periods within those fiscal years, beginning after November 15, 2008.
The Company is currently evaluating the impact of adopting the provisions of FSP
157-2.




11.
Subsequent Events




On April 18, 2008, Avistar received a deficiency
letter from The NASDAQ Stock Market indicating that Avistar does not comply with
Marketplace Rule 4310(c)(4), which requires the Company to have a minimum bid
price of $1.00 for continued listing.  The NASDAQ Staff noted that for
the 30 consecutive business days prior to the date of its letter, the bid price
of Avistar’s common stock closed below $1.00 per share.  The Company
has been provided 180 calendar days, or until October 15, 2008, to regain
compliance.




If
Avistar is unable to regain compliance by October 15, 2008, the NASDAQ Staff
will determine whether Avistar meets The NASDAQ Capital Market initial listing
criteria as set forth in Marketplace Rule 4310(c), except for the bid price
requirement.   If Avistar meets such initial listing
requirements, the NASDAQ Staff may grant an additional 180 day compliance
period.  However, if the Company is unable to meet such requirements,
the NASDAQ Staff will provide written notification that Avistar’s securities are
subject to delisting.  At such time, Avistar may be permitted to
appeal the NASDAQ Staff’s determination to delist its securities to a Listing
Qualifications Panel.




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




The
following discussion should be read in conjunction with the unaudited Condensed
Consolidated Financial Statements and the Notes to Condensed Consolidated
Financial Statements elsewhere herein, and the Audited Consolidated Financial
Statements and the Notes thereto contained in our Annual Report on Form 10-K for
the year ended December 31, 2007, as filed with the SEC on March 31,
2008.




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




Overview




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




15


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




Since
inception, we have recognized the innovative value of our research and
development efforts, and have invested in securing protection for these
innovations through domestic and foreign patent applications and issuance. As of
March 31, 2008, we held 80 U.S. and foreign patents, which we look to
license to others in the collaboration technology marketplace.




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




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




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




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




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




·
            Implementing
      aggressive cost control measures including a reduction in our employees
      from an average of 88 in  2007 to approximately 61 on March 31,
      2008; and




·
            Pursuing
      multiple distribution, services and technology
  partners.




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




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




Critical
Accounting Policies




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




16


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




·
            Revenue
      recognition;




·
            Income
      from settlement and patent
licensing;




·
            Stock-based
      compensation;




·
            Valuation
      of accounts receivable; and




·
            Valuation
      of inventories.




Revenue
Recognition




We derive
product revenue from the sale and licensing of our video-enabled networked
communications system, consisting of a suite of Avistar-designed software and
hardware products, including third party components. We also derive revenue from
fees for installation, maintenance, support, training services and software
development. In addition, we derive revenue from the licensing of our
intellectual property portfolio. Product revenue as a percentage of total
revenue was 22% and 53% for three months ended March 31, 2008 and 2007,
respectively.




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




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




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




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




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




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






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




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




17


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




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




We also
recognize revenue from the licensing of our intellectual property portfolio,
according to SOP 97-2, based on the terms of the royalty, partnership and
cross-licensing agreements involved. In the event that a license to our
intellectual property is granted after the commencement of litigation between us
and the licensee, the proceeds of such transaction are recognized as licensing
revenue by us only if sufficient historical evidence exists for the
determination of fair value of the licensed patents to support the segregation
of the proceeds between a gain on litigation settlement and patent license
revenues, consistent with FASB CON 6. As of March 31, 2008, these criteria for
recognizing license revenue following the commencement of litigation have not
been met, and proceeds received after commencement of litigation have therefore
been recorded in “income from settlement and patent licensing” in our statement
of operations.




In July 2006, we entered into a Patent License Agreement with Sony
Corporation (Sony) and Sony Computer Entertainment, Inc. (SCEI). Under the
license agreement, we granted Sony and its subsidiaries, including SCEI a
license to all of our patents with a filing date on or before January 1,
2006 for a specific field of use relating to video conferencing. The license
covers Sony’s video conferencing apparatus as well as other products, including
video-enabled personal computer products and certain SCEI PlayStation products.
Future royalties under this license are being recognized as they estimated
royalty based sales occur in accordance with SOP 97-2.  We use
historical and forward looking sales forecasts provided by SCEI and third party
sources in conjunction with actual royalty reports provided periodically by SCEI
directly to us, to develop an estimate of royalties recognized for each
quarterly reporting period.  The royalty reports directly from SCEI to
us are delayed beyond the period in which the actual royalties occur, and thus
the estimate of current period royalties requires significant management
judgment and is subject to corrections in a future period once actual royalties
become known.




To date,
a significant portion of our revenue has resulted from sales to a limited number
of customers, particularly Deutsche Bank AG, UBS AG and their affiliates, and
Sony and SCEI. Collectively, Deutsche Bank AG, UBS AG and their affiliates and
Sony and SCEI accounted for approximately 87% and 69% of total revenue for the
three month periods ended March 31, 2008 and 2007, respectively. As of
March 31, 2008, approximately 83% of our gross accounts receivable was
concentrated with two customers, each of whom represented more than 10% of our
gross accounts receivable. As of March 31, 2007, approximately 64% of our
gross accounts receivable was concentrated with three customers, each of whom
represented more than 10% of our gross accounts receivable.




International
revenue, which consists of sales to customers with operations principally in
Western Europe and Asia, comprised 52% of total revenue for the three months
ended March 31, 2008 and 2007.




Income
from Settlement and Patent Licensing




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




18


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






Stock-Based
      Compensation




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




Valuation
      of Accounts Receivable




Estimates
are used in determining our allowance for doubtful accounts and are based on our
historical collection experience, historical write-offs, current trends, and the
credit quality of our customer base and the characteristics of our accounts
receivable by aging category. If the allowance for doubtful accounts were to be
understated, our operating income could be significantly reduced. The impact of
any such change or deviation may be increased by our reliance on a relatively
small number of customers for a large portion of our total revenue. As of
March 31, 2008, two customers represented 47% and 36% of our gross accounts
receivable balance. As of December 31, 2007, three customers represented
38%, 30% and 10% of our gross accounts receivable balance.




Valuation
      of Inventories




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





Results
of Operations




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







Percentage of Total RevenueThree Months Ended
              March 31,2008
            
            
            2007Revenue:Product
            
            
            22
            %
            
            
            52
            %Licensing
            
            
            13
            
            
            
            10Services,
      maintenance and support
            
            
            65
            
            
            
            38Total
      revenue
            
            
            100
            
            
            
            100Costs
      and Expenses:Cost
      of product revenue
            
            
            31
            
            
            
            31Cost
      of services, maintenance and support revenue
            
            
            45
            
            
            
            28Income
      from settlement and patent licensing
            
            
            (92
            )
            
            
            (546
            )Research
      and development
            
            
            161
            
            
            
            69Sales
      and marketing
            
            
            115
            
            
            
            62General
      and administrative
            
            
            163
            
            
            
            270Total
      costs and expenses
            
            
            423
            
            
            
            (86
            )(Loss)
      income from operations
            
            
            (323
            )
            
            
            186Other
      (expense) income:Interest
      income
            
            
            4
            
            
            
            4Other
      expense, net
            
            
            (7
            )
            
            
            (2
            )Total
      other (expense) income, net
            
            
            (3
            )
            
            
            2Net
      (loss) income
            
            
            (326
            )%
            
            
            188
            %




COMPARISON
OF THE THREE MONTHS ENDED MARCH 31, 2008 AND 2007


Revenue
  Total
revenue decreased by $1.2 million or 52%, to $1.2 million for the three month
period ended March 31, 2008, from $2.4 million for the three months ended March
31, 2007. The decrease was due primarily the lack of new customers and delayed
spending from existing enterprise customers during the three months ended March
31, 2008 compared to $1.3 million in new product revenue during the same period
in 2007.
  
         Product revenue decreased by $1.0 million or 80%, to $249,000
      for the three months ended March 31, 2008, from $1.3 million for the three
      months ended March 31, 2007. The decrease was due to lower new customer
      revenue in the three month period ended March 31, 2008, as compared to the
      same period in 2007.
  
         Licensing revenue, relating to the licensing of our patent
      portfolio, decreased by $78,000, or 34%, to $154,000 for the three months
      ended March 31, 2008, from $232,000 for the three months ended March 31,
      2007 due primarily to a decrease in royalty revenues from a
      licensee.
  
         Services, maintenance and support revenue, which includes our
      installation services, funded software development and maintenance and
      support, decreased by $154,000, or 17%, to $748,000 for three months ended
      March 31, 2008, from $902,000 for the three months ended March 31, 2007
      due primarily to a decrease in revenue from funded software development
      projects.
  For the
three months ended March 31, 2008, revenue from three customers accounted for
87% of total revenue compared to 69% for the three months ended March 31, 2007,
each of whom accounted for greater than 10% of total revenue.  The level of
sales to any customer may vary from quarter to quarter. We expect that there
will be significant customer concentration in future
quarters. The loss of any one of those customers would have a materially adverse
impact on our financial condition and operating results.












Costs
and Expenses




Cost of product revenue. Cost
of product revenue decreased by $370,000, or 51%, to $359,000 for the three
months ended March 31, 2008, from $729,000 for the three months ended March 31,
2007. This decrease in cost of product revenue was primarily due to the decrease
in product revenue.




Cost of services, maintenance and
support revenue. Cost of services, maintenance and support revenue
decreased by $157,000, or 23%, to $519,000 for the three months ended March 31,
2008, from $676,000 for the three months ended March 31, 2007. The
decrease was primarily due to a decrease in personnel and personnel-related
expenses during the quarter ended March 31, 2008, caused by no allocation of
labor costs to a funded software project during the quarter ended March 31, 2008
compared a similar allocation during the quarter ended March 31,
2007.


20


Income from settlement and patent
licensing.  Income from settlement and patent licensing
decreased by $12.0 million, or 92% to $1.1 million for the three month period
ended March 31, 2008, from $13.1 million for the three month period ended March
31, 2007. The decrease was due to the settlement and patent license agreement
entered into with Tandberg ASA and its subsidiaries in February 2007, which
resulted in a cash payment to us of $12.0 million. No similar transaction
occurred in the three months ended March 31, 2008.  Income from
settlement and patent licensing for the three months ended March 31, 2008 and
2007 also reflects the amortization in each period of $1.1 million of the $21.1
million in net proceeds from our November 2004 settlement and cross-license
agreement with Polycom, Inc., which is being recognized over a five year period
beginning in November 2004 and ending in November 2009.




Research and development.
Research and development expenses increased by $194,000, or 12%, to $1.9 million
for the three months ended March 31, 2008 from $1.7 million for the three months
ended March 31, 2007.  This increase was primarily due to no
allocation of engineering employee expenses to cost of services associated with
a funded software projects during the quarter ended March 31, 2008, compared to
similar allocations in the quarter ended March 31, 2007, and due to
severance charges due to eliminated personnel positions during the three months
ended March 31, 2008,partially offset by decreased stock-based
compensation of $141,000 and decreased external labor expense.  The
decrease in stock-based compensation was primarily due to an increase in the
forfeiture rate input to calculating the stock-based expense under SFAS 123R,
which causes a current period expense credit.




Sales and marketing. Sales
and marketing expenses decreased by $160,000, or 11%, to $1.3 million for the
three months ended March 31, 2008 from $1.5 million for the three months ended
March 31, 2007.  This decrease was primarily due to decreased
stock-based compensation of $221,000.




General and administrative.
General and administrative expenses decreased by $4.6 million or 71% to $1.9
million for the three months ended March 31, 2008 from $6.5 million for the
three months ended March 31, 2007. This decrease was primarily due to litigation
expense of $4.5 million in 2007, including $3.8 million of contingent fees
associated with the settlement of our litigation against Tandberg ASA and its
subsidiaries for patent infringement.




Other
      Income




Interest
income, decreased by $67,000, or 59%, to $46,000 for the three months ended
March 31, 2008, from $113,000 for the three months ended March 31, 2007. The
decrease was due to lower interest income due to both a decrease in interest
rates and the average outstanding balance of investments that earn interest in
the three months ended March 31, 2008 compared to the same period in
2007.




Other
expense, net, increased by $30,000, or 55%, to $85,000 for the three months
ended March 31, 2008, from $55,000 for the three months ended March 31, 2007.
The increase was due to higher interest expense due to a higher outstanding
balance of debt outstanding during the three months ended March 31, 2008
compared to the same period in 2007.




Liquidity
and Capital Resources




We had
cash and cash equivalents of $6.0 million as of March 31, 2008, and cash, cash
equivalents and short-term investments of $4.9 million as of December 31, 2007.
For the three months ended March 31, 2008, we had a net decrease in cash, cash
equivalents and short-term investments of $1.1 million. The net cash used by
operations of $4.8 million resulted primarily from the net loss of $3.8 million,
a decrease in deferred income from settlement and patent licensing of $1.4
million, a decrease in account payable of $325,000 offset by an increase in
accrued liabilities and other of $450,000, a decrease in deferred settlement and
patent licensing costs of $318,000 and non-cash expenses of $288,000.  The
net cash provided by investing activities of $764,000 was primarily due to the
purchase of maturities of short-term investments of $799,000.  The net cash
provided by financing activities of $6.0 million related primarily to $7.0
million in proceeds from the issuance of debt less payments made on our line of
credit of $1.1 million.




At March
31, 2008, we had open purchase orders and other contractual obligations of
approximately $683,000, primarily related to inventory purchase commitments. We
also have commitments that consist of obligations under our operating leases.
These purchase order commitments and contractual obligations are reflected in
our financial statements once goods or services have been received or payments
related to the obligations become due. A table summarizing our minimum purchase
commitments to our contract manufacturers and our minimum commitments under
non-cancelable operating leases as of December 31, 2007 is included in our
Annual Report on Form 10-K for the year ended December 31, 2007, filed with the
Securities and Exchange Commission on March 31, 2008. No material changes have
occurred in our contractual commitments from December 31, 2007 through March 31,
2008.




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




21


We
currently believe that our existing cash and cash equivalents balance and line
of credit will provide us with sufficient funds to finance our operations for
the next 12 months. We intend to continue to invest in the development of new
products and enhancements to our existing products. Our future liquidity and
capital requirements will depend upon numerous factors, including without
limitation, general economic conditions and conditions in the financial services
industry in particular, the level and timing of product, services and patent
licensing revenues and income, the costs and timing of our product development
efforts and the success of these development efforts, the costs and timing of
our sales and marketing activities, the extent to which our existing and new
products gain market acceptance, competing technological and market
developments, and the costs involved in maintaining and enforcing patent claims
and other intellectual property rights, all of which may impact our ability to
achieve and maintain profitability or generate positive cash flows.




Recent
      Accounting Pronouncements




In September 2006, the FASB issued FASB Statement No. 157, Fair Value Measurements (SFAS
157). The standard provides guidance for using fair value to measure assets and
liabilities and responds to investors’ requests for expanded information about
the extent to which companies measure assets and liabilities at fair value, the
information used to measure fair value, and the effect of fair value
measurements on earnings. The standard applies whenever other standards require
or permit assets or liabilities to be measured at fair value. The standard does
not expand the use of fair value in any new circumstances.  We adopted
SFAS 157 prospectively on January 1, 2008.  The adoption of SFAS
157 did not have any impact on our financial position or results of
operations.




In February 2007, the FASB issued Statement No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities, including an amendment of FASB Statement
No. 115 (SFAS 159). The standard provides entities with the
irrevocable option to elect fair value for the initial and subsequent
measurement for certain financial assets and liabilities under an
instrument-by-instrument election. Subsequent measurements for the financial
assets and liabilities an entity elects to fair value will be recognized in
earnings. SFAS 159 also establishes additional disclosure
requirements.  We adopted SFAS 159 prospectively on January 1,
2008.  The adoption of SFAS 159 did not have any impact on our
financial position or results of operations.




In
February 2008, the FASB issued FASB Staff Position No. FAS 157-2, Effective Date of FASB Statement No.
157 (FSP 157-2), to partially defer SFAS 157. FSP 157-2 defers the
effective date of SFAS 157 for nonfinancial assets and nonfinancial liabilities,
except those that are recognized or disclosed at fair value in the financial
statements on a recurring basis (at least annually), to fiscal years, and
interim periods within those fiscal years, beginning after November 15, 2008. We
are currently evaluating the impact of adopting the provisions of FSP
157-2.





Item 4T. Controls and
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 in
providing 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 executed, 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.




22


PART II - OTHER INFORMATION




Item 1A. Risk
Factors




Factors
      Affecting Future Operating Results




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




We
recorded a net loss of $3.8 million for the three months ended March 31, 2008, a
net loss of $2.9 million for fiscal year 2007, and a net loss of $8.1 million
for fiscal year 2006. As of March 31, 2008, our accumulated deficit was $110
million. Our revenue and income from settlement and patent licensing may
not increase, or even remain at its current level. In addition, our operating
expenses, which have been reduced recently, may increase as we continue to
develop our business and pursue licensing opportunities. As a result, to become
profitable, we will need to increase our revenue and income from settlement and
patent licensing by increasing sales to existing customers and by attracting
additional new customers and licensees. If our expenses increase more rapidly
than our revenue, we may not become or remain profitable. Due to the volatility
of our product and licensing revenue and our income from settlement and patent
licensing activities, we may not be able to achieve, sustain or increase
profitability on a quarterly or annual basis. If we fail to achieve or to
maintain profitability or to sustain or grow our profits within the time frame
expected by investors, the market price of our common stock may be adversely
impacted.




Our
expected future working capital needs may require that we seek additional debt
or equity funding which, if not available on acceptable terms, could cause our
business to suffer.




We may
need to arrange for the availability of additional funding in order to meet our
future business requirements. If we are unable to obtain additional funding when
needed on acceptable terms, we may not be able to develop or enhance our
products, take advantage of opportunities, respond to competitive pressures or
unanticipated requirements, or finance our efforts to protect and enforce our
intellectual property rights, which could seriously harm our business, financial
condition, results of operations and ability to continue
operations.  We have in the past and may in the future reduce our
expenditures on research and development and significantly reduce our employee
headcount in order to better align our expenditures with our available
resources.  Any such reductions may adversely affect our ability to
maintain or grow our business.




We
are in the process of implementing changes in our organizational structure,
sales, marketing and distribution strategies, licensing efforts and strategic
direction, which, if unsuccessful, could adversely affect our business and
results of operations.




In July
2007, Simon Moss was appointed as President of the products division of our
company.  In September 2007, William Campbell resigned from the
position of Chief Operating Officer, and in November 2007, we announced that
Gerald Burnett was resigning from his position as our Chief Executive Officer
effective January 1, 2008 and would be replaced in that position by Simon
Moss.  In addition, during the second half of 2007 and the three
months ended March 31, 2008, we implemented a number of other management
changes.   In September 2007, we announced an intensive set of
corporate initiatives aimed at increasing our product sales, expanding our
customer deployments and support, improving our corporate efficiency and
increasing our development capacity.  The components of this
initiative included:




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




·
            Implementing
      aggressive cost control measures including a reduction in our employees
      from an average of 88 in  2007 to approximately 61 at March 31,
      2008; and




·
            Pursuing
      multiple distribution, services and technology licensing
      partners.




These and
other changes in our business are aimed at reducing our structural costs,
increasing our organizational and partner-driven capacity, leveraging our
reputation for innovation and intellectual property leadership, and growing and
expanding our business.  However, these organizational changes and
initiatives involve transitional costs and expenses and result in uncertainty in
terms of their implementation and their impact on our business.  As
with any significant organizational change, our initiatives will take time to
implement, and the results of these initiatives may not be apparent in the near
term.  If our initiatives are unsuccessful in achieving our stated
objectives, our business could be harmed and our results of operations and
financial condition could be adversely affected.




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




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






23


On April
18, 2008, we received a deficiency letter from The NASDAQ Stock Market
indicating that Avistar does not comply with Marketplace Rule 4310(c)(4), which
requires the Company to have a minimum bid price of $1.00 for continued
listing.  The NASDAQ Staff noted that for the 30 consecutive business
days prior to the date of its letter, the bid price of Avistar’s common stock
closed below $1.00 per share.  We have been provided 180 calendar
days, or until October 15, 2008, to regain compliance.




If we are
unable to regain compliance by October 15, 2008, the NASDAQ Staff will determine
whether we meet The NASDAQ Capital Market initial listing criteria as set forth
in Marketplace Rule 4310(c), except for the bid price
requirement.   If we meet such initial listing requirements, the
NASDAQ Staff may grant an additional 180 day compliance
period.  However, if we are unable to meet such requirements, the
NASDAQ Staff will provide written notification that our securities are subject
to delisting.  At such time, we may be permitted to appeal the NASDAQ
Staff’s determination to delist our securities to a Listing Qualifications
Panel.




There can
be no assurance that we will remain in compliance with The NASDAQ’s continued
listing standards during the NASDAQ’s special compliance monitoring period or
thereafter.  If we are unable to continue to list our common stock for
trading on The NASDAQ Capital Market, there may be an adverse impact on the
market price and liquidity of our common stock, and our stock may be subject to
the “penny stock rules” contained in Section 15(g) of the Securities Exchange
Act of 1934, as amended, and the rules promulgated thereunder. Delisting of our
common stock from The NASDAQ Capital Market could also have a materially adverse
effect on our business, including, among other things: our ability to raise
additional financing to fund our operations; our ability to attract and retain
customers; and our ability to attract and retain personnel, including management
personnel. In addition, institutional investors may no longer be able to retain
their interests in and/or make further investments in our common stock because
of their internal rules and protocols.




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




The
trading price of our common stock has in the past been and could in the future
be subject to significant fluctuations in response to:




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




·
            quarterly
      variations in our results of
operations;




·
            announcements
      regarding our product developments;




·
            the
      size and timing of agreements to license our patent
    portfolio;




·
            developments
      in the examination of our patent applications and the potential
      re-examination of our issued patents by the U.S. Patent and Trademark
      Office;




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




·
            announcements
      of competitive product introductions by our
  competitors;




·
            changes
      in the status of our listing on The NASDAQ Capital
  Market;




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




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




If our
revenue and results of operations are below the expectations of public market
securities analysts or investors, then significant fluctuations in the market
price of our common stock could occur. In addition, the securities markets have,
from time to time, experienced significant price and volume fluctuations, which
have particularly affected the market prices for high technology companies, and
which often are unrelated and disproportionate to the operating performance of
specific companies. These broad market fluctuations, as well as general
economic, political and market conditions, may negatively affect the market
price of our common stock.




24


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




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




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




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




Our
executive officers, directors and entities affiliated with them, in the
aggregate, beneficially owned approximately 63% of our common stock as of
March 31, 2008. If they were to act together, these stockholders would be
able to exercise control over most matters requiring approval by our
stockholders, including the election of directors and approval of significant
corporate transactions. These actions may be taken even if they are opposed by
other investors. This concentration of ownership may also have the effect of
delaying or preventing a change in control of Avistar, which could cause the
market price of our common stock to decline.







Our
market is in the early stages of development, and our system may not be widely
accepted.




Our
ability to achieve profitability depends in part on the widespread adoption of
networked video communications systems and the sale and adoption of our video
system in particular, either as a separate solution or as a technology
integrated into a unified communications platform. If the market for our system
and technology fails to grow or grows more slowly than we anticipate, we may not
be able to increase revenue or achieve profitability. The market for our system
is relatively new and evolving. We have to devote substantial resources to
educating prospective customers about the uses and benefits of our system. Our
efforts to educate potential customers may not result in our system achieving
broad market acceptance. In addition, businesses that have invested or may
invest substantial resources in other video products may be reluctant or slow to
adopt our system. Consequently, the conversion from traditional methods of
communication to the extensive use of networked video and unified communications
may not occur as rapidly as we wish.




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




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




Our
lengthy sales cycle is one of the factors that has caused, and may continue to
cause our operating results to vary significantly from quarter-to-quarter and
year-to-year in the future. This makes it difficult for us to forecast revenue,
and could cause volatility in the market price of our common stock. A lost or
delayed order could result in lower than expected revenue in a particular
quarter or year. There is also a tendency in the technology industry to close
business deals at the end of a quarter, thereby increasing the likelihood that a
possible material deal would not be concluded in a current quarter, but slip
into a subsequent reporting period. This kind of delay may result in a given
quarter’s performance being below shareholder expectations.




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




Our
customers typically place limited initial orders for our networked video
communications system, as they seek to evaluate its utilization and resultant
value. Our strategy is to pursue additional and larger follow-on orders after
these initial orders. Product revenue generated from follow-on orders accounted
for approximately 99%, and 95% of our product revenue for the three months ended
March 31, 2008 and 2007, respectively. Our future product revenue depends on the
adoption of our products by new customers and successful generation of follow-on
orders as the Avistar network expands within a customer’s organization. If our
system does not meet the needs and expectations of customers, we may not be able
to generate follow-on orders.




25


Because
we depend on a few customers for a majority of our product revenue, services
revenue, and income from settlement and patent licensing, the loss of one or
more of them could cause a significant decrease in our operating
results.




To date,
a significant portion of our revenue and income from settlement and patent
licensing has resulted from sales or licenses to a limited number of customers,
particularly Deutsche Bank AG, UBS AG, Polycom, Inc., Sony and SCEI and their
affiliates.  Collectively, Deutsche Bank AG, UBS AG, Polycom, Inc., Sony
Corporation, and their affiliates accounted for approximately 93% of combined
revenues and income from settlement and patent licensing for the three months
ended March 31, 2008. As of March 31, 2008, approximately 83% of our gross
accounts receivable was concentrated with two customers, each of whom
represented more than 10% of our gross accounts receivable. As of
December 31, 2007, approximately 78% of our gross accounts receivable was
concentrated with three customers, each of whom represented more than 10% of our
gross accounts receivable.




The loss
of a major customer or the reduction, delay or cancellation of orders from one
or more of our significant customers could cause our revenue to decline and our
losses to increase.  For example, income from settlement and licensing
activities from Tandberg, which was $12.0 million in the first quarter of 2007,
was a one-time payment. Additionally, we expect to complete the amortization of
the Polycom, Inc. proceeds in 2009. If we are unable to license our patent
portfolio to additional parties on terms equal to or better than our agreements
with Polycom, Inc. and Tandberg, our licensing revenue and our income from
settlement and licensing will decline, which could cause our losses to increase.
We currently depend on a limited number of customers with lengthy budgeting
cycles and unpredictable buying patterns, and as a result, our revenue from
quarter-to-quarter or year-to-year may be volatile. Adverse changes in our
revenue or operating results as a result of these budgeting cycles or any other
reduction in capital expenditures by our large customers could substantially
reduce the trading price of our common stock.




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




Future
hardware and software platforms embodying new technologies and the emergence of
new industry standards and customer requirements could render our system
non-competitive or even obsolete.  Additionally, communication and
collaboration products and technologies are moving towards integrated platforms
characterized as unified communications. The market for our system
reflects:




·
            rapid
      technological change;




·
            the
      emergence of new competitors;




·
            significant
      development costs;




·
            changes
      in the requirements of our customers and their communities of
      users;




·
            integration
      of joint solutions in collaboration
platforms;




·
            evolving
      industry standards; and




·
            transition
      to Internet protocol connectivity for video at the desktop, with
      increasing availability of bandwidth and quality of
    service.




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




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




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




26


Competition
could reduce our market share and decrease our revenue.




The
market in which we operate is highly competitive. In addition, because our
industry is relatively new and is characterized by rapid technological change,
evolving user needs, developing industry standards and protocols and the
introduction of new products and services, it is difficult for us to predict
whether or when new competing technologies or new competitors will enter our
market. Currently, our competition comes from many other kinds of companies,
including communication equipment, integrated solution, broadcast video and
stand-alone “point solution” providers. Within the video-enabled network
communications market, we compete primarily against Polycom, Inc., Tandberg ASA,
Sony Corporation, Apple Inc., Radvision Ltd. and Emblaze-VCON Ltd.  Many of
these companies, including Polycom, Inc., Tandberg, Sony, Radvision and
Emblaze-VCON have acquired rights to use our patented technology through
licensing agreements with us, which, in some cases, include rights to use future
patents filed by us.  With increasing interest in the power of video
collaboration and the establishment of communities of users, we believe we face
increasing competition from alternative video communications solutions that
employ new technologies or new combinations of technologies from companies such
as Cisco Systems, Inc., Avaya, Inc., Microsoft Corporation and Nortel
Networks Corporation that enable web-based or network-based video communications
with low-cost digital camera systems.




We expect
competition to increase in the future from existing competitors, partnerships of
competitors, and from new market entrants with products that may be less
expensive than ours, or that may provide better performance or additional
features not currently provided by our products. Many of our current and
potential competitors have substantially greater financial, technical,
manufacturing, marketing, distribution and other resources, greater name
recognition and market presence, longer operating histories, lower cost
structures and larger customer bases than we do. As a result, they may be able
to adapt more quickly to new or emerging technologies and changes in customer
requirements.




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




General
economic conditions may impact our revenues and harm our business in the future,
as they have in the past.




The
international economic slowdown and the downturn in the investment banking
industry that began in 2000 and continued for a number of years to negatively
affect our business, and a reoccurrence of a difficult economic environment may
do so in the future. During the previous economic downturn, the investment
banking industry suffered a sharp decline, which caused many of our existing and
potential customers to cancel or delay orders for our products. The U.S. economy
may slow, and our customers and potential customers may delay ordering our
products, and we could fall short of our revenue expectations for 2008 and
beyond. Slower growth among our customers, tightening of customers’ operating
budgets, retrenchment in the capital markets and other general economic factors
all have had, and could in the future have, a materially adverse effect on our
revenue, capital resources, financial condition and results of
operations.




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




Because
our licensing cycle is a lengthy process, the accurate prediction of future
revenues and income from settlement and patent licensing from new licensees is
difficult. The process of persuading companies to adopt our technologies, or
convincing them that their products infringe upon our intellectual property
rights, can be lengthy. There is also a tendency in the technology industry to
close business deals at the end of a quarter, thereby increasing the likelihood
that a possible material deal would not be concluded in a current quarter, but
slip into a subsequent reporting period. This kind of delay may result in a
given quarter’s performance being below analyst or shareholder expectations. The
proceeds of our intellectual property licensing and enforcement efforts tend to
be sporadic and difficult to predict. Recognition of those proceeds as revenue
or income from settlement and licensing activities depends on the terms of the
license agreement involved, and the circumstances surrounding the agreement. As
a result, our licensing and enforcement efforts are expected to result in
significant volatility in our quarterly and annual financial condition and
results of operations, which may result in us missing investor expectations,
which may cause our stock price to decline.




Our
U.S. Patents are the subject of a re-examination request filed with the U.S.
Patent and Trademark Office by Microsoft Corporation, which could adversely
affect our business and results of operations.




On
February 25, 2008 we announced that Microsoft Corporation had filed requests for
re-examination of our 29 U.S. patents.  Subsequently, Microsoft also
filed requests for re-examination of the remaining 5 U.S.
patents.  Some of the re-examination requests were initially rejected
by the USPTO on procedural grounds. If all procedural flaws are corrected, the
USPTO has approximately two months to decide whether to grant the requests and
engage in a formal re-examination. Patent re-examination, if undertaken by the
USPTO, could take between six months and two years.  In addition, we
have elected to withdraw and re-submit for examination seven about-to-issue
patent applications. This will give the USPTO the opportunity to evaluate
Microsoft’s re-examination documents in the context of these applications as
well.  We believe that our U.S. patents are valid and we intend to
defend our patents through any re-examination process.  However, the
re-examination of patents by the USPTO is a time consuming and expensive process
in which the ultimate outcome is uncertain.   If the USPTO elects
to re-examine some or all of our U.S. patents, we will be required to spend
substantial time and resources defending our patents, including the fees and
expenses of our legal advisors.  The re-examination of some or all of
our U.S. patents, if granted by the USPTO, may adversely impact our licensing
negotiations in process, our financial condition, and results of operations and
may require us to seek additional financing to fund our operations and defense
of our patents.  We may also enter into contingency arrangements with
investors, legal counsel or other advisors that would give such parties a
significant portion of any future licensing and settlement amounts we derive
from our patent portfolio.  If the USPTO elects to re-examine our U.S.
patents and determines that some or all of such patents should not be affirmed,
our business, financial condition and future licensing prospects may be
materially and adversely affected.






27


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




We regard
our system as open but proprietary. In an effort to protect our proprietary
rights, we rely primarily on a combination of patent, copyright, trademark and
trade secret laws, as well as licensing, non-disclosure and other agreements
with our consultants, suppliers, customers and employees. However, these laws
and agreements provide only limited protection of our proprietary rights. In
addition, we may not have signed agreements in every case, and the contractual
provisions that are in place and the protection they produce may not provide us
with adequate protection in all circumstances. Although we hold patents and have
filed patent applications covering some of the inventions embodied in our
systems, our means of protecting our proprietary rights may not be adequate. It
may be possible for a third party to copy or otherwise obtain and use our
technology without authorization and without our detection. In the event that we
believe a third party is infringing our intellectual property rights, an
infringement claim brought by us could, regardless of the outcome, result in
substantial cost to us, divert our management’s attention and resources, be time
consuming to prosecute and result in unpredictable damage awards. A third party
may also develop similar technology independently, without infringing upon our
patents and copyrights. In addition, the laws of some countries in which we sell
our system may not protect our software and intellectual property rights to the
same extent as the laws of the United States or other countries where we hold
patents. As we move to more of a software based system, inadequate licensing
controls, unauthorized copying, and use, or reverse engineering of our system
could harm our business, financial condition or results of
operations.




Others
may bring infringement claims against us or challenge the legitimacy of our
patents, which could be time-consuming and expensive to defend.




In recent
years, there has been significant litigation in the United States involving
patents and other intellectual property rights. We have been party to such
litigation in the past and may be again in the future. The prosecution and
defense of such lawsuits would require us to expend significant financial and
managerial resources, and therefore may have a material negative impact on our
financial position and results of operations. The duration and ultimate outcome
of these proceedings are uncertain. We may be a party to additional litigation
in the future to protect our intellectual property, or as a result of an alleged
infringement of the intellectual property of others. These claims and any
resulting lawsuit could subject us to significant liability for damages and
invalidation of our proprietary rights. In addition, the validity of our patents
has been challenged in the past and may be challenged in the future through
re-examination requests or other means. These lawsuits or challenges of our
patents legitimacy in the US or foreign patent offices, regardless of their
success, would likely be time-consuming and expensive to resolve and would
divert management’s time and attention. Any potential intellectual property
litigation also could force us to do one or more of the following:




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




·
            obtain
      from the owner of the infringed intellectual property a license to the
      relevant intellectual property, which may require us to license our
      intellectual property to such owner, or may not be available on reasonable
      terms or at all; and




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




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




Our
inability to protect the intellectual property created by us would cause our
business to suffer.




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




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




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




28


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




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




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




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




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




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




We depend
on outside manufacturers to produce components of our systems, such as cameras,
microphones, gateway, speakers and monitors that we install at desktops and in
conference rooms. One supplier, Pacific Corporation, is a single source supplier
for a key component for one of our products. Another supplier, Equator
Technologies Inc., is our only current source of a component used in our IP
gateway product. In addition, during 2006, we began using an offshore contract
resource in China for product development work and may use offshore resources in
the future. Our reliance on these third parties involves a number of risks,
including:




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




·
            if
      the components necessary for our system were to become unavailable, the
      need to qualify new or alternative components for our use or reconfigure
      our system and manufacturing process could be lengthy and expensive for
      those products impacted;




·
            the
      likelihood that, if particular components or human resources were not
      available, we would suffer an interruption in the manufacture and shipment
      of our systems until these components or alternatives become
      available;




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




·
            the
      possible unavailability of, or interruption in, access to some
      technologies due to infringement claims, production/supply issues or other
      hindrances; and




·
            the
      possible misappropriation of our source code through reverse engineering
      or other means by contract developers or other
  parties.




We do not
have long-term supply contracts with most of our manufacturers and
suppliers.If these manufacturers or
suppliers cease to provide us with the assistance or the components necessary
for the operation of our business, we may not be able to identify alternate
sources in a timely fashion. Any transition to alternate manufacturers or
suppliers would likely result in operational problems and increased expenses,
and could cause delays in the shipment of or otherwise limit our ability to
provide some of our products. We cannot assure you that we would be able to
enter into agreements with new manufacturers or suppliers on commercially
reasonable terms, or at all. Any disruption in product flow may limit our
revenue, delay our product development, seriously harm our competitive position
and/or result in additional costs or cancellation of orders by our customers.
While we are seeking to reduce the hardware elements of our product offering, we
may not be successful in reducing our dependencies on specialized hardware
manufacturers.




29


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




To
increase our revenue, we must increase the size and/or the productivity of our
direct sales force and add indirect distribution channels, such as systems
integrators, product partners and/or value-added resellers, and/or effect sales
through our customers. If we are unable to maintain or increase our direct sales
force or add indirect distribution channels due to our own cost constraints,
limited availability of qualified personnel or other reasons, our future revenue
growth may be limited and our future operating results may suffer. We cannot
assure you that we will be successful in attracting, integrating, motivating and
retaining sales personnel. Furthermore, it can take several months before a new
hire becomes a productive member of our sales force. The loss of existing
salespeople, or the failure of new salespeople and/or indirect sales partners to
develop the necessary skills in a timely manner, could impact our revenue
growth.




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




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




Our
products and technologies are complex, and to successfully implement our
business strategy and manage our business, an in-depth understanding of video
communication and collaboration technologies and their potential uses is
required. We need to attract and retain highly skilled technical and managerial
personnel for whom there is intense competition. If we are unable to attract and
retain qualified technical and managerial personnel due to our own cost
constraints, limited availability of qualified personnel or other reasons, our
results of operations could suffer and we may never achieve profitability. The
failure of new personnel to develop the necessary skills in a timely manner
could harm our business.




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




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




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




International
revenue, which consists of sales to customers with operations principally in
Western Europe and Asia, comprised 52% of total revenues for the three months
ended March 31, 2008 and 2007.  International revenue comprised 72% and 75%
of total revenues for the years ended December 31, 2007 and 2006, respectively.
Some of the risks we may encounter in conducting international business
activities include the following:




·
            tariffs
      and other trade barriers;




·
            unexpected
      changes in foreign regulatory requirements and
  laws;




·
            economic
      and political instability;




·
            increased
      risk of infringement claims;




·
            protection
      of our intellectual property;




·
            restrictions
      on the repatriation of funds;




·
            potentially
      adverse tax consequences;




·
            timing,
      cost and potential difficulty of adapting our system to the local language
      standards in those foreign countries that do not use the English
      language;




·
            fluctuations
      in foreign currencies; and




·
            limitations
      in communications infrastructures in some foreign
    countries.




30


Some of
our products are subject to various federal, state and international laws
governing substances and materials in products, including those restricting the
presence of certain substances in electronics products. We could incur
substantial costs, including fines and sanctions, or our products could be
enjoined from entering certain jurisdictions, if we were to violate
environmental laws or if our products become non-compliant with environmental
laws. We also face increasing complexity in our product design and procurement
operations as we adjust to new and future requirements relating to the materials
composition of our products, including the restrictions on lead and certain
other substances that apply to specified electronics products sold in the
European Union as of July 1, 2006 (Restriction of Hazardous Substances
Directive). The ultimate costs under environmental laws and the timing of these
costs are difficult to predict. Similar legislation has been or may be enacted
in other regions, including in the United States, the cumulative impact of which
could be significant.




International
political instability may increase our cost of doing business and disrupt our
business.




Increased
international political instability, evidenced by the threat or occurrence of
terrorist attacks, enhanced national security measures and/or sustained military
action may halt or hinder our ability to do business, may increase our costs and
may adversely affect our stock price. This increased instability has had and may
continue to have negative effects on financial markets, including significant
price and volume fluctuations in securities markets. If this international
political instability continues or escalates, our business and results of
operations could be harmed and the market price of our common stock could
decline.




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




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




Item
2. Unregistered Sales of Equity Securities and Use of Proceeds




Not
applicable.




Item
3. Defaults Upon Senior Securities




Not
applicable.




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




Not
applicable.




Item
5. Other
Information




On
January 1, 2008, Simon Moss succeeded Dr. Gerald J. Burnett as Chief Executive
Officer of Avistar.  Dr. Burnett will continue in his role as Chairman
of the Board of Directors of Avistar.




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




On April
18, 2008, we received a deficiency letter from The NASDAQ Stock Market
indicating that Avistar does not comply with Marketplace Rule 4310(c)(4), which
requires the Company to have a minimum bid price of $1.00 for continued
listing.  The NASDAQ Staff noted that for the 30 consecutive business
days prior to the date of its letter, the bid price of Avistar’s common stock
closed below $1.00 per share.  We have been provided 180 calendar
days, or until October 15, 2008, to regain compliance.




If we are
unable to regain compliance by October 15, 2008, the NASDAQ Staff will determine
whether we meet The NASDAQ Capital Market initial listing criteria as set forth
in Marketplace Rule 4310(c), except for the bid price
requirement.   If we meet such initial listing requirements, the
NASDAQ Staff may grant an additional 180 day compliance
period.  However, if we are unable to meet such requirements, the
NASDAQ Staff will provide written notification that our securities are subject
to delisting.  At such time, we may be permitted to appeal the NASDAQ
Staff’s determination to delist our securities to a Listing Qualifications
Panel.






31





Item 6.Exhibits





Exhibit No.
            
            Description10.21*
            
            Convertible
      Note Purchase Agreement among the Company and the Purchasers named therein
      dated January 4, 200810.22*
            
            Security
      Agreement among the Company, Baldwin Enterprises, Inc., as Collateral
      Agent, and the Purchasers named therein dated January 4,
    200810.23*
            
            Form
      of 4.5% Convertible Subordinated Secured Note Due 201010.24*
            
            Inter-creditor
      Agreement among the Purchasers of the 4.5% Convertible Subordinated
      Secured Notes Due 2010 dated January 4, 200831.1
            
            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.




*Filed on
January 9, 2008, as an exhibit to the Registrant’s Current Report on Form
8-K





32





SIGNATURES




Pursuant
to the requirements of the Securities and Exchange Act of 1934, the registrant
has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized, on the 15th day of May 2008.





AVISTAR
      COMMUNICATIONS CORPORATIONBy:
            /s/ SIMON MOSSSimon
      MossChief
      Executive Officer(Principal
      Executive Officer)By:
            /s/ ROBERT J. HABIGRobert
      J. HabigChief
      Financial Officer(Principal
      Financial and Accounting Officer)




33









EXHIBIT
INDEX





Exhibit No.
            
            
            Description10.21*
            
            Convertible
      Note Purchase Agreement among the Company and the Purchasers named therein
      dated January 4, 200810.22*
            
            Security
      Agreement among the Company, Baldwin Enterprises, Inc., as Collateral
      Agent, and the Purchasers named therein dated January 4,
    200810.23*
            
            Form
      of 4.5% Convertible Subordinated Secured Note Due 201010.24*
            
            Inter-creditor
      Agreement among the Purchasers of the 4.5% Convertible Subordinated
      Secured Notes Due 2010 dated January 4, 200831.1
            
            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.




*Filed on
January 9, 2008, as an exhibit to the Registrant’s Current Report on Form
8-K