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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549


FORM 10-Q

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

For the quarterly period ended September 30, 2003

OR

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

For the transition period from ___________ to ___________

Commission file number: 000-31121

AVISTAR COMMUNICATIONS CORPORATION

(Exact name of registrant as specified in its charter)


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

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

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

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

Yes [X]       No [  ]

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).

Yes [  ]
      No [X]

At September 30, 2003, 25,372,624 shares of common stock of the Registrant were
outstanding.





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AVISTAR COMMUNICATIONS CORPORATION

INDEX


TABLE OF CONTENTS



|                               |                                                                                               |                                                      |  |  |  |  |  | 
|------------------------------ | --------------------------------------------------------------------------------------------- | ---------------------------------------------------- |  |  |  |  |  | 
|PART I - FINANCIAL INFORMATION
|                               | Item 1. Financial Statements                                                                 
|                               |                                                                                               | CONDENSED CONSOLIDATED BALANCE SHEETS               
|                               |                                                                                               | CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS     
|                               |                                                                                               | CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS     
|                               |                                                                                               | NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
|                               | Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
|                               |                                                                                               | Factors Affecting Future Operating Results          
|                               | Item 3. Quantitative and Qualitative Disclosures About Market Risk                           
|                               | Item 4. Controls and Procedures                                                              
|PART II - OTHER INFORMATION   
|                               | Item 1. Legal Proceedings                                                                    
|                               | Item 2. Changes in Securities and Use of Proceeds                                            
|                               | Item 6. Exhibits                                                                             
|SIGNATURES                    
|EXHIBIT INDEX                 
|EXHIBIT 10.12                 
|EXHIBIT 10.13                 
|EXHIBIT 31.0                  
|EXHIBIT 32.0                  



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|           |  |                                                                                       |  |  |    |          |  | 
|---------- |  | ------------------------------------------------------------------------------------- |  |  | -- | -------- |  | 
|           |  |                                                                                       |  |  |    | PAGE NO.
|           |  |                                                                                       |  |  |    |         
|PART I.    |  | FINANCIAL INFORMATION                                                                 |  |  |    |         
|Item 1.    |  | Financial Statements                                                                  |  |  | 3  |         
|           |  | Condensed Consolidated Balance Sheets                                                 |  |  | 3  |         
|           |  | Condensed Consolidated Statements of Operations                                       |  |  | 4  |         
|           |  | Condensed Consolidated Statements of Cash Flows                                       |  |  | 5  |         
|           |  | Notes to Condensed Consolidated Financial Statements                                  |  |  | 6  |         
|Item 2.    |  | Managements Discussion and Analysis of Financial Condition and Results of Operations |  |  | 13 |         
|           |  | Factors Affecting Future Operating Results                                            |  |  | 19 |         
|Item 3.    |  | Quantitative and Qualitative Disclosures About Market Risk                            |  |  | 29 |         
|Item 4.    |  | Controls and Procedures                                                               |  |  | 29 |         
|PART II.   |  | OTHER INFORMATION                                                                     |  |  |    |         
|Item 1.    |  | Legal Proceedings                                                                     |  |  | 30 |         
|Item 2.    |  | Changes in Securities and Use of Proceeds                                             |  |  | 30 |         
|Item 6.    |  | Exhibits                                                                              |  |  | 31 |         
|SIGNATURES |  |                                                                                       |  |  | 32 |         

2



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PART I - FINANCIAL INFORMATION




Item 1.Financial Statements

AVISTAR COMMUNICATIONS CORPORATION AND SUBSIDIARIES




CONDENSED CONSOLIDATED BALANCE SHEETS
as of September 30, 2003 and December 31, 2002
(in thousands, except share and per share data)

|                                      |                       |                                                                                                                                                                                                              |                                            |   |               |       |              |   |         |        | 
|------------------------------------- | --------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | ------------------------------------------ | - | ------------- | ----- | ------------ | - | ------- | ------ | 
|                                      |                       |                                                                                                                                                                                                              |                                            |   | September 30, |       | December 31,
|                                      |                       |                                                                                                                                                                                                              |                                            |   | 2003          |       | 2002        
|                                      |                       |                                                                                                                                                                                                              |                                            |   |               |       |             
|                                      |                       |                                                                                                                                                                                                              |                                            |   | (unaudited)   |       |              |   |        
|Assets:                               |                       |                                                                                                                                                                                                              |                                            |   |               |       |              |  
|                                      | Current assets:       |                                                                                                                                                                                                              |                                            |   |               |       |              |   |        
|                                      |                       | Cash and cash equivalents                                                                                                                                                                                    |                                            | $ | 2,494         |       |              | $ | 4,783   |       
|                                      |                       | Short-term investments                                                                                                                                                                                       |                                            |   |              |       |              |   | 2,402   |       
|                                      |                       | Accounts receivable, net of allowance for doubtful
accounts of $38 at September 30, 2003 and $69 at December 31, 2002                                                                                        |                                            |   | 965           |       |              |   | 740     |       
|                                      |                       | Inventories, including inventory shipped to customers sites, not
yet installed of $32 at September 30, 2003 and $71 at December 31, 2002                                                                    |                                            |   | 855           |       |              |   | 1,148   |       
|                                      |                       | Prepaid expenses and other current assets                                                                                                                                                                    |                                            |   | 442           |       |              |   | 629     |       
|                                      |                       |                                                                                                                                                                                                              |                                            |   |               |       |              |   |         |       
|                                      |                       |                                                                                                                                                                                                              | Total current assets                       |   |               | 4,756 |              |   |         | 9,702  | 
|                                      |                       | Property and equipment, net                                                                                                                                                                                  |                                            |   | 273           |       |              |   | 378     |       
|                                      |                       | Other assets                                                                                                                                                                                                 |                                            |   | 349           |       |              |   | 320     |       
|                                      |                       |                                                                                                                                                                                                              |                                            |   |               |       |              |   |         |       
|                                      |                       |                                                                                                                                                                                                              | Total assets                               |   | $             | 5,378 |              |   | $       | 10,400 | 
|                                      |                       |                                                                                                                                                                                                              |                                            |   |               |       |              |   |         |       
|Liabilities and Stockholders Equity: |                       |                                                                                                                                                                                                              |                                            |   |               |       |              |  
|                                      | Current liabilities:  |                                                                                                                                                                                                              |                                            |   |               |       |              |   |        
|                                      |                       | Line of Credit                                                                                                                                                                                               |                                            | $ | 1,500         |       |              | $ |        |       
|                                      |                       | Accounts payable                                                                                                                                                                                             |                                            |   | 546           |       |              |   | 558     |       
|                                      |                       | Deferred revenue and customer deposits                                                                                                                                                                       |                                            |   | 482           |       |              |   | 996     |       
|                                      |                       | Accrued liabilities and other                                                                                                                                                                                |                                            |   | 1,150         |       |              |   | 898     |       
|                                      |                       |                                                                                                                                                                                                              |                                            |   |               |       |              |   |         |       
|                                      |                       |                                                                                                                                                                                                              | Total current liabilities                  |   |               | 3,678 |              |   |         | 2,452  | 
|                                      |                       |                                                                                                                                                                                                              |                                            |   |               |       |              |   |         |       
|                                      | Stockholders equity: |                                                                                                                                                                                                              |                                            |   |               |       |              |   |        
|                                      |                       | Common stock, $0.001 par value; 250,000,000 shares authorized at
September 30, 2003 and December 31, 2002; 26,552,249 and
26,465,058 shares
issued at September 30, 2003 and December 31, 2002, respectively |                                            |   | 26            |       |              |   | 26      |       
|                                      |                       | Less: treasury common stock, 1,179,625 shares at September 30, 2003
and December 31, 2002, at cost                                                                                                           |                                            |   | (51           | )     |              |   | (51     | )     
|                                      |                       | Additional paid-in-capital                                                                                                                                                                                   |                                            |   | 80,363        |       |              |   | 80,254  |       
|                                      |                       | Deferred stock compensation                                                                                                                                                                                  |                                            |   | (22           | )     |              |   | (135    | )     
|                                      |                       | Other comprehensive income                                                                                                                                                                                   |                                            |   |              |       |              |   | 2       |       
|                                      |                       | Accumulated deficit                                                                                                                                                                                          |                                            |   | (78,616       | )     |              |   | (72,148 | )     
|                                      |                       |                                                                                                                                                                                                              |                                            |   |               |       |              |   |         |       
|                                      |                       |                                                                                                                                                                                                              | Total stockholders equity                 |   |               | 1,700 |              |   |         | 7,948  | 
|                                      |                       |                                                                                                                                                                                                              |                                            |   |               |       |              |   |         |       
|                                      |                       |                                                                                                                                                                                                              | Total liabilities and stockholders equity |   | $             | 5,378 |              |   | $       | 10,400 | 
|                                      |                       |                                                                                                                                                                                                              |                                            |   |               |       |              |   |         |       

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

3



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AVISTAR COMMUNICATIONS CORPORATION AND SUBSIDIARIES




CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
for the three and nine months ended September 30, 2003 and 2002
(in thousands, except per share data)

|                                                                                    |                                               |                          |        |                    |        |                   |        |               |        |               |        |       |        |   |        |       |        |  
|----------------------------------------------------------------------------------- | --------------------------------------------- | ------------------------ | ------ | ------------------ | ------ | ----------------- | ------ | ------------- | ------ | ------------- | ------ | ----- | ------ | - | ------ | ----- | ------ | -
|                                                                                    |                                               |                          |        | Three Months Ended |        | Nine Months Ended
|                                                                                    |                                               |                          |        |                    |        |                  
|                                                                                    |                                               |                          |        | September 30,      |        | September 30,     |        | September 30, |        | September 30,
|                                                                                    |                                               |                          |        | 2003               |        | 2002              |        | 2003          |        | 2002         
|                                                                                    |                                               |                          |        |                    |        |                   |        |               |        |              
|                                                                                    |                                               |                          |        | (unaudited)        |        | (unaudited)      
|Revenue:                                                                            |                                               |                          |        |                    |        |                   |        |               |        |               |        |       |        |   |        |      
|                                                                                    | Product                                       |                          | $      | 837                |        |                   | $      | 1,206         |        |               | $      | 2,207 |        |   | $      | 3,628 |       
|                                                                                    | Services, maintenance and support             |                          |        | 1,198              |        |                   |        | 1,136         |        |               |        | 2,976 |        |   |        | 3,415 |       
|                                                                                    |                                               |                          |        |                    |        |                   |        |               |        |               |        |       |        |   |        |      
|                                                                                    |                                               | Total revenue            |        |                    | 2,035  |                   |        |               | 2,342  |               |        |       | 5,183  |   |        |       | 7,043  |  
|                                                                                    |                                               |                          |        |                    |        |                   |        |               |        |               |        |       |        |   |        |      
|Cost of revenue:                                                                    |                                               |                          |        |                    |        |                   |        |               |        |               |        |       |        |   |        |      
|                                                                                    | Product                                       |                          |        | 390                |        |                   |        | 503           |        |               |        | 1,091 |        |   |        | 1,751 |       
|                                                                                    | Services, maintenance and support             |                          |        | 570                |        |                   |        | 567           |        |               |        | 1,698 |        |   |        | 1,809 |       
|                                                                                    |                                               |                          |        |                    |        |                   |        |               |        |               |        |       |        |   |        |      
|                                                                                    |                                               | Total cost of revenue    |        |                    | 960    |                   |        |               | 1,070  |               |        |       | 2,789  |   |        |       | 3,560  |  
|                                                                                    |                                               |                          |        |                    |        |                   |        |               |        |               |        |       |        |   |        |      
|                                                                                    |                                               | Gross margin             |        |                    | 1,075  |                   |        |               | 1,272  |               |        |       | 2,394  |   |        |       | 3,483  |  
|                                                                                    |                                               |                          |        |                    |        |                   |        |               |        |               |        |       |        |   |        |      
|Operating Expenses:                                                                 |                                               |                          |        |                    |        |                   |        |               |        |               |        |       |        |   |        |      
|                                                                                    | Research and development                      |                          |        | 549                |        |                   |        | 894           |        |               |        | 1,860 |        |   |        | 2,984 |       
|                                                                                    | Sales and marketing                           |                          |        | 939                |        |                   |        | 875           |        |               |        | 2,854 |        |   |        | 2,782 |       
|                                                                                    | General and administrative                    |                          |        | 1,397              |        |                   |        | 1,179         |        |               |        | 4,579 |        |   |        | 3,376 |       
|                                                                                    | Amortization of deferred stock compensation * |                          |        | 23                 |        |                   |        | 74            |        |               |        | 113   |        |   |        | 293   |       
|                                                                                    |                                               |                          |        |                    |        |                   |        |               |        |               |        |       |        |   |        |      
|                                                                                    |                                               | Total operating expenses |        |                    | 2,908  |                   |        |               | 3,022  |               |        |       | 9,406  |   |        |       | 9,435  |  
|                                                                                    |                                               |                          |        |                    |        |                   |        |               |        |               |        |       |        |   |        |      
|                                                                                    |                                               | Loss from operations     |        |                    | (1,833 | )                 |        |               | (1,750 | )             |        |       | (7,012 | ) |        |       | (5,952 | )
|                                                                                    |                                               |                          |        |                    |        |                   |        |               |        |               |        |       |        |   |        |      
|Other income (expense):                                                             |                                               |                          |        |                    |        |                   |        |               |        |               |        |       |        |   |        |      
|                                                                                    | Interest income                               |                          |        | 5                  |        |                   |        | 58            |        |               |        | 33    |        |   |        | 222   |       
|                                                                                    | Other income (expense), net                   |                          |        | 521                |        |                   |        | (5            | )      |               |        | 511   |        |   |        | 215   |       
|                                                                                    |                                               |                          |        |                    |        |                   |        |               |        |               |        |       |        |   |        |      
|                                                                                    |                                               | Total other income, net  |        |                    | 526    |                   |        |               | 53     |               |        |       | 544    |   |        |       | 437    |  
|                                                                                    |                                               |                          |        |                    |        |                   |        |               |        |               |        |       |        |   |        |      
|Net loss                                                                            |                                               | $                        | (1,307 | )                  |        | $                 | (1,697 | )             |        | $             | (6,468 | )     |        | $ | (5,515 | )    
|                                                                                    |                                               |                          |        |                    |        |                   |        |               |        |               |        |       |        |   |        |      
|Net loss per share - basic and diluted                                              |                                               | $                        | (0.05  | )                  |        | $                 | (0.07  | )             |        | $             | (0.26  | )     |        | $ | (0.22  | )    
|                                                                                    |                                               |                          |        |                    |        |                   |        |               |        |               |        |       |        |   |        |      
|Weighted average shares used in calculating
basic and diluted net loss per share    |                                               |                          | 25,371 |                    |        |                   | 25,273 |               |        |               | 25,345 |       |        |   | 25,252 |      
|                                                                                    |                                               |                          |        |                    |        |                   |        |               |        |               |        |       |        |   |        |      
|* Amortization of deferred stock compensation excluded
from the following expenses: |                                               |                          |        |                    |        |                   |        |               |        |               |        |       |        |   |        |      
|                                                                                    | Cost of revenue                               |                          | $      | 3                  |        |                   | $      | 7             |        |               | $      | 13    |        |   | $      | 35    |       
|                                                                                    | Research and development                      |                          |        | 2                  |        |                   |        | 6             |        |               |        | 10    |        |   |        | 26    |       
|                                                                                    | Sales and marketing                           |                          |        | 17                 |        |                   |        | 60            |        |               |        | 87    |        |   |        | 226   |       
|                                                                                    | General and administrative                    |                          |        | 1                  |        |                   |        | 1             |        |               |        | 3     |        |   |        | 6     |       
|                                                                                    |                                               |                          |        |                    |        |                   |        |               |        |               |        |       |        |   |        |      
|                                                                                    |                                               | $                        | 23     |                    |        | $                 | 74     |               |        | $             | 113    |       |        | $ | 293    |      
|                                                                                    |                                               |                          |        |                    |        |                   |        |               |        |               |        |       |        |   |        |      

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

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AVISTAR COMMUNICATIONS CORPORATION AND SUBSIDIARIES




CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
for the nine months ended September 30, 2003 and 2002
(in thousands)

|                                      |  |                                                                             |                                               |                                           |        |                   |      |               |        |     |       |   |  |  |  |  |  |  |  | 
|------------------------------------- |  | --------------------------------------------------------------------------- | --------------------------------------------- | ----------------------------------------- | ------ | ----------------- | ---- | ------------- | ------ | --- | ----- | - |  |  |  |  |  |  |  | 
|                                      |  |                                                                             |                                               |                                           |        | Nine Months Ended |      |               |        |     |       |   |  | 
|                                      |  |                                                                             |                                               |                                           |        |                   |      |               |        |     |       |   |  | 
|                                      |  |                                                                             |                                               |                                           |        | September 30,     |      | September 30, |        |     |       |   |  |  |  | 
|                                      |  |                                                                             |                                               |                                           |        | 2003              |      | 2002          |        |     |       |   |  |  |  | 
|                                      |  |                                                                             |                                               |                                           |        |                   |      |               |        |     |       |   |  |  |  | 
|                                      |  |                                                                             |                                               |                                           |        | (unaudited)       |      |               |        |     |       |   |  | 
|Cash Flows from Operating Activities: |  |                                                                             |                                               |                                           |        |                   |      |              
|                                      |  | Net loss                                                                    |                                               | $                                         | (6,468 | )                 |      | $             | (5,515 | )  
|                                      |  | Adjustments to reconcile net loss to net cash used in operating activities: |                                               |                                           |        |                   |      |               |        |    
|                                      |  |                                                                             | Depreciation                                  |                                           |        | 155               |      |               |        | 261 |      
|                                      |  |                                                                             | Stock-based compensation                      |                                           |        | 113               |      |               |        | 367 |      
|                                      |  |                                                                             | Compensation on options issued to consultants |                                           |        | 32                |      |               |        |    |      
|                                      |  |                                                                             | Provision for doubtful accounts               |                                           |        | 75                |      |               |        | 140 |      
|                                      |  |                                                                             | Changes in current assets and liabilities:    |                                           |        |                   |      |               |        |     |      
|                                      |  |                                                                             |                                               | Accounts receivable                       |        |                   | (300 | )             |        |     | 1,556 |  
|                                      |  |                                                                             |                                               | Inventories                               |        |                   | 293  |               |        |     | 41    |  
|                                      |  |                                                                             |                                               | Prepaid expenses and other current assets |        |                   | 187  |               |        |     | 316   |  
|                                      |  |                                                                             |                                               | Other assets                              |        |                   | (29  | )             |        |     | (8    | )
|                                      |  |                                                                             |                                               | Accounts payable                          |        |                   | (12  | )             |        |     | (348  | )
|                                      |  |                                                                             |                                               | Deferred revenue and customer deposits    |        |                   | (514 | )             |        |     | (145  | )
|                                      |  |                                                                             |                                               | Accrued liabilities and other             |        |                   | 252  |               |        |     | (922  | )
|                                      |  |                                                                             |                                               |                                           |        |                   |      |               |        |    
|                                      |  | Net cash used in operating activities                                       |                                               |                                           | (6,216 | )                 |      |               | (4,257 | )  
|                                      |  |                                                                             |                                               |                                           |        |                   |      |               |        |    
|Cash Flows from Investing Activities: |  |                                                                             |                                               |                                           |        |                   |      |              
|                                      |  | Sale of short-term investments                                              |                                               |                                           | 2,400  |                   |      |               | 2,404  |    
|                                      |  | Purchase of property and equipment                                          |                                               |                                           | (50    | )                 |      |               | (99    | )  
|                                      |  |                                                                             |                                               |                                           |        |                   |      |               |        |    
|                                      |  | Net cash provided by investing activities                                   |                                               |                                           | 2,350  |                   |      |               | 2,305  |    
|                                      |  |                                                                             |                                               |                                           |        |                   |      |               |        |    
|Cash Flows from Financing Activities: |  |                                                                             |                                               |                                           |        |                   |      |              
|                                      |  | Decrease in bank overdraft                                                  |                                               |                                           |       |                   |      |               | (149   | )  
|                                      |  | Proceeds from issuance of common stock                                      |                                               |                                           | 77     |                   |      |               | 113    |    
|                                      |  | Repurchases of common stock                                                 |                                               |                                           |       |                   |      |               | (11    | )  
|                                      |  | Proceeds from draw on line of credit                                        |                                               |                                           | 1,500  |                   |      |               |       |    
|                                      |  |                                                                             |                                               |                                           |        |                   |      |               |        |    
|                                      |  | Net cash provided by (used in) financing activities                         |                                               |                                           | 1,577  |                   |      |               | (47    | )  
|                                      |  |                                                                             |                                               |                                           |        |                   |      |               |        |    
|                                      |  | Net decrease in cash and cash equivalents                                   |                                               |                                           | (2,289 | )                 |      |               | (1,999 | )  
|                                      |  | Cash and cash equivalents, beginning of period                              |                                               |                                           | 4,783  |                   |      |               | 7,455  |    
|                                      |  |                                                                             |                                               |                                           |        |                   |      |               |        |    
|                                      |  | Cash and cash equivalents, end of period                                    |                                               | $                                         | 2,494  |                   |      | $             | 5,456  |    
|                                      |  |                                                                             |                                               |                                           |        |                   |      |               |        |    

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

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

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

Business

Avistar Communications Corporation (Avistar or the Company) provides
the Avistar vBusiness integrated suite of video-enabled applications, including
networked video communications software and hardware products and services.
Avistars products include applications for interactive video calling, content
creation and publishing, broadcast video and video-on-demand, as well as data
sharing, directory services and network management. Avistar designs, develops,
markets, sells, manufactures and/or assembles and installs and supports its
products. Avistars real-time and non-real-time products are based upon its
architecture and Video Operating System (AvistarVOS) platform, which
facilitates distribution over local and wide area networks using telephony or
Internet services as appropriate. Avistars services include software
development, consulting, implementation, training, maintenance and support. In
addition, Avistar seeks to prosecute, maintain, support and license the
intellectual property developed by the Company through its wholly-owned
subsidiary, Collaboration Properties, Inc., a Nevada corporation (CPI).

Basis of Presentation

The unaudited balance sheet as of September 30, 2003 presents the
consolidated financial position of Avistar and its two wholly-owned operating
subsidiaries, Avistar Systems U.K. Limited (ASUK) and CPI after elimination of
all intercompany accounts and transactions. The consolidated results are
referred to, collectively, as those of Avistar or the Company in these notes.

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

The Companys fiscal year coincides with the calendar year ending on
December 31. Certain reclassifications were made to the prior year presentation
to conform to the current period presentation.

Risks and Uncertainties

The markets for the Companys products and services are in the early
stages of development. Some of the Companys products utilize changing and
emerging technologies. As is typical in industries of this nature, demand and
market acceptance are subject to a high level of uncertainty, particularly when
there are adverse conditions in the economy. Acceptance of the Companys
products over time is critical to the Companys success. The Companys
prospects must be evaluated in light of difficulties encountered by it and its
competitors in further developing this evolving marketplace. The Company has
generated losses since inception and had an accumulated deficit of $78.6
million as of September 30, 2003. The Companys operating results may
fluctuate significantly in the future as a result of a variety of factors,
including, but not limited to, the economic environment, the adoption of
different distribution channels, and the timing of new product announcements by
the Company or its competitors.

The Companys future liquidity and capital requirements will depend upon
numerous factors, including, but not limited to, the costs and timing of its
expansion of product development efforts and the success of these development
efforts, the costs and timing of its expansion of sales and marketing
activities, the extent to which its existing and new products gain market
acceptance, competing technological and market developments, the costs involved
in maintaining, enforcing and defending patent claims and other intellectual
property rights, the level and timing of revenue and other factors. The
Company may need to raise additional funds, and additional financing may not be
available on favorable terms, if at all. If the Company cannot raise
additional funds, if needed, on acceptable terms, the Company may not be able
to develop or enhance its products, take advantage of future opportunities or
respond to competitive pressures or unanticipated requirements, which could
seriously harm the Companys business, financial condition, results of
operations and ability to continue operations. If additional funds are raised
through the issuance of equity securities, the Companys net tangible book
value per share is likely to decrease, the percentage ownership of then current
stockholders may be diluted and such equity securities may have rights,
preferences or privileges senior to those of the holders of the Companys
common stock. Debt financing, if available, may involve significant fees,
interest payment obligations and restrictive covenants. Strategic arrangements,
if necessary to raise additional funds, may require us to relinquish our rights
to certain of our technologies or products.

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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 Securities
and Exchange Commission. 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. The December 31,
2002 Condensed Consolidated Balance Sheet was derived from audited financial
statements, but does not include all disclosures required by accounting
principles generally accepted in the United States of America.

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, 2002 included in the Companys annual report on Form 10-K filed
with the Securities and Exchange Commission on March 25, 2003.

Use of Estimates

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

Cash and Cash Equivalents and Short Term Investments

The Company considers all investment instruments purchased with a
remaining maturity of three months or less to be cash equivalents. The
Companys cash equivalents at September 30, 2003 and December 31, 2002
consisted of money market funds and short-term securities. The Company has
classified all investments not classified as cash equivalents as short term
since it has the intent and ability to redeem them within one year. The
Company classifies its short-term investments as available for sale with
unrealized gains or losses reported as a separate component of stockholders
equity. The fair value of the Companys investments was determined based on
quoted market prices at the reporting date for those instruments. As of
September 30, 2003, there was no difference between the cost and fair value of
the Companys investments.

Supplemental Cash Flow Information

During the nine months ended September 30, 2003, the Company paid
approximately $8,000 in interest. During the nine months ended September 30,
2003, no cash was paid for income taxes. During the nine months ended September
30, 2002, no cash was paid for income taxes or interest.

Significant Concentrations

A relatively small number of customers accounted for a significant
percentage of the Companys net sales. Sales to these customers as a percentage
of sales were as follows for the three and nine months ended September 30, 2003
and 2002:

|           |  |                    |    |                   |  |      |    |      |  |  |    |   |  |  |    |  
|---------- |  | ------------------ | -- | ----------------- |  | ---- | -- | ---- |  |  | -- | - |  |  | -- | -
|           |  | THREE MONTHS ENDED |    | NINE MONTHS ENDED
|           |  | SEPTEMBER 30,      |    | SEPTEMBER 30,    
|           |  |                    |    |                  
|           |  | 2003               |    | 2002              |  | 2003 |    | 2002
|           |  |                    |    |                   |  |      |    |     
|           |  | (UNAUDITED)        |    | (UNAUDITED)      
|Customer A |  |                    | 61 | %                 |  |      | 41 | %    |  |  | 61 | % |  |  | 55 | %
|Customer B |  |                    | *  |                   |  |      | 20 | %    |  |  | *  |   |  |  | 12 | %



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

Financial instruments that potentially subject the Company to
concentrations of credit risk consist primarily of 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 and restrict
placement of these investments to financial institutions evaluated as highly
credit worthy. Concentration of credit risk with respect to trade receivables
relate to those trade receivables from both United States and foreign entities.
As of September 30, 2003, approximately 66% of accounts receivable were
concentrated with one customer. As of December 31, 2002, approximately 65% of
accounts receivable were concentrated with one customer.

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):

|                                                       |  |               |     |              |  |   |       | 
|------------------------------------------------------ |  | ------------- | --- | ------------ |  | - | ----- | 
|                                                       |  | SEPTEMBER 30, |     | DECEMBER 31,
|                                                       |  | 2003          |     | 2002        
|                                                       |  |               |     |             
|                                                       |  | (UNAUDITED)   |     |              |  |  
|Raw materials and subassemblies                        |  | $             | 107 |              |  | $ | 70    | 
|Finished goods                                         |  |               | 716 |              |  |   | 1,007 | 
|Inventory shipped to customer sites, not yet installed |  |               | 32  |              |  |   | 71    | 
|                                                       |  |               |     |              |  |   |       | 
|                                                       |  | $             | 855 |              |  | $ | 1,148 | 
|                                                       |  |               |     |              |  |   |       | 

Inventory shipped to customer sites, not yet installed, represents product
shipped to customer sites pending completion of the installation process by the
Company. As of September 30, 2003 and December 31, 2002, the Company had billed
approximately $75,000 and $50,000, respectively, to customers related to these
shipments, but did not record the revenue, as the installations had not been
completed and confirmed by the customer. Although customers are billed in
accordance with customer agreements, these deferred revenue amounts are netted
against accounts receivable until the customer confirms installation.

Revenue Recognition and Deferred Revenue

The Company recognizes revenue in accordance with Statement of Position
(SOP) 97-2, Software Revenue Recognition, and SOP 98-9, Modification of
SOP 97-2, Software Revenue Recognition, with Respect to Certain Transactions.
The Company recognizes revenue from product sales when all of the following
conditions are met: the product has been shipped, an arrangement exists with
the customer at a fixed price and the Company has the right to invoice the
customer, collection of the receivable is probable, and the Company has
fulfilled all of its material contractual obligations to the customer.

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. 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 are due upon
providing the services, subject to specific payment terms. If payments for
systems are made in advance of the completion of installation, such amounts are
deferred and recorded as deferred revenue and customer deposits in the
accompanying balance sheets until installation has occurred and the customer
has provided confirmation. Reimbursements received for out-of-pocket expenses
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, 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 percentage of product list prices as stipulated in
the customer agreement. Customers have the option to renew the maintenance
and/or support arrangement in subsequent periods at the same rate as paid in
the initial year. 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, and training
revenue is recognized upon performance of the service.

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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.

Stock-Based Compensation

The Company applies the intrinsic-value-based method of accounting for
stock-based compensation prescribed by Accounting Principles Board (APB)
Opinion No. 25, Accounting for Stock Issued to Employees, and related
interpretations including FASB Interpretation No. 44, Accounting for Certain
Transactions involving Stock Compensation, an interpretation of APB Opinion No.
25, issued in March 2000, to account for its fixed-plan stock options. Under
this method, compensation expense is recorded on the date of grant only if the
current market price of the underlying stock exceeded the exercise price. SFAS
No. 123, Accounting for Stock-Based Compensation, established accounting and
disclosure requirements using a fair-value-based method of accounting for
stock-based employee compensation plans. As allowed by SFAS No. 123, the
Company has elected to continue to apply the intrinsic-value-based method of
accounting described above, and has adopted only the disclosure requirements of
SFAS No. 123. The following table illustrates the effect on net income if the
fair-value-based method had been applied to all outstanding and unvested awards
in each period (in thousands, except per share data).

|                                                                                                                            |             |   |                     |       |                     |   |        |       |      |   |        |       |   |   |        |       |  
|--------------------------------------------------------------------------------------------------------------------------- | ----------- | - | ------------------- | ----- | ------------------- | - | ------ | ----- | ---- | - | ------ | ----- | - | - | ------ | ----- | -
|                                                                                                                            |             |   | Three Months        |       | Nine Months        
|                                                                                                                            |             |   | Ended September 30, |       | Ended September 30,
|                                                                                                                            |             |   |                     |       |                    
|                                                                                                                            |             |   | 2003                |       | 2002                |   | 2003   |       | 2002
|                                                                                                                            |             |   |                     |       |                     |   |        |       |     
|Net loss, as reported                                                                                                       |             | $ | (1,307              | )     |                     | $ | (1,697 | )     |      | $ | (6,468 | )     |   | $ | (5,515 | )    
|Add stock  based employee compensation expense
included in reported net loss, net of tax                                   |             |   | 23                  |       |                     |   | 74     |       |      |   | 113    |       |   |   | 293    |      
|Deduct total stock-based employee compensation expense determined
under fair-value-based method for all rewards, net of tax |             |   | (1,078              | )     |                     |   | (998   | )     |      |   | (3,157 | )     |   |   | (2,932 | )    
|                                                                                                                            |             |   |                     |       |                     |   |        |       |      |   |        |       |   |   |        |      
|Pro forma net loss                                                                                                          |             | $ | (2,362              | )     |                     | $ | (2,621 | )     |      | $ | (9,512 | )     |   | $ | (8,154 | )    
|Basic and diluted loss per share                                                                                            |            
|                                                                                                                            | As reported |   | $                   | (0.05 | )                   |   | $      | (0.07 | )    |   | $      | (0.26 | ) |   | $      | (0.22 | )
|                                                                                                                            | Pro forma   |   | $                   | (0.09 | )                   |   | $      | (0.10 | )    |   | $      | (0.38 | ) |   | $      | (0.32 | )

The fair value of options granted for the three months ended September 30,
2003 and 2002 is estimated on the date of grant using the following
assumptions:

|                                |  |      |     |      |  |  |     |  
|------------------------------- |  | ---- | --- | ---- |  |  | --- | -
|                                |  | 2003 |     | 2002
|                                |  |      |     |     
|Expected
dividend               |  |      | 0   | %    |  |  | 0   | %
|Average risk-free interest
rate |  |      | 2.9 | %    |  |  | 4.0 | %
|Expected
volatility             |  |      | 187 | %    |  |  | 187 | %
|Expected term (in
years)        |  |      | 4   |      |  |  | 4   |  

Recent Accounting Pronouncements

In December 2002, the FASB issued SFAS 148, Summary of Statement No. 148
Accounting for Stock-Based Compensation-Transition and Disclosure-an Amendment
of FASB Statement No. 123. SFAS 148 amends SFAS 123, Accounting for
Stock-Based Compensation, to provide alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-based
employee compensation. In addition, SFAS 148 amends the disclosure requirements
of SFAS 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. The Company
has adopted the disclosure requirements of SFAS 148.

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In May 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity,
which establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity.
Financial instruments that are within the scope of the statement, which
previously were often classified as equity, must now be classified as
liabilities. This statement is effective for financial instruments entered into
or modified after May 31, 2003, and otherwise shall be effective at the
beginning of the first interim period beginning after June 15, 2003. The
adoption of SFAS No. 150 did not have a material impact on the Companys
condensed consolidated financial statements.



3. Line of Credit

On February 27, 2002, the Company entered into a Loan and Security
Agreement with a financial institution to borrow up to $4.5 million as a
revolving line of credit and $0.5 million as an equipment term loan. The first
$1.0 million of the revolving line was available on a non-formula basis, and
the remainder was limited to 80% of the Companys eligible accounts receivable.
As collateral under this Loan and Security Agreement, the Company granted a
first priority security interest in all of the Companys assets, excluding
intellectual property. The revolving line of credit and the equipment term
loan required certain covenants to be met. On December 15, 2002, the Company
entered into an amendment to the Loan and Security Agreement to increase the
maximum funds available thereunder to $6.0 million and extend the term of the
agreement. The amended Loan and Security Agreement, as further amended in
March 2003, has an expiration date of February 27, 2004. The agreement, as
amended, retains a first priority security interest in all of the Companys
assets, excluding intellectual property. Furthermore, Gerald Burnett, Chairman
and Chief Executive Officer of the Company, has provided a collateralized
guarantee to the financial institution, assuring payment of the Companys
obligations under the agreement. As a consequence, restrictive covenants from
the original Loan and Security agreement have been deleted in the amendment,
except for a quick ratio covenant, allowing the Company greater access to the
full amount of the facility. As of September 30, 2003, the Company has borrowed
$1.5 million under this line of credit, and additionally, the Company was
eligible to borrow up to an additional $4.5 million under the line of credit.

Gerald Burnett had previously committed to provide funds up to $6.0
million (inclusive of any funds drawn by the Company under the Loan and
Security Agreement and subject to his collateralized guarantee of the Companys
obligations thereunder) through February 27, 2004 in the event that the full
$6.0 million under the Loan and Security Agreement is not available to the
Company for any reason. See Note 8. Subsequent Events for information
regarding the recent equity investment in the Company by Dr. Burnett and other
members of his family, the majority satisfaction of Dr. Burnetts commitment to provide
up to $6 million in funds and the termination of the Loan and Security
Agreement and Dr. Burnetts related guarantee.

4. Related Party Transactions

Robert P. Latta, a member of the law firm Wilson Sonsini Goodrich &
Rosati, Professional Corporation (WSGR), has served as a director of the
Company since February 2001. Mr. Latta and WSGR have represented the Company
and its predecessors as corporate counsel since 1997. During the nine months
ended September 30, 2003 and 2002, payments of approximately $175,000 and
$125,000, respectively, were made to WSGR for legal services provided to the
Company.

During the nine months ended September 30, 2003 and 2002, payments for
consulting fees of approximately $100,000 and $165,000, respectively, were made
to R. Stephen Heinrichs, a former officer of the Company, who is also a member
of the Board of Directors, pursuant to a Separation Agreement between Mr.
Heinrichs and the Company dated April 26, 2001.

Gerald Burnett, Chairman and Chief Executive Officer of the Company has
provided a collateralized guarantee, assuring payment of the Companys
obligations under a Loan and Security Agreement with a financial institution
dated February 27, 2002, as amended. In addition, Gerald Burnett had
previously committed to provide funds up to $6.0 million (inclusive of any
funds drawn by the Company under the Loan and Security Agreement and subject to
his collateralized guarantee of the Companys obligations thereunder) through
February 27, 2004 in the event that the full $6.0 million under the Loan and
Security Agreement is not available to the Company for any reason.
See Note 8. Subsequent Events for information regarding the recent equity
investment in the Company by Dr. Burnett and other members of his family, the
majority satisfaction of Dr. Burnetts commitment to provide up to $6 million in funds
and the termination of the Loan and Security Agreement and Dr.
Burnetts related guarantee.

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5. Legal Proceedings

On September 23, 2002, CPI, a wholly owned subsidiary of the Company,
filed a patent infringement lawsuit against Polycom, Inc., alleging that
several Polycom videoconferencing products infringe four patents of CPI.
Polycom responded to CPIs claims on November 14, 2002, at which time it both
answered the complaint and asserted counterclaims against CPI for
non-infringement, invalidity and unenforceability. On January 31, 2003,
Polycom filed a motion with the court, which was subsequently granted by the
court on March 7, 2003, requesting permission to amend its counterclaims to
incorporate claims of alleged infringements by Avistar Communications of four
PictureTel patents that Polycom has told us it has had assigned to it. Three of
the four counterclaims involved a third party, and these three counterclaims
were dropped by Polycom on June 23, 2003, subsequent to an agreement between
Polycom and the third party. On August 9, 2003, CPI and Polycom filed motions
for summary judgment with the court, seeking judgment as a matter of law
concerning CPIs ability to qualify for small entity status in the filing of
its four patents being asserted against Polycom. On October 16,
2003, the court
denied Polycoms motion for summary judgment and granted CPIs motion for
summary judgment, thereby negating Polycoms defense of unenforceablity
concerning CPIs having filed these patents as a small entity. A trial date
for CPIs claims against Polycom and Polycoms counterclaims has not yet been
set.

6. Net Loss Per Share

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

In accordance with SFAS 128, basic net loss per share has been computed
using the weighted average number of shares of common stock outstanding during
the period, less shares subject to repurchase. Diluted net loss per share is
computed on the basis of the weighted average number of shares and common
equivalent shares outstanding during the period. Common equivalent shares
result from the assumed exercise of outstanding stock options that have a
dilutive effect when applying the treasury stock method. The Company has
excluded all convertible preferred stock, outstanding stock options and shares
subject to repurchase from the calculation of diluted net loss per share for
the three and nine months ended September 30, 2003 and 2002, because all such
securities are antidilutive. Accordingly, diluted net loss per share
approximates basic net loss per share for all periods presented.

The total number of shares excluded from the calculations of diluted net
loss per share was 179,282 and 136,231 for the three months ended September 30,
2003 and 2002, respectively, and 297,187 and 269,039 for the nine months ended
September 30, 2003 and 2002, respectively.

7. Segment Reporting

Disclosure of segments is presented in accordance with SFAS No. 131 (SFAS
131), Disclosures About Segments of an Enterprise and Related Information.
SFAS 131 establishes standards for disclosures regarding operating segments,
products and services, geographic areas and major customers. The Company is
organized and operates as two operating segments: (1) the design, development,
manufacturing, sale and marketing of networked video communications products
(Avistar) and (2) the prosecution, maintenance, support and licensing of the
intellectual property used in the Companys products (CPI). Service revenue
relates mainly to the maintenance, support, training, software development and
installation of products and is included in Avistar for purposes of reporting
and decision-making. Avistar also performs corporate functions and provides
financing and services to its subsidiaries. The Companys chief operating
decision maker, its Chief Executive Officer, monitors the Companys operations
based upon the information reflected in the following table (in thousands):

|                                      |                          |  |         |        |     |  |       |      |   |  |   |        |  
|------------------------------------- | ------------------------ |  | ------- | ------ | --- |  | ----- | ---- | - |  | - | ------ | -
|                                      |                          |  | Avistar |        | CPI |  | Total
|                                      |                          |  |         |        |     |  |      
|Three Months Ended September 30, 2003 |                          |  |         |        |     |  |       |      |   |  |   |       
|                                      | Revenue                  |  | $       | 2,035  |     |  | $     |     |   |  | $ | 2,035  |  
|                                      | Gross margin             |  |         | 1,075  |     |  |       |     |   |  |   | 1,075  |  
|                                      | Depreciation expense     |  |         | (45    | )   |  |       | (5   | ) |  |   | (50    | )
|                                      | Total operating expenses |  |         | (2,247 | )   |  |       | (661 | ) |  |   | (2,908 | )
|                                      | Interest income          |  |         | 5      |     |  |       |     |   |  |   | 5      |  
|                                      | Net loss                 |  |         | (646   | )   |  |       | (661 | ) |  |   | (1,307 | )
|                                      | Assets                   |  |         | 5,336  |     |  |       | 42   |   |  |   | 5,378  |  

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|                                      |                          |  |         |        |     |  |       |        |   |  |   |        |  
|------------------------------------- | ------------------------ |  | ------- | ------ | --- |  | ----- | ------ | - |  | - | ------ | -
|                                      |                          |  | Avistar |        | CPI |  | Total
|                                      |                          |  |         |        |     |  |      
|Three Months Ended September 30, 2002 |                          |  |         |        |     |  |       |        |   |  |   |       
|                                      | Revenue                  |  | $       | 2,342  |     |  | $     |       |   |  | $ | 2,342  |  
|                                      | Gross margin             |  |         | 1,272  |     |  |       |       |   |  |   | 1,272  |  
|                                      | Depreciation expense     |  |         | (72    | )   |  |       | (1     | ) |  |   | (73    | )
|                                      | Total operating expenses |  |         | (2,640 | )   |  |       | (382   | ) |  |   | (3,022 | )
|                                      | Interest income          |  |         | 58     |     |  |       |       |   |  |   | 58     |  
|                                      | Net loss                 |  |         | (1,315 | )   |  |       | (382   | ) |  |   | (1,697 | )
|                                      | Assets                   |  |         | 12,532 |     |  |       | 63     |   |  |   | 12,595 |  
|Nine Months Ended September 30, 2003  |                          |  |         |        |     |  |       |        |   |  |   |       
|                                      | Revenue                  |  | $       | 5,183  |     |  | $     |       |   |  | $ | 5,183  |  
|                                      | Gross margin             |  |         | 2,394  |     |  |       |       |   |  |   | 2,394  |  
|                                      | Depreciation expense     |  |         | (149   | )   |  |       | (6     | ) |  |   | (155   | )
|                                      | Total operating expenses |  |         | (7,546 | )   |  |       | (1,860 | ) |  |   | (9,406 | )
|                                      | Interest income          |  |         | 33     |     |  |       |       |   |  |   | 33     |  
|                                      | Net loss                 |  |         | (4,608 | )   |  |       | (1,860 | ) |  |   | (6,468 | )
|Nine Months Ended September 30, 2002  |                          |  |         |        |     |  |       |        |   |  |   |       
|                                      | Revenue                  |  | $       | 7,043  |     |  | $     |       |   |  | $ | 7,043  |  
|                                      | Gross margin             |  |         | 3,483  |     |  |       |       |   |  |   | 3,483  |  
|                                      | Depreciation expense     |  |         | (257   | )   |  |       | (4     | ) |  |   | (261   | )
|                                      | Total operating expenses |  |         | (8,616 | )   |  |       | (819   | ) |  |   | (9,435 | )
|                                      | Interest income          |  |         | 222    |     |  |       |       |   |  |   | 222    |  
|                                      | Net loss                 |  |         | (4,696 | )   |  |       | (819   | ) |  |   | (5,515 | )

International revenue, which consists of sales to customers with
operations principally in Western Europe and Asia, comprised 55% and 57% of
total revenue for the three months ended September 30, 2003 and 2002,
respectively. International revenue comprised 57% and 52% for the nine months
ended September 30, 2003 and 2002, respectively. For the three months ended
September 30, 2003 and 2002, international revenues from customers in the
United Kingdom accounted for 41% and 25%, respectively, of total revenue. For
the nine months ended September 30, 2003 and 2002, international revenues from
customers in the United Kingdom accounted for 40% and 27%, respectively, of
total revenue. All of the Companys sales are currently billed in United States
dollars. The Company had no significant long-lived assets in any country other
than in the United States for any period presented.

8. Subsequent Events

On October 15, 2003, the Company completed a private placement or sale of
4,615,385 shares of its common stock to Gerald J. Burnett and other members of
his family at a price per share of $1.30 resulting in gross proceeds to the
Company of $6 million. The estimated fees for this transaction are $300,000,
resulting in net proceeds to the Company of $5.7 million. As a result of this
private placement, the Companys total stockholders equity increased by
approximately $5.7 million as of October 15, 2003. Under the terms of the
financing, Dr. Burnett agreed to certain restrictions on 1,602,847 of the
3,661,539 shares purchased by him in the private placement. These restrictions
require Dr. Burnett to vote such shares in the same proportion as the other
outstanding voting stock of the Company not beneficially owned by Dr. Burnett. Dr. Burnetts previous commitment to
provide funds up to $6 million has been largely satisfied
through his approximate $4.8 million participation in the
private placement. In addition,
the Company has used a portion of the proceeds of the private placement to
repay the $1.5 million outstanding balance under the Companys Loan and
Security Agreement with Comerica Bank. Dr. Burnett, the
Company's Chairman, President and CEO has provided a collateralized
guarantee of the Company's obligations under the Loan and Security
Agreement. This guarantee and the Loan and Security Agreement itself
will be terminated in the near future. Thereafter, Avistar may seek a replacement line of credit
without any guarantee or with a reduced guarantee. There can be no assurance
that a replacement line of credit will be available on terms acceptable to the
Company.

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

The following discussion should be read in conjunction with the Unaudited
Condensed Consolidated Interim Financial Statements and the Notes thereto
included elsewhere herein, and the audited consolidated financial statements
contained in our Annual Report on Form 10-K for the year ended December 31,
2002, as filed with the Securities and Exchange Commission on March 25, 2003.

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

Although we believe that the expectations reflected in the forward looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements. We are under no duty to update any of
the forward-looking statements after the date of this report on Form 10-Q to
conform our prior statements to actual results.

Overview

We develop, market and support an integrated suite of video-enabled
vBusiness applications, all powered by our AvistarVOS software. From the
desktop, we deliver TV-quality interactive video calling, content creation and
publishing, broadcast origination and distribution, video-on-demand and
integrated data sharing. Our video and data collaboration applications are all
managed by the AvistarVOS video operating system. Our customers use our system
to improve productivity and communication within their enterprise, and between
enterprises to enhance relationships with customers, suppliers and partners.
Using AvistarVOS software and leveraging video, telephony and Internet
networking standards, our applications 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
sell our system directly to enterprises in selected strategic vertical markets
and have focused initially on the financial services and manufacturing
industries. Our objective is to establish our technology as the standard for
networked video.

We operate in two segments. We engage in the design, development,
manufacturing, sale and marketing of networked video communications products,
and associated support services and Collaboration Properties, Inc., or CPI, our
wholly-owned subsidiary, engages in the prosecution, maintenance, support and
licensing of the intellectual property that we have developed, some of which is
used in our products. As of September 30, 2003, CPI had not entered into any
such third party licensing agreements.

Critical Accounting Policies

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

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



| |  |  | Revenue recognition;                 
| | - |  | -------------------------------------
|
| |  |  | Valuation of accounts receivable; and
|
| |  |  | Valuation of inventories.            

Revenue Recognition

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We derive product revenue principally from the sale and licensing of our
video-enabled networked communications system, consisting of a suite of
Avistar-designed software and hardware products, including third party
components. In addition, we derive revenue from fees for installation,
maintenance, support, training services and software development. Product
revenue as a percentage of total revenue was 41% for the three-month period
ended September 30, 2003 and 51% for the three-month period ended September 30,
2002. Product revenue as a percentage of total revenue was 43% for the
nine-month period ended September 30, 2003 and 52% for the nine-month period
ended September 30, 2002.

We recognize revenue from product sales when all of the following
conditions are met: the product has been shipped, an arrangement exists with
the customer at a fixed price and we have the right to invoice the customer,
collection of the receivable is probable, and we have fulfilled all of our
material contractual obligations to the customer. When we provide installation
services, the product and installation revenue is recognized upon completion of
installation and receipt of customer confirmation, subject to the satisfaction
of the revenue recognition criteria described above. 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. The price charged for maintenance and/or support services is
stipulated in the customer contract and is based on a percentage of product
revenue. Customers have the option to renew the maintenance and/or support
services in subsequent periods at the same rate as paid in the initial year.
Revenue from maintenance and support is recognized pro-rata over the
maintenance and/or support term, which is typically one year in length.
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 and training revenue is recognized upon
performance of the service. We recognize service revenue from software
development contracts 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 a deliverable of the contract, verification of completion of
the deliverable has been received, and collection of the receivable is
probable. Reimbursements received for out-of-pocket expenses 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, Income Statement Characterization of Reimbursements Received
for Out of Pocket Expenses Incurred.

To date, a significant portion of our revenue has resulted from sales to a
limited number of customers. For the nine months ended September 30, 2003, we
recorded revenue of approximately $3.1 million, or 61% of total revenue, from
Deutsche Bank AG and its affiliates. No other customers individually accounted
for greater than 10% of our total revenue for the nine months ended September
30, 2003. For the nine months ended September 30, 2002, we recorded revenue of
approximately $4.7 million, or 67% of total revenue, from Deutsche Bank AG and
JP Morgan Chase and their affiliates, who each generated greater than 10% of
our total revenue. We anticipate that our revenue, and therefore, our operating
results for any given period, will continue to depend to a significant extent
on a limited number of customers. As a result, the loss of or a reduction in
sales to any one of these customers would have a significant adverse impact on
our operations and financial performance.

International revenue, which consists of sales to customers with
operations principally in Western Europe and Asia, comprised 57% of total
revenue for the nine months ended September 30, 2003, and 52% for the nine
months ended September 30, 2002.

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 was 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 September 30, 2003, approximately 66% of
our accounts receivable balance was concentrated with one customer. As of
December 31, 2002, approximately 65% of our accounts receivable were
concentrated with one customer.

Valuation of Inventories

We record a provision for obsolete or excess inventory for models 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

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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 effect our
operating income for such period.

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Results of Operations

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

|                        |                                             |                          |     |                             |     |                   |     |      |     |      |      |    |     |  |     |    |     | 
|----------------------- | ------------------------------------------- | ------------------------ | --- | --------------------------- | --- | ----------------- | --- | ---- | --- | ---- | ---- | -- | --- |  | --- | -- | --- | 
|                        |                                             |                          |     | PERCENTAGE OF TOTAL REVENUE
|                        |                                             |                          |     |                            
|                        |                                             |                          |     | THREE MONTHS ENDED          |     | NINE MONTHS ENDED
|                        |                                             |                          |     | SEPTEMBER 30,               |     | SEPTEMBER 30,    
|                        |                                             |                          |     |                             |     |                  
|                        |                                             |                          |     | 2003                        |     | 2002              |     | 2003 |     | 2002
|                        |                                             |                          |     |                             |     |                   |     |      |     |     
|Revenue:                |                                             |                          |     |                             |     |                   |     |      |     |      |      |    |     |  |     |   
|                        | Product                                     |                          |     | 41                          | %   |                   |     | 52   | %   |      |      | 43 | %   |  |     | 52 | %  
|                        | Services, maintenance and support           |                          |     | 59                          |     |                   |     | 48   |     |      |      | 57 |     |  |     | 48 |    
|                        |                                             |                          |     |                             |     |                   |     |      |     |      |      |    |     |  |     |    |    
|                        |                                             | Total revenue            |     |                             | 100 |                   |     |      | 100 |      |      |    | 100 |  |     |    | 100 | 
|                        |                                             |                          |     |                             |     |                   |     |      |     |      |      |    |     |  |     |    |    
|Cost of revenue:        |                                             |                          |     |                             |     |                   |     |      |     |      |      |    |     |  |     |   
|                        | Product                                     |                          |     | 19                          |     |                   |     | 22   |     |      |      | 21 |     |  |     | 25 |    
|                        | Services, maintenance and support           |                          |     | 28                          |     |                   |     | 24   |     |      |      | 33 |     |  |     | 26 |    
|                        |                                             |                          |     |                             |     |                   |     |      |     |      |      |    |     |  |     |    |    
|                        |                                             | Total cost of revenue    |     |                             | 47  |                   |     |      | 46  |      |      |    | 54  |  |     |    | 51  | 
|                        |                                             |                          |     |                             |     |                   |     |      |     |      |      |    |     |  |     |    |    
|Gross margin            |                                             |                          | 53  |                             |     |                   | 54  |      |     |      | 46   |    |     |  | 49  |   
|                        |                                             |                          |     |                             |     |                   |     |      |     |      |      |    |     |  |     |    |    
|Operating expenses:     |                                             |                          |     |                             |     |                   |     |      |     |      |      |    |     |  |     |   
|                        | Research and development                    |                          |     | 27                          |     |                   |     | 38   |     |      |      | 36 |     |  |     | 42 |    
|                        | Sales and marketing                         |                          |     | 46                          |     |                   |     | 38   |     |      |      | 55 |     |  |     | 40 |    
|                        | General and administrative                  |                          |     | 69                          |     |                   |     | 50   |     |      |      | 88 |     |  |     | 48 |    
|                        | Amortization of deferred stock compensation |                          |     | 1                           |     |                   |     | 3    |     |      |      | 2  |     |  |     | 4  |    
|                        |                                             |                          |     |                             |     |                   |     |      |     |      |      |    |     |  |     |    |    
|                        |                                             | Total operating expenses |     |                             | 143 |                   |     |      | 129 |      |      |    | 181 |  |     |    | 134 | 
|                        |                                             |                          |     |                             |     |                   |     |      |     |      |      |    |     |  |     |    |    
|Loss from operations    |                                             |                          | (90 | )                           |     |                   | (75 | )    |     |      | (135 | )  |     |  | (85 | ) 
|                        |                                             |                          |     |                             |     |                   |     |      |     |      |      |    |     |  |     |    |    
|Other income (expense): |                                             |                          |     |                             |     |                   |     |      |     |      |      |    |     |  |     |   
|                        | Interest income                             |                          |     |                            |     |                   |     | 2    |     |      |      | 1  |     |  |     | 3  |    
|                        | Other income (expense), net                 |                          |     | 26                          |     |                   |     |     |     |      |      | 10 |     |  |     | 3  |    
|                        |                                             |                          |     |                             |     |                   |     |      |     |      |      |    |     |  |     |    |    
|                        |                                             | Total other income       |     |                             | 26  |                   |     |      | 2   |      |      |    | 11  |  |     |    | 6   | 
|                        |                                             |                          |     |                             |     |                   |     |      |     |      |      |    |     |  |     |    |    
|Net loss                |                                             |                          | (64 | )%                          |     |                   | (73 | )%   |     |      | (124 | )% |     |  | (78 | )%
|                        |                                             |                          |     |                             |     |                   |     |      |     |      |      |    |     |  |     |    |    

COMPARISON OF THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002

Revenue

Total revenue decreased by 13% to $2.0 million for the three months ended
September 30, 2003 from $2.3 million for the three months ended September 30,
2002 and decreased by 26% to $5.2 million for the nine months ended September
30, 2003 from $7.0 million for the nine months ended September 30, 2002. The
decrease in the three and nine month periods was due primarily to lower product
sales, reflecting continued weakness in the United States and global economies,
particularly in the financial services sector. This weakness has led to a
continued delay in procurement decisions and increasingly constrained
technology spending among our existing and potential customers.

For the three months ended September 30, 2003, revenue from one customer
accounted for 61% of total revenue. No other customers individually accounted
for greater than 10% of our total revenue for the three months ended September
30, 2003. For the three months ended September 30, 2002, revenue from two
customers accounted for 61% of total revenue, each of whom accounted for
greater than 10% of our total revenue. For the nine months ended September 30,
2003, revenue from one customer accounted for 61% of total revenue. No other
customers individually accounted for greater than 10% of our total revenue for
the nine months ended September 30, 2003. For the nine months ended September
30, 2002, revenue from two customers accounted for 67% of our total revenue,
each of whom accounted for greater than 10% of our 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 material adverse impact on our financial
condition and operating results.

Cost of Revenue

The cost of revenue declined by 10% to $1.0 million for the three months
ended September 30, 2003 from $1.1 million for the three months ended September
30, 2002 and decreased by 22% to $2.8 million for the nine months ended
September 30, 2003 from $3.6 million for the nine months ended September 30,
2002. Cost of product revenue declined by 22% to $0.4 million for the three
months ended September 30, 2003 from $0.5 million for the three months ended
September 30, 2002 and decreased by 38% to $1.1
16Table of Contents

million for the nine months ended September 30, 2003 from $1.8 million for
the nine months ended September 30, 2002. This decline in cost of product
revenue was directly due to the lower level of product sales and the associated
direct product costs. Cost of service revenue remained flat at $0.6 million for
the three months ended September 30, 2003 compared to the three months ended
September 30, 2002 and decreased by 6% to $1.7 million for the nine months
ended September 30, 2003 from $1.8 million for the nine months ended September
30, 2002. This decline in cost of service revenue was due primarily to
declines in the fixed components of the cost of service revenue, including a
reduction in personnel and personnel related expenses, partially offset by an
increase in costs related to software development contracts.

Gross Margin

Gross margin as a percentage of revenue remained relatively flat at 53%
for the three months ended September 30, 2003 from 54% for the three months
ended September 30, 2002, and decreased to 46% for the nine months ended
September 30, 2003 from 49% for the nine months ended September 30, 2002. The
decrease in the nine month period ended September 30, 2003 relative to the same
period in 2002 was due primarily to the lower overall revenue base, which
provided more limited coverage of the fixed components of the cost of sales.
Product gross margin as a percentage of total product revenue decreased to 53%
for the three month period ended September 30, 2003 compared to 58% for the
three month period ended September 30, 2002, and decreased slightly to 51% for
the nine months ended September 30, 2003 compared to 52% for the nine months
ended September 30, 2002. Services gross margin as a percentage of total
service revenue increased to 52% for the three months ended September 30, 2003
compared to 50% for the three months ended September 30, 2002, and decreased to
43% for the nine months ended September 30, 2003 compared to 47% for the nine
months ended September 30, 2002 due primarily to a decrease in services
revenue, which provided more limited coverage of the fixed components of the
cost of our maintenance services, and an increase in costs related to software
development contracts, partially offset by the decline in personnel and
personnel related expenses.

Operating expenses

Research and development.Research and development expenses decreased by
39% to $0.5 million for the three months ended September 30, 2003 from $0.9
million for the three months ended September 30, 2002, and decreased by 38% to
$1.9 million for the nine months ended September 30, 2003 from $3.0 million for
the nine months ended September 30, 2002. The decrease was due to reductions in
personnel related expenses, outside services and external consulting expenses
and reduced capital expenditures and an increase in software development
contract costs reclassified to cost of sales.

Sales and marketing.Sales and marketing expenses stayed flat at $0.9
million for the three months ended September 30, 2003 compared to the three
months ended September 30, 2002, and remained relatively flat at $2.9 million
for the nine months ended September 30, 2003 compared to $2.8 million for the
nine months ended September 30, 2002.

General and administrative.General and administrative expenses increased
by 18% to $1.4 million for the three months ended September 30, 2003 from $1.2
million for the three months ended September 30, 2002, and increased by 36% to
$4.6 million for the nine months ended September 30, 2003 from $3.4 million for
the nine months ended September 30, 2002. The increase was due primarily to an
increase in legal fees, offset in part by a decrease in other outside service
costs.

Amortization of deferred stock compensation.Amortization of deferred
stock compensation decreased by 69% to $23,000 for the three months ended
September 30, 2003 from $74,000 for the three months ended September 30, 2002,
and decreased by 61% to $113,000 for the nine months ended September 30, 2003
from $293,000 for the nine months ended September 30, 2002. The decrease was
due to the completion of option amortization, and the forfeitures of stock
options by employees no longer with our company.

Other Income (Expense)

Other income, net increased by 892% to $526,000 for the three months ended
September 30, 2003 from $53,000 for the three months ended September 30, 2002,
and increased 24% to $544,000 for the nine months ended September 30, 2003 from
$437,000 for the nine months ended September 30, 2002. The increase in the
three and nine month periods was due primarily to net insurance proceeds of
$570,000 received in the three month period ending September 30, 2003. These
insurance proceeds were received in satisfaction of a business interruption
claim filed for losses incurred by our New York City office following the
September 11, 2001 terrorist attack on the World Trade Center.

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Liquidity and Capital Resources

We have funded our operations since inception primarily from product and
services revenue, the net proceeds of $31.3 million from our August 2000
initial public offering of Common Stock, lines of credit with related parties
and financial institutions, and, to a lesser extent, the proceeds of
approximately $6.4 million from the sale of Series B Preferred Stock in
December 1999.

We had cash and cash equivalents of $2.5 million as of September 30, 2003
compared to cash and cash equivalents of $4.8 million and short-term
investments of $2.4 million as of December 31, 2002. For the nine months ended
September 30, 2003 we had an overall net cash outflow of $2.3 million,
resulting primarily from net cash used in operations of $6.2 million, offset
partially by the net cash provided by investing activities of $2.4 million and
the net cash provided by financing activities of $1.6 million. The net cash
used in operating activities of $6.2 million resulted from a net loss of $6.5
million, an increase in accounts receivable of $0.3 million, a decrease in
deferred revenue and customer deposits of $0.5 million, offset by a decrease in
prepaid expenses and other current assets of $0.2 million and an decrease in
inventories of $0.3 million. The net cash provided by investing activities
resulted from the net sale of short-term investments of $2.4 million. The net
cash provided by financing activities resulted primarily from draws on our line
of credit with Comerica Bank  California totaling $1.5 million.

At September 30, 2003, we had open purchase orders and other contractual
obligations of approximately $0.7 million, primarily related to inventory
purchases. 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.

The following table represents our future commitments under minimum annual
lease payments as of September 30, 2003 (in thousands):

|                             |  |        |       | 
|---------------------------- |  | ------ | ----- | 
|Year Ending December 31,     |  | Amount
|                             |  |       
|Fourth Quarter of 2003       |  | $      | 170   | 
|2004                         |  |        | 663   | 
|2005                         |  |        | 732   | 
|2006                         |  |        | 701   | 
|2007                         |  |        | 970   | 
|Thereafter                   |  |        | 921   | 
|                             |  |        |       | 
|Total minimum lease payments |  | $      | 4,158 | 
|                             |  |        |       | 

In July 2003 we entered into a non-cancelable operating lease to remain at
our current office facility in Redwood Shores, California. The new operating
lease commenced on October 1, 2003 and expires on September 30, 2007. The
commitments for this new lease are reflected in the table above. The previous
operating lease expired on September 30, 2003.

On February 27, 2002, we entered into a Loan and Security Agreement with a
financial institution to borrow up to $4.5 million as a revolving line of
credit and $0.5 million as an equipment term loan. On December 15, 2002, we
entered into an amendment to the Loan and Security Agreement to increase the
maximum funds available thereunder to $6.0 million and extend the term of the
agreement. The amended Loan and Security Agreement, as further amended in
March 2003, has an expiration date of February 27, 2004. The agreement, as
amended, retains a first priority security interest in all our assets,
excluding intellectual property. Gerald J. Burnett, our Chairman and Chief
Executive Officer, has provided a collateralized guarantee to the financial
institution, assuring payment of our obligations under the agreement and as a
consequence, a number of restrictive covenants from the original Loan and
Security agreement have been deleted in the amendment, except for a quick ratio
covenant, allowing us greater access to the full amount of the facility. In
addition, Gerald J. Burnett had previously committed to provide funds up to $6.0
million (inclusive of any funds drawn by us under the Loan and Security
Agreement and subject to his collateralized guarantee of our obligations
thereunder) through February 27, 2004 in the event that the full $6.0 million
under the Loan and Security Agreement is not available to us for any reason. As
of September 30, 2003, we have borrowed $1.5 million under this line of credit,
and additionally, we were eligible to borrow up to an additional $4.5 million.

On October 15, 2003, we completed the private sale of 4,615,385 shares of
our common stock to Gerald J. Burnett, our Chairman, President and Chief
Executive Officer, and other members of his family at a price per share of
$1.30. The net proceeds of this private financing, after deducting estimated
expenses of the financing, are expected to be approximately $5.7 million. Under
the terms of the

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private placement, Dr. Burnett agreed to certain restrictions on 1,602,847
of the 3,661,539 shares purchased by him. These restrictions require Dr.
Burnett to vote such shares in the same proportion as our outstanding common
stock not beneficially owned by Dr. Burnett. As a result of this private
placement, Dr. Burnetts previous commitment to provide us with up to $6
million in funds has been largely satisfied through his approximate
$4.8 million participation in the private placement. In addition, we have used a
portion of the net proceeds of this private placement to repay the $1.5 million
outstanding balance under our Loan and Security Agreement with Comerica Bank. Dr. Burnetts guarantee of our obligations under such
Loan and Security Agreement will be removed, and the existing line of credit
will be terminated. Thereafter, we may seek a replacement line of credit
without any guarantee or with a reduced guarantee. There can be no assurance
that such a replacement line of credit will be available to us.

We intend to continue to invest in the development of new products and
enhancements to our existing products. We currently believe that existing cash
and cash equivalents balances, including the proceeds of our October 2003
private placement, and short-term investments will provide us with sufficient
funds to finance our operations for the next 12 months. 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 revenue, 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, the costs involved in maintaining and
enforcing patent claims and other intellectual property rights including,
without limitation, the costs and result of CPIs litigation with Polycom and
other factors, all of which may impact our ability to achieve and maintain
profitability.

We may need to arrange for the availability of additional funding either
through a line of credit with a financial institution or through other means,
in order to meet our future business requirements. Additional funds and
additional financing may not be available on favorable terms, or at all. If we
are unable to obtain additional funding on acceptable terms, we may not be able
to develop or enhance our products, take advantage of future opportunities, or
respond to competitive pressures or unanticipated requirements, which could
seriously harm our business, financial condition, results of operations and
ability to continue operations. Furthermore, any additional equity financing
may be dilutive to stockholders and such equity securities may have rights,
preferences or privileges senior to those of the holders of our common stock,
and debt financing, if available, may involve significant fees, interest
payment obligations and restrictive covenants. Strategic arrangements, if
necessary to raise additional funds, may require us to relinquish our rights to
certain of our technologies or products.

Recent Accounting Pronouncements

In December 2002, the FASB issued SFAS 148, Summary of Statement No. 148
Accounting for Stock-Based Compensation-Transition and Disclosure-an Amendment
of FASB Statement No. 123. SFAS 148 amends SFAS 123, Accounting for
Stock-Based Compensation, to provide alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-based
employee compensation. In addition, SFAS 148 amends the disclosure requirements
of SFAS 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. We have
adopted the disclosure requirements of SFAS 148.

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity,
which establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity.
Financial instruments that are within the scope of the statement, which
previously were often classified as equity, must now be classified as
liabilities. This statement is effective for financial instruments entered into
or modified after May 31, 2003, and otherwise shall be effective at the
beginning of the first interim period beginning after June 15, 2003. The
adoption of SFAS No. 150 did not have a material impact on our condensed
consolidated financial statements.




Factors Affecting Future Operating Results

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

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

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Consequently, the conversion from traditional methods of communication to
the extensive use of networked video may not occur as rapidly as we wish.

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

We incurred net losses of $6.5 million for the nine months ended September
30, 2003, $7.6 million for the year 2002, and $7.9 million for the year 2001.
As of September 30, 2003, our accumulated deficit was $78.6 million. Our
revenue may not increase, or even remain at its current level. In addition,
our operating expenses may increase as we continue to develop our business in
the future. As a result, to become profitable, we will need to increase our
revenue by increasing sales to existing customers and by attracting additional
customers. If our expenses increase more rapidly than our revenue, or if
revenue and expense levels remain the same, we may never become profitable. We
may need to raise additional funds in order to meet our future business
requirements and additional financing may not be available on favorable terms,
if at all.

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

General economic conditions have and may continue to impact our revenues
and harm our business.

The economic environment in the United States is such that industries are
continuing to delay or reduce technology purchases. These conditions have
negatively affected our business in 2003 and 2002, and will in the future if
these conditions persist. The outlook for the video communications industry is
uncertain and it is very difficult to predict how long the current environment
will last. 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 continue to have a materially adverse
effect on our revenue, capital resources, financial condition and results of
operations.

We have filed a complaint alleging patent infringement against Polycom,
Inc. The prosecution of this lawsuit could require us to expend significant
financial and managerial resources and may have a material negative impact on
our business. If we do not prevail, we may be required to pay monetary
damages.

On September 23, 2002, CPI, our wholly-owned subsidiary, commenced a
patent infringement lawsuit against Polycom, Inc. alleging that several Polycom
videoconferencing products infringe four patents held by CPI. The suit was
filed in the United States District Court for the Northern District of
California. The four patents involved are U.S. Patent Nos. 5,867,654,
5,896,500, 6,212,547 and 6,343,314. These patents cover technologies relating
to video and data conferencing over unshielded twisted pair (UTP) networks,
distributed call-state management, separate monitors for simultaneous
computer-based data sharing and videoconferencing and remote participant hold
and disconnect functions in multi-party conferencing. Polycom responded to
CPIs claims on November 14, 2002, at which time it both answered the complaint
and asserted counterclaims against CPI for non-infringement, invalidity and
unenforceability On January 31, 2003, Polycom filed a motion with the court,
which was subsequently granted by the court on March 7, 2003, requesting permission
to amend its counterclaims to incorporate claims of alleged infringements by
Avistar Communications of four PictureTel patents that Polycom has told us it
has had assigned to it. Three of the four counterclaims involved a third party,
and these three counterclaims were dropped by Polycom on June 23, 2003,
subsequent to an agreement between Polycom and the third party. On August 9,
2003, CPI and Polycom filed motions for summary judgment with the court,
seeking judgment as a matter of law concerning CPIs ability to qualify for
small entity status in the filing of its four patents being asserted against
Polycom. On October 16, 2003, the court denied Polycoms motion for summary
judgment and granted CPIs motion for summary judgment, thereby negating
Polycoms defense of unenforceablity concerning CPIs having filed these
patents as a small entity.

A trial date for CPIs claims against Polycom and Polycoms counterclaims
has not yet been set. The prosecution of this lawsuit and the defense of the
Polycom counterclaim may require us to expend significant financial and
managerial resources and therefore may have a material negative impact on our
business. The duration and ultimate outcome of this litigation are uncertain.
In addition, an adverse judgment, if entered against CPI or Avistar, could
require CPI or Avistar to pay substantial compensation and/or damages to
Polycom, which could harm our business, financial position and results of
operations and cause our stock price to decline substantially. Litigation such
as this suit can take years to resolve and can be expensive to prosecute and
defend. Regardless of the outcome, the prosecution of CPIs claims and defense
of the counterclaims in this lawsuit may require us to obtain additional
financing.

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

Our future liquidity and working capital requirements will depend upon
numerous factors, including:



| |  |  | general economic conditions, and conditions in the financial services industry in particular;                                                            
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | the level and timing of our revenue;                                                                                                                     
|
| |  |  | the costs and timing of product development efforts and the success of these development efforts;                                                        
|
| |  |  | the costs and timing of sales and marketing activities;                                                                                                  
|
| |  |  | the extent to which our existing and new products gain market acceptance;                                                                                
|
| |  |  | competing technological and market developments;                                                                                                         
|
| |  |  | the costs involved in maintaining and enforcing patent claims and
other IP rights, including the costs associated with CPIs litigation
with Polycom; and
|
| |  |  | available borrowings under line of credit arrangements and other
factors.                                                                                

Although we have in place a Loan and Security Agreement, which provides a
credit line of $6.0 million, this line of credit may be terminated or reduced
in connection with the cancellation of Dr. Burnetts personal guarantee. As a
result, 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 future opportunities,
respond to competitive pressures or unanticipated requirements, or finance our
litigation with Polycom, which could seriously harm our business, financial
condition, results of operations and ability to continue operations. There can
be no assurance that such funding will be available on terms attractive to us,
or at all. Furthermore, any additional equity financing may be dilutive to
stockholders and such equity securities may have rights, preferences or
privileges senior to those of the holders of our common stock, and debt
financing, if available, may involve restrictive covenants. Strategic
arrangements, if necessary to raise additional funds, may adversely impact the
Companys current common shareholders.

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

We have generally experienced a product sales cycle of four to nine months
for new customers or large follow-on orders due to the time needed to educate
customers about the uses and benefits of our system, and the significant
investment decisions that our prospective customers must make when they decide
to buy our system. Many of our prospective customers have neither budgeted
expenses for networked video communications systems, or 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. Continued economic uncertainty has contributed to
additional deliberation, and an associated delay in the sales cycle and/or a
reduction in initial order size.

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

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

Our customers typically place limited initial orders for our networked
video communications system, as they seek to evaluate its usefulness and value.
Our strategy is to pursue additional and larger follow-on orders after these
initial orders. Revenue generated from follow-on orders accounted for
approximately 94% and 98% of our revenue for the nine months ended September
30, 2003 and 2002, respectively. Current economic conditions have led to
decreases in our clients capital spending, and we have experienced a decrease
in the size and number of follow-on orders. Our future financial performance
depends on successful initial installations of our system and successful
generation of follow-on orders as the Avistar network expands within a customer
organization. If our system does not meet the needs and expectations of
customers, we may not be able to generate follow-on orders.

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

We have historically derived the majority of our revenue from a limited
number of customers, particularly Deutsche Bank AG and its affiliates.
Collectively, this customer accounted for 61% of our revenue for the nine
months ended September 30, 2003. No other customers individually contributed
greater than 10% of our total revenue for the nine months ended September 30,
2003. For the nine months ended September 30, 2002, Deutsche Bank AG and JP
Morgan Chase and their affiliates accounted for 67% of our revenue, each of
whom accounted for greater than 10% of our total revenue. This contribution
reflects the acquisition by Deutsche Bank and JP Morgan Chase of other
financial services firms that were previously Avistar customers, as well as the
purchase of Avistar technology by Deutsche Bank for new accounts as part of
Deutsche Banks client connectivity program. We expect to continue to depend
upon a limited number of customers for a substantial portion of our revenue.
As of September 30, 2003, approximately 66% of our accounts receivable were
concentrated with one customer. As of December 31, 2002, approximately 65% of
our accounts receivable were concentrated with one customer.

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. Because we currently depend on a limited
number of customers with lengthy budgeting cycles and unpredictable buying
patterns, 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. The market for our system is
characterized by:



| |  |  | rapid technological change;                                                                                      
| | - |  | -----------------------------------------------------------------------------------------------------------------
|
| |  |  | significant development costs;                                                                                   
|
| |  |  | changes in the requirements of our customers and their communities of users;                                     
|
| |  |  | evolving industry standards; and                                                                                 
|
| |  |  | transition to Internet protocol connectivity for video at the desktop, with increasing availability of bandwidth.

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

Difficulties or delays in installing our products, fulfilling software
development, or delivering other professional service contracts could harm our
revenue and margins.

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

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Competition could reduce our market share and decrease our revenue.

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, Tandberg Inc. and
VCON Telecommunications Ltd. 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., Hewlett-Packard
Company, Microsoft Corporation, RealNetworks, Inc. and WebEx Communications,
Inc., that enable web-based or network-based video communications with low-cost
digital camera systems. The market in which we operate is highly competitive.
In addition, because our industry is relatively new and one which is
characterized by rapid technological change, evolving user needs, developing
industry standards and protocols and the frequent introduction of new products
and services, it is difficult for us to predict whether or when new competing
technologies or new competitors will enter our market.

We expect competition to increase in the future from existing 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, or that competitive pressures faced by us will not harm our
business, financial condition and results of operations.

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

We regard our system as open but proprietary. In an effort to protect our
proprietary rights, we rely primarily on a combination of patent, copyright,
trademark and trade secret laws, as well as licensing, non-disclosure and other
agreements with our consultants, suppliers, customers and employees. However,
these laws and agreements provide only limited protection of our proprietary
rights. In addition, we may not have signed agreements in every case and the
contractual provisions that are in place and the protection they produce may
not provide us with adequate protection in all circumstances. Although CPI
holds patents and has 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. Unauthorized copying, use or reverse engineering of our system could
harm our business, financial condition or results of operations.

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

A third party could claim that our technology infringes upon its
proprietary rights. As the number of software systems in our target market
increases and the functionality of these systems overlap, we believe that the
number of infringement suits filed by software developers may increase. At a
hearing held on March 7, 2003, the judge in the existing lawsuit in which CPI
is claiming that Polycom infringes four CPI patents granted Polycoms motion to
amend its counterclaims to include claims of alleged infringements by Avistar
Communications of four PictureTel patents that Polycom has told us it has had
assigned to it. Three of the four counterclaims for patent infringement
related to equipment provided to Avistar by a third-party and Avistars
agreement with that third-party supplier provided for indemnification of
Avistar by that third party. The three counterclaims involving the third party
were dropped on June 23, 2003, subsequent to an agreement between Polycom and
the third party.

A trial date for CPIs claims against Polycom and Polycoms proposed
counterclaims has not yet been set. Prosecuting and defending against any
infringement claims, even those that are not meritorious, could result in the
expenditure of significant financial and managerial resources, could take years
to resolve and may require us to obtain additional financing. In addition, if
we are found liable for infringement, it could require CPI or Avistar to pay
substantial compensation and/or damages to Polycom and we may not be able to
continue offering that portion of our system that is found to be infringing.
Redesigning our system components to avoid alleged or actual infringement could
result in the expenditure of significant and managerial resources and diminish
the value of our system, which could harm our business, financial position and
results of operations and cause our stock price to decline substantially.

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

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

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

Our license agreements with our customers typically contain provisions
designed to limit our exposure to potential product liability and certain
contract claims. Our license agreements also typically limit a customers
entire remedy to either a refund of the price paid or modification of our
system to satisfy our warranty. However, these provisions vary as to their
terms and may not be effective under the laws of some jurisdictions. Although
we maintain product liability insurance coverage, we cannot assure you that
such coverage will be adequate. A product liability, warranty or other claim
could harm our business, financial condition and/or results of operations.
Performance interruptions at a customers site could negatively affect 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 contract manufacturers to produce components of our
systems. A large percentage of our compression and decompression product, or
gateway product, is currently supplied by a single source, Tandberg, Inc. In
addition, we depend on various third party suppliers for the cameras,
microphones, speakers and monitors that we install at desktops and in
conference rooms as a part of each video communications network system. Two of
these contract manufacturers, SAE Materials Inc. and Pacific Corporation, are
single source suppliers for key components of our products. Another supplier,
Equator Technologies Inc., is our only current source of a component to be used
in products recently introduced or to be introduced into the marketplace. Our
reliance on these third parties involves a number of risks, including:



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

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 could result in operational
problems and increased expenses and could cause delays in the shipment of or
otherwise limit our ability to
24Table of Contents

provide our products. In the case of the gateway component, we believe a
delay could be several months or more. We cannot assure you that we would be
able to enter into agreements with new manufacturers or suppliers on
commercially reasonable terms, or at all. Any disruption in product flow may
limit our revenue, delay our product development, seriously harm our
competitive position and/or result in additional costs or cancellation of
orders by our customers.

If the communications networks utilized by our customers experience
difficulties or become incompatible with our products, our customers
perceptions of our system may suffer and our business may be adversely
affected.

Our system is designed to work with a variety of hardware and software
configurations and data networking infrastructures used by our customers.
However, our products may not operate correctly on other networking structures
adopted by our customers. Our systems require the existence and maintenance of
network infrastructures by our customers or third party network providers. If
these network providers fail to properly maintain such networks, experience
network failures or make changes to their networks that are incompatible with
our products, our products may not operate correctly. If such network-related
problems were to occur, our customers may perceive our systems as the source of
the problem, and our relationships with such customers may be adversely
affected causing our business to suffer.

We are utilizing a private provider of virtual private networks, or VPNs,
for our internal network, and we have introduced this provider to several of
our customers for their video network needs. Some of our customers have
retained this provider. Although the resulting contractual relationship is
between our customer and this provider, in the event that this provider fails
to meet the performance expectations of our customers, our customers
dissatisfaction with this provider could impact their perception of our
products and/or adversely impact our relationship with them.

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

To increase our revenue over time, we must increase the size of our direct
sales force and add indirect distribution channels, such as systems
integrators, product partners and/or value-added resellers, 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. There is intense pressure to contain our sales and marketing costs in
response to continued weak market conditions. We cannot assure you that we
will be successful in attracting, integrating, motivating and retaining the
appropriate number of qualified sales personnel. Furthermore, it can take
several months before a new hire becomes a productive member of our sales
force. The loss of existing direct and/or indirect salespeople, or the failure
of new salespeople and/or indirect sales partners to develop the necessary
skills in a timely manner, could reduce our revenues.

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.

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 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.

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 manage growth effectively will harm our business,
financial condition and operating results. Furthermore, in order to remain
competitive or to expand our business, we may find it necessary or desirable 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.

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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 57% of total
revenue for the nine months ended September 30, 2003 and 52% for the nine
months ended September 30, 2002. 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.                                                                                     

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 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.

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

Continued listing on The NASDAQ SmallCap Market requires that the minimum
closing bid price of our common stock not fall below $1.00 for 30 consecutive
trading days. On April 29, 2003, we received notification from The NASDAQ Stock
Market that we are out of compliance with the minimum closing bid price
requirement of $1.00 per share set forth in Marketplace Rule 4310(c)(4).
Therefore, our common stock may be delisted from trading on The NASDAQ SmallCap
Market on or about October 27, 2003 if the minimum closing bid price of our
common stock does not equal or exceed $1.00 for a minimum of ten consecutive
trading days. Additionally, if we demonstrate at the end of this grace period
that we are in compliance with The NASDAQ SmallCap Market new listing standards
(that is, either $750,000 net income for the most recently completed fiscal
year, stockholders equity of at least $5 million or market capitalization of
at least $50 million), we may be allowed an additional 180-day grace period to
meet the $1.00 minimum closing bid price requirement, or until April 24, 2004.
After giving effect to our private placement of common stock on October 15,
2003, which resulted in net proceeds to us of approximately $5.7 million, we
expect that we will have stockholders equity in excess of $5 million on
October 27, 2003. Accordingly, we believe that we will qualify for the
additional 180 day grace period, which would give us until April 24, 2004 to
meet the minimum closing bid price requirement. If we do not satisfy the
continued listing requirements prior to the expiration of applicable grace
periods, we may attempt to seek review of The NASDAQ Stock Markets decision to
delist our stock, or may apply for quotation of our common stock on any other
organized market on which
26Table of Contents

the shares may be eligible for trading. There can be no assurance that our
common stock will satisfy the requirements for continued listing on The NASDAQ
SmallCap Market.

If we are unable to maintain the listing of our common stock for trading
on The NASDAQ SmallCap Market, there may be 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 there under. Delisting of our common
stock from The NASDAQ SmallCap Market could also materially adversely affect
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, if we were unable to list our common stock for trading
on The NASDAQ SmallCap Market, many institutional investors would 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, that 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:



| |  |  | quarterly variations in our results of operations;                                                                                                                          
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | announcements regarding our product developments or our financing activities;                                                                                               
|
| |  |  | announcements of technological innovations or new products by us, our customers or competitors;                                                                             
|
| |  |  | announcements of competitive product introductions by our competitors or our customers;                                                                                     
|
| |  |  | 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, including our litigation with Polycom, 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 particular companies. These broad market
fluctuations, as well as general economic, political and market conditions, may
negatively affect the market price of our common stock.

If our share price is volatile, we may be the target of securities
litigation, which is costly 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.

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

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

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

Our principal stockholders can exercise a controlling influence over our
business affairs, and they may make business decisions with which you disagree
that will affect the value of your investment.
27Table of Contents

Our executive officers, directors and entities affiliated with them, in
the aggregate, beneficially owned approximately 73% of our common stock as of
October 15, 2003. This ownership percentage reflects the effect of the
additional shares purchased by Gerald J. Burnett in the private equity
financing of October 15, 2003. 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 the control of our company, which could
cause the market price of our common stock to decline.

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Item 3.Quantitative and Qualitative Disclosures About Market Risk

We develop products primarily in the United States and sell those products
primarily in North America, Europe and Asia. International revenue, which
consists of sales to customers with operations principally in Western Europe
and Asia, comprised 55% of total revenue for the three months ended September
30, 2003 and 57% for the three months ended September 30, 2002. International
revenue comprised 57% of total revenue for the nine months ended September 30,
2003 and 52% for the nine months ended September 30, 2002. As a result, our
financial condition could be affected by factors such as changes in foreign
currency exchange rates or weak economic conditions in foreign markets. As all
of our sales are currently made in United States dollars, a strengthening of
the United States dollar could make our products less competitive in foreign
markets. We do not use derivative financial instruments for speculative or
trading purposes, nor do we engage in any foreign currency hedging
transactions.

Our interest income is sensitive to changes in the general level of United
States interest rates, particularly since the majority of our investments are
in short-term instruments. We expect that our interest income will be
negatively affected by declines in short-term interest rates. There has not
been a material change in our exposure to interest rate and foreign currency
risk since the date of our annual report on Form 10-K for the year ended
December 31, 2002 filed with the Securities and Exchange Commission on March
25, 2003.

Cash and Cash Equivalents and Short-Term Investments

Cash equivalents consist primarily of commercial paper and money market
and municipal bond funds acquired with remaining maturity periods of three
months or less and are stated at cost, plus accrued interest that approximates
market value. Short-term investments consist of corporate notes that are
classified as available for sale and are stated at fair value. We would not
expect our operating results or cash flow to be significantly impacted by the
effect of sudden changes in market interest rates given the nature of our
short-term investments.

The following table provides information about our investment portfolio.
For investment securities, the table presents cash and cash equivalents and
short-term investments and related weighted average interest rates by category
at September 30, 2003.

|                                                      |                                  |  |                |       |               |  |                  |      |  
|----------------------------------------------------- | -------------------------------- |  | -------------- | ----- | ------------- |  | ---------------- | ---- | -
|                                                      |                                  |  |                |       |               |  | Weighted Average
|                                                      |                                  |  | Amounts        |       | Interest Rate
|                                                      |                                  |  |                |       |              
|                                                      |                                  |  | (in thousands) |       |               |  |                 
|Description                                           |                                  |  |                |       |               |  |                  |     
|Cash and cash equivalents and short-term investments: |                                  |  |                |       |               |  |                  |     
|                                                      | Cash                             |  | $              | 293   |               |  |                  |     |  
|                                                      | Market preferreds                |  |                | 1,000 |               |  |                  |     |  
|                                                      | Other cash equivalents           |  |                | 1,201 |               |  |                  | 0.77 | %
|                                                      |                                  |  |                |       |               |  |                  |     
|                                                      | Fair Value at September 30, 2003 |  | $              | 2,494 |               |  |                  |      |  
|                                                      |                                  |  |                |       |               |  |                  |     




Item 4.Controls and Procedures

Evaluation of disclosure controls and procedures.Our management
evaluated, with the participation of our Chief Executive Officer and our 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 our Chief Financial
Officer have concluded that our disclosure controls and procedures are
effective to ensure that information we are required to disclose in reports
that we file or submit under the Securities Exchange Act of 1934 is recorded,
processed, summarized and reported within the time periods specified in
Securities and Exchange Commission rules and forms.

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.

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PART II - OTHER INFORMATION




Item 1.Legal Proceedings

On September 23, 2002, CPI, our wholly-owned subsidiary, commenced a
patent infringement lawsuit against Polycom, Inc. alleging that several Polycom
videoconferencing products infringe four patents held by CPI. The suit was
filed in the United States District Court for the Northern District of
California. The four patents involved are U.S. Patent Nos. 5,867,654,
5,896,500, 6,212,547 and 6,343,314. These patents cover technologies relating
to video and data conferencing over unshielded twisted pair (UTP) networks,
distributed call-state management, separate monitors for simultaneous
computer-based data sharing and videoconferencing and remote participant hold
and disconnect functions in multi-party conferencing. Polycom responded to
CPIs claims on November 14, 2002, at which time it both answered the complaint
and asserted counterclaims against CPI for non-infringement, invalidity and
unenforceability. On January 31, 2003, Polycom filed a motion with the court,
which was subsequently granted by the court on March 7, 2003, requesting permission
to amend its counterclaims to incorporate claims of alleged infringements by
Avistar Communications of four PictureTel patents that Polycom has told us it
has had assigned to it. Three of the four counterclaims involved a third party,
and these three counterclaims were dropped by Polycom on June 23, 2003,
subsequent to an agreement between Polycom and the third party. On August 9,
2003, CPI and Polycom filed motions for summary judgment with the court,
seeking judgment as a matter of law concerning CPIs ability to qualify for
small entity status in the filing of its four patents being asserted against
Polycom. On October 16, 2003, the court denied Polycoms motion for summary
judgment and granted CPIs motion for summary judgment, thereby negating
Polycoms defense of unenforceablity concerning CPIs having filed these
patents as a small entity.

A trial date for CPIs claims against Polycom and Polycoms counterclaims
has not yet been set.

The prosecution of this lawsuit and the defense of the Polycom
counterclaim may require us to expend significant financial and managerial
resources and therefore may have a material negative impact on our business.
The duration and ultimate outcome of this litigation are uncertain. In
addition, an adverse judgment, if entered against CPI or Avistar, could require
CPI or Avistar to pay substantial compensation and/or damages to Polycom, which
could harm our business, financial position and results of operations and cause
our stock price to decline substantially. Litigation such as this suit can
take years to resolve and can be expensive to prosecute and defend. Regardless
of the outcome, the prosecution of CPIs claims and defense of the
counterclaims in this lawsuit may require us to obtain additional financing.




Item 2.Changes in Securities and Use of Proceeds

Recent Sales of Unregistered Securities

On October 15, 2003, we issued and sold 4,615,385 shares of our common
stock at a purchase price of $1.30 per share to Gerald J. Burnett, our
Chairman, President and Chief Executive Officer and other members of Dr.
Burnetts family, each of whom are accredited investors. The aggregate offering
price was $6.0 million. The estimated fees for this transaction are $300,000,
resulting in net proceeds of approximately $5.7 million. Pursuant to the
foregoing sale, we agreed to register the shares under the Securities Act of
1933, as amended, in the event that we determine to register any of our
securities either for our own account or the account of our other stockholders.
Under the terms of the private placement, Dr. Burnett agreed to certain
restrictions on 1,602,847 of the 3,661,539 shares purchased by him. These
restrictions require Dr. Burnett to vote such shares in the same proportion as
our outstanding common stock not beneficially owned by him.

The foregoing transaction did not involve any public offering, and we
believe that the transaction was exempt from the registration requirements of
the Securities Act by virtue of Section 4(2) thereof or Regulation D
promulgated thereunder. The purchasers in the foregoing transaction represented
their intention to acquire the securities for investment only and not with a
view to or for resale in connection with any distribution thereof, and
appropriate legends were affixed to the share certificates and instruments
issued in the foregoing transaction. All purchasers had adequate access,
through their relationships with Avistar, to information about us.

We have used a portion of the proceeds of the private placement were used
to repay the $1.5 million outstanding balance under our $6 million line of
credit from Comerica Bank. With that repayment, the personal guarantee of Dr.
Burnett securing the line of credit will be removed, and the existing line of
credit will be terminated. Thereafter, we may seek a replacement line
of credit without any guarantee or with a reduced guarantee. We intend to use
the remaining net proceeds of the financing for working capital purposes.

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Item 6.Exhibits



| | (a) |  | Exhibits
| | --- |  | --------



| | 10.12 |  | Office Lease Agreement dated July 30, 2003 between CA-Twin Dolphin Plaza Limited Partnership and Avistar
Communications Corporation for Suites 170, 180 and 360 of 555 Twin Dolphin Drive, Redwood City, California.
| | ----- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | 10.13 |  | Common Stock Purchase Agreement dated October 15, 2003 among Avistar Communications Corporation, The Gerald
J. Burnett and Marjorie J. Burnett Revocable Trust and members of the Burnett family.                   
|
| | 31.0  |  | Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Exchange Act
Rules 13a-14(a) and 15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                   
|
| | 32.0  |  | 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.                                      



| | (b) |  | Reports on Form 8-K.
| | --- |  | --------------------



| | (i) |  | Report on Form 8-K furnished on July 28, 2003 in connection with the announcement of Avistars financial results
for the three months ended June 30, 2003.
| | --- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------

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SIGNATURES

Pursuant to the requirements of the Securities and Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized, on this 23rd day of October 2003.

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

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EXHIBIT INDEX

|            |  |                                                                                                                                                                                                                     
|----------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description                                                                                                                                                                                                         
|            |  |                                                                                                                                                                                                                     
|10.12       |  | Office Lease Agreement dated July 30, 2003 between CA-Twin Dolphin Plaza
Limited Partnership and Avistar Communications Corporation for Suites 170,
180 and 360 of 555 Twin Dolphin Drive, Redwood City, California.
|            |  |                                                                                                                                                                                                                     
|10.13       |  | Common Stock Purchase Agreement dated October 15, 2003 among Avistar
Communications Corporation, The Gerald J. Burnett and Marjorie J. Burnett
Revocable Trust and members of the Burnett family.                   
|            |  |                                                                                                                                                                                                                     
|31.0        |  | Certification of Chief Executive Officer and Chief Financial Officer
Pursuant to Exchange Act
Rules 13a-14(a) and 15d-14(a), as Adopted Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002                   
|            |  |                                                                                                                                                                                                                     
|32.0        |  | 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.                                      

33