UNITED
      STATES
                  SECURITIES
      AND EXCHANGE COMMISSION
                  Washington,
      D.C. 20549FORM
      10-Q(Mark
      One)x
                QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                  SECURITIES
      EXCHANGE ACT OF 1934For
      the quarterly period ended June 30, 2009oro
                TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                  SECURITIES
      EXCHANGE ACT OF 1934For
      the transition period from _________________ to
      _______________________Commission
      file number: 000-31121AVISTAR
      COMMUNICATIONS CORPORATION(Exact
      name of registrant as specified in its charter)DELAWARE
                88-0463156(State
      or other jurisdiction of
                  incorporation
      or organization)
                (I.R.S.
      Employer
                  Identification
      Number)1875
      South Grant Street,
                  10THFloor, San Mateo, CA
                94402(Address
      of principal executive offices)
                (Zip
      Code))Registrant's
      telephone number, including area code: (650) 525-3300Indicate
      by check mark whether the registrant (1) has filed all reports required to
      be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
      during the preceding 12 months (or for such shorter period that the
      registrant was required to file such reports), and (2) has been subject to
      such filing requirements for the past 90 days.Yes
      xNo
      oIndicate by check mark whether the registrant has
      submitted electronically and posted on its corporate Web site, if any,
      every Interactive Data File required to be submitted and posted pursuant
      to Rule 405 of Regulation S-T during the preceding 12 months (or for such
      shorter period that the registrant was required to submit and post such
      files).Yes oNo oIndicate
      by check mark whether the registrant is a large accelerated filer, an
      accelerated filer, a non-accelerated filer, or a smaller reporting
      company.  See definition of "accelerated filer," "large
      accelerated filer" and "smaller reporting company" in Rule 12b-2 of the
      Exchange Act.  (check one):Large
      accelerated filer o
                  Non-accelerated
      filer o
                  (Do
      not check if a small reporting company)
                Accelerated
      filer o
                  Smaller
      reporting company xIndicate
      by check mark whether the registrant is a shell company (as defined in
      Rule 12b-2 of the Exchange Act).
                  Yes o No xAt
      July 27, 2009, 38,956,858 shares of common stock of the Registrant were
      outstanding.

























AVISTAR
COMMUNICATIONS CORPORATION




INDEX





PART
      I.
            FINANCIAL INFORMATION
            3Item
      1.
            Financial Statements (unaudited)
            3Condensed Consolidated Balance
Sheets
            3Condensed Consolidated Statements of
      Operations
            4Condensed Consolidated Statements of Cash
      Flows
            5Notes to Condensed Consolidated Financial
      Statements
            6Item
      2.
            Management’s Discussion and Analysis of Financial
      Condition and Results of Operations
            18Item
      3.
            Omitted
            24Item
      4T.
            Controls and Procedures
            25PART
      II.
            OTHER INFORMATION
            25Item
      1.
            Legal Proceedings
            25Item
      1A.
            Risk Factors
            25Item
      2.
            Unregistered Sales of Equity Securities and Use
      of Proceeds
            33Item
      3.
            Defaults Upon Senior
    Securities
            33Item
      4.
            Submissions of Matters to a Vote of Security
      Holders
            34Item
      5.
            Other Information
            34Item
      6.
            Exhibits
            34SIGNATURES
            
            35




2





PART I - FINANCIAL INFORMATION




Item
1.                      Financial
Statements







AVISTAR COMMUNICATIONS CORPORATION AND
SUBSIDIARY




CONDENSED
CONSOLIDATED BALANCE SHEETS




as of June 30, 2009 and December 31,
2008




(in thousands, except share and per share
data)





June 30,
                      2009
                    
                    
                    December 31,
                      2008(unaudited)Assets:Current assets:Cash and cash equivalents
                    
                    $
                    126
                    
                    
                    $
                    4,898Accounts receivable, net of allowance for doubtful
      accounts of $20 at June 30, 2009 and December 31, 2008,
      respectively
                    
                    
                    2,767
                    
                    
                    
                    2,701Inventories
                    
                    
                    194
                    
                    
                    
                    307Deferred settlement and patent licensing
      costs
                    
                    
                    463
                    
                    
                    
                    1,100Prepaid expenses and other current
      assets
                    
                    
                    225
                    
                    
                    
                    320Total current assets
                    
                    
                    3,775
                    
                    
                    
                    9,326Property and equipment, net
                    
                    
                    230
                    
                    
                    
                    310Other assets
                    
                    
                    157
                    
                    
                    
                    157Total assets
                    
                    $
                    4,162
                    
                    
                    $
                    9,793Liabilities and Stockholders’ Equity
      (Deficit):Current liabilities:Line of credit
                    
                    $
                    5,075
                    
                    
                    $
                    7,000Convertible debt
                    
                    
                    4,060
                    
                    
                    
                    —Accounts payable
                    
                    
                    984
                    
                    
                    
                    579Deferred income from settlement and patent
      licensing
                    
                    
                    2,001
                    
                    
                    
                    4,751Deferred services revenue and customer
      deposits
                    
                    
                    1,782
                    
                    
                    
                    3,687Accrued liabilities and other
                    
                    
                    1,305
                    
                    
                    
                    1,382Total current liabilities
                    
                    
                    15,207
                    
                    
                    
                    17,399Long-term liabilities:Long-term convertible debt
                    
                    
                    —
                    
                    
                    
                    7,000Other liabilities
                    
                    
                    72
                    
                    
                    
                    23Total liabilities
                    
                    
                    15,279
                    
                    
                    
                    24,422Commitments and contingencies (Note
    9)Stockholders’ equity (deficit):Common stock, $0.001 par value; 250,000,000 shares
      authorized at June 30, 2009 and December 31, 2008; 40,139,733 and
      35,750,680 shares issued including treasury shares at June 30, 2009 and
      December 31, 2008, respectively
                    
                    
                    40
                    
                    
                    
                    36Less: treasury common stock, 1,182,875 shares at June
      30, 2009 and December 31, 2008, at cost
                    
                    
                    (53
                    )
                    
                    
                    (53
                    )Additional paid-in-capital
                    
                    
                    101,580
                    
                    
                    
                    97,506Accumulated deficit
                    
                    
                    (112,684
                    )
                    
                    
                    (112,118
                    )Total stockholders’ equity (deficit)
                    
                    
                    (11,117
                    )
                    
                    
                    (14,629
                    )Total liabilities and stockholders’ equity
      (deficit)
                    
                    $
                    4,162
                    
                    
                    $
                    9,793






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






3





AVISTAR
COMMUNICATIONS CORPORATION AND SUBSIDIARY




CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS




for
the three and six months ended June 30, 2009 and 2008




(in
thousands, except per share data)








Three
      Months Ended
                    
                    
                    Six
      Months EndedJune
      30,
                    
                    
                    June
      30,
                    
                    
                    June
      30,
                    
                    
                    June
      30,2009
                    
                    
                    2008
                    
                    
                    2009
                    
                    
                    2008(unaudited)
                    
                    
                    (unaudited)Revenue:Product
                    
                    $
                    1,599
                    
                    
                    $
                    553
                    
                    
                    $
                    2,946
                    
                    
                    $
                    802Licensing
                    
                    
                    102
                    
                    
                    
                    153
                    
                    
                    
                    222
                    
                    
                    
                    307Services,
      maintenance and support
                    
                    
                    1,177
                    
                    
                    
                    1,084
                    
                    
                    
                    2,340
                    
                    
                    
                    1,832Total
      revenue
                    
                    
                    2,878
                    
                    
                    
                    1,790
                    
                    
                    
                    5,508
                    
                    
                    
                    2,941Costs
      and Expenses:Cost
      of product revenue*
                    
                    
                    288
                    
                    
                    
                    565
                    
                    
                    
                    663
                    
                    
                    
                    924Cost
      of services, maintenance and support revenue*
                    
                    
                    861
                    
                    
                    
                    603
                    
                    
                    
                    1,663
                    
                    
                    
                    1,122Income
      from settlement and patent licensing
                    
                    
                    (1,057
                    )
                    
                    
                    (1,057
                    )
                    
                    
                    (2,114
                    )
                    
                    
                    (2,114
                    )Research
      and development*
                    
                    
                    975
                    
                    
                    
                    959
                    
                    
                    
                    1,886
                    
                    
                    
                    2,810Sales
      and marketing*
                    
                    
                    640
                    
                    
                    
                    789
                    
                    
                    
                    1,363
                    
                    
                    
                    2,118General
      and administrative*
                    
                    
                    1,211
                    
                    
                    
                    1,436
                    
                    
                    
                    2,434
                    
                    
                    
                    3,314Total
      costs and expenses
                    
                    
                    2,918
                    
                    
                    
                    3,295
                    
                    
                    
                    5,895
                    
                    
                    
                    8,174Loss
      from operations
                    
                    
                    (40
                    )
                    
                    
                    (1,505
                    )
                    
                    
                    (387
                    )
                    
                    
                    (5,233
                    )Other
      (expense) income:Interest
      income
                    
                    
                    2
                    
                    
                    
                    21
                    
                    
                    
                    8
                    
                    
                    
                    67Other
      expense,  net
                    
                    
                    (113
                    )
                    
                    
                    (128
                    )
                    
                    
                    (187
                    )
                    
                    
                    (213
                    )Total
      other expense, net
                    
                    
                    (111
                    )
                    
                    
                    (107
                    )
                    
                    
                    (179
                    )
                    
                    
                    (146
                    )Net
      loss
                    
                    $
                    (151
                    )
                    
                    $
                    (1,612
                    )
                    
                    $
                    (566
                    )
                    
                    $
                    (5,379
                    )Net
      loss per share - basic and diluted
                    
                    $
                    (0.00
                    )
                    
                    $
                    (0.05
                    )
                    
                    $
                    (0.02
                    )
                    
                    $
                    (0.16
                    )Weighted
      average shares used in calculatingbasic
      and diluted net loss per share
                    
                    
                    36,561
                    
                    
                    
                    34,547
                    
                    
                    
                    35,634
                    
                    
                    
                    34,538





*Including
      stock based compensation of:Cost
      of product, services, maintenance and support revenue
                  
                  $
                  62
                  
                  
                  $
                  19
                  
                  
                  $
                  122
                  
                  
                  $
                  26Research
      and development
                  
                  
                  158
                  
                  
                  
                  88
                  
                  
                  
                  325
                  
                  
                  
                  151Sales
      and marketing
                  
                  
                  51
                  
                  
                  
                  (60
                  )
                  
                  
                  107
                  
                  
                  
                  (96
                  )General
      and administrative
                  
                  
                  225
                  
                  
                  
                  156
                  
                  
                  
                  424
                  
                  
                  
                  269









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







4







AVISTAR
COMMUNICATIONS CORPORATION AND SUBSIDIARY
  CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS
  for the six months ended June 30, 2009 and 2008
  (in thousands)
  
 Six Months EndedJune 30,
                    
                    
                    June 30,2009
                    
                    
                    2008(unaudited)Cash Flows from Operating Activities:Net loss
                    
                    $
                    (566
                    )
                    
                    $
                    (5,379
                    )Adjustments to reconcile net loss to net cash used in
      operating activities:Depreciation
                    
                    
                    120
                    
                    
                    
                    268Stock based compensation for options issued to consultants
      and employees
                    
                    
                    978
                    
                    
                    
                    350Provision for doubtful accounts
                    
                    
                    —
                    
                    
                    
                    (3
                    )Changes in assets and liabilities:Accounts receivable
                    
                    
                    (66
                    )
                    
                    
                    273Inventories
                    
                    
                    113
                    
                    
                    
                    (30
                    )Prepaid expenses and other current
    assets
                    
                    
                    95
                    
                    
                    
                    68Deferred settlement and patent licensing
      costs
                    
                    
                    637
                    
                    
                    
                    636Other assets
                    
                    
                    —
                    
                    
                    
                    81Accounts payable
                    
                    
                    405
                    
                    
                    
                    (706
                    )Deferred income from settlement and patent licensing and
      other long-term liabilities
                    
                    
                    (2,701
                    )
                    
                    
                    (2,827
                    )Deferred services revenue and customer
      deposits
                    
                    
                    (1,905
                    )
                    
                    
                    (929
                    )Accrued liabilities and other
                    
                    
                    (77
                    )
                    
                    
                    140Net cash used in operating activities
                    
                    
                    (2,967
                    )
                    
                    
                    (8,058
                    )Cash Flows from Investing Activities:Maturities of short-term investments
                    
                    
                    —
                    
                    
                    
                    799Sale of property and equipment
                    
                    
                    —
                    
                    
                    
                    8Purchase of property and equipment
                    
                    
                    (40
                    )
                    
                    
                    (35
                    )Net cash (used in) provided by investing
      activities
                    
                    
                    (40
                    )
                    
                    
                    772Cash Flows from Financing Activities:Line of credit payments
                    
                    
                    (3,900
                    )
                    
                    
                    (5,100
                    )Proceeds from line of credit
                    
                    
                    1,975
                    
                    
                    
                    7,000Proceeds from convertible debt issuance
                    
                    
                    —
                    
                    
                    
                    7,000Net proceeds from issuance of common
    stock
                    
                    
                    160
                    
                    
                    
                    56Net cash (used in) provided by
      financing activities
                    
                    
                    (1,765
                    )
                    
                    
                    8,956Net (decrease) increase in cash and cash
      equivalents
                    
                    
                    (4,772
                    )
                    
                    
                    1,670Cash and cash equivalents, beginning of
      period
                    
                    
                    4,898
                    
                    
                    
                    4,077Cash and cash equivalents, end of
period
                    
                    $
                    126
                    
                    
                    $
                    5,747Non-cash financing activities:Debt converted to equity
                    
                    $
                    2,940
                    
                    
                    $
                    —
  
  The accompanying notes are an integral part of these financial
statements.


5







AVISTAR
COMMUNICATIONS CORPORATION AND SUBSIDIARY


NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)




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




Business




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




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




The
Company’s Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current
Reports on Form 8-K, and amendments to reports filed pursuant to Sections 13(a)
and 15(d) of the Securities Exchange Act of 1934, as amended, are available free
of charge on the Avistar website when such reports are available on the U.S.
Securities and Exchange Commission (SEC) website (see “Company—Investor
Relations—SEC Information”). The public may read and copy any materials filed by
Avistar with the SEC at the SEC’s Public Reference Room at 100 F Street, NE,
Washington, D.C. 20549. The public may obtain information on the operation of
the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC
maintains an Internet site that contains reports, proxy and information
statements and other information regarding issuers that file electronically with
the SEC at http://www.sec.gov. The contents of these websites are not
incorporated into this filing.




Basis
of Presentation




The
unaudited condensed consolidated balance sheet as of June 30, 2009, the
unaudited condensed consolidated results of operations for the three and six
months ended June 30, 2009 and 2008 and the unaudited condensed consolidated
cash flows for the six months ended June 30, 2009 and 2008 present the
consolidated financial position of Avistar and ASUK after the elimination of all
intercompany accounts and transactions. The unaudited condensed consolidated
balance sheet of Avistar as of December 31, 2008 was derived from audited
financial statements, but does not contain all disclosures required by
accounting principles generally accepted in the United States of America, and
certain information and footnote disclosures normally included have been
condensed or omitted pursuant to the rules and regulations of the SEC.  The
consolidated results are referred to, collectively, as those of Avistar or the
Company in these notes.




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




The
Company’s fiscal year end is December 31.




Risks
and Uncertainties




The
markets for the Company’s products and services are in the early stages of
development. Some of the Company’s products utilize changing and emerging
technologies. As is typical in industries of this nature, demand and market
acceptance are subject to a high level of uncertainty, particularly when there
are adverse conditions in the economy. Acceptance of the Company’s products,
over time, is critical to the Company’s success. The Company’s prospects must be
evaluated in light of difficulties encountered by it and its competitors in
further developing this evolving marketplace. The Company has generated losses
since inception and had an accumulated deficit of $112.7 million as of June 30,
2009. 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 ability to become profitable or
generate positive cash flow from operations, current discussions with the
holders of the convertible debt (Notes) to convert the Notes into shares of
common stock at or prior to maturity in January 2010 or extend the term of the
Notes, the Company’s cost reduction efforts, Dr. Burnett’s personal guarantee to
Avistar to support an extension of the revolving line of credit through March
31, 2010, the Company’s ability to obtain a renewal or extension of its existing
line of credit or a new line of credit with another bank, 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. If adequate funds are not available on acceptable terms or at all, the
Company’s ability to achieve or sustain positive cash flows, maintain current
operations, fund any potential expansion, take advantage of unanticipated
opportunities, develop or enhance products or services, or otherwise respond to
competitive pressures would be significantly limited.




6




2.
Summary of Significant Accounting Policies




Unaudited
Interim Financial Information




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




In the
opinion of management, the unaudited financial statements furnished in this
report reflect all adjustments (consisting of normal recurring adjustments)
necessary for a fair presentation of the results of operations for the interim
periods covered and of the Company’s financial position as of the interim
balance sheet date. The results of operations for the interim periods are not
necessarily indicative of the results for the entire year. These financial
statements should be read in conjunction with the Company’s audited consolidated
financial statements and the accompanying notes for the year ended
December 31, 2008, included in the Company’s annual report on Form 10-K
filed with the SEC on March 31, 2009.




Use
of Estimates




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




Cash
and Cash Equivalents and Short and Long-term Investments




The
Company considers all investment instruments purchased with an original maturity
of three months or less to be cash equivalents. Investment securities with
original or remaining maturities of more than three months but less than one
year are considered short-term investments. Auction rate securities with
original or remaining maturities of more than three months are considered
short-term investments even if they are subject to re-pricing within three
months.  The Company was not invested in any auction rate securities
as of June 30, 2009 and December 31, 2008. Investment securities held with the
intent to reinvest or hold for longer than a year, or with remaining maturities
of one year or more, are considered long-term investments. The Company’s cash
equivalents at June 30, 2009 and December 31, 2008 consisted of money market
funds with original maturities of three months or less, and are therefore
classified as cash and cash equivalents in the accompanying balance
sheets.




The
Company accounts for its short-term and long-term investments in accordance with
Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for Certain Investments
in Debt and Equity Securities. The Company’s short and long-term
investments in securities are classified as available-for-sale and are reported
at fair value, with unrealized gains and losses, net of tax, recorded in other
comprehensive income (loss). Realized gains or losses and declines in value
judged to be other than temporary, if any, on available- for-sale securities are
reported in other income, net. The Company reviews the securities for
impairments considering current factors including the economic environment,
market conditions and the operational performance and other specific factors
relating to the business underlying the securities. The Company records
impairment charges equal to the amount that the carrying value of its
available-for-sale securities exceeds the estimated fair market value of the
securities as of the evaluation date. The fair value for publicly held
securities is determined based on quoted market prices as of the evaluation
date. In computing realized gains and losses on available-for-sale securities,
the Company determines cost based on amounts paid, including direct costs such
as commissions, to acquire the security using the specific identification
method. The Company did not have any short or long-term investments at June 30,
2009 and December 31, 2008.




Cash and
cash equivalents consisted of cash and money market funds of $126,000 and $4.9
million at June 30, 2009 and December 31, 2008, respectively.




See Note
3 for further information on fair value.







7




Significant
Concentrations




A
relatively small number of customers accounted for a significant percentage of
the Company’s revenues for the three and six months ended June 30, 2009 and
2008. Revenues from these customers as a percentage of total revenues were as
follows for the three and six months ended June 30, 2009 and 2008:




Three Months Ended June
      30,
                    
                    
                    Six
      Months Ended June 30,2009
                    
                    
                    2008
                    
                    
                    2009
                    
                    
                    2008(unaudited)
                    
                    
                    (unaudited)Customer
      A
                    
                    
                    57
                    %
                    
                    
                    —
                    
                    
                    
                    49
                    %
                    
                    
                    —Customer
      B
                    
                    
                    18
                    %
                    
                    
                    —
                    
                    
                    
                    15
                    %
                    
                    
                    —Customer
      C
                    
                    
                    *
                    %
                    
                    
                    69
                    %
                    
                    
                    10
                    %
                    
                    
                    63
                    %Customer
      D
                    
                    
                    *
                    %
                    
                    
                    14
                    %
                    
                    
                    *
                    %
                    
                    
                    17
                    %Customer
      E
                    
                    
                    *
                    %
                    
                    
                    *
                    %
                    
                    
                    *
                    %
                    
                    
                    10
                    %




* Less
than 10%




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




Financial
instruments that potentially subject the Company to concentrations of credit
risk consist primarily of temporary cash investments and trade receivables. The
Company has cash and investment policies that limit the amount of credit
exposure to any one financial institution, or restrict placement of these
investments to financial institutions evaluated as highly credit worthy. As of
June 30, 2009, the Company had cash and cash equivalents on deposit with a major
financial institution that were below the FDIC insured limits. Concentrations of
credit risk with respect to trade receivables relate to those trade receivables
from both United States and foreign entities. As of June 30, 2009, approximately
91% of the Company’s gross accounts receivable was concentrated with three
customers, each of whom represented more than 10% of the total gross accounts
receivable. As of December 31, 2008, approximately 98% of the Company’s gross
accounts receivable was concentrated with four customers, each of whom
represented more than 10% of the total gross accounts receivable. No other
customer individually accounted for greater than 10% of total accounts
receivable as of June 30, 2009 and December 31, 2008.




Allowance
for Doubtful Accounts




The
Company uses estimates in determining the allowance for doubtful accounts based
on historical collection experience, historical write-offs, current trends and
the credit quality of the Company’s customer base, and the characteristics of
accounts receivable by aging category. Accounts are generally considered
delinquent when they are thirty days past due. Uncollectible accounts are
written off directly to the allowance for doubtful accounts. If the allowance
for doubtful accounts was understated, operating income could be significantly
reduced. The impact of any such change or deviation may be increased by the
Company’s reliance on a relatively small number of customers for a large portion
of its total revenue.




Fair
Value of Financial Instruments


The
carrying amounts of the Company’s financial assets and liabilities, including
cash and cash equivalents, accounts receivable, line of credit, and accounts
payable at June 30, 2009 and December 31, 2008, approximate fair value
because of the short maturity of these instruments.




The
convertible debt was stated at cost at June 30, 2009 and December 31, 2008 since
there were no unamortized discounts and the Company did not elect to measure the
instrument at fair value in accordance with SFAS No. 159,The Fair Value Option for Financial
Assets and Financial Liabilities, including an amendment of FASB Statement No.
115.  As of June 30, 2009, the carrying amount of the
convertible debt is $4.1 million and the estimated fair value is $5.8
million.  As of December 31, 2008, the carrying amount of the
convertible debt was $7.0 million, and the estimated fair value was $11.2
million. The fair
value is estimated as the sum of the present value of future interest and
principal payments of the debt based on rates available to the Company for debt
with similar terms and remaining maturities, and the fair value of the
conversion feature calculated based on the Black-Scholes method.See Note
8 for further details on the terms of the convertible debt.




8




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):




June
      30,
                    2009
                  
                  
                  December 31,
                    2008(unaudited)Raw
      materials and subassemblies
                  
                  $
                  1
                  
                  
                  $
                  10Finished
      goods
                  
                  
                  193
                  
                  
                  
                  297Total
      Inventories
                  
                  $
                  194
                  
                  
                  $
                  307




Revenue
Recognition and Deferred Revenue




The
Company recognizes product and services revenue in accordance with Statement of
Position (SOP) 97-2, Software
Revenue Recognition (SOP 97-2), as amended by SOP 98-9, Modification of SOP 97-2, Software
Revenue Recognition, With Respect to Certain Transactions (SOP 98-9), or
Emerging Issues Task Force (EITF) Issue  No. 00-21, Revenue Arrangements with Multiple
Deliverables. The Company derives product revenue from the sale and
licensing of a set of desktop (endpoint) products (hardware and software) and
infrastructure products (hardware and software) that combine to form an Avistar
video-enabled collaboration solution. Services revenue includes revenue from
post-contract customer support, training and software development. The fair
value of all product, post-contract customer support and training offered to
customers is determined based on the price charged when such products or
services are sold separately




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




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




·
            Delivery has
      occurred.  The Company delivers software and hardware to
      customers either electronically or physically and the Company has no
      further obligations with respect to the agreement. The standard delivery
      terms are FOB shipping point.




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




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




If there
are any undelivered elements, the Company defers revenue for those elements, as
long as vendor specific objective evidence (VSOE) exists for the undelivered
elements. Payment for product is due upon shipment, subject to specific payment
terms. Payment for professional services is due in advance of providing the
services, subject to specific payment terms. Reimbursements received for
out-of-pocket expenses and shipping costs, which have not been significant to
date, are recognized as revenue in accordance with Emerging Issues Task Force
(EITF) Issue No. 01-14 (EITF 01-14), Income Statement Characterization
of Reimbursements Received for “Out of Pocket” Expenses
Incurred.




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




9


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. Product and
implementation revenue related to contracts for software development is
recognized using the percentage of completion method, in accordance with the
“Input Method”, when all of the following conditions are met: a contract exists
with the customer at a fixed price, the Company expects to fulfill all of its
material contractual obligations to the customer for each deliverable of the
contract, a reasonable estimate of the costs to complete the contract can be
made, and collection of the receivable is probable. The amount of revenue
recognized is based on the total project fee under the agreement and the
percentage of completion achieved.  The percentage of completion is
measured by monitoring progress using records of actual time incurred to date in
the project compared to the total estimated project requirements, which
corresponds to the costs related to the earned revenues. The amounts billed to
customers in excess of revenues recognized to date are deferred and recorded as
deferred revenue and customer deposits in the accompanying balance sheets.
Assumptions used for recording revenue and earnings are adjusted in the period
of change to reflect revisions in contract value and estimated costs to complete
the contract. Any anticipated losses on contracts in progress are charged to
earnings when identified.




The
Company recognizes revenue from the licensing of its intellectual property
portfolio according to SOP 97-2, based on the terms of the royalty, partnership
and cross-licensing agreements involved. In the event that a license to the
Company’s intellectual property is granted after the commencement of litigation
proceedings between the Company and the licensee, the proceeds of such
transaction are recognized as licensing revenue only if sufficient historical
evidence exists for the determination of fair value of the licensed patents to
support the segregation of the proceeds between a gain on litigation settlement
and patent license revenues consistent with Financial Accounting Standards Board
(FASB) Concepts Statement No. 6, Elements of Financial
Statements (CON 6). As of June 30, 2009, these criteria for recognizing
license revenue following the commencement of litigation had not been
met.




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




On
September 8, 2008 and on September 9, 2008, Avistar entered into a Licensed
Works Agreement, Licensed Works Agreement Statement of Work and a Patent License
Agreement with International Business Machines Corporation, or IBM, under which
Avistar agreed to integrate its bandwidth management technology and related
intellectual property into future Lotus Unified Communications offerings by IBM,
and to provide maintenance support services. An initial cash payment of $3.0
million was made by IBM to Avistar on November 7, 2008.  Avistar
expects IBM to make two additional non-refundable payments of $1.5 million, each
associated with scheduled phases of delivery.  IBM has agreed to make
future royalty payments to Avistar equal to two percent of the world-wide net
revenue derived by IBM from Lotus Unified Communications products sold that
exceeds a contractual base amount, and maintenance payments received from
existing customers, which incorporate Avistar’s technology.  The
agreements have a five year term and are non-cancelable except for material
default by either party.  The agreements convey to IBM a non-exclusive
world-wide license to Avistar’s patent portfolio existing at the time of the
agreements and for all subsequent patents issued with an effective filing date
of up to five years from the date of the agreements.  The agreements
also provide for a release of each party for any and all claims of past
infringement.  In April 2009, the agreements were amended to extend
the initial term from five years to six years.  The Company has
determined the value of maintenance based on VSOE, and allocated the residual
portion of the initial $6.0 million to the integration project.  The
residual portion is being recognized under the percentage of completion method,
in accordance with the “Input Method”, and the maintenance revenue will be
recognized over the future maintenance service period.  As the Company
believes there are no future deliverables associated with the intellectual
property patent licenses, no additional provision for this element has been
made.  For the six months ended June 30, 2009, the Company has
recognized $2.2 million in product revenue and $453,000 in service revenue. The
remaining $1.1 million is expected to be recognized in product and service
revenue under the percentage of completion method over the remaining projected
development time of six months. The estimate of current period percentage of
completion requires significant management judgment and is subject to updates in
future periods until the project is complete.




Income
from Settlement and Patent Licensing


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




10


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




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




Taxes Collected from Customers and
Remitted to Governmental Authorities




Taxes
collected from customers and remitted to governmental authorities are recognized
on a net basis in the accompanying statement of operations.




Warranty




The
Company accrues the estimated costs of fulfilling the warranty provisions of its
contracts over the warranty period, which is typically 90 days. There was no
warranty accrual as of June 30, 2009 and December 31, 2008.




Research and
Development




Research
and development costs include engineering expenses, such as salaries and related
benefits, depreciation, professional services and overhead expenses related to
the general development of Avistar’s products, and are expensed as incurred.
Software development costs are capitalized beginning when a product’s
technological feasibility has been established and ending when a product is
available for general release to customers. For the three and six months ended
June 30, 2009, Avistar did not capitalize any software development costs since
the period between establishing technological feasibility and general release of
the product was relatively short, and these costs were not
significant.




Stock-Based
Compensation




Effective
January 1, 2006, the Company adopted the provisions of SFAS No. 123
(R), Share-Based
Payment (SFAS 123R), which establishes accounting for
stock-based awards exchanged for employee services. Accordingly, stock-based
compensation cost is measured at grant date, based on the fair value of the
award, and is recognized as an expense over the employee’s service
period.




11


The
effect of recording stock-based compensation for the three and six months ended
June 30, 2009 and 2008 was as follows (in thousands):


Three Months Ended
      June 30,
                              
                              
                              Six
      Months Ended June 30,2009
                              
                              2008
                              
                              
                              2009
                              
                              
                              2008(unaudited)
                              
                              
                              (unaudited)Stock-based
      compensation expense by type of award:Employee
      stock options
                              
                              $
                              488
                              
                              
                              $
                              193
                              
                              
                              $
                              964
                              
                              
                              $
                              347Non-employee
      stock options
                              
                              
                              4
                              
                              
                              
                              3
                              
                              
                              
                              5
                              
                              
                              
                              6Employee
      stock purchase plan
                              
                              
                              4
                              
                              
                              
                              7
                              
                              
                              
                              9
                              
                              
                              
                              (3
                              )Total
      stock-based compensation
                              
                              
                              496
                              
                              
                              
                              203
                              
                              
                              
                              978
                              
                              
                              
                              350Tax
      effect of stock-based compensation
                              
                              
                              —
                              
                              
                              
                              —
                              
                              
                              
                              —
                              
                              
                              
                              —Net
      effect of stock-based compensation on net loss
                              
                              $
                              496
                              
                              
                              $
                              203
                              
                              
                              $
                              978
                              
                              
                              $
                              350




As of
June 30, 2009, the Company had an unrecognized stock-based compensation balance
related to stock options of approximately $3.3 million before estimated
forfeitures and after actual cancellations. SFAS No. 123R requires forfeitures
to be estimated at the time of grant and revised if necessary in subsequent
periods if actual forfeitures differ from those estimates. Based on the
Company’s historical experience of option pre-vesting cancellations, the Company
has assumed an annualized forfeiture rate of 11% for its executive options and
38% for non-executive options. Accordingly, as of June 30, 2009, the Company
estimated that the stock-based compensation for the awards not expected to vest
was approximately $1.2 million and therefore, the unrecognized deferred
stock-based compensation balance related to stock options was adjusted to
approximately $2.1 million after estimated forfeitures and after actual
cancellations. This amount will be recognized over an estimated weighted average
period of 2.4 years. For the three months ended June 30, 2009 and 2008, the
Company granted 957,428 and 1,904,818 stock options to employees, with an
estimated total grant-date fair value of $668,000 and $876,000, or $0.70 and
$0.46 per share, respectively.  For the six months ended June 30, 2009
and 2008, the Company granted 1,335,428 and 2,403,318 stock options with an
estimated total grant-date fair value of $923,000 and $1.2 million, or $0.69 and
$0.50 per share, respectively.




Valuation
Assumptions




The
Company estimated the fair value of stock options granted during the three and
six months ended June 30, 2009 and 2008 using a Black-Scholes-Merton valuation
model, consistent with the provisions of SFAS 123R and SEC Staff Accounting
Bulletin (SAB) No. 107 (SAB 107). The fair value of each option grant is
estimated on the date of grant using the Black-Scholes-Merton option valuation
model and the straight-line attribution approach with the following
weighted-average assumptions for  both the three and six month periods
ended June 30, 2009 and 2008, respectively:


Three
      and Six Months Ended June 30,2009
                                  
                                  
                                  2008(unaudited)
                                  
                                  
                                  (unaudited)Employee Stock Option PlanExpected
      dividend
                                  
                                  
                                  —
                                  
                                  %
                                  
                                  
                                  —
                                  
                                  %Average
      risk-free interest rate
                                  
                                  
                                  1.5
                                  
                                  %
                                  
                                  
                                  2.3
                                  
                                  %Expected
      volatility
                                  
                                  
                                  109
                                  
                                  %
                                  
                                  
                                  114
                                  
                                  %Expected
      term (years)
                                  
                                  
                                  4.1
                                  
                                  
                                  
                                  
                                  2.4Three
      and Six Months Ended June 30,2009
                                  
                                  
                                  2008(unaudited)
                                  
                                  
                                  (unaudited)Employee Stock Purchase PlanExpected
      dividend
                                  
                                  
                                  —
                                  
                                  %
                                  
                                  
                                  —
                                  
                                  %Average
      risk-free interest rate
                                  
                                  
                                  0.4
                                  
                                  %
                                  
                                  
                                  2.3
                                  
                                  %Expected
      volatility
                                  
                                  
                                  148
                                  
                                  %
                                  
                                  
                                  176
                                  
                                  %Expected
      term (months)
                                  
                                  
                                  6.0
                                  
                                  
                                  
                                  
                                  6.0




The
dividend yield of zero is based on the fact that the Company has never paid cash
dividends and has no present intention to pay cash dividends. The risk-free
interest rates are taken from the Daily Federal Yield Curve Rates as of the
grant dates as published by the Federal Reserve, and represent the yields on
actively traded treasury securities for terms that approximate the expected term
of the options. Expected volatility is based on the historical volatility of the
Company’s common stock over a period consistent with the expected term of the
stock-option. For the three and six months ended June 30, 2009, the expected
term of employee stock options represents the weighted average period the stock
options are expected to remain outstanding and is based on the entire history of
exercises and cancellations on all past option grants made by the Company during
which its equity shares have been publicly traded, the contractual term, the
vesting period and the expected remaining term of the outstanding
options.  For the three and six months ended June 30, 2008, the
expected term calculation is based on an average prescribed by SAB 107, based on
the weighted average of the vesting periods, which is generally one quarter
vesting after one year and one sixteenth vesting quarterly for twelve quarters,
and adding the term of the option, which is generally ten years, and dividing by
two.




12


Comprehensive
Income




SFAS
No. 130 (SFAS 130), Reporting Comprehensive Income, establishes standards
for the reporting and the display of comprehensive income (loss) and its
components. This standard defines comprehensive income (loss) as the changes in
equity of an enterprise, except those resulting from stockholder transactions.
Accordingly, comprehensive income (loss) includes certain changes in equity that
are excluded from the net income or loss.




The
components of comprehensive loss were as follows (in thousands):


Three Months Ended
      June 30,
                        
                        
                        Six
      Months Ended June 30,2009
                        
                        
                        2008
                        
                        
                        2009
                        
                        
                        2008(unaudited)
                        
                        
                        (unaudited)Net
      loss
                        
                        $
                        (151
                        )
                        
                        $
                        (1,612
                        )
                        
                        $
                        (566
                        )
                        
                        $
                        (5,379
                        )Other
      comprehensive income (loss)
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        —Total
      comprehensive loss
                        
                        $
                        (151
                        )
                        
                        $
                        (1,612
                        )
                        
                        $
                        (566
                        )
                        
                        $
                        (5,379
                        )




3.
Fair Value Measurement




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




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


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


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




In
accordance with FAS 157, the following table represents the Company’s fair value
hierarchy for its financial assets (cash equivalents) as of June 30, 2009 (in
thousands):


Fair
      Value
                      
                      
                      Level
      1
                      
                      
                      Level
      2
                      
                      
                      Level
      3Cash
      Equivalents (unaudited):Money
      market funds
                      
                      $
                      5
                      
                      
                      $
                      5
                      
                      
                      $
                      —
                      
                      
                      $
                      —Total
      cash equivalents
                      
                      $
                      5
                      
                      
                      $
                      5
                      
                      
                      $
                      —
                      
                      
                      $
                      —






4.
Related Party Transactions




UBS
Warburg LLC, which is an affiliate of UBS AG, is a stockholder of the Company
and is also a customer of the Company. As of June 30, 2009 and December 31,
2008, UBS Warburg LLC held less than 5% of the Company’s stock. Revenue from UBS
Warburg LLC and its affiliates represented 4% and 14% of the Company’s total
revenue for the three months ended June 30, 2009 and 2008, respectively, and 6%
and 17% of the Company’s total revenue for the six months ended June 30, 2009
and 2008, respectively.  Management believes the transactions with UBS
Warburg LLC and its affiliates are at terms comparable to those provided to
unrelated third parties. As of June 30, 2009 and December 31, 2008, the Company
had accounts receivable outstanding from UBS Warburg LLC and its affiliates of
approximately $28,000 and $350,000, respectively.




On
January 4, 2008, Avistar issued $7,000,000 of 4.5% Convertible Subordinated
Secured Notes (the Notes), which are due in 2010. The Notes were sold pursuant
to a Convertible Note Purchase Agreement to Baldwin Enterprises, Inc., a
subsidiary of Leucadia National Corporation, directors Gerald Burnett, R.
Stephen Heinrichs, William Campbell, and Craig Heimark, officers Simon Moss and
Darren Innes, and WS Investment Company, a fund associated with Wilson Sonsini
Goodrich & Rosati (WSGR), the Company’s legal counsel.  In May
2009, all Note holders, except Baldwin Enterprise, Inc. and Darren Innes, an
officer of the Company, elected to have the principal amounts outstanding under
their respective Notes converted into common stock of the
Company.   See Note 8 for further details.




13


5.
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 potential common shares
outstanding during the period. Potential common shares result from the assumed
exercise of outstanding stock options that have a dilutive effect when applying
the treasury stock method. The Company excluded all outstanding stock options
from the calculation of diluted net loss per share for the three months and six
months ended June 30, 2009 and 2008, because all such securities are
anti-dilutive (owing to the fact that the Company was in a loss position during
the time period). Accordingly, diluted net loss per share is equal to basic net
loss per share for those periods.




The total
number of potential dilutive common shares excluded from the calculation of
diluted net loss per share for the three months ended June 30, 2009 and 2008 was
224,810 and 304,335, respectively. The total number of potential dilutive common
shares excluded from the calculation of diluted net loss per share for the six
months ended June 30, 2009 and 2008 was 254,266 and 300,736,
respectively.




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




Three Months Ended June
      30,
                  
                  
                  Six
      Months Ended June 30,2009
                  
                  
                  2008
                  
                  
                  2009
                  
                  
                  2008(unaudited)
                  
                  
                  (unaudited)Numerator
      – basic and diluted:Net
      loss
                  
                  $
                  (151
                  )
                  
                  $
                  (1,612
                  )
                  
                  $
                  (566
                  )
                  
                  $
                  (5,379
                  )Denominator
      – basic and diluted:Weighted
      average shares of common stock used in computing net loss per
      share
                  
                  
                  36,561
                  
                  
                  
                  34,547
                  
                  
                  
                  35,634
                  
                  
                  
                  34,538Net
      loss per share – basic and diluted
                  
                  $
                  (0.00
                  )
                  
                  $
                  (0.05
                  )
                  
                  $
                  (0.02
                  )
                  
                  $
                  (0.16
                  )







6.
Income Taxes




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




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




The
Company accounts for uncertain tax positions according to the provisions of FASB
Financial Accounting Standards Interpretation No. 48, Accounting for Uncertainty in Income
Taxes (FIN 48).   FIN 48 contains a two-step approach for
recognizing and measuring uncertain tax positions accounted for in accordance
with SFAS 109. Tax positions are evaluated for recognition by determining if the
weight of available evidence indicates that it is probable that the position
will be sustained on audit, including resolution of related appeals or
litigation. Tax benefits are then measured as the largest amount which is more
than 50% likely of being realized upon ultimate settlement. The Company
considers many factors when evaluating and estimating tax positions and tax
benefits, which may require periodic adjustments and which may not accurately
anticipate actual outcomes.  No material changes have occurred in the
Company’s tax positions taken as of December 31, 2008 during the three and six
months ended June 30, 2009.




As of
December 31, 2008, the Company had a net deferred tax asset of $26.8 million and
unrecognized tax benefit under FIN 48 of $915,000.  A valuation
allowance has been provided for the entire net deferred tax assets.




14




7.
Segment Reporting




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




Intellectual
      Property
                      Division
                    
                    
                    Products
      Division
                    
                    
                    Reconciliation
                    
                    
                    TotalThree
      Months Ended June 30, 2009 (unaudited)Revenue
                    
                    $
                    1,159
                    
                    
                    $
                    2,776
                    
                    
                    $
                    (1,057
                    )
                    
                    $
                    2,878Depreciation
      expense
                    
                    
                    —
                    
                    
                    
                    (61
                    )
                    
                    
                    —
                    
                    
                    
                    (61
                    )Total
      costs and expenses
                    
                    
                    (477
                    )
                    
                    
                    (3,498
                    )
                    
                    
                    1,057
                    
                    
                    
                    (2,918
                    )Interest
      income
                    
                    
                    —
                    
                    
                    
                    2
                    
                    
                    
                    —
                    
                    
                    
                    2Interest
      expense
                    
                    
                    —
                    
                    
                    
                    (108
                    )
                    
                    
                    —
                    
                    
                    
                    (108
                    )Net
      income (loss)
                    
                    
                    682
                    
                    
                    
                    (833
                    )
                    
                    
                    —
                    
                    
                    
                    (151
                    )Assets
                    
                    
                    803
                    
                    
                    
                    3,359
                    
                    
                    
                    —
                    
                    
                    
                    4,162Three
      Months Ended June 30, 2008 (unaudited)Revenue
                    
                    $
                    1,210
                    
                    
                    $
                    1,637
                    
                    
                    $
                    (1,057
                    )
                    
                    $
                    1,790Depreciation
      expense
                    
                    
                    —
                    
                    
                    
                    (137
                    )
                    
                    
                    —
                    
                    
                    
                    (137
                    )Total
      costs and expenses
                    
                    
                    (558
                    )
                    
                    
                    (3,794
                    )
                    
                    
                    1,057
                    
                    
                    
                    (3,295
                    )Interest
      income
                    
                    
                    —
                    
                    
                    
                    21
                    
                    
                    
                    —
                    
                    
                    
                    21Interest
      expense
                    
                    
                    —
                    
                    
                    
                    (128
                    )
                    
                    
                    —
                    
                    
                    
                    (128
                    )Net
      income (loss)
                    
                    
                    652
                    
                    
                    
                    (2,264
                    )
                    
                    
                    —
                    
                    
                    
                    (1,612
                    )Assets
                    
                    
                    2,138
                    
                    
                    
                    8,044
                    
                    
                    
                    —
                    
                    
                    
                    10,182Six
      Months Ended June 30, 2009 (unaudited)Revenue
                    
                    $
                    2,336
                    
                    
                    $
                    5,286
                    
                    
                    $
                    (2,114
                    )
                    
                    $
                    5,508Depreciation
      expense
                    
                    
                    —
                    
                    
                    
                    (120
                    )
                    
                    
                    —
                    
                    
                    
                    (120
                    )Total
      costs and expenses
                    
                    
                    (837
                    )
                    
                    
                    (7,172
                    )
                    
                    
                    2,114
                    
                    
                    
                    (5,895
                    )Interest
      income
                    
                    
                    —
                    
                    
                    
                    8
                    
                    
                    
                    —
                    
                    
                    
                    8Interest
      expense
                    
                    
                    —
                    
                    
                    
                    (240
                    )
                    
                    
                    —
                    
                    
                    
                    (240
                    )Net
      income (loss)
                    
                    
                    1,499
                    
                    
                    
                    (2,065
                    )
                    
                    
                    —
                    
                    
                    
                    (566
                    )Assets
                    
                    
                    803
                    
                    
                    
                    3,359
                    
                    
                    
                    —
                    
                    
                    
                    4,162Six
      Months Ended June 30, 2008 (unaudited)Revenue
                    
                    $
                    2,421
                    
                    
                    $
                    2,634
                    
                    
                    $
                    (2,114
                    )
                    
                    $
                    2,941Depreciation
      expense
                    
                    
                    —
                    
                    
                    
                    (268
                    )
                    
                    
                    —
                    
                    
                    
                    (268
                    )Total
      costs and expenses
                    
                    
                    (1,329
                    )
                    
                    
                    (8,959
                    )
                    
                    
                    2,114
                    
                    
                    
                    (8,174
                    )Interest
      income
                    
                    
                    —
                    
                    
                    
                    67
                    
                    
                    
                    —
                    
                    
                    
                    67Interest
      expense
                    
                    
                    —
                    
                    
                    
                    (213
                    )
                    
                    
                    —
                    
                    
                    
                    (213
                    )Net
      income (loss)
                    
                    
                    1,092
                    
                    
                    
                    (6,471
                    )
                    
                    
                    —
                    
                    
                    
                    (5,379
                    )Assets
                    
                    
                    2,138
                    
                    
                    
                    8,044
                    
                    
                    
                    —
                    
                    
                    
                    10,182




International
revenue, which consists of sales to customers with operations principally in
Western Europe and Asia, comprised 32% and 52% of total revenues for the three
months ended June 30, 2009 and 2008, respectively, and 31% and 52% of total
revenues for the six months ended June 30, 2009 and 2008, respectively. For the
three months ended June 30, 2009 and 2008, international revenues from customers
in the United Kingdom accounted for 28% and 19% of total product and services
revenue, respectively, and 26% and 24% for the six months ended June 30, 2009
and 2008, respectively.  The Company had no significant long-lived
assets in any country other than in the United States for any period
presented.




15


8.  Borrowings




Line
of Credit




On
December 22, 2008, the Company renewed its Revolving Credit and Promissory Note
and a Security Agreement with a financial institution to borrow up to $10.0
million under a revolving line of credit. The agreement includes a first
priority security interest in all of the Company’s assets. Gerald Burnett,
Chairman of the Company, provided a collateralized guarantee to the financial
institution, assuring payment of the Company’s obligations under the agreement
and as a consequence, there are no restrictive covenants, allowing the Company
greater access to the full amount of the facility. In addition to the guarantee
provided to the financial institution, on March 29, 2009, Dr. Burnett provided a
personal guarantee to Avistar, assuring the Company a line of credit of $10.0
million with the same terms and mechanisms as the existing revolving line of
credit in the event the existing revolving line of credit from the financial
institution was unavailable for any reason during the period from its
termination on December 21, 2009 to March 31, 2010. The line of credit requires
monthly interest-only payments based on Adjusted LIBOR plus 1.25% or Prime Rate
plus 1.25%. The Company elected Prime Rate plus 1.25% or 4.5% at June 30, 2009
and December 31, 2008. In January 2009, the Company repaid $3.9 million of the
$7.0 million revolving line of credit outstanding as of December 31, 2008. The
Company borrowed $2.0 million under the revolving line of credit for the six
months ended June 30, 2009, and has a balance of $5.1 million outstanding as of
June 30, 2009.  The Revolving Credit and Promissory Note matures on
December 21, 2009, and is subject to annual renewal with the consent of the
Company and the lender.




Convertible
Debt




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




In May
2009, the Company issued a total of 4,199,997 shares of the Company’s common
stock to Gerald Burnett, R. Stephen Heinrichs, William Campbell, Craig Heimark,
Simon Moss and WS Investment Company upon their election to convert their
respective notes into common stock.  The total principal amount of
notes so converted was $2.9 million.  $4.1 million in aggregate
principal amount of notes remain outstanding as of June 30, 2009.






9.
Commitments and Contingencies
  Facilities
Leases




The
Company leases its facilities under operating leases that expire at various
dates through March 2017.  During 2008 and 2009, the Company has
subleased some of its operating facilities in San Mateo, California and New
York, New York, and assigned its primary facility lease in London, United
Kingdom to third parties. As a result of these subleases and assignment, the
future minimum lease commitments under all facility leases as of June 30, 2009,
net of sublease proceeds, are as follows (in thousands):




Minimum
      lease payments
                    
                    
                    Sublease
      proceeds
                    
                    
                    Net(unaudited)
                    
                    
                    (unaudited)
                    
                    
                    (unaudited)Six
      Months Ending December 31,2009
                    
                    $
                    629
                    
                    
                    $
                    (306
                    )
                    
                    $
                    323Years
      Ending December 31,2010
                    
                    
                    1,280
                    
                    
                    
                    (532
                    )
                    
                    
                    7482011
                    
                    
                    1,333
                    
                    
                    
                    (343
                    )
                    
                    
                    9902012
                    
                    
                    567
                    
                    
                    
                    (290
                    )
                    
                    
                    2772013
                    
                    
                    310
                    
                    
                    
                    (284
                    )
                    
                    
                    26thereafter
                    
                    
                    1,008
                    
                    
                    
                    (954
                    )
                    
                    
                    54Total
      future minimum lease payments
                    
                    $
                    5,127
                    
                    
                    $
                    (2,709
                    )
                    
                    $
                    2,418







16




Software
Indemnifications




Avistar
enters into standard indemnification agreements in the ordinary course of
business. Pursuant to these agreements, Avistar indemnifies, holds harmless, and
agrees to reimburse the indemnified party for losses suffered or incurred by the
indemnified party, generally Avistar’s business partners or customers, in
connection with any patent, copyright or other intellectual property
infringement claim by any third party with respect to its products. The term of
these indemnification agreements is generally perpetual. The maximum potential
amount of future payments Avistar could be required to make under these
indemnification agreements is generally limited to the cost of products
purchased per customer, but may be material when customer purchases since
inception are considered in aggregate. Avistar has never incurred costs to
defend lawsuits or settle claims related to these indemnification agreements.
Accordingly, Avistar has no liabilities recorded for these agreements as of June
30, 2009.




Microsoft




In
fiscal 2008, Microsoft Corporation (Microsoft) filed requests for re-examination
of 29 U.S. patents held by Avistar. In June 2008, the U.S. Patent and Trademark
Office (USPTO) completed its review of Microsoft’s requests for re-examination
and rejected 19 of the re-examination applications in their entirety, and the
majority of the arguments for one additional application. The USPTO agreed to
re-examine, either in part or fully, 10 of the Company’s existing U.S.
patents.




During
2008, Microsoft submitted five petitions for reconsideration of the USPTO’s
rejection of Microsoft’s re-examination applications.  As of July 31,
2009, two of the Microsoft petitions were denied. These denials are final and
cannot be appealed. The other three petitions by Microsoft are still
pending.




During
the six months ended June 30, 2009, the Company responded to the USPTO on the 10
patents in re-examination within the time permitted.  As of July 31,
2009, six of the 10 re-examined patents were rejected by the USPTO to which
the Company has thus far filed three notices of appeal to the USPTO Board of
Appeals.  The Company believes that the remaining three of the 10
re-examined patents are in condition for allowance and one is currently under
review by the USPTO.




Avistar
believes that its U.S. patents are valid and intends to defend its patents
through the re-examination process.  However, the re-examination of
patents by the USPTO is a lengthy, time consuming and expensive process in which
the ultimate outcome is uncertain.  Once initiated, the USPTO may take
between six months and two years to complete patent
re-examinations.  The re-examination process by the USPTO may
adversely impact the Company’s licensing negotiations in process, and may
require the Company to spend substantial time and resources defending its
patents, including the fees and expenses of legal advisors.  This may
impact the Company’s results of operations negatively and require the Company to
seek additional financing to fund its operations as well as the expense incurred
in the legal defense of the Company’s patents.




The
Company has not recorded an expense related to damages in this matter because
any potential loss is not currently probable or reasonably estimable under SFAS
No. 5, Accounting for
Contingencies.


10.
Recent Accounting Pronouncements


In June
2008, the FASB ratified Emerging Issues Task Force (EITF) Issue No. 07-5, Determining Whether an Instrument
(or an Embedded Feature) is Indexed to an Entity’s Own Stock (EITF 07-5).
EITF 07-5 provides that an entity should use a two-step approach to evaluate
whether an equity-linked financial instrument (or embedded feature) is indexed
to its own stock, including evaluating the instrument’s contingent exercise and
settlement provisions. EITF 07-5 is effective for financial statements issued
for fiscal years beginning after December 15, 2008, and interim periods within
those fiscal years. Early application is not permitted. The Company adopted this
statement on January 1, 2009.  The adoption of EITF 07-5 did not have
a material impact on the Company’s financial condition and results of
operations.




In April
2009, the FASB issued FASB Staff Position No. FAS 141(R)-1, Accounting for Assets Acquired and
Liabilities Assumed in a Business Combination That Arise from
Contingencies (FSP FAS 141(R)-1), to amend SFAS 141 (revised 2007), Business Combinations. FSP
FAS 141(R)-1 addresses the initial recognition, measurement and subsequent
accounting for assets and liabilities arising from contingencies in a business
combination, and requires that such assets acquired or liabilities assumed be
initially recognized at fair value at the acquisition date if fair value can be
determined during the measurement period. If the acquisition-date fair value
cannot be determined, the asset acquired or liability assumed arising from a
contingency is recognized only if certain criteria are met. This FSP also
requires that a systematic and rational basis for subsequently measuring and
accounting for the assets or liabilities be developed depending on their nature.
FSP FAS 141(R)-1 is effective for assets or liabilities arising from
contingencies in business combinations for which the acquisition date is on or
after the beginning of the first annual reporting period beginning on or after
December 15, 2008.  The Company adopted this statement upon its
issuance.  The impact of FSP FAS 141(R)-1 on accounting for business
combinations is dependent upon acquisition activity on or after its effective
date.




In April
2009, the FASB issued three FASB Staff Position (FSP) statements intended to
provide additional guidance and enhance disclosures regarding fair value
measurements and impairments of securities.  FASB Staff Position No.
FAS 157-4, Determining Fair
Value When the Volume and Level of Activity for the Asset or Liability Have
Significantly Decreased and Identifying Transactions That Are Not Orderly
(FSP FAS 157-4) provides guidelines for making fair value measurements more
consistent with the principles presented in FASB Statement No. 157, Fair Value
Measurements.  FASB Staff Position No. FAS 107-1 and APB 28-1,
Interim Disclosures about Fair
Value of Financial Instruments (FSP FAS 107-1 and APB 28-1), enhances
consistency in financial reporting by increasing the frequency of fair value
disclosures.  FASB Staff Position No. 115-2 and FAS 124-2, Recognition and Presentation of
Other-Than-Temporary Impairments (FSP FAS 115-2 and FAS 124-2), provides
additional guidance designed to create greater clarity and consistency in
accounting for and presenting impairment losses on securities.  These
FSPs are effective for interim and annual reporting periods ending after June
15, 2009, with early adoption permitted for periods ending after March 15, 2009
only if all three FSPs are early adopted at the same time. The Company adopted
these FSPs on June 30, 2009.  The adoption of these statements did not
have a material impact on the Company’s financial condition and results of
operations.




17


In
May 2009, the FASB issued Statement No. 165, Subsequent Events(SFAS No.
165). SFAS No. 165 is intended to establish general standards of accounting for
and disclosure of events that occur after the balance sheet date but before
financial statements are issued or are available to be issued. It requires the
disclosure of the date through which an entity has evaluated subsequent events
and the basis for selecting that date, that is, whether that date represents the
date the financial statements were issued or were available to be issued. SFAS
No. 165 is effective for interim or annual financial periods ending after June
15, 2009.  The Company adopted this statement on June 30, 2009.The adoption of SFAS No.
165 did not have a material impact on the Company’s financial condition and
results of operations.




In
June  2009, the FASB issued Statement No. 168, The FASB Accounting Codification and
Hierarchy of Generally Accepted Accounting Principles- a replacement of FASB No.
162(SFAS No. 168)  The FASB Accounting Standards
CodificationTM  (“Codification”)
does not change U. S. GAAP, but combines all authoritative standards such as
those issued by the FASB, AICPA, and EITF, into a comprehensive, topically
organized online database.  The Codification was released on July 1,
2009 and will become the single source of authoritative U. S. GAAP applicable
for all nongovernmental entities, except for rules and interpretive releases of
the SEC.  The Codification is effective for all interim periods and
year ends subsequent to September 15, 2009. The Company expects that this will
have an impact on the Company’s financial statement disclosure references since
all future references to authoritative accounting literature will be references
in accordance with SFAS 168, but it is not expected to have an impact on the
Company’s financial condition and results of operations.






11.
Other Matters




Effective June 24,
2009, the Company’s common stock was suspended from trading on
Nasdaq.  On June 12, 2009, the Company received a letter from The
Nasdaq Stock Market, or Nasdaq, indicating that the Nasdaq Hearings Panel, or
the Panel, had determined to delist the shares of the Company from Nasdaq and
would suspend the common stock of the Company from trading on Nasdaq effective
at the open of trading on June 24, 2009.  The Panel's decision to
suspend the Company's common stock was the result of the Company not evidencing
a market value of listed securities above $35 million for ten consecutive
trading days, or otherwise demonstrating compliance with alternative continued
listing standards, during the period from April 2, 2009 and June 22,
2009.




On June 17, 2009, the Company requested a review by the
Nasdaq Listing and Hearing Review Council, or the Council, of the Panel’s
decision.TheCouncil grantedthe Company’s
request for a reviewand requested
additional information from the Company be submitted by August 7,
2009.  There can be no assurance that the Council’sreview will result in areversalof the
Panel’s decision to delist the Company’s common stock.




The Company’s
common stockiscurrentlyquotedand tradedon
thePink Sheets, which is an
over-the-counter securities market, under the symbol
AVSR.PK.






12.
Subsequent Events




On July 8, 2009, Simon B. Mossvoluntarilyresigned from allof thepositions he
held with the Company, including his positionsas Chief Executive Officer and Board member.Shortly thereafter,
the Board of Directors of the Company appointed Robert F. Kirk as the Chief
Executive Officer of theCompany, effective
as of July 14, 2009 and additionally to the Board of Director effective as of
July 15, 2009.




The Company has evaluated subsequent events throughAugust 4, 2009,the date the unaudited condensed consolidated financial
statements are issued.






18




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




The
following discussion and analysis should be read in conjunction with the
unaudited Condensed Consolidated Financial Statements and the related Notes
thereto included in this Quarterly Report on Form 10-Q and with Management’s
Discussion and Analysis of Financial Condition and Results of Operations
contained in our Annual Report on Form 10-K for the year ended December 31,
2008, as filed with the SEC on March 31, 2009.




This
“Management’s Discussion and Analysis of Financial Condition and Results of
Operations” contains both historical information and forward-looking statements.
These forward-looking 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. In some cases, you can identify forward-looking
statements by terminology such as “may”, “will”, “should”, “expects”, “intends”,
“plans”, “anticipates”, “believes”, “estimates”, “predicts”, “potential”,
“continue” or the negative of these terms, or other comparable terminology.
These statements are only predictions. Actual events or results may differ
materially. In evaluating these statements, you should specifically consider the
various risks and other factors that were discussed  under “Risk
Factors” and elsewhere in the 2008 Annual Report on Form 10-K and this Quarterly
Report on Form 10-Q. These factors may cause our actual results to differ
materially from any forward looking statement.   Although we believe that
the expectations reflected in the forward looking statements are reasonable, we
cannot guarantee future results, levels of activity, performance or
achievements. Moreover, we are under no duty to update any of the
forward-looking statements after the date of this Quarterly Report on Form 10-Q
to conform these statements to actual results.  These forward-looking
statements are made in reliance upon the safe harbor provision of The Private
Securities Litigation Reform Act of 1995.  In addition, historical
information should not be considered an indicator of future
performance.




Overview




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




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




Since
inception, we have recognized the innovative value of our research and
development efforts, and have invested in securing protection for these
innovations through domestic and foreign patent applications and issuance. As of
June 30, 2009, we held 98 U.S. and foreign patents, which we look to license to
others in the collaboration technology marketplace.




In late
2007 and 2008, we implemented corporate initiatives aimed at increasing our
product sales, expanding our customer deployments and support, improving our
corporate efficiency and increasing our development capacity.  The
components of these initiatives included:




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




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




·
            Engaging
      the market with a new, dynamic application integration and software-only
      product set with video as the primary, empowering
    technology;




·
            Implementing
      aggressive cost control measures structured to effectively align
      operations and to address Microsoft's requests for re-examination of our
      U.S. Patents, while still allowing us to continue to invest in our product
      line and to license our intellectual property and
    technology,




·
            A
      reduction in our employees from an average of 88 in 2007 to approximately
      51 on June 30, 2009; and




·
            Pursuing
      multiple distribution, services and technology
  partners.




19


These and
other changes in our business were aimed at reducing our structural costs,
increasing our organizational and partner-driven capacity, and leveraging our
reputation for innovation and intellectual property leadership in order to grow
and expand our business.  However, these organizational changes and
initiatives involve transitional costs and expenses and result in uncertainty in
terms of their implementation and their impact on our business.




On
February 25, 2008 we announced that Microsoft Corporation had filed requests for
re-examination of 24 of our 29 U.S. patents. Subsequently, Microsoft also filed
requests for re-examination of our remaining five U.S. patents.  On
June 10, 2008 we announced that the U.S. Patent and Trademark Office (USPTO) had
completed its review of Microsoft’s requests for re-examination and had rejected
19 of the re-examination applications in their entirety, and the majority of the
arguments for one additional application. The USPTO agreed to re-examine, either
in part or fully, 10 of our existing U.S. patents.




During
2008, Microsoft submitted five petitions for reconsideration of the USPTO’s
rejection of Microsoft’s re-examination applications.  As of July 31,
2009 two of the Microsoft petitions were denied. These denials are final and
cannot be appealed. The three other petitions by Microsoft are still
pending.




During
the six months ended June 30, 2009, we responded to the USPTO regarding the 10
patents being re-examined within the required time frame.  As of July
31, 2009, six of the 10 re-examined patents were rejected to which we have thus
far filed three notices of appeal to the USPTO Board of Appeals. We believe the
remaining three of the 10 re-examined patents are in condition for allowance and
one is currently under review by the USPTO.  .




We
believe that our U.S. patents are valid and we intend to defend our patents
through the re-examination process.  However, the re-examination of
patents by the USPTO is a lengthy, time consuming and expensive process in which
the ultimate outcome is uncertain. Once initiated, the USPTO may take between
six months and two years to complete patent
re-examinations.   The re-examination process by the USPTO may
adversely impact and delay our present and future licensing negotiations, and
may require us to spend substantial time and resources defending our patents,
including the fees and expenses of our legal advisors.  The potential
impact to our results of operations may require us to reduce our other operating
expenses and seek additional financing to fund our operations and the defense of
our patents.




Critical
Accounting Policies




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




Management
believes that there have been no significant changes to our critical accounting
policies during the three and six months ended June 30, 2009 from those
disclosed in Management's Discussion and Analysis of Financial Condition and
Results of Operations in our Annual Report on Form 10-K for the fiscal year
ended December 31, 2008.




20




Results
of Operations




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




Percentage
      of Total Revenue
                    
                    
                    Percentage
      of Total RevenueThree
      Months EndedJune
      30,
                    
                    
                    Six
      Months EndedJune
      30,2009
                    
                    
                    2008
                    
                    
                    2009
                    
                    
                    2008Revenue:Product
                    
                    
                    56
                    %
                    
                    
                    31
                    %
                    
                    
                    54
                    %
                    
                    
                    27
                    %Licensing
                    
                    
                    3
                    
                    
                    
                    8
                    
                    
                    
                    4
                    
                    
                    
                    11Services,
      maintenance and support
                    
                    
                    41
                    
                    
                    
                    61
                    
                    
                    
                    42
                    
                    
                    
                    62Total
      revenue
                    
                    
                    100
                    
                    
                    
                    100
                    
                    
                    
                    100
                    
                    
                    
                    100Costs
      and Expenses:Cost
      of product revenue
                    
                    
                    10
                    
                    
                    
                    32
                    
                    
                    
                    12
                    
                    
                    
                    31Cost
      of services, maintenance and support revenue
                    
                    
                    30
                    
                    
                    
                    34
                    
                    
                    
                    30
                    
                    
                    
                    38Income
      from settlement and patent licensing
                    
                    
                    (37
                    )
                    
                    
                    (59
                    )
                    
                    
                    (38
                    )
                    
                    
                    (72
                    )Research
      and development
                    
                    
                    34
                    
                    
                    
                    53
                    
                    
                    
                    34
                    
                    
                    
                    96Sales
      and marketing
                    
                    
                    22
                    
                    
                    
                    44
                    
                    
                    
                    25
                    
                    
                    
                    72General
      and administrative
                    
                    
                    42
                    
                    
                    
                    80
                    
                    
                    
                    44
                    
                    
                    
                    113Total
      costs and expenses
                    
                    
                    101
                    
                    
                    
                    184
                    
                    
                    
                    107
                    
                    
                    
                    278Loss
      from operations
                    
                    
                    (1
                    )
                    
                    
                    (84
                    )
                    
                    
                    (7
                    )
                    
                    
                    (178
                    )Other
      income (expense):Interest
      income
                    
                    
                    —
                    
                    
                    
                    1
                    
                    
                    
                    —
                    
                    
                    
                    2Other
      expense, net
                    
                    
                    (4
                    )
                    
                    
                    (7
                    )
                    
                    
                    (3
                    )
                    
                    
                    (7
                    )Total
      other expense, net
                    
                    
                    (4
                    )
                    
                    
                    (6
                    )
                    
                    
                    (3
                    )
                    
                    
                    (5
                    )Net
      loss
                    
                    
                    (5
                    )%
                    
                    
                    (90
                    )%
                    
                    
                    (10
                    )%
                    
                    
                    (183
                    )%




COMPARISON
OF THE THREE MONTHS ENDED JUNE 30, 2009 AND 2008




Revenue




Total
revenue increased by $1.1 million or 61%, to $2.9 million for the three month
period ended June 30, 2009, from $1.8 million for the three months ended June
30, 2008, primarily due to increase in software product revenue.




·
            Product
      revenue increased by $1.0 million or 189%, to $1.6 million for the three
      month period ended June 30, 2009 from $553,000 for the three months ended
      June 30, 2008. The increase was due primarily to software product revenue
      of $1.3 million from IBM in the quarter ended June 30,
    2009.




·
            Licensing
      revenue, relating to the licensing of our patent portfolio, decreased by
      $51,000 or 33%, to $102,000 for the three months ended June 30, 2009 from
      $153,000 for the three months ended June 30, 2008, mainly due to a decline
      in the ongoing royalty revenue from
Sony.




·
            Services,
      maintenance and support revenue, which includes funded software
      development and maintenance and support, increased by $93,000, or 9%, to
      $1.2 million for the three months ended June 30, 2009, from $1.1 million
      for the three months ended June 30, 2008, due primarily to an increase in
      revenue from software implementation and enhancement services provided to
      existing customers, offset by a decrease in revenue from maintenance
      contracts with existing customers in the quarter ended June 30,
      2009.




For the
three months ended June 30, 2009, revenue from two customers accounted for 75%
of total revenue compared to two customers and 83% for the three months ended
June 30, 2008. No other customer accounted for greater than 10% of total
revenue.  The level of sales to any customer may vary from quarter to
quarter. We expect that there will be significant customer concentration in
future quarters. The loss of any one of those customers would have a materially
adverse impact on our financial condition and operating results.




Costs
and expenses




Cost of product revenue.Cost of product revenue
decreased by $277,000 or 49%, to $288,000 for the three months ended June 30,
2009 from $565,000 for the three months ended June 30, 2008.  The
decrease was mainly attributable to lower hardware product sales in the quarter
ended June 30, 2009 which carried a higher cost than software sales




Cost of services, maintenance and
support revenue.Cost of services,
maintenance and support revenue increased by $258,000, or 43%, to $861,000 for
the three months ended June 30, 2009, from $603,000 for the three months ended
June 30, 2008, primarily due to an increase in software implementation and
enhancement services for the customers in the quarter ended June 30, 2009
compared to the same period in 2008.




21







Income from settlement and patent
licensing.Income from settlement
and patent licensing was $1.1 million for the three months ended June 30, 2009
and 2008, respectively, reflecting the amortization of the net proceeds from the
November 2004 Polycom settlement and cross-license agreement over a five year
period, beginning in November 2004 and ending in November 2009.




Research and
development.Research and development
expenses increased by $16,000, or 2%, to $975,000 for the three months ended
June 30, 2009 from $959,000 for the three months ended June 30,
2008.  This increase was primarily due to an increase of $70,000 in
stock based compensation expense, offset by greater allocation of engineering
employee and external labor expenses to cost of services associated with the
increased number of software implementation and enhancement service deliveries
and reduction in overhead expenses.




Sales and marketing. Sales
and marketing expenses decreased by $149,000, or 19%, to $640,000 for the three
months ended June 30, 2009, from $789,000 for the three months ended June 30,
2008. The decrease was due primarily to a reduction in personnel and personnel
related expenses and cost optimization efforts,  partially offset by
an increase of $111,000 in stock based compensation expense.




General and administrative.
General and administrative expenses decreased by $225,000, or 16% to $1.2
million for the three months ended June 30, 2009, from $1.4 million for the
three months ended June 30, 2008. The decrease was due primarily to a reduction
in legal expense associated with patent prosecution and filing expenses, a
decrease in personnel and personnel related expenses and cost optimization
efforts, partially offset by an increase of $69,000 in stock based compensation
expense.




Other
income (expense)




Interest income. Interest
income decreased by $19,000, or 90%, to $2,000 for the three months ended June
30, 2009, from $21,000 for the three months ended June 30, 2008, primarily due
to lower average outstanding balance of cash and cash equivalents that earned
interest in the three months ended June 30, 2009 compared to the same period in
2008.




Other expense, net. Other
expense, net, decreased by $15,000, or 12%, to $113,000 for the three months
ended June 30, 2009, from $128,000 for the three months ended June 30, 2008,
primarily due to a decrease in interest expense due to lower average convertible
debt and line of credit balances outstanding during the quarter






COMPARISON
OF THE SIX MONTHS ENDED JUNE 30, 2009 AND 2008




Revenue




Total
revenue increased by $2.6 million or 87%, to $5.5 million for the six month
period ended June 30, 2009, from $2.9 million for the six months ended June 30,
2008, primarily due to increase in software product revenue.




·
            Product
      revenue increased by $2.1 million or 267%, to $2.9 million for the six
      month period ended June 30, 2009 from $802,000 for the six months ended
      June 30, 2008. The increase was due primarily to software product revenue
      of $2.2 million from IBM in the six months ended June 30,
      2009.




·
            Licensing
      revenue, relating to the licensing of our patent portfolio, decreased by
      $85,000 or 28%, to $222,000 for the six months ended June 30, 2009 from
      $307,000 for the six months ended June 30, 2008, mainly due to a decline
      in the ongoing royalty revenue from
Sony.




·
            Services,
      maintenance and support revenue, which includes  funded software
      development and maintenance and support, increased by $508,000, or 28%, to
      $2.3 million for the six months ended June 30, 2009, from $1.8 million for
      the six months ended June 30, 2008,  due primarily to increase
      in revenue from software implementation and enhancement services and
      professional on-site services provided to existing customers, offset by a
      decrease in revenue from maintenance contracts with existing customers in
      the six months ended June 30, 2009.




For the
six months ended June 30, 2009, revenue from three customers accounted for 74%
of total revenue compared to three customers and 90% for the six months ended
June 30, 2008. No other customer accounted for greater than 10% of total
revenue.  The level of sales to any customer may vary from quarter to
quarter. We expect that there will be significant customer concentration in
future quarters. The loss of any one of those customers would have a materially
adverse impact on our financial condition and operating results.




Costs
and expenses




Cost of product revenue.Cost of product revenue
decreased by $261,000 or 28%, to $663,000 for the six months ended June 30, 2009
from $924,000 for the six months ended June 30, 2008.  The decrease
was mainly attributable to lower hardware product sales which carried a higher
cost than software sales, offset by an increase of $96,000 in stock based
compensation expense in the six months ended June 30, 2009.


22






Cost of services, maintenance and
support revenue.Cost of services,
maintenance and support revenue increased by $541,000, or 48%, to $1.7 million
for the six months ended June 30, 2009, from $1.1 million for the six months
ended June 30, 2008, primarily due to an increase in software implementation and
enhancement services for the customers in the six months ended June 30, 2009
compared to the same period in 2008.




Income from settlement and patent
licensing.Income from settlement
and patent licensing was $2.1 million for the six months ended June 30, 2009 and
2008, respectively, reflecting the amortization of the net proceeds from the
November 2004 Polycom settlement and cross-license agreement over a five year
period, beginning in November 2004 and ending in November 2009.




Research and
development.Research and development
expenses decreased by $924,000, or 33%, to $1.9 million for the six months ended
June 30, 2009 from $2.8 million for the six months ended June 30, 2008. This
decrease was primarily due to a reduction in personnel and personnel related
expenses, greater allocation of engineering employee and external labor expenses
to cost of services associated with the increased number of software
implementation and enhancement service deliveries in the six months ended June
30, 2009, partially offset by an increase of $174,000 in stock based
compensation expense.




Sales and marketing. Sales
and marketing expenses decreased by $755,000, or 36%, to $1.4 million for the
six months ended June 30, 2009, from $2.1 million for the six months ended June
30, 2008. The decrease was due primarily to a reduction in personnel and
personnel related expenses and cost optimization efforts,  partially
offset by an increase of $203,000 in stock based compensation
expense.




General and administrative.
General and administrative expenses decreased by $880,000, or 27% to $2.4
million for the six months ended June 30, 2009, from $3.3 million for the six
months ended June 30, 2008. The decrease was due primarily to a reduction in
legal expense associated with patent prosecution and filing expenses, a decrease
in personnel and personnel related expenses and cost optimization efforts,
partially offset by an increase of $155,000 in stock based compensation
expense.




Other
income (expense)




Interest income. Interest
income decreased by $59,000, or 88%, to $8,000 for the six months ended June 30,
2009, from $67,000 for the six months ended June 30, 2008, primarily due to both
a decrease in interest rates and a decrease in the average outstanding balance
of cash and cash equivalents that earned interest in the six months ended June
30, 2009 compared to the same period in 2008.




Other expense, net. Other
expense, net, decreased by $26,000, or 12%, to $187,000 for the six months ended
June 30, 2009, from $213,000 for the six months ended June 30, 2008, primarily
attributable to a decrease in the interest expense due to  lower
average convertible debt and line of credit balances outstanding during the six
months ended June 30, 2009.






Liquidity
and Capital Resources




We had
cash and cash equivalents of $126,000 and $4.9 million as of June 30, 2009 and
December 31, 2008, respectively. For the six months ended June 30, 2009, we had
a net decrease in cash and cash equivalents of $4.8 million. The net cash used
by operations of $3.0 million for the six months ended June 30, 2009 resulted
primarily from the net loss of $566,000, a decrease in deferred income from
settlement and patent licensing of $2.7 million, a decrease in deferred services
revenue and customer deposits of $1.9 million, offset by a decrease in inventory
of $113,000, an increase in account payable of $405,000, a decrease in deferred
settlement and patent licensing costs of $637,000 and non-cash expenses of $1.1
million.  The net cash used in investing activities of $40,000 for the six
months ended June 30, 2009 was related to purchases of equipment.  The net
cash used in financing activities of $1.8 million for the six months ended
June 30, 2009 related primarily to payments made on our line of credit of $3.9
million in January 2009, offset by $2.0 million of borrowings on our line of
credit and $160,000 in proceeds from the issuance of common stock under employee
stock option and stock purchase plans




At June
30, 2009, we had approximately $2.4 million in minimum commitments under
non-cancelable operating leases net of sublease proceeds.




On December 22, 2008, werenewed ourRevolving Credit and Promissory Note and a Security Agreement with a financial
institution to borrow up to $10.0 million under a revolving line of credit. The
agreement includes a first priority security interest in all of our assets.
Gerald Burnett, our Chairman, provided a collateralized guarantee to the
financial institution, assuring payment of our obligations under the agreement
and as a consequence, there are no restrictive covenants, allowing us greater
access to the full amount of the facility.  In addition to the
guarantee provided to the financial institution, on March 29, 2009, Dr. Burnett
provided a personal guarantee to us assuring us a line of credit of $10.0
million with the same terms and mechanisms as the existing revolving line of
credit in the event the existing revolving line of credit from the financial
institution was unavailable for any reason during the period from its
termination on December 21, 2009 to March 31, 2010.The line of credit
required monthly interest-only payments based on Adjusted LIBOR plus 1.25% or
Prime Rate plus 1.25%. We elected Prime Rate plus 1.25% or 4.5% at June 30, 2009
and December 31, 2008. In January 2009, we repaid $3.9 million of the $7.0
million revolving line of credit outstanding as of December 31, 2008. We
borrowed $2.0 million under the revolving line of credit for the six months
ended June 30, 2009 and have a balance of $5.1 million outstanding as of June
30, 2009.  The Revolving Credit and Promissory Note matures on
December 21, 2009, and is subject to annual renewal with the consent of the
Company and the lender.




23


On January 4, 2008, we issued $7,000,000 of 4.5%
Convertible Subordinated Secured Notes, which are due in 2010 (Notes). The Notes
were sold pursuant to a Convertible Note Purchase Agreement to Baldwin
Enterprises, Inc., a subsidiary of Leucadia National Corporation, directors
Gerald Burnett, R. Stephen Heinrichs, William Campbell, and Craig Heimark,
officers Simon Moss and Darren Innes, and WS Investment Company. Our obligations
under the Notes are secured by the grant of a security interest in substantially
all our tangible and intangible assets pursuant to a Security Agreement between
us and the purchasers. The Notes have a two year term, will be due on January 4,
2010 and are convertible prior to maturity.  Interest on the Notes
accrues at the rate of 4.5% per annum and is payable semi-annually in arrears on
June 4 and December 4 of each year.Commencing on the one-year
anniversary of the issuance of the Notes, the Note holders became entitled to
convert the Notes into common stock at an initial conversion price of $0.70 per
share.  In May 2009, we issued a total of 4,199,997 shares of common
stock to Gerald Burnett, R. Stephen Heinrichs, William Campbell, Craig Heimark,
Simon Moss and WS Investment Company upon their election to convert their notes
with an aggregate principal amount of $2.9 million into common
stock.  $4.1 million in notes remained outstanding as of June 30,
2009.




As ofJune
30, 2009, we had no material off-balance
sheet arrangements, other than the operating leases described
above.   We enter into indemnification provisions under
agreements with other companies in our ordinary course of business, typically
with our contractors, customers, landlords and our investors. Under these
provisions, we generally indemnify and hold harmless the indemnified party for
losses suffered or incurred by the indemnified party as a result of our
activities or, in some cases, as a result of the indemnified party's activities
under the agreement. These indemnification provisions generally survive
termination of the underlying agreement. The maximum potential amount of future
payments we could be required to make under these indemnification provisions is
generally unlimited. As ofJune
30, 2009, we have not incurred material
costs to defend lawsuits or settle claims related to these indemnifications
agreements and therefore, we have no liabilities recorded for these agreements
as ofJune 30, 2009.




We are currently in discussions with the remaining
holders of the Notes to convert the Notes into shares of common stock in January
2010 or extend the term of the Notes.  Assuming the successful conversion or
extension of the Notes in conjunction with the results of our cost reduction
efforts, including Dr. Burnett's personal guarantee to Avistar to support an
extension of the revolving line of credit, we believe that our existing cash and
cash equivalents balance and line of credit will provide us with sufficient
funds to finance our operations for the next 12 months. We intend to continue to invest in the development of
new products and enhancements to our existing products. Our future liquidity and
capital requirements will depend upon numerous factors, including without
limitation, whether or not the holders of the Notes elect to convert such Notes
into our common stock, general economic conditions and conditions in the
financial services industry in particular, the level and timing of product,
services and patent licensing revenues and income, the maintenance of our cost
control measures structured to align operations with predictable revenues, the
costs and timing of our product development efforts and the success of these
development efforts, the costs and timing of our sales, partnering and marketing
activities, the extent to which our existing and new products gain market
acceptance, competing technological and market developments, and the costs
involved in maintaining, defending and enforcing patent claims and other
intellectual property rights, all of which may impact our ability to achieve and
maintain profitability or generate positive cash flows.




From time to time, we may be required to raise
additional funds through public or private financing, strategic relationships or
other arrangements. There can be no assurance that such funding, if needed, will
be available on terms attractive to us, or at all. Furthermore, any additional
debt or equity financing arrangements may be dilutive to stockholders, and debt
financing, if available, may involve restrictive covenants. Strategic
arrangements, if necessary to raise additional funds, may require us to
relinquishsome or all ofour rights to certain of our technologies or products.
Ourpotential inabilityto raise capital when needed could have a material
adverse effect on our business, operating results and financial
condition.




Recent
Accounting Pronouncements




See Note 10 to our unaudited condensed consolidated
financial statements included in this report for recently issued accounting
standards, including the expected dates of adoption and estimated effects on our
condensed consolidated financial statements.






Item
3.                      Quantitative and QualitativeDisclosures about Market
Risk




As a
“smaller reporting company” as defined by Regulation S-K, the Company is not
required to provide information required by this item.




24




Item
4T.                    Controls and
Procedures




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




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






PART II - OTHER
INFORMATION




Item
1.                        Legal
Proceedings




We are
not currently party to any legal proceedings and are not aware of any threatened
legal proceedings against us.




From time
to time we may encounter other claims in the normal course of business that are
not expected to have a material effect on our business.  However,
dispute resolution is inherently unpredictable, and the costs and other effects
of pending or future claims, litigation, legal and administrative cases and
proceedings, and changes in any such matters, and developments or assertions by
or against us relating to intellectual property rights and intellectual property
licenses, could have a material adverse effect on our business, financial
condition and operating results.




Item 1A.                     Risk Factors




This Quarterly Report on Form 10-Q, or Form 10-Q,
including any information incorporated by reference herein, contains
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, referred to as the Securities Act, and Section 21E of
the Securities Exchange Act of 1934, as amended, referred to as the Exchange
Act.  In some cases, you can identify forward-looking statements by
terms such as “may,” “will,” “should,” “expect,” “plan,” “intend,” “forecast,”
“anticipate,” “believe,” “estimate,” “predict,” “potential,” “continue” or the
negative of these terms or other comparable terminology.  The
forward-looking statements contained in this Form 10-Q involve known and unknown
risks, uncertainties and situations that may cause our or our industry’s actual
results, level of activity, performance or achievements to be materially
different from any future results, levels of activity, performance or
achievements expressed or implied by these statements.  These factors
include those listed below in this Item 1A and those discussed elsewhere in this
Form 10-Q.  We encourage investors to review these factors
carefully.  We may from time to time make additional written and oral
forward-looking statements, including statements contained in our filings with
the SEC.  However, we do not undertake to update any forward-looking
statement that may be made from time to time by or on behalf of
us.




Before you invest in our securities, you should be aware
that our business faces numerous financial and market risks, including those
described below, as well as general economic and business risks.  The
following discussion provides information concerning the material risks and
uncertainties that we have identified and believe may adversely affect our
business, our financial condition and our results of
operations.  Before you decide whether to invest in our securities,
you should carefully consider these risks and uncertainties, together with all
of the other information included in this Quarterly Report on Form 10-Q, our
Annual Report on Form 10-K for the year ended December 31, 2008 and in our other
public filings.




This risks set forth below include any material changes
to and supersedes the description of the risk factors associated with our
business previously disclosed in Part I, Item 1A of our Annual Report on Form
10-K for the year ended December 31, 2008.






25




Risks Relating to the Stock Markets and Our Stock
Price




Our Stock is quoted on the Pink Sheets, which may
decrease the liquidity of our common stock.




On June 24, 2009, the Nasdaq Stock Market, Inc.
suspended our common stock from trading on Nasdaq because we did not evidence a
market value of listed securities above $35 million for ten consecutive trading
days, or otherwise demonstrate compliance with alternative continued listing
standards, during the period from April 2, 2009 and June 22,
2009.  Since that time our common stock has been quoted on the Pink
Sheets under the symbol AVSR.PK.  Broker-dealers often decline to
trade in Pink Sheet stocks given that the market for such securities is often
limited, the stocks are more volatile, and the risk to investors is greater than
with stocks listed on other national securities exchanges. Consequently, selling
our common stock can be difficult because smaller quantities of shares can be
bought and sold, transactions can be delayed and news media coverage of our
Company may be reduced. These factors could result in lower prices and larger
spreads in the bid and ask prices for shares of our common stock as well as
lower trading volume. We requested a review of our suspension by the Nasdaq
Listing and Hearing Review Council.  There is no assurance that we
will be successful in these efforts.  Investors should realize that
they may be unable to sell shares of our common stock that they purchase.
Accordingly, investors must be able to bear the financial risks associated with
losing their entire investment in our common stock.




Our common stock may be subject to penny stock rules,
which may make it more difficult for our stockholders to sell their common
stock.




Our common stock may be considered a “penny stock”
pursuant to Rule 3a51-1 of the Exchange Act. Broker-dealer practices in
connection with transactions in penny stocks are regulated by certain penny
stock rules adopted by the SEC. Penny stocks generally are defined as equity
securities with a price of less than $5.00 per share. The penny stock rules
require a broker-dealer, prior to purchase or sale of a penny stock not
otherwise exempt from the rules, to deliver to the customer a standardized risk
disclosure document that provides information about penny stocks and the risks
associated with the penny stock market. The broker-dealer also must provide the
customer with current bid and offer quotations for the penny stock, the
compensation of the broker-dealer and its salesperson in the transaction, and
monthly account statements showing the market value of each penny stock held in
the customer account. In addition, the penny stock rules generally require that,
prior to a transaction in a penny stock, the broker-dealer make a special
written determination that the penny stock is a suitable investment for the
purchaser and receive the purchaser’s written agreement to the transaction.
These disclosure requirements may have the effect of reducing the level of
trading activity in the secondary market of a stock that becomes subject to the
penny stock rules.




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




We recorded a net loss of $566,000 for the six months
ended June 30, 2009, a net loss of $6.4 million for fiscal year 2008 and a net
loss of $2.9 million for fiscal year 2007. As of June 30, 2009, our accumulated
deficit was $112.7 million. Our revenue and income from settlement and patent
licensing may not increase, or even remain at its current level. In addition,
our operating expenses, which have been reduced recently, may increase as we
continue to develop our business and pursue licensing opportunities. As a
result, to become profitable, we will need to increase our revenue and income
from settlement and patent licensing by increasing sales to existing customers
and by attracting additional new customers, distribution partners and licensees.
If our revenue does not increase adequately, we may not become profitable. Due
to the volatility of our product and licensing revenue and our income from
settlement and patent licensing activities, we may not be able to achieve,
sustain or increase profitability on a quarterly or annual basis. If we fail to
achieve or to maintain profitability or to sustain or grow our profits within
the time frame expected by investors, the market price of our common stock may
be adversely impacted.




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




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




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




•      quarterly
variations in our results of operations;




•      announcements
regarding our product developments;




•      the size and timing
of agreements to license our patent portfolio or enter into technology or
distribution partnerships;




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




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




•      announcements of
competitive product introductions by our competitors;




•      changes in the
status of our listing on the Nasdaq Capital Market;




•      limited trading
volume of shares; and,




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




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




26


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




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




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




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




Our executive officers, directors and entities
affiliated with them, in the aggregate, beneficially owned approximately 64% of
our common stock as of June 30, 2009. If they were to act together, these
stockholders would be able to exercise control over most matters requiring
approval by our stockholders, including the election of directors and approval
of significant corporate transactions. These actions may be taken even if they
are opposed by other investors. This concentration of ownership may also have
the effect of delaying or preventing a change in control of Avistar, which could
cause the market price of our common stock to decline.




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.




Risks Related to Our Business




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




We may need to arrange for the availability of
additional funding in order to meet our future business requirements. We have a
revolving credit facility under which $5.1 million was outstanding on June 30,
2009, which matures on December 21, 2009, and $4.1 million in outstanding
convertible promissory notes that become due and payable on January 4, 2010 if
not earlier converted. If we are unable to obtain additional funding when needed
on acceptable terms, we may not be able to develop or enhance our products, take
advantage of opportunities, respond to competitive pressures or unanticipated
requirements, or finance our efforts to protect and enforce our intellectual
property rights, which could seriously harm our business, financial condition,
results of operations and ability to continue operations.  We have in
the past, and may in the future, reduce our expenditures by reducing our
employee headcount in order to better align our expenditures with our available
resources.  Any such reductions may adversely affect our ability to
maintain or grow our business.





27




We have implemented significant changes in our
organizational structure, sales, marketing and distribution strategies,
licensing efforts and strategic direction, which, if unsuccessful, could
adversely affect our business and results of operations.




In July 2009, Simon Moss voluntarily resigned from all
of the positions which he held with our Company, including his positions as
Chief Executive Officer and board member.  Shortly thereafter, Robert
Kirk was appointed to replace Simon Moss as the Company’s Chief Executive
Officer.  Previously, in July 2007, Simon Moss had been appointed as
President of the products division of our Company.  In September 2007,
William Campbell resigned from the position of Chief Operating Officer, and on
January 1, 2008 Gerald Burnett resigned from his position as our Chief Executive
Officer and was replaced in that position by Simon Moss.  In January
2009, Bob Habig resigned from the position of Chief Financial Officer and he was
replaced in that position by Elias MurrayMetzger, the Company's Corporate
Controller.  In addition, during the second half of 2007 and in 2008,
we implemented a number of other management changes.  In 2007 and
2008, we implemented an intensive set of corporate initiatives aimed at
increasing our product sales, expanding our customer deployments and support,
improving our corporate efficiency and increasing our development
capacity.  The components of this initiative
included:




•
            Supplementing our position in the financial
      services vertical by expanding our market focus to additional verticals
      through indirect distribution partners, where our collaboration products
      can help global organizations speed business processes, save costs and
      reduce their carbon footprints;




•
            Implementing aggressive cost control measures
      structured to effectively align operations  with predictable
      revenues and to address Microsoft's requests for re-examination of our
      U.S. Patents, while still allowing us to continue to invest in our product
      line and to license our intellectual property and
      technology;




•      A reduction in our
employees from an average of 88 in 2007 to approximately 51 at June 30, 2009;
and




•      Pursuing multiple
distribution, services and technology licensing partners.




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




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




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




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




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




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




28


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




To date, a significant portion of our revenue and income
from settlement and patent licensing has resulted from sales or licenses to a
limited number of customers. For the six months ended June 30, 2009, revenue
from three customers accounted for 74% of total revenue. For the six months
ended June 30, 2008, revenue from three customers accounted for 90% of total
revenue. No other customer accounted for greater than 10% of total
revenue. As of June 30, 2009, approximately 91% of the Company’s gross
accounts receivable was concentrated with three customers, each of whom
represented more than 10% of the total gross accounts receivable. As of December
31, 2008, approximately 98% of our gross accounts receivable was concentrated
with four customers, each of whom represented more than 10% of our gross
accounts receivable.




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




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




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




•      rapid technological
change;




•      the emergence of
new competitors;




•      significant
development costs;




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




•      integration of
joint solutions in collaboration platforms;




•      evolving industry
standards;




•      transition from
hardware appliances and infrastructure to software; and




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




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




Difficulties or delays in integrating our products with
technology partner’s products could harm our revenue and
margins.




We generally recognize initial product and installation
revenue upon the installation of our system in those cases where we are
responsible for installation, which often entails working with sophisticated
software and computing and communications systems. Under certain circumstances
initial product and installation revenue is recognized under the percentage of
completion method. The estimate of current period percentage of completion
requires significant management judgment and is subject to updates in future
periods until the project is complete. If we experience difficulties with
installations or do not meet deadlines due to delays caused by our customers or
ourselves, we could be required to devote more customer support, technical,
engineering and other resources to a particular installation, modification or
enhancement project, and revenue may be delayed.




29


Competition could reduce our market share and decrease
our revenue.




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




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




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




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




The U.S. and global economy has entered a recession and
our customers and potential customers, partners and distributors may delay or
forego ordering our products, and we could fall short of our revenue
expectations for 2009 and beyond. Slower growth among our customers, tightening
of customers’ operating budgets, retrenchment in the capital markets and other
general economic factors all have had, and could in the future have, a
materially adverse effect on our revenue, capital resources, financial condition
and results of operations.




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




Because our licensing cycle is a lengthy process, the
accurate prediction of future revenues and income from settlement and patent
licensing from new licensees is difficult. The process of persuading companies
to adopt our technologies, or convincing them that their products infringe upon
our intellectual property rights, can be lengthy. The reexamination of our
patents by the USPTO as described below or other challenges to our patent
portfolio further complicate and delay our patent licensing
efforts.  There is also a tendency in the technology industry to close
business deals at the end of a quarter, thereby increasing the likelihood that a
possible material deal would not be concluded in a current quarter, but slip
into a subsequent reporting period. This kind of delay may result in a given
quarter’s performance being below analyst or shareholder expectations. The
proceeds of our intellectual property licensing and enforcement efforts tend to
be sporadic and difficult to predict. Recognition of those proceeds as revenue
or income from settlement and licensing activities depends on the terms of the
license agreement involved, and the circumstances surrounding the agreement. To
finance litigation to defend or enforce our intellectual property rights, we may
enter into contingency arrangements and other strategic transactions with
investors, legal counsel or other advisors that would give such parties a
significant portion of any future licensing and settlement amounts derived from
our patent portfolio. As a result, our licensing and enforcement efforts are
expected to result in significant volatility in our quarterly and annual
financial condition and results of operations, which may result in us missing
investor expectations, which may cause our stock price to
decline.




30


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




On February 25, 2008 we announced that Microsoft
Corporation had filed requests for re examination of 24 of our 29 U.S.
patents.  Subsequently, Microsoft also filed requests for
re-examination of our remaining five U.S. patents.  On June 10, 2008
we announced that the USPTO had completed its review of Microsoft's requests for
re examination and had rejected 19 of the re-examination applications in their
entirety, and the majority of the arguments for one additional
application.  The USPTO agreed to re-examine, either in part or fully,
10 of our existing patents.




During 2008, Microsoft submitted five petitions for
reconsideration of the USPTO’s rejection of Microsoft’s re-examination
applications.  As of July 31, 2009, two of the Microsoft petitions
were denied by USPTO. These denials are final and cannot be appealed. The three
other petitions by Microsoft are still pending.




During the first half of 2009, we responded to the USPTO
on the 10 patents in re-examination. As of July 31, 2009, six of the 10
re-examined patents were rejected to which we have thus far filed three
notices of appeal to the USPTO Board of Appeals. We believe that the remaining
three of the 10 re-examined patents are in condition for allowance and one is
currently under review by the USPTO,




We believe that our U.S. patents are valid and we intend
to defend our patents through the re-examination process.  However,
the re-examination of patents by the USPTO is a lengthy, time consuming and
expensive process in which the ultimate outcome is uncertain.  Once
initiated, the USPTO may take between six months and two years to complete
patent re-examinations. The re-examination process by the USPTO may adversely
impact our licensing negotiations in process, and may require us to spend
substantial time and resources defending our patents, including the fees and
expenses of our legal advisors.  The potential impact to our results
of operations may require us to seek additional financing to fund our operations
and the defense of our patents.




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




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




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




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




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




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




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





31




Our Compliance with the Sarbanes-Oxley Act and SEC rules
concerning internal controls may be time-consuming, difficult and costly for
us.




It may be time consuming, difficult and costly for us to
fully implement internal controls and reporting procedures required by the
Sarbanes-Oxley Act which relate to auditor attestation.  We may need
to hire additional financial reporting, internal control and other finance staff
in order to support the auditor attestation of  appropriate
internal controls and reporting procedures.  If we are unable to
comply with these additional requirements of the Sarbanes-Oxley Act, we may not
be able to obtain the independent accountant certifications/attestations that
the Sarbanes-Oxley Act requires of smaller reporting companies effective for
issuers with fiscal years ending on or after December 15, 2009.




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




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




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




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




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




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




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




If we are unable to expand our indirect distribution
channel, our business will suffer.




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




32


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




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




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




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




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




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




International revenue, which consists of sales to
customers with operations principally in Western Europe and Asia, comprised 31 %
and 52% of total revenues for the six months ended June 30, 2009, and 2008,
respectively. International revenue comprised 51% and 72% of total revenue for
the years ended December 31, 2008 and 2007, respectively.  Some of the
risks we may encounter in conducting international business activities include
the following:




•      tariffs and other
trade barriers;




•      unexpected changes
in foreign regulatory requirements and laws;




•      economic and
political instability;




•      increased risk of
infringement claims;




•      protection of our
intellectual property;




•      restrictions on the
repatriation of funds;




•      potentially adverse
tax consequences;




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




•      fluctuations in
foreign currencies; and




•      limitations in
communications infrastructures in some foreign countries.




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




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




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




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




Not applicable.




Item
3.                      Defaults Upon Senior
Securities




Not applicable.




33




Item
4.                      Submissionof
Matters to a Vote of Security Holders




At our Annual Meeting of Stockholders held June 3, 2009
at our office in San Mateo, California, our stockholders approved the following
two matterswith the
respective vote counts indicated:




1. Election of seven (7) directors of the Company to
serve for the ensuing year and until their successors are elected or until such
director’s earlier resignation or removal.





Nominee
                    
                    For
                    
                    
                    WithheldGerald J. Burnett
                    
                    
                    31,124,671
                    
                    
                    
                    718,257William L. Campbell
                    
                    
                    31,124,671
                    
                    
                    
                    718,257Craig F. Heimark
                    
                    
                    31,777,620
                    
                    
                    
                    65,308R. Stephen Heinrichs
                    
                    
                    30,029,052
                    
                    
                    
                    1,813,876Robert M. Metcalfe
                    
                    
                    31,728,469
                    
                    
                    
                    114,459Simon B. Moss
                    
                    
                    31,250,260
                    
                    
                    
                    592,668James W. Zeigon
                    
                    
                    31,778,170
                    
                    
                    
                    64,758




2. Ratification of the appointment of Burr, Pilger &
Mayer LLP as our independent auditors for the fiscal year ending December 31,
2009.




For
                    
                    
                    Against
                    
                    
                    Withheld31,771,791
                    
                    
                    
                    40,965
                    
                    
                    
                    30,172







Item 5.                      Other
Information




Not applicable.






Item 6.Exhibits





Exhibit Number
            
            Description31.1
            
            Rule 13a-14(a)/15d-14(a)
      Certification by the Chief Executive Officer.31.2
            
            Rule 13a-14(a)/15d-14(a)
      Certification by the Chief Financial Officer.32.1
            
            Certification
      of Chief Executive Officer and Chief Financial Officer Pursuant to 18
      U.S.C. Section 1350, as adopted pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002.





34





SIGNATURES




Pursuant
to the requirements of the Securities and Exchange Act of 1934, the registrant
has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized, on the 4th day of August 2009.





AVISTAR
      COMMUNICATIONS CORPORATIONBy:
            /s/
      Robert F. KirkRobert
      F. KirkChief
      Executive Officer(Principal
      Executive Officer)By:
            /s/
      Elias A. MurrayMetzgerElias
      A. MurrayMetzgerChief
      Financial Officer(Principal
      Financial and Accounting Officer)




35









EXHIBIT
INDEX





Exhibit Number
            
            Description31.1
            
            Rule 13a-14(a)/15d-14(a)
      Certification by the Chief Executive Officer.31.2
            
            Rule 13a-14(a)/15d-14(a)
      Certification by the Chief Financial Officer.32.1
            
            Certification
      of Chief Executive Officer and Chief Financial Officer Pursuant to 18
      U.S.C. Section 1350, as adopted pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002.






36