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 March 31, 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
      xNooIndicate 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
                  Accelerated
      filer o
                    Smaller
      reporting companyxIndicate
      by check mark whether the registrant is a shell company (as defined in
      Rule 12b-2 of the Exchange Act).
                    Yes oNoxAt
      May 1, 2009, 34,756,861 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
              16Item
      3.
              Omitted
              21Item
      4T.
              Controls and Procedures
              21PART
      II.
              OTHER INFORMATION
              21Item
      1.
              Legal Proceedings
              21Item
      1A.
              Risk Factors
              21Item
      2.
              Unregistered Sales of Equity Securities and Use of
      Proceeds
              21Item
      3.
              Defaults Upon Senior
Securities
              21Item
      4.
              Submissions of Matters to a Vote of Security
      Holders
              21Item
      5.
              Other Information
              21Item
      6.
              Exhibits
              21SIGNATURES
              
              22




2





PART I -
FINANCIAL INFORMATION




Item
1.                      Financial
Statements







AVISTAR
COMMUNICATIONS CORPORATION AND SUBSIDIARY




CONDENSED
CONSOLIDATED BALANCE SHEETS




as
of March 31, 2009 and December 31, 2008




(in
thousands, except share and per share data)





March
      31,
                            2009
                          
                          
                          December 31,
                            2008(unaudited)Assets:Current
      assets:Cash
      and cash equivalents
                          
                          $
                          475
                          
                          
                          $
                          4,898Accounts
      receivable, net of allowance for doubtful accounts of $20 at March 31,
      2009 and December 31, 2008, respectively
                          
                          
                          1,307
                          
                          
                          
                          2,701Inventories
                          
                          
                          263
                          
                          
                          
                          307Deferred
      settlement and patent licensing costs
                          
                          
                          782
                          
                          
                          
                          1,100Prepaid
      expenses and other current assets
                          
                          
                          258
                          
                          
                          
                          320Total
      current assets
                          
                          
                          3,085
                          
                          
                          
                          9,326Property
      and equipment, net
                          
                          
                          271
                          
                          
                          
                          310Other
      assets
                          
                          
                          157
                          
                          
                          
                          157Total
      assets
                          
                          $
                          3,513
                          
                          
                          $
                          9,793Liabilities
      and Stockholders’ Equity (Deficit):Current
      liabilities:Line
      of credit
                          
                          $
                          3,600
                          
                          
                          $
                          7,000Convertible
      debt
                          
                          
                          7,000
                          
                          
                          
                          —Accounts
      payable
                          
                          
                          693
                          
                          
                          
                          579Deferred
      income from settlement and patent licensing
                          
                          
                          3,376
                          
                          
                          
                          4,751Deferred
      services revenue and customer deposits
                          
                          
                          1,906
                          
                          
                          
                          3,687Accrued
      liabilities and other
                          
                          
                          1,313
                          
                          
                          
                          1,382Total
      current liabilities
                          
                          
                          17,888
                          
                          
                          
                          17,399Long-term
      liabilities:Long-term
      convertible debt
                          
                          
                          —
                          
                          
                          
                          7,000Other
      liabilities
                          
                          
                          27
                          
                          
                          
                          23Total
      liabilities
                          
                          
                          17,915
                          
                          
                          
                          24,422Commitments
      and contingencies (Note 9)Stockholders’
      equity (deficit):Common
      stock, $0.001 par value; 250,000,000 shares authorized at March 31, 2009
      and December 31, 2008; 35,939,736 and 35,750,680 shares issued
      including treasury shares at March 31, 2009 and December 31, 2008,
      respectively
                          
                          
                          36
                          
                          
                          
                          36Less:
      treasury common stock, 1,182,875 shares at March 31, 2009 and
      December 31, 2008, at cost
                          
                          
                          (53
                          )
                          
                          
                          (53
                          )Additional
      paid-in-capital
                          
                          
                          98,148
                          
                          
                          
                          97,506Accumulated
      deficit
                          
                          
                          (112,533
                          )
                          
                          
                          (112,118
                          )Total
      stockholders’ equity (deficit)
                          
                          
                          (14,402
                          )
                          
                          
                          (14,629
                          )Total
      liabilities and stockholders’ equity (deficit)
                          
                          $
                          3,513
                          
                          
                          $
                          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 months ended March 31, 2009 and 2008




(in
thousands, except per share data)








Three
      Months EndedMarch
      31,
                
                
                March
      31,2009
                
                
                2008(unaudited)Revenue:Product
                
                $
                1,347
                
                
                $
                249Licensing
                
                
                120
                
                
                
                154Services,
      maintenance and support
                
                
                1,163
                
                
                
                748Total
      revenue
                
                
                2,630
                
                
                
                1,151Costs
      and Expenses:Cost
      of product revenue*
                
                
                375
                
                
                
                359Cost
      of services, maintenance and support revenue*
                
                
                802
                
                
                
                519Income
      from settlement and patent licensing
                
                
                (1,057
                )
                
                
                (1,057
                )Research
      and development*
                
                
                911
                
                
                
                1,851Sales
      and marketing*
                
                
                723
                
                
                
                1,329General
      and administrative*
                
                
                1,223
                
                
                
                1,878Total
      costs and expenses
                
                
                2,977
                
                
                
                4,879Loss
      from operations
                
                
                (347
                )
                
                
                (3,728
                )Other
      (expense) income:Interest
      income
                
                
                6
                
                
                
                46Other
      (expense) income, net
                
                
                (74
                )
                
                
                (85
                )Total
      other (expense) income, net
                
                
                (68
                )
                
                
                (39
                )Net
      loss
                
                $
                (415
                )
                
                $
                (3,767
                )Net
      loss per share - basic and diluted
                
                $
                (0.01
                )
                
                $
                (0.11
                )Weighted
      average shares used in calculatingbasic
      and diluted net loss per share
                
                
                34,698
                
                
                
                34,532





*Including
      stock based compensation of:Cost
      of product, services, maintenance and support revenue
                
                $
                60
                
                
                $
                7Research
      and development
                
                
                167
                
                
                
                63Sales
      and marketing
                
                
                56
                
                
                
                (36
                )General
      and administrative
                
                
                199
                
                
                
                113









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


4





AVISTAR
COMMUNICATIONS CORPORATION AND SUBSIDIARY




CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS




for
the three months ended March 31, 2009 and 2008




(in
thousands)







Three Months EndedMarch
      31
                
                
                March
      312009
                
                
                2008(unaudited)Cash
      Flows from Operating Activities:Net
      loss
                
                $
                (415
                )
                
                $
                (3,767
                )Adjustments
      to reconcile net loss to net cash used in operating
      activities:Depreciation
                
                
                59
                
                
                
                131Stock
      based compensation for options issued to consultants and
      employees
                
                
                482
                
                
                
                147Provision
      for doubtful accounts
                
                
                —
                
                
                
                10Changes
      in assets and liabilities:Accounts
      receivable
                
                
                1,394
                
                
                
                (195
                )Inventories
                
                
                44
                
                
                
                (64
                )Prepaid
      expenses and other current assets
                
                
                62
                
                
                
                11Deferred
      settlement and patent licensing costs
                
                
                318
                
                
                
                318Other
      assets
                
                
                —
                
                
                
                (2
                )Accounts
      payable
                
                
                114
                
                
                
                (325
                )Deferred
      income from settlement and patent licensing and other
                
                
                (1,371
                )
                
                
                (1,376
                )Deferred
      services revenue and customer deposits
                
                
                (1,781
                )
                
                
                (160
                )Accrued
      liabilities and other
                
                
                (69
                )
                
                
                450Net
      cash used in operating activities
                
                
                (1,163
                )
                
                
                (4,822
                )Cash
      Flows from Investing Activities:Maturities
      of short-term investments
                
                
                —
                
                
                
                799Purchase
      of property and equipment
                
                
                (20
                )
                
                
                (35
                )Net
      cash (used in) provided by investing activities
                
                
                (20
                )
                
                
                764Cash
      Flows from Financing Activities:Line
      of credit payments
                
                
                (3,900
                )
                
                
                (1.100
                )Proceeds
      from line of credit
                
                
                500
                
                
                
                7,000Net
      proceeds from issuance of common stock
                
                
                160
                
                
                
                56Net
      cash (used in) provided by financing activities
                
                
                (3,240
                )
                
                
                5,956Net
      (decrease) increase in cash and cash equivalents
                
                
                (4,423
                )
                
                
                1,898Cash
      and cash equivalents, beginning of period
                
                
                4,898
                
                
                
                4,077Cash
      and cash equivalents, end of period
                
                $
                475
                
                
                $
                5,975









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


5





AVISTAR
COMMUNICATIONS CORPORATION AND SUBSIDIARY


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)




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




Business




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 March 31, 2009, the
unaudited condensed consolidated results of operations for the three months
ended March 31, 2009 and 2008 and the unaudited condensed consolidated cash
flows for the three months ended March 31, 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 $112.5 million as of March 31,
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 March 31, 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 March 31, 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 March 31,
2009 and December 31, 2008.




Cash and
cash equivalents consisted of cash and money market funds of $475,000 and $4.9
million at March 31, 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 months ended March 31, 2009 and 2008.
Revenues from these customers as a percentage of total revenues were as follows
for the three months ended March 31, 2009 and 2008:




Three Months Ended March
      31,2009
                          
                          
                          2008(Unaudited)Customer
      A
                          
                          
                          40
                          %
                          
                          
                          —Customer
      B
                          
                          
                          14
                          %
                          
                          
                          —Customer
      C
                          
                          
                          12
                          %
                          
                          
                          54
                          %Customer
      D
                          
                          
                          12
                          %
                          
                          
                          —Customer
      E
                          
                          
                          *
                          %
                          
                          
                          20
                          %Customer
      F
                          
                          
                          *
                          %
                          
                          
                          13
                          %





* 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
March 31, 2009, the Company had cash and cash equivalents on deposit with a
major financial institution that were in excess of FDIC insured limits.
Historically, the Company has not experienced any loss of its cash and cash
equivalents due to such concentration of credit risk. Concentrations of credit
risk with respect to trade receivables relate to those trade receivables from
both United States and foreign entities, primarily in the financial services
industry. As of March 31, 2009, approximately 75% of our gross accounts
receivable was concentrated with three customers, each of whom represented more
than 10% of our 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. No other customer individually accounted for greater than 10% of
total accounts receivable as of March 31, 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.




Inventories




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




March
      31,
                  2009
                
                
                December 31,
                  2008(Unaudited)Raw
      materials and subassemblies
                
                $
                10
                
                
                $
                10Finished
      goods
                
                
                253
                
                
                
                297Total
      Inventories
                
                $
                263
                
                
                $
                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.




8




·
            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.




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 March 31, 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.




9




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 quarter ended March 31, 2009, the Company has
recognized $883,000 in product revenue and $177,000 in service revenue. The
remaining $2.7 million is expected to be recognized in product and service
revenue under the percentage of completion method over the remaining projected
development time of 9 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.




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.




10




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 March 31, 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. In the quarter ended March 31, 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.




The
effect of recording stock-based compensation for the three months ended March
31, 2009 and 2008 was as follows (in thousands):




Three Months EndedMarch
      31,2009
                        
                        2008(Unaudited)Stock-based
      compensation expense by type of award:Employee
      stock options
                        
                        $
                        476
                        
                        
                        $
                        154Non-employee
      stock options
                        
                        
                        1
                        
                        
                        
                        3Employee
      stock purchase plan
                        
                        
                        5
                        
                        
                        
                        (10
                        )Total
      stock-based compensation
                        
                        
                        482
                        
                        
                        
                        147Tax
      effect of stock-based compensation
                        
                        
                        —
                        
                        
                        
                        —Net
      effect of stock-based compensation on net income (loss)
                        
                        $
                        482
                        
                        
                        $
                        147




As of
March 31, 2009, the Company had an unrecognized stock-based compensation balance
related to stock options of approximately $3.2 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
39% for non-executive options. Accordingly, as of March 31, 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 $2.0 million after estimated forfeitures and after actual
cancellations. This amount will be recognized over an estimated weighted average
period of 2.2 years. For the three months ended March 31, 2009 and 2008, the
Company granted 378,000 and 499,000 stock options to employees, with an
estimated total grant-date fair value of $255,000 and $335,000, or $0.67 and
$0.67 per share, respectively.




Valuation
Assumptions




The
Company estimated the fair value of stock options granted during the three
months ended March 31, 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 of the three months ended March 31, 2009 and 2008,
respectively:




Three
      Months Ended March 31,2009
                    
                    
                    2008Employee Stock Option PlanExpected
      dividend
                    
                    
                    —
                    
                    %
                    
                    
                    —
                    
                    %Average
      risk-free interest rate
                    
                    
                    1.4
                    
                    %
                    
                    
                    3.0
                    
                    %Expected
      volatility
                    
                    
                    109
                    
                    %
                    
                    
                    131
                    
                    %Expected
      term (years)
                    
                    
                    4.0
                    
                    
                    
                    
                    6.1






11





Three
      Months Ended March 31,2009
                    
                    
                    2008Employee Stock Purchase PlanExpected
      dividend
                    
                    
                    —
                    
                    %
                    
                    
                    —
                    
                    %Average
      risk-free interest rate
                    
                    
                    0.4
                    
                    %
                    
                    
                    2.2
                    
                    %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 months ended March 31, 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 months ended March 31, 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.




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 comprehensive loss was $415,000
and $3.8 million for the three months ended March 31, 2009 and 2008,
respectively.




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


Three Months EndedMarch
      31,2009
                        
                        
                        2008(Unaudited)Net
      loss
                        
                        $
                        (415
                        )
                        
                        $
                        (3,767
                        )Other
      comprehensive income (loss)
                        
                        
                        —
                        
                        
                        
                        —Total
      comprehensive loss
                        
                        $
                        (415
                        )
                        
                        $
                        (3,767
                        )




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 March 31, 2009 (in
thousands):




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






12





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 March 31, 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 8% and 20% of the Company’s total
revenue for the three months ended March 31, 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 March
31, 2009 and December 31, 2008, the Company had accounts receivable outstanding
from UBS Warburg LLC and its affiliates of approximately $53,000 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.  See Note 8
for further details.






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 ended
March 31, 2008 and 2009, 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 March 31, 2009 and 2008
was 290,044 and 298,471, respectively.




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




Three Months Ended March
      31,2009
                
                
                2008(Unaudited)Numerator
      – basic and diluted:Net
      loss
                
                $
                (415
                )
                
                $
                (3,767
                )Denominator
      – basic and diluted:Weighted
      average shares of common stock used in computing net loss per
      share
                
                
                34,698
                
                
                
                34,532Net
      loss per share – basic and diluted
                
                $
                (0.01
                )
                
                $
                (0.11
                )




6.
Income Taxes




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




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




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




As of
December 31, 2008, the Company has 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.






13




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 March 31, 2009 (unaudited)Revenue
                
                $
                1,177
                
                
                $
                2,510
                
                
                $
                (1,057
                )
                
                $
                2,630Depreciation
      expense
                
                
                —
                
                
                
                (59
                )
                
                
                —
                
                
                
                (59
                )Total
      costs and expenses
                
                
                (360
                )
                
                
                (3,674
                )
                
                
                1,057
                
                
                
                (2,977
                )Interest
      income
                
                
                —
                
                
                
                6
                
                
                
                —
                
                
                
                6Interest
      expense
                
                
                —
                
                
                
                (132
                )
                
                
                —
                
                
                
                (132
                )Net
      income (loss)
                
                
                817
                
                
                
                (1,232
                )
                
                
                —
                
                
                
                (415
                )Assets
                
                
                1,394
                
                
                
                2,119
                
                
                
                —
                
                
                
                3,513Three
      Months Ended March 31, 2008 (unaudited)Revenue
                
                $
                1,211
                
                
                $
                997
                
                
                $
                (1,057
                )
                
                $
                1,151Depreciation
      expense
                
                
                —
                
                
                
                (131
                )
                
                
                —
                
                
                
                (131
                )Total
      costs and expenses
                
                
                (771
                )
                
                
                (5,165
                )
                
                
                1,057
                
                
                
                (4,879
                )Interest
      income
                
                
                —
                
                
                
                46
                
                
                
                —
                
                
                
                46Interest
      expense
                
                
                —
                
                
                
                (80
                )
                
                
                —
                
                
                
                (80
                )Net
      income (loss)
                
                
                440
                
                
                
                (4,207
                )
                
                
                —
                
                
                
                (3,767
                )Assets
                
                
                2,646
                
                
                
                8,856
                
                
                
                —
                
                
                
                11,502




International
revenue, which consists of sales to customers with operations principally in
Western Europe and Asia, comprised 29% and 52% of total revenues for the three
months ended March 31, 2009 and 2008, respectively. For the three months ended
March 31, 2009 and 2008, international revenues from customers in the United
Kingdom accounted for 24% and 11% of total product and services revenue,
respectively. The Company had no significant long-lived assets in any country
other than in the United States for any period presented.




8.  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 March 31, 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 $500,000 under the revolving line of credit for the three
months ended March 31, 2009, and has a balance of $3.6 million outstanding as of
March 31, 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.




14




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.  From the one-year anniversary of the issuance of the Notes
until maturity, the holders of the Notes will be entitled to convert the Notes
into shares of common stock at an initial conversion price per share of
$0.70.




9.
      Commitments and Contingencies




Software
Indemnifications




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




During
the quarter ended March 31, 2009, the Company responded to the USPTO on the 10
patents in re-examination within the time permitted, and is currently waiting
for the reply from USPTO. The USPTO’s review of the five petitions for
reconsideration is currently in process, with an indeterminate time period
established for their decision on Microsoft’s request.  Once
undertaken, the USPTO may take between six months and two years to complete
patent re-examinations.  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.  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 on January 1,
2009.  The impact of FSP FAS 141(R)-1 on accounting for business
combinations is dependent upon acquisition activity on or after its effective
date.




15




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 expects
to adopt these FSPs for the interim reporting period ending June 30, 2009, and
is currently evaluating the impact of adopting the provisions of these
FSPs.




11.
Other Matters




On November 21, 2008,
the Company received a deficiency letter from The NASDAQ Stock Market indicating
that the Company did not comply with Marketplace Rule 4310(c)(3), which requires
that Avistar have a minimum of $2,500,000 in stockholders’ equity or $35,000,000
in market value of listed securities or $500,000 of net income from continuing
operations for the most recently completed fiscal year or two of the three most
recently completed fiscal years.  Avistar was granted a 30 day grace
period, or until December 22, 2008 to regain compliance with the $35,000,000
provision of the Rule by recording a minimum closing bid price of $1.02 for a
minimum of ten consecutive business days.




On December 24, 2008, the Company received a notice from
The Nasdaq Stock Market stating that Avistar has not regained compliance with
Nasdaq Marketplace Rule 4310(c)(3)(B) and, as a result, Avistar’s securities are
subject to de-listing from The Nasdaq Capital Market unless Avistar appeals the
Nasdaq Staff’s determination to a Nasdaq Listing Qualifications
Panel.




On January 29, 2009, the Company appealed the Nasdaq
Staff’s determination to the Listing Qualifications Panel which automatically
resulted in the stay of the Staff’s de-listing of Avistar’s common
stock.




On April 2, 2009, the Company received a notice from the
Nasdaq Hearings Panel indicating that it has determined to grant Avistar’s
request for continued listing on The Nasdaq Stock Market, subject to certain
conditions. Avistar must maintain a market value ofitslisted
securities above $35 million for ten consecutive trading days, or otherwise
demonstrate compliance with the alternative continued listing standards during
the period from April 2, 2009toJune 22, 2009,
to regain compliance with Nasdaq’s continued listing standards.  If
Avistar is unable to meet the continued listing standards by June 22, 2009, the
Panel will issue a final delisting determination and suspend trading of the
Company’s shares on the second business day after the date of the delisting
determination.




In January 2009, Robert Habig resigned from
theCompany  as itsChief Financial Officer and  Elias
MurrayMetzger, the Company’s Corporate Controllerwas promoted to Acting Chief Financial Officer. On
April 15, 2009, Elias MurrayMetzger was promoted from Acting Chief Financial
Officer to Chief Financial Officer.






Item
2.                      Management’s
Discussion and Analysis of 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.




16




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
March 31, 2009, we held 97 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
      52 on March 31, 2009; and




·
            Pursuing
      multiple distribution, services and technology
  partners.




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.  Subsequently,
Microsoft submitted five petitions for reconsideration of the USPTO’s rejection
of Microsoft’s re-examination applications.




17




During
the quarter ended March 31, 2009, we responded to the USPTO regarding the 10
patents being re-examined within the required time frame, and we are currently
waiting for a response  from the USPTO. The USPTO’s review of the five
petitions for reconsideration is currently in process, with an indeterminate
time period established for their decision on Microsoft’s
request.  Once undertaken, the USPTO may take between six months and
two years to complete patent re-examinations.  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.  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 months ended March 31, 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.




Results
of Operations




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




Percentage of Total RevenueThree
      Months EndedMarch
      31,2009
                                
                                
                                2008Revenue:Product
                                
                                
                                51
                                %
                                
                                
                                22
                                %Licensing
                                
                                
                                5
                                
                                
                                
                                13Services,
      maintenance and support
                                
                                
                                44
                                
                                
                                
                                65Total
      revenue
                                
                                
                                100
                                
                                
                                
                                100Costs
      and Expenses:Cost
      of product revenue
                                
                                
                                14
                                
                                
                                
                                31Cost
      of services, maintenance and support revenue
                                
                                
                                30
                                
                                
                                
                                45Income
      from settlement and patent licensing
                                
                                
                                (40
                                )
                                
                                
                                (92
                                )Research
      and development
                                
                                
                                35
                                
                                
                                
                                161Sales
      and marketing
                                
                                
                                27
                                
                                
                                
                                115General
      and administrative
                                
                                
                                47
                                
                                
                                
                                163Total
      costs and expenses
                                
                                
                                113
                                
                                
                                
                                423Loss
      from operations
                                
                                
                                (13
                                )
                                
                                
                                (323
                                )Other
      income (expense):Interest
      income
                                
                                
                                -
                                
                                
                                
                                4Other
      expense, net
                                
                                
                                (3
                                )
                                
                                
                                (7
                                )Total
      other (expense) income, net
                                
                                
                                (3
                                )
                                
                                
                                (3
                                )Net
      loss
                                
                                
                                (16
                                )%
                                
                                
                                (326
                                )%




COMPARISON
OF THE THREE MONTHS ENDED MARCH 31, 2009 AND 2008




Revenue




Total
revenue increased by $1.5 million or 128%, to $2.6 million for the three month
period ended March 31, 2009, from $1.2 million for the three months ended March
31, 2008, primarily due to increase in software product
revenue.




·
            Product
      revenue increased by $1.1 million or 441%, to $1.3 million for the three
      month period ended March 31, 2009 from $249,000 for the three months ended
      March 31, 2008. The increase was due primarily to software product revenue
      of $883,000 from IBM in the quarter ended March 31,
  2009.




·
            Licensing
      revenue, relating to the licensing of our patent portfolio, decreased by
      $34,000 or 22%, to $120,000 for the three months ended March 31, 2009 from
      $154,000 for the three months ended March 31, 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 $415,000, or 55%, to
      $1.2 million for the three months ended March 31, 2009, from $748,000 for
      the three months ended March 31, 2008.  The increase was due
      primarily to service revenue of $370,000 and $177,000 from the software
      implementation and enhancement services for LifeSize and IBM,
      respectively, offset by a decrease in revenue from maintenance contracts
      with existing customers in the quarter ended March 31,
    2009.




For the
three months ended March 31, 2009, revenue from four customers accounted for 78%
of total revenue compared to three customers and 87% for the three months ended
March 31, 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.




18




Costs
      and expenses




Cost of product revenue.Cost of product revenue
increased by $16,000 or 4%, to $375,000 for the three months ended March 31,
2009 from $359,000 for the three months ended March 31, 2008.  The
increase was mainly attributable to  an increase of $53,000 in stock
based compensation expense, offset by lower hardware product costs due to the
product mix, in the quarter ended March 31, 2009.




Cost of services, maintenance and
support revenue.Cost of services,
maintenance and support revenue increased by $283,000, or 55%, to $802,000 for
the three months ended March 31, 2009, from $519,000 for the three months ended
March 31, 2008. The increase was primarily due to allocation of labor costs to
software  implementation and enhancement services for IBM and LifeSize
in the quarter ended March 31, 2009 compared to no such project costs for the
same period in 2008.




Income from settlement and patent
licensing.Income from settlement
and patent licensing was $1.1 million for the three months ended March 31, 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 $940,000, or 51%, to $911,000 for the three months ended
March 31, 2009 from $1.9 million for the three months ended March 31,
2008.  This decrease was primarily due to allocation of engineering
employee and external labor expenses to cost of services associated with
software implementation and enhancement services in the quarter ended March 31,
2009 compared to no such project costs for the same period in 2008, and a
reduction in personnel and personnel related expenses partially offset by an
increase of $104,000 in stock based compensation expense.




Sales and marketing. Sales
and marketing expenses decreased by $606,000, or 46%, to $723,000 for the three
months ended March 31, 2009, from $1.3 million for the three months ended March
31, 2008. The decrease was due primarily to a reduction in personnel and
personnel related expenses partially offset by an increase of $92,000 in stock
based compensation expense.




General and administrative.
General and administrative expenses decreased by $655,000, or 35% to $1.2
million for the three months ended March 31, 2009, from $1.9 million for the
three months ended March 31, 2008. The decrease was due primarily to a reduction
in legal expense associated with patent prosecution and filing expenses, and a
decrease in personnel and personnel related expenses partially offset by an
increase of $86,000 in stock based compensation expense.




Other
      income (expense)




Interest income. Interest
income decreased by $40,000, or 87%, to $6,000 for the three months ended March
31, 2009, from $46,000 for the three months ended March 31, 2008. The decrease
was 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
three months ended March 31, 2009 compared to the same period in
2008.




Other expense, net. Other
expense, net, decreased by $11,000, or 13%, to $74,000 for the three months
ended March 31, 2009, from $85,000 for the three months ended March 31, 2008.
The decrease was due to recognition of corporate income tax benefit for ASUK,
offset by an increase in interest expense due to higher interest rate during the
three months ended March 31, 2009 compared to the same period in
2008.




Liquidity
and Capital Resources




We had
cash and cash equivalents of $475,000 and $4.9 million as of March 31, 2009 and
December 31, 2008, respectively. For the three months ended March 31, 2009, we
had a net decrease in cash and cash equivalents of $4.4 million. The net cash
used by operations of $1.2 million for the three months ended March 31, 2009
resulted primarily from the net loss of $415,000, a decrease in deferred income
from settlement and patent licensing of $1.4 million, a decrease in deferred
services revenue and customer deposits of $1.8 million, offset by a decrease in
accounts receivable of $1.4 million, an increase in account payable of $114,000,
a decrease in deferred settlement and patent licensing costs of $318,000 and
non-cash expenses of $541,000 .  The net cash used in investing activities
of $20,000 for the three months ended March 31, 2009 was related to purchases of
equipment.  The net cash used in financing activities of $3.2 million
for the three months ended March 31, 2009 related primarily to payments made on
our line of credit of $3.9 million in January 2009, offset by $500,000 of
borrowings on our line of credit in March 2009 and $160,000 in proceeds from the
issuance of common stock under employee stock option and stock purchase
plans.




19




Our
accounts receivable at March 31, 2009 decreased 52% over the balance as of
December 31, 2008 from $2.7 million to $1.3 million mainly due to a $1.0 million
advance billing of services to a customer in December 2008 that was subsequently
collected in January 2009.




At March
31, 2009, we had approximately $2.8 million in minimum commitments under
non-cancelable operating leases net of projected 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 March 31,
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 $500,000 under the revolving line of credit for the three months ended
March 31, 2009 and have a balance of $3.6 million outstanding as of March 31,
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.




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
Agreementbetweenus 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.  From the one year anniversary of the issuance of the Notes
until maturity, the holders of the Notes will be entitled to convert the Notes
into shares of common stock at an initial conversion priceof $0.70per
share.




As of March 31, 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 of March 31, 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 of March
31, 2009.




We are currently in discussions with the holders of the
Notes to convert the Notes into shares of common stock in January 2010 or extend
the term of the Notes.  Assuming thesuccessfulconversion or extension of the Notes in conjunction with
the results of our cost reduction efforts,
includingDr. 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.




20




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
consolidated financial statements.




Item
3.                      Omitted




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




In
addition to the other information set forth in this report, you should carefully
consider the factors discussed in Item 1A – “Risk Factors” in our Annual Report
on Form 10-K for the year ended December 31, 2008, which could materially affect
our business, financial condition or future results of operations. Management
believes that there have been no material changes in our risk factors from those
disclosed in our Annual Report on Form 10-K for the year ended December 31,
2008.




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




Not
applicable.




Item
3.                     Defaults
Upon Senior Securities




Not
applicable.




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




Not
applicable.




Item
5.                     Other
Information




Not applicable.




Item 6.Exhibits





Exhibit No.
            
            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.







21








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 8th day of May
2009.





AVISTAR COMMUNICATIONS
    CORPORATIONBy:
            /s/ Simon
      B. MossSimon B. MossChief Executive Officer(Principal Executive
Officer)By:
            /s/ Elias
      A. MurrayMetzgerElias A. MurrayMetzgerChief Financial Officer(Principal Financial and Accounting
      Officer)






22




EXHIBIT
INDEX
 
 Exhibit No.
              
              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.