UNITED
STATES




SECURITIES
AND EXCHANGE COMMISSION




WASHINGTON,
D.C. 20549




FORM
10-Q






            
            QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
              SECURITIES
      AND EXCHANGE ACT OF 1934For
      the quarterly period ended September 30, 2008OR
            
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
              SECURITIES
      AND EXCHANGE ACT OF 1934For
      the transition period from
                
      toCommission
      file number: 000-31121






AVISTAR
COMMUNICATIONS CORPORATION




(Exact
name of registrant as specified in its charter)





DELAWARE
            
            88-0463156(State
      or other jurisdiction
            
            (I.R.S.
      Employer Identification Number)of
      incorporation or organization)1875 SOUTH GRANT STREET,
      10 THFLOOR, SAN MATEO, CA
      94402(Address
      of Principal Executive Office) (Zip Code)Registrant’s
      telephone number, including area code: (650)
      525-3300




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




Yes xNo 




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





Large accelerated filer 
            
            Accelerated
      filer 




Non-accelerated
      filer 
            
            Smaller reporting
      company x




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




Yes 
      No x




At
November 10, 2008, 34,567,805 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
              14Item
      3.
              Intentionally
      OmittedItem
      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
              29Item
      3.
              Defaults Upon Senior
      Securities
              29Item
      4.
              Submissions of Matters to a Vote of Security
      Holders
              29Item
      5.
              Other Information
              29Item
      6.
              Exhibits
              30SIGNATURES
              
              31




Page
2





`PART I - FINANCIAL
INFORMATION




Item 1.Financial
Statements







AVISTAR
COMMUNICATIONS CORPORATION AND SUBSIDIARY




CONDENSED
CONSOLIDATED BALANCE SHEETS




as
of September 30, 2008 and December 31, 2007




(in
thousands, except share and per share data)





September 30,
      2008
                
                
                December 31,
      2007(unaudited)Assets:Current
      assets:Cash
      and cash equivalents
                
                $
                4,444
                
                
                $
                4,077Short-term
      investments
                
                
                —
                
                
                
                799Total
      cash, cash equivalents and short-term investments
                
                
                4,444
                
                
                
                4,876Accounts
      receivable, net of allowance for doubtful accounts of $43 and $24 at
      September 30, 2008 and December 31, 2007,
respectively
                
                
                4,070
                
                
                
                1,385Inventories
                
                
                434
                
                
                
                428Deferred
      settlement and patent licensing costs
                
                
                1,256
                
                
                
                1,256Prepaid
      expenses and other current assets
                
                
                233
                
                
                
                462Total
      current assets
                
                
                10,437
                
                
                
                8,407Property
      and equipment, net
                
                
                442
                
                
                
                767Long-term
      deferred settlement and patent licensing costs
                
                
                162
                
                
                
                1,117Other
      assets
                
                
                205
                
                
                
                286Total
      assets
                
                $
                11,246
                
                
                $
                10,577Liabilities
      and Stockholders’ Equity (Deficit):Current
      liabilities:Line
      of credit
                
                $
                7,000
                
                
                $
                5,100Accounts
      payable
                
                
                892
                
                
                
                1,287Deferred
      income from settlement and patent licensing
                
                
                5,520
                
                
                
                5,520Deferred
      services revenue and customer deposits
                
                
                3,725
                
                
                
                2,231Accrued
      liabilities and other
                
                
                1,468
                
                
                
                1,451Total
      current liabilities
                
                
                18,605
                
                
                
                15,589Long-term
      liabilities:Long-term
      convertible debt
                
                
                7,000
                
                
                
                —Long-term
      deferred income from settlement and patent licensing
                
                
                612
                
                
                
                4,814Total
      liabilities
                
                
                26,217
                
                
                
                20,403Commitments
      and contingencies (Note 9)Stockholders’
      equity (deficit):Common
      stock, $0.001 par value; 250,000,000 shares authorized at
      September 30, 2008 and December 31, 2007; 35,750,680 and
      35,678,807 shares issued including treasury shares at September 30,
      2008 and December 31, 2007, respectively
                
                
                36
                
                
                
                36Less:
      treasury common stock, 1,182,875 shares at September 30, 2008 and
      December 31, 2007, at cost
                
                
                (53
                )
                
                
                (53
                )Additional
      paid-in-capital
                
                
                96,933
                
                
                
                95,925Accumulated
      deficit
                
                
                (111,887
                )
                
                
                (105,734
                )Total
      stockholders’ equity (deficit)
                
                
                (14,971
                )
                
                
                (9,826
                )Total
      liabilities and stockholders’ equity (deficit)
                
                $
                11,246
                
                
                $
                10,577






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


Page
3





AVISTAR
COMMUNICATIONS CORPORATION AND SUBSIDIARY




CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS




for
the three and nine months ended September 30, 2008 and 2007




(in
thousands, except per share data)








Three
      Months Ended
                
                
                Nine
      Months EndedSeptember
      30,
                
                
                September
      30,
                
                
                September
      30,
                
                
                September
      30,2008
                
                
                2007
                
                
                2008
                
                
                2007(unaudited)
                
                
                (unaudited)Revenue:Product
                
                $
                1,313
                
                
                $
                555
                
                
                $
                2,115
                
                
                $
                2,517Licensing
                
                
                367
                
                
                
                313
                
                
                
                674
                
                
                
                4,866Services,
      maintenance and support
                
                
                1,025
                
                
                
                883
                
                
                
                2,857
                
                
                
                2,658Total
      revenue
                
                
                2,705
                
                
                
                1,751
                
                
                
                5,646
                
                
                
                10,041Costs
      and Expenses:Cost
      of product revenue*
                
                
                720
                
                
                
                658
                
                
                
                1,644
                
                
                
                2,098Cost
      of services, maintenance and support revenue*
                
                
                584
                
                
                
                493
                
                
                
                1,706
                
                
                
                1,740Income
      from settlement and patent licensing
                
                
                (1,057
                )
                
                
                (1,057
                )
                
                
                (3,171
                )
                
                
                (15,171
                )Research
      and development*
                
                
                1,122
                
                
                
                2,020
                
                
                
                3,932
                
                
                
                5,517Sales
      and marketing*
                
                
                634
                
                
                
                1,583
                
                
                
                2,752
                
                
                
                4,619General
      and administrative*
                
                
                1,369
                
                
                
                2,217
                
                
                
                4,683
                
                
                
                10,628Total
      costs and expenses
                
                
                3,372
                
                
                
                5,914
                
                
                
                11,546
                
                
                
                9,431(Loss)
      income from operations
                
                
                (667
                )
                
                
                (4,163
                )
                
                
                (5,900
                )
                
                
                610Other
      (Expense) income:Interest
      income
                
                
                15
                
                
                
                93
                
                
                
                82
                
                
                
                307Other
      (expense) income, net
                
                
                (122
                )
                
                
                (56
                )
                
                
                (335
                )
                
                
                (162
                )Total
      other (expense) income, net
                
                
                (107
                )
                
                
                37
                
                
                
                (253
                )
                
                
                145Net
      (loss) income
                
                $
                (774
                )
                
                $
                (4,126
                )
                
                $
                (6,153
                )
                
                $
                755Net
      (loss) income per share - basic and diluted
                
                $
                (0.02
                )
                
                $
                (0.12
                )
                
                $
                (0.18
                )
                
                $
                0.02Weighted
      Average Shares Used in Calculating:Basic
      net (loss) income per share
                
                
                34,561
                
                
                
                34,379
                
                
                
                34,546
                
                
                
                34,238Diluted
      net (loss) income per share
                
                
                34,561
                
                
                
                34,379
                
                
                
                34,546
                
                
                
                35,018





*Including
      Stock Based Compensation of:Cost
      of product, services, maintenance and support revenue
                
                $
                54
                
                
                $
                29
                
                
                $
                80
                
                
                $
                142Research
      and development
                
                
                160
                
                
                
                246
                
                
                
                311
                
                
                
                630Sales
      and marketing
                
                
                72
                
                
                
                176
                
                
                
                (24
                )
                
                
                469General
      and administrative
                
                
                298
                
                
                
                254
                
                
                
                567
                
                
                
                722









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


Page
4





AVISTAR
COMMUNICATIONS CORPORATION AND SUBSIDIARY




CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS




for
the nine months ended September 30, 2008 and 2007




(in
thousands)







Nine Months EndedSeptember
      30,
                
                
                September
      30,2008
                
                
                2007(unaudited)Cash
      Flows from Operating Activities:Net
      (loss) income
                
                $
                (6,153
                )
                
                $
                755Adjustments
      to reconcile net (loss) income to net cash used in operating
      activities:Depreciation
                
                
                404
                
                
                
                279Stock
      based compensation for options issued to consultants and
      employees
                
                
                934
                
                
                
                1,963Provision
      for doubtful accounts
                
                
                19
                
                
                
                3Changes
      in assets and liabilities:Accounts
      receivable
                
                
                (2,704
                )
                
                
                137Inventories
                
                
                (6
                )
                
                
                222Prepaid
      expenses and other current assets
                
                
                229
                
                
                
                63Deferred
      settlement and patent licensing costs
                
                
                955
                
                
                
                955Other
      assets
                
                
                81
                
                
                
                (2
                )Accounts
      payable
                
                
                (395
                )
                
                
                36Deferred
      income from settlement and patent licensing and other
                
                
                (4,202
                )
                
                
                (4,119
                )Deferred
      services revenue and customer deposits
                
                
                1,494
                
                
                
                (765
                )Accrued
      liabilities and other
                
                
                17
                
                
                
                (807
                )Net
      cash used in operating activities
                
                
                (9,327
                )
                
                
                (1,280
                )Cash
      Flows from Investing Activities:Purchase
      of short-term investments
                
                
                —
                
                
                
                (795
                )Maturities
      of short-term investments
                
                
                799
                
                
                
                —Sale
      of property and equipment
                
                
                8
                
                
                
                —Purchase
      of property and equipment
                
                
                (87
                )
                
                
                (800
                )Net
      cash provided by (used in) investing activities
                
                
                720
                
                
                
                (1,595
                )Cash
      Flows from Financing Activities:Line
      of credit payments
                
                
                (5,100
                )
                
                
                —Borrowings
      on line of credit
                
                
                7,000
                
                
                
                —Proceeds
      from debt issuance
                
                
                7,000
                
                
                
                —Net
      proceeds from issuance of common stock
                
                
                74
                
                
                
                353Net
      cash provided by financing activities
                
                
                8,974
                
                
                
                353Net
      increase (decrease) in cash and cash equivalents
                
                
                367
                
                
                
                (2,522
                )Cash
      and cash equivalents, beginning of period
                
                
                4,077
                
                
                
                7,854Cash
      and cash equivalents, end of period
                
                $
                4,444
                
                
                $
                5,332









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


Page
5





AVISTAR
COMMUNICATIONS CORPORATION AND SUBSIDIARY


NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)




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




Business




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




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




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




Basis
of Presentation




The unaudited condensed consolidated
balance sheet as of September 30, 2008, the unaudited condensed consolidated
results of operations for the three and nine months ended September 30, 2008 and
2007 and the unaudited condensed consolidated cash flows for the nine months
ended September 30, 2008 and 2007 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, 2007 was derived from audited financial statements, but does not
contain all disclosures required by accounting principles generally accepted in
the United States of America, and certain information and footnote disclosures
normally included have been condensed or omitted pursuant to the rules and
regulations of the SEC.  The consolidated results are referred to,
collectively, as those of Avistar or the Company in these
notes.




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




The
Company’s fiscal year end is December 31.




Risks
and Uncertainties




The
markets for the Company’s products and services are in the early stages of
development. Some of the Company’s products utilize changing and emerging
technologies. As is typical in industries of this nature, demand and market
acceptance are subject to a high level of uncertainty, particularly when there
are adverse conditions in the economy. Acceptance of the Company’s products,
over time, is critical to the Company’s success. The Company’s prospects must be
evaluated in light of difficulties encountered by it and its competitors in
further developing this evolving marketplace. The Company has generated annual
losses since inception and had an accumulated deficit of $112 million as of
September 30, 2008. The Company’s operating results may fluctuate
significantly in the future as a result of a variety of factors, including, but
not limited to, the economic environment, the adoption of different distribution
channels, the timing of new product announcements by the Company or its
competitors, and the timing of the Company’s licensing and settlement
activities.




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




2.
Summary of Significant Accounting Policies




Unaudited
Interim Financial Information




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




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




Use
of Estimates




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




Page
6


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 September 30, 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
September 30, 2008 and December 31, 2007 consisted of money market funds and
short-term commercial paper with original maturities of three months or less,
and are therefore classified as cash and cash equivalents in the accompanying
balance sheets.




The
Company accounts for its short-term and long-term investments in accordance with
Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for Certain Investments
in Debt and Equity Securities. The Company’s short and long-term
investments in securities are classified as available-for-sale and are reported
at fair value, with unrealized gains and losses, net of tax, recorded in other
comprehensive income (loss). Realized gains or losses and declines in value
judged to be other than temporary, if any, on available-for-sale securities are
reported in other income, net. The Company reviews the securities for
impairments, considering current factors including the economic environment,
market conditions, and the operational performance and other specific factors
relating to the businesses underlying the securities. The Company records
impairment charges equal to the amount that the carrying value of its
available-for-sale securities exceeds the estimated fair market value of the
securities as of the evaluation date. The fair value for publicly held
securities is determined based on quoted market prices as of the evaluation
date. In computing realized gains and losses on available-for-sale securities,
the Company determines cost based on amounts paid, including direct costs such
as commissions to acquire the security using the specific identification method.
The Company did not have any short or long-term investments at September 30,
2008. The Company had no net unrealized losses on its short-term investment
securities at December 31, 2007.




See Note
3 for further information on fair value.




Cash,
cash equivalents and short-term investments consisted of the following at
September 30, 2008 and December 31, 2007 (in thousands):




September
      30, 2008
                      
                      December 31,
      2007(Unaudited)Cash
      and cash equivalents:Cash
      and money market funds
                      
                      $
                      4,444
                      
                      
                      $
                      740Commercial
      paper cash equivalents
                      
                      
                      —
                      
                      
                      
                      3,337Total
      cash and cash equivalents
                      
                      
                      4,444
                      
                      
                      
                      4,077Short-term
      investments:Short-term
      investments (average 27 remaining days to maturity on December 31,
      2007)
                      
                      
                      —
                      
                      
                      
                      799Total
      cash, cash equivalents and short-term investments
                      
                      $
                      4,444
                      
                      
                      $
                      4,876







Significant
Concentrations




A
relatively small number of customers accounted for a significant percentage of
the Company’s revenues for the three and nine months ended September 30, 2008
and 2007. Revenues to these customers as a percentage of total revenues were as
follows for the three and nine months ended September 30, 2008 and
2007:




Three Months Ended September
      30,
                                
                                Nine
      Months Ended September 30,2008
                                
                                2007
                                
                                2008
                                
                                2007(Unaudited)
                                
                                (Unaudited)Customer
      A
                                
                                
                                28
                                %
                                
                                
                                34
                                %
                                
                                
                                46
                                %
                                
                                
                                19
                                %Customer
      B
                                
                                
                                30
                                %
                                
                                
                                30
                                %
                                
                                
                                23
                                %
                                
                                
                                19
                                %Customer
      C
                                
                                
                                13
                                %
                                
                                
                                18
                                %
                                
                                
                                12
                                %
                                
                                
                                *
                                %Customer
      D
                                
                                
                                18
                                %
                                
                                
                                *
                                %
                                
                                
                                *
                                %
                                
                                
                                *
                                %Customer
      E
                                
                                
                                *
                                %
                                
                                
                                *
                                %
                                
                                
                                *
                                %
                                
                                
                                40
                                %




* Less than 10%




Any
negative 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
September 30, 2008, the Company had cash and cash equivalents on deposit with a
major financial institution that were in excess of FDIC insured limits.
Historically, the Company has not experienced any loss of its cash and cash
equivalents due to such concentration of credit risk. Concentrations of credit
risk with respect to trade receivables relate to those trade receivables from
both United States and foreign entities, primarily in the financial services
industry. As of September 30, 2008, approximately 88% of gross accounts
receivable were concentrated with two customers, each of whom represented more
than 10% of the Company’s total gross accounts receivable balance. As of
December 31, 2007, approximately 78% of accounts receivable were
concentrated with three customers, each of whom represented more than 10% of the
Company’s total gross accounts receivable balance. No other customer
individually accounted for greater than 10% of total accounts receivable as of
September 30, 2008 and December 31, 2007.




Inventories




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







September
      30, 2008
                  
                  
                  December 31,
      2007(Unaudited)Raw
      materials and subassemblies
                  
                  $
                  18
                  
                  
                  $
                  25Finished
      goods
                  
                  
                  416
                  
                  
                  
                  403Total
      Inventories
                  
                  $
                  434
                  
                  
                  $
                  428




Page
7


Revenue
Recognition and Deferred Revenue




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




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




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




·
            Delivery has occurred.
      The Company delivers software and hardware to customers physically and the
      Company has no further obligations with respect to the agreement for which
      it does not have vendor specific objective evidence of fair value. The
      standard delivery terms are FOB shipping
point.




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




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




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




Payment
for product is due upon shipment, subject to specific payment terms. Payment for
installation and professional services is due upon providing the services,
subject to specific payment terms. Reimbursements received for out-of-pocket
expenses incurred during installation and support services, which have not been
significant to date and shipping costs, 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, 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 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 September 30, 2008, these criteria for
recognizing license revenue following the commencement of litigation had not
been met.


Page
8




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




On
September 8, 2008 and on September 9, 2008, Avistar entered into a Licensed
Works Agreement, Licensed Works Agreement Statement of Work and a Patent License
Agreement with International Business Machines Corporation, or IBM, under which
Avistar agreed to integrate our 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, 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 also 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.




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 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 September 30, 2008, the Company has
recognized $376,000 in product revenue and $113,000 in is service revenue. The
remaining $4.8 million is expected to be recognized in product revenue under the
percentage of completion method over the projected development time of 15
months.







Income
from Settlement and Patent Licensing




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




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




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




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




Page
9


Stock-Based
Compensation




Effective
January 1, 2006, the Company adopted the provisions of SFAS No. 123
(R), Share-Based
Payment (SFAS 123R), which establishes accounting for
stock-based awards exchanged for employee services. Accordingly, stock-based
compensation cost is measured at grant date, based on the fair value of the
award, and is recognized as expense over the employee’s service period. The
effect of recording stock-based compensation for the three and nine months ended
September 30, 2008 and 2007 was as follows (in thousands, except per share
data):




Three Months EndedSeptember
      30,
                  
                  
                  Nine
      Months Ended September 30,2008
                  
                  
                  2007
                  
                  
                  2008
                  
                  2007(Unaudited)
                  
                  
                  (Unaudited)Stock-based
      compensation expense by type of award:Employee
      stock options
                  
                  $
                  576
                  
                  
                  $
                  668
                  
                  
                  $
                  923
                  
                  
                  $
                  1,807Non-employee
      stock options
                  
                  
                  3
                  
                  
                  
                  7
                  
                  
                  
                  9
                  
                  
                  
                  66Employee
      stock purchase plan
                  
                  
                  5
                  
                  
                  
                  30
                  
                  
                  
                  2
                  
                  
                  
                  90Total
      stock-based compensation
                  
                  
                  584
                  
                  
                  
                  705
                  
                  
                  
                  934
                  
                  
                  
                  1,963Tax
      effect of stock-based compensation
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —Net
      effect of stock-based compensation on net income (loss)
                  
                  $
                  584
                  
                  
                  $
                  705
                  
                  
                  $
                  934
                  
                  
                  $
                  1,963







As of
September 30, 2008, the Company had an unrecognized stock-based
compensation balance related to stock options of approximately $5.7 million
before estimated forfeitures. SFAS 123R requires forfeitures to be
estimated at the time of grant and revised if necessary in subsequent periods if
actual forfeitures differ from those estimates. Based on the Company’s
historical experience of option pre-vesting cancellations, the Company has
assumed an annualized forfeiture rate of 9% for its executive options and 39%
for non-executive options. Accordingly, as of September 30, 2008, the Company
estimated that the stock-based compensation for the awards not expected to vest
was approximately $2.3 million, and therefore, the unrecognized stock-based
compensation balance related to stock options was adjusted to approximately $3.4
million after estimated forfeitures.  This net amount will be
recognized over an estimated weighted average amortization period of 2.3 years.
During the three months ended September 30, 2008 and 2007, the Company granted
46,000 and 1,152,000 stock options with an estimated total grant-date fair value
of $56,000 and $1.5 million, respectively. During the nine months ended
September 30, 2008 and 2007, the Company granted 2,449,318 and 2,671,500 stock
options with an estimated total grant-date fair value of $1.3 million and $3.7
million, respectively.




Valuation
Assumptions




The
Company estimated the fair value of stock options granted during the three and
nine months ended September 30, 2008 and 2007 using a Black-Scholes-Merton
valuation model, consistent with the provisions of SFAS 123R and SEC Staff
Accounting Bulletin (SAB) No. 107 (SAB 107). The fair value of each option
grant is estimated on the date of grant using the Black-Scholes-Merton option
valuation model and the straight-line attribution approach with the following
weighted-average assumptions of both the three and nine month periods ended
September 30, 2008 and 2007:




Employee Stock Option Plan







Three
      and Nine Months EndedSeptember
      30, 2008
                        
                        September
      30, 2007Expected
      dividend
                        
                        —
                        %
                        —
      %Average
      risk-free interest rate
                        
                        2.2
                        %
                        4.6
      %Expected
      volatility
                        
                        115
                        %
                        134
      %Expected
      term (years)
                        
                        2.9
                        
                        6.1






Employee Stock Purchase Plan





Three
      and Nine Months EndedSeptember
      30, 2008
                
                September
      30, 2007Expected
      dividend
                
                —
                %
                —
                %Average
      risk-free interest rate
                
                1.9
                %
                5.0
                %Expected
      volatility
                
                144
                %
                154
                %Expected
      term (months)
                
                6.0
                
                6.0




The
dividend yield of zero is based on the fact that the Company has never paid cash
dividends and has no present intention to pay cash dividends. The risk-free
interest rates are taken from the Daily Federal Yield Curve Rates as of the
grant dates as published by the Federal Reserve, and represent the yields on
actively traded treasury securities for terms that approximate the expected term
of the options. Expected volatility is based on the historical volatility of the
Company’s common stock over a period consistent with the expected term of the
stock-option. The expected term calculation is based on an average prescribed by
SAB 107, based on the weighted average of the vesting periods, which is
generally one quarter vesting after one year and one sixteenth vesting quarterly
for twelve quarters, and adding the term of the option, which is generally ten
years, and dividing by two. The Company uses this method because it does not
have sufficient historical exercise data to provide a reasonable basis upon
which to estimate expected term due to the limited number of exercises that have
occurred over the previous eight years during which its equity shares have been
publicly traded. In April 2008, the Company granted 1.9 million options to
employees, with one third vesting after six months and the remaining two thirds
vesting monthly thereafter until the entire grant is fully vested after 20
months.  These options have a 3 year contractual term, with the
expected term calculation also based on an average prescribed by SAB
107.




Page
10


3.
Fair Value Measurement




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




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




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




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




In
accordance with FAS 157, the following table represents the Company’s fair value
hierarchy for its financial assets (cash equivalents and available for sale
investments) as of September 30, 2008 (in thousands):





Fair
      Value
                  Level
      1
                  
                  Level
      2
                  Level
      3Cash
      Equivalents:Money
      market funds
                  $     3,893
                  $3,893
                  
                  $
                  —
                  
                  $        —Commercial
      paper
                  —
                  —
                  
                  
                  —
                  
                  —Total
      cash equivalents
                  $     3,893
                  $   3,893
                  
                  $
                  —
                  
                  $        —





4.
Related Party Transactions




Robert P.
Latta, a member of the law firm Wilson Sonsini Goodrich & Rosati,
Professional Corporation (WSGR), served as a director of the Company from
February 2001 until June 2007. Mr. Latta and WSGR have represented the
Company andits
predecessors as corporate counsel since 1997. During the three and nine months
ended September 30, 2007, payments of approximately $64,000, and $150,000 were
made to WSGR for legal services provided to the Company,
respectively.




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




5.
      Net (Loss) Income Per Share




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




In
accordance with SFAS 128, basic net (loss) income per share has been computed
using the weighted average number of shares of common stock outstanding during
the period, less shares subject to repurchase. Diluted net (loss) income per
share is computed on the basis of the weighted average number of shares and
potential common shares outstanding during the period. Potential common shares
result from the assumed exercise of outstanding stock options that have a
dilutive effect when applying the treasury stock method. The Company excluded
all outstanding stock options from the calculation of diluted net loss per share
for the three and nine months ended September 30, 2008 and the three months
ended September 30, 2007, 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. For the nine months ended September 30, 2007, due to the
Company’s net income for the period, the Company included the net effect of the
weighted average number of shares and dilutive potential common shares
outstanding during the period in the calculation of diluted net income per
share.




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 September
      30,
                  
                  
                  Nine
      Months Ended September 30,2008
                  
                  
                  2007
                  
                  
                  2008
                  
                  
                  2007(Unaudited)
                  
                  
                  (Unaudited)Numerator:Net
      (loss) income
                  
                  $
                  (774
                  )
                  
                  $
                  (4,126
                  )
                  
                  $
                  (6,153
                  )
                  
                  $
                  755Denominator:Basic
      weighted average shares outstanding
                  
                  
                  34,561
                  
                  
                  
                  34,379
                  
                  
                  
                  34,546
                  
                  
                  
                  34,238Add:
      dilutive employee and non employee stock options
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  780Diluted
      weighted average shares outstanding
                  
                  
                  34,561
                  
                  
                  
                  34,379
                  
                  
                  
                  34,546
                  
                  
                  
                  35,018Basic
      and diluted net (loss) income per share
                  
                  $
                  (0.02
                  )
                  
                  $
                  (0.12
                  )
                  
                  $
                  (0.18
                  )
                  
                  $
                  0.02




Due to
the net loss position in the three months and nine months ended September 30,
2008 and the three months ended September 30, 2007, the total number of
potential common shares excluded from the calculation of diluted net loss per
share for the period was 2,143,638, 1,418,827 and 2,162,198
respectively.




Page
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, 2007 during the nine months
ended September 30, 2008.




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




7.
Segment Reporting




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




Intellectual
      Property Division
                    
                    
                    Products
      Division
                    
                    
                    Reconciliation
                    
                    
                    TotalThree
      Months Ended September 30, 2008 (unaudited)Revenue
                    
                    $
                    1,424
                    
                    
                    $
                    2,338
                    
                    
                    $
                    (1,057
                    )
                    
                    $
                    2,705Depreciation
      expense
                    
                    
                    —
                    
                    
                    
                    (136
                    )
                    
                    
                    —
                    
                    
                    
                    (136
                    )Total
      costs and expenses
                    
                    
                    (417
                    )
                    
                    
                    (4,012
                    )
                    
                    
                    1,057
                    
                    
                    
                    (3,372
                    )Interest
      income
                    
                    
                    —
                    
                    
                    
                    15
                    
                    
                    
                    —
                    
                    
                    
                    15Interest
      expense
                    
                    
                    —
                    
                    
                    
                    (122
                    )
                    
                    
                    —
                    
                    
                    
                    (122
                    )Net
      income (loss)
                    
                    
                    1,007
                    
                    
                    
                    (1,781
                    )
                    
                    
                    —
                    
                    
                    
                    (774
                    )Assets
                    
                    
                    2,038
                    
                    
                    
                    9,208
                    
                    
                    
                    —
                    
                    
                    
                    11,246Three
      Months Ended September 30, 2007 (unaudited)Revenue
                    
                    $
                    1,370
                    
                    
                    $
                    1,438
                    
                    
                    $
                    (1,057
                    )
                    
                    $
                    1,751Depreciation
      expense
                    
                    
                    —
                    
                    
                    
                    (131
                    )
                    
                    
                    —
                    
                    
                    
                    (131
                    )Total
      costs and expenses
                    
                    
                    (962
                    )
                    
                    
                    (6,009
                    )
                    
                    
                    1,057
                    
                    
                    
                    (5,914
                    )Interest
      income
                    
                    
                    —
                    
                    
                    
                    93
                    
                    
                    
                    —
                    
                    
                    
                    93Interest
      expense
                    
                    
                    —
                    
                    
                    
                    (56
                    )
                    
                    
                    —
                    
                    
                    
                    (56
                    )Net
      income (loss)
                    
                    
                    408
                    
                    
                    
                    (4,534
                    )
                    
                    
                    —
                    
                    
                    
                    (4,126
                    )Assets
                    
                    
                    3,280
                    
                    
                    
                    8,835
                    
                    
                    
                    —
                    
                    
                    
                    12,115Nine
      Months Ended September 30, 2008 (unaudited)Revenue
                    
                    $
                    3,845
                    
                    
                    $
                    4,972
                    
                    
                    $
                    (3,171
                    )
                    
                    $
                    5,646Depreciation
      expense
                    
                    
                    —
                    
                    
                    
                    (404
                    )
                    
                    
                    —
                    
                    
                    
                    (404
                    )Total
      costs and expenses
                    
                    
                    (1,746
                    )
                    
                    
                    (7,325
                    )
                    
                    
                    3,171
                    
                    
                    
                    (5,900
                    )Interest
      income
                    
                    
                    —
                    
                    
                    
                    82
                    
                    
                    
                    —
                    
                    
                    
                    82Interest
      expense
                    
                    
                    —
                    
                    
                    
                    (335
                    )
                    
                    
                    —
                    
                    
                    
                    (335
                    )Net
      income (loss)
                    
                    
                    2,099
                    
                    
                    
                    (8,252
                    )
                    
                    
                    —
                    
                    
                    
                    (6,153
                    )Assets
                    
                    
                    2,038
                    
                    
                    
                    9,208
                    
                    
                    
                    —
                    
                    
                    
                    11,246Nine
      Months Ended September 30, 2007 (unaudited)Revenue
                    
                    $
                    19,957
                    
                    
                    $
                    5,255
                    
                    
                    $
                    (15,171
                    )
                    
                    $
                    10,041Depreciation
      expense
                    
                    
                    —
                    
                    
                    
                    (279
                    )
                    
                    
                    —
                    
                    
                    
                    (279
                    )Total
      costs and expenses
                    
                    
                    (6,882
                    )
                    
                    
                    (17,720
                    )
                    
                    
                    15,171
                    
                    
                    
                    (9,431
                    )Interest
      income
                    
                    
                    —
                    
                    
                    
                    307
                    
                    
                    
                    —
                    
                    
                    
                    307Interest
      expense
                    
                    
                    —
                    
                    
                    
                    (162
                    )
                    
                    
                    —
                    
                    
                    
                    (162
                    )Net
      income (loss)
                    
                    
                    13,075
                    
                    
                    
                    (12,320
                    )
                    
                    
                    —
                    
                    
                    
                    755Assets
                    
                    
                    3,280
                    
                    
                    
                    8,835
                    
                    
                    
                    —
                    
                    
                    
                    12,115







International
revenue, which consists of sales to customers with operations principally in
Western Europe and Asia, comprised 50% and 62% of total revenues for the three
months ended September 30, 2008 and 2007, respectively, and 51% and 75% of
total revenues for the nine months ended September 30, 2008 and 2007,
respectively. For the three months ended September 30, 2008 and 2007,
international revenues from customers in the United Kingdom accounted for 12%
and 14% of total product and services revenue, respectively, and 14% and 48% for
the nine months ended September 30, 2008 and 2007, respectively. The Company had
no significant long-lived assets in any country other than in the United States
for any period presented.




Page
12


8.  Notes
      Payable




On
January 4, 2008, Avistar issued $7,000,000 of 4.5% Convertible Subordinated
Secured Notes (Notes). The Notes were sold pursuant to a Convertible Note
Purchase Agreement to Baldwin Enterprises, Inc., a subsidiary of Leucadia
National Corporation, directors Gerald Burnett, Simon Moss, R. Stephen
Heinrichs, William Campbell, and Craig Heimark, officer 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 will accrue at the rate of 4.5% per
annum and will be payable semi-annually in arrears on June 4 and December 4 of
each year, commencing on June 4, 2008.  From the one-year anniversary
of the issuance of the Notes until maturity, the holders of the Notes will be
entitled to convert the Notes into shares of common stock at an initial
conversion price per share of $0.70.




9.
      Commitments and Contingencies






Facilities
leases




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




Three
      Months Ending  December 31,
                    
                    Amount2008
                    
                    $
                    146Year
      Ending December 31,2009
                    
                    
                    5812010
                    
                    
                    5962011
                    
                    
                    7052012
                    
                    
                    221thereafter
                    
                    
                    173Total
      future minimum lease payments
                    
                    $
                    2,422




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
September 30, 2008.




10.
      Recent Accounting Pronouncements




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






In
December 2007, the FASB Emerging Issues Task Force reached a consensus and
published Issue No. 07-01, Accounting for Collaborative
Arrangements (EITF 07-01). EITF 07-01 defines a collaborative arrangement
as a contractual arrangement in which the parties are active participants to the
arrangements and exposed to significant risks and rewards that depend on the
commercial success of the endeavor. EITF 07-01 requires that costs incurred and
revenues generated from transactions with third parties should be reported by
the collaborators on the appropriate line item in their respective income
statements. EITF 07-01 also states that the income statement characterization of
payments between the participants to a collaborative arrangement should be based
on other authoritative literature if the payments are within the scope of such
literature. EITF 07-01 requires collaborators to disclose, in the footnotes to
financial statements in the initial period of adoption and annually thereafter,
the income statement classification and amounts attributable to transactions
arising from collaborative arrangements between participants for each period for
which an income statement is presented and information regarding the nature and
purpose of the collaborative arrangement, the collaborators' rights and
obligations under the arrangement, and any accounting policies for the
collaborative arrangement. EITF 07-01 is effective for fiscal years beginning
after December 15, 2008. The Company is currently evaluating the impact of
adopting the provisions EITF 07-01.




11.
Other Matters




On November 16, 2007,
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 the Company 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.




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




On June
30, 2008, Avistar received a notice from The NASDAQ Stock Market’s Listing
Qualifications Panel that the Panel has decided to grant Avistar an exception to
the continued listing requirements of the NASDAQ Capital Market through August
29, 2008. Under the terms of the exception, during the period from July 1, 2008
to August 29, 2008, Avistar was required to demonstrate the ability to close
above a $35 million market value for its listed securities for ten consecutive
trading days.




On August
19, 2008, Avistar received a notice from The NASDAQ Stock Market’s Listing
Qualifications Director, and on August 25, 2008 Avistar received a subsequent
letter from the NASDAQ Hearings Panel that Avistar had re-gained full compliance
with the continued listing standards of the NASDAQ Capital Market.




Page
13


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




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




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




Overview




Avistar
creates technology that provides the missing critical element in unified
communications: bringing people in organizations face-to-face, through enhanced
communications for true collaboration anytime, anyplace. Our latest product,
Avistar C3, draws on over a decade of market experience to deliver a
single-click desktop videoconferencing and collaboration experience that moves
business communications into a new era. Available as a stand-alone solution, or
integrated with existing unified communications software from other vendors,
Avistar C3 users gain an instant messaging-style ability to initiate video
communications across and outside the enterprise. Patented bandwidth management
enables thousands of users to access desktop videoconferencing, Voice over IP
(VoIP) and streaming media without requiring substantial new network investment
or impairing network performance.  By integrating Avistar C3 tightly
into the way they work, our customers can use our solutions to help reduce costs
and improve productivity and communications within their enterprise and between
enterprises, and to enhance their relationships with customers, suppliers and
partners. Using Avistar C3 software and leveraging video, telephony and Internet
networking standards, Avistar solutions are designed to be scalable, reliable,
cost effective, easy to use, and capable of evolving with communications
networks as bandwidth increases and as new standards and protocols emerge. We
currently sell our system directly and indirectly to the small and medium sized
business, or SMB and globally distributed organizations, or Enterprise, markets
comprising the Global 5000. Our objective is to establish our technology as the
standard for networked visual unified communications and collaboration through
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
September 30, 2008, we held 80 U.S. and foreign patents, which we look to
license to others in the collaboration technology marketplace.




In
September 2007 and March 2008, we announced 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 include:




·
            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
      49 on September 30, 2008; and




·
            Pursuing
      multiple distribution, services and technology
  partners.




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




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.  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 our licensing negotiations in process, and may require us to spend
substantial time and resources defending our patents, including the fees and
expenses of our legal advisors.  The potential impact to our results
of operations may require us to reduce our other operating expenses and seek
additional financing to fund our operations and the defense of our
patents.






Page
14


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.
  We
believe the following critical accounting policies, among others, affect our
more significant judgments and estimates used in the preparation of our
Condensed Consolidated Financial Statements:
  ·
              Revenue
      recognition;
  ·
              Income
      from settlement and patent
licensing;
  ·
              Stock-based
      compensation;
  ·
              Valuation
      of accounts receivable; and
  ·
              Valuation
      of inventories.
  Revenue
Recognition


We derive
product revenue from the sale and licensing of our video-enabled networked
communications system, consisting of a suite of Avistar-designed software and
hardware products, including third party components. We also derive revenue from
fees for installation, maintenance, support, training services and software
development. In addition, we derive revenue from the licensing of our
intellectual property portfolio. Product revenue as a percentage of total
revenue was 48% and 32% for three months ended September 30, 2008 and 2007,
respectively and 37% and 25% for nine months ended September 30, 2008 and 2007,
respectively.




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




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




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




·
            Delivery has occurred.
      We deliver software and hardware to our customers physically and the
      Company has no further obligations with respect to the agreement for which
      it does not have vendor specific objective evidence of fair value. Our
      standard delivery terms are FOB shipping
point.




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




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




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




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





Page
15


The price
charged for maintenance and/or support is defined in the product sale contract,
and is based on a fixed price for both hardware and software components as
stipulated in the customer agreement. Customers have the option to renew the
maintenance and/or support services in subsequent periods at the same or similar
rate as paid in the initial year subject to contractual adjustments for
inflation in some cases. Revenue from maintenance and support is recognized
pro-rata over the maintenance and/or support term, which is typically one year
in length. Payments for services made in advance of the provision of services
are recorded as deferred revenue and customer deposits in the accompanying
balance sheets. Training services are offered independently of the purchase of
product. The value of these training services is determined based on the price
charged when such services are sold separately. Training revenue is recognized
upon performance of the service.
  We
recognize service revenue from software development contracts in accordance with
SOP 81-1, Accounting for
Performance of Construction-Type and Certain Production-Type Contracts.
Product and implementation revenue related to contracts for software development
is recognized using the percentage of completion method, when all of the
following conditions are met: a contract exists with the customer at a fixed
price, we expect to fulfill all of our 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. Amounts billed to customers in excess of revenues recognized to
date are deferred and recorded as deferred revenue and customer deposits in the
accompanying balance sheets. Assumptions used for recording revenue and earnings
are adjusted in the period of change to reflect revisions in contract value and
estimated costs to complete the contract. Any anticipated losses on contracts in
progress are charged to earnings when identified.


We also
recognize revenue from the licensing of our intellectual property portfolio
according to SOP 97-2, based on the terms of the royalty, partnership and
cross-licensing agreements involved. In the event that a license to our
intellectual property is granted after the commencement of litigation between us
and the licensee, the proceeds of such transaction are recognized as licensing
revenue by us only if sufficient historical evidence exists for the
determination of fair value of the licensed patents to support the segregation
of the proceeds between a gain on litigation settlement and patent license
revenues, consistent with FASB CON 6. As of September 30, 2008, these criteria
for recognizing license revenue following the commencement of litigation have
not been met, and proceeds received after commencement of litigation have
therefore been recorded in “income from settlement and patent licensing” in our
statement of operations.




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




In June
2007, we entered into a Patent License Agreement with Radvision Ltd. Under the
license agreement, we granted Radvision and its subsidiaries a license in the
field of videoconferencing to all of our patents, patent applications and
patents issuing therefrom with a filing date on or before May 15, 2007. Also
under the license agreement, Radvision granted to us a license in the field of
videoconferencing to all of Radvision’s patents, patent applications and patents
issuing therefrom with a filing date on or before May 15, 2007. The license
agreement includes mutual releases of the parties from claims of past
infringement of the licensed patents. As partial consideration for the licenses
and releases granted under the agreement, Radvision made a one-time license
payment to us of $4.0 million, which was recognized as licensing revenue in the
three months ended June 30, 2007.




On
September 8, 2008 and on September 9, 2008, we 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
we agreed to integrate our 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 us on November 7, 2008.  We expect 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 us equal to two percent of the world-wide net revenue
derived by IBM from Lotus Unified Communications products sold, and maintenance
payments received from existing customers, which incorporate our
technology.  The agreements have a five year term and are
non-cancelable except for material default by either party.  The
agreements also convey to IBM a non-exclusive world-wide license to our 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.




We have
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
and the maintenance revenue will be recognized over the future maintenance
service period.  We believe 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
September 30, 2008, we recognized $376,000 in product revenue and $113,000 is in
service revenue. The remaining $4.8 million is expected to be recognized in
product revenue under the percentage of completion method over the projected
development time of 15 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.




To date,
a significant portion of our revenue has resulted from sales to a limited number
of customers, particularly Deutsche Bank AG, UBS AG and their affiliates, Sony,
SCEI and Radvision. Collectively, Deutsche Bank AG, UBS AG and their affiliates,
Sony and SCEI and Radvision accounted for approximately 81% and 86% of total
revenue for the nine month periods ended September 30, 2008 and 2007,
respectively. As of September 30, 2008, approximately 88% of our gross
accounts receivable was concentrated with two customers, each of whom
represented more than 10% of our gross accounts receivable. As of
September 30, 2007, approximately 82% of our gross accounts receivable was
concentrated with three customers, each of whom represented more than 10% of our
gross accounts receivable.




International
revenue, which consists of sales to customers with operations principally in
Western Europe and Asia, comprised 50% and 62% of total revenues for the three
months ended September 30, 2008 and 2007, respectively, and 51% and 75% of
total revenues for the nine months ended September 30, 2008 and 2007,
respectively.




Income
from Settlement and Patent Licensing




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




Page
16




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


Stock-Based
      Compensation




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




Valuation
      of Accounts Receivable




Estimates
are used in determining our allowance for doubtful accounts and are based on our
historical collection experience, historical write-offs, current trends, and the
credit quality of our customer base and the characteristics of our accounts
receivable by aging category. If the allowance for doubtful accounts were to be
understated, our operating income could be significantly reduced. The impact of
any such change or deviation may be increased by our reliance on a relatively
small number of customers for a large portion of our total revenue. As of
September 30, 2008, two customers represented 73% and 15% of our gross
accounts receivable balance. As of December 31, 2007, three customers
represented 38%, 30% and 10% of our gross accounts receivable
balance.




Valuation
      of Inventories




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




Results
of Operations




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







Percentage of Total Revenue
                                
                                Percentage of Total RevenueThree
      Months Ended
                                  September
      30,
                                Nine
      Months Ended
                                  September
      30,2008
                                2007
                                2008
                                2007Revenue:Product
                                
                                48
                                %
                                32
                                %
                                37
                                %
                                25
                                %Licensing
                                
                                14
                                
                                18
                                
                                12
                                
                                48Services,
      maintenance and support
                                
                                38
                                
                                50
                                
                                51
                                
                                27Total
      revenue
                                
                                100
                                
                                100
                                
                                100
                                
                                100Costs
      and Expenses:Cost
      of product revenue
                                
                                27
                                
                                38
                                
                                29
                                
                                21Cost
      of services, maintenance and support revenue
                                
                                22
                                
                                28
                                
                                30
                                
                                17Income
      from settlement and patent licensing
                                
                                (39
                                )
                                (60
                                )
                                (56
                                )
                                (151
                                )Research
      and development
                                
                                41
                                
                                115
                                
                                70
                                
                                55Sales
      and marketing
                                
                                23
                                
                                90
                                
                                49
                                
                                46General
      and administrative
                                
                                51
                                
                                127
                                
                                83
                                
                                106Total
      costs and expenses
                                
                                125
                                
                                338
                                
                                205
                                
                                94(Loss)
      income from operations
                                
                                (25
                                )
                                (238
                                )
                                (105
                                )
                                6Other
      income (expense):Interest
      income
                                
                                1
                                
                                5
                                
                                2
                                
                                3Other
      expense, net
                                
                                (5
                                )
                                (3
                                )
                                (6
                                )
                                (2
                                )Total
      other (expense) income, net
                                
                                (4
                                )
                                2
                                
                                (4
                                )
                                1Net
      income (loss)
                                
                                (29
                                )%
                                (236
                                )%
                                (109
                                )%
                                7
                                %




Page
17


COMPARISON
OF THE THREE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007




Revenue




Total
revenue increased by $954,000 or 54%, to $2.7 million for the three month period
ended September 30, 2008, from $1.8 million for the three months ended September
30, 2007. The increase was due primarily to an increase in revenue from a
technology partner in the quarter ended September 30, 2008, and an increase from
professional on-site services provided to an existing customer.




•    
      Product revenue increased by $758,000 or 137%, to $1.3 million for the
      three month period ended September 30, 2008, from $555,000 for the three
      months ended September 30, 2007. The increase was due primarily to revenue
      of $376,000 from IBM in the quarter ended September 30,
    2008.




•    
      Licensing revenue, relating to the licensing of our patent portfolio,
      increased by $54,000, or 17%, to $367,000 for the three months ended
      September 30, 2008, from $313,000 for the three months ended September 30,
      2007, due to an increase in ongoing royalty revenue from
      Sony.  No new licensing agreements occurred in the quarter ended
      September 30, 2008 or 2007.




•    
      Services, maintenance and support revenue, which includes our installation
      services, funded software development and maintenance and support,
      increased by $142,000, or 16%, to $1.0 million for the three months ended
      September 30, 2008, from $883,000 for the three months ended September 30,
      2007, due primarily to an increase in revenue from professional on-site
      services provided to an existing
customer.




For the
three months ended September 30, 2008, revenue from four customers accounted for
89% of total revenue compared to three customers and 82% for the three months
ended September 30, 2007. No other customer accounted for greater than 10% of
total revenue.  The level of sales to any customer may vary from quarter to
quarter. We expect that there will be significant customer concentration in
future quarters. The loss of any one of those customers would have a materially
adverse impact on our financial condition and operating results.




Costs
      and Expenses





Cost of product revenue.  Cost
of product revenue increased by $62,000, or 9%, to $720,000 for the three months
ended September 30, 2008, from $658,000 for the three months ended September 30,
2007. The cost of product revenue increase was less than proportional to the
increase in product revenue primarily due to the mix of IBM revenue, which has
no associated cost of sales.
  Cost of services,
maintenance and support revenue.




Income from settlement and patent
licensing.Income from settlement
and patent licensing was $1.1 million for the three month periods ended
September 30, 2008 and September 30, 2007, 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 $898,000, or 44%, to $1.1 million for the three months
ended September 30, 2008 from $2.0 million for the three months ended September
30, 2007.  This decrease was primarily due to a reduction in personnel
and personnel related expenses, including an $86,000 reduction in stock based
compensation expense and a decrease in the use of external labor.




Sales and marketing. Sales
and marketing expenses decreased by $949,000, or 60%, to $634,000 for the three
months ended September 30, 2008, from $1.6 million for the three months ended
September 30, 2007. The decrease was due primarily to a reduction in personnel
and personnel related expenses, including a $104,000 reduction in stock based
compensation expense.




General and administrative.
General and administrative expenses decreased by $848,000, or 38% to $1.4
million for the three months ended September 30, 2008, from $2.2 million for the
three months ended September 30, 2007. 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.




Other
      Income




Interest
income decreased by $78,000, or 84%, to $15,000 for the three months ended
September 30, 2008, from $93,000 for the three months ended September 30, 2007.
The decrease was due to lower interest income due to both a decrease in interest
rates and a decrease in the average outstanding balance of investments that
earned interest in the three months ended September 30, 2008 compared to the
same period in 2007.




Other
expense, net, increased by $66,000, or 118%, to $122,000 for the three months
ended September 30, 2008, from $56,000 for the three months ended September 30,
2007. The increase was due to higher interest expense due to a higher balance of
debt outstanding during the three months ended September 30, 2008 compared to
the same period in 2007.




Page
18


COMPARISON
OF THE NINE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007





Revenue




Total
revenue decreased by $4.4 million, or 44%, to $5.6 million for the nine months
ended September 30, 2008, from $10.0 million for the nine months ended September
30, 2007. The decrease was primarily the result of the $4.0 million of revenue
from Radvision recognized in 2007, and decreased products sold to new customers
in 2008 compared to 2007.




•Product revenue decreased by $402,000, or 16%, to $2.1 million for
      the nine months ended September 30, 2008, from $2.5 million for the nine
      months ended September 30, 2007. The decrease was due to decreased sales
      to existing customers in the nine month period ended September 30, 2008,
      as compared to the same period in
2007.




•Licensing revenue, relating to the licensing of our patent
      portfolio, decreased by $4.2 million, or 86%, to $674,000 for the nine
      months ended September 30, 2008, from $4.9 million for the nine months
      ended September 30, 2007. The decrease was primarily attributable to the
      lack of new licensing agreements in the nine months ended September 30,
      2008 compared to the Radvision licensing agreement, which resulted in an
      additional $4.0 million in licensing revenue in the nine months ended
      September 30, 2007.




•Services, maintenance and support revenue, which includes our
      installation services, funded software development and maintenance and
      support, increased by $199,000, or 7%, to $2.9 million for the nine months
      ended September 30, 2008, from $2.7 million for the nine months ending
      September 30, 2007.   The increase was primarily
      attributable to an increase in revenue from professional on-site services
      provided to an existing
customer.





For the
nine months ended September 30, 2008, revenue from three customers accounted for
81% of total revenue, each of whom accounted for greater than 10% of total
revenue. For the nine months ended September 30, 2007, revenue from three
customers accounted for 78% of total revenue, each of whom accounted for greater
than 10% of total revenue. We expect that there will be significant customer
concentration in future quarters.  The loss of any one of those
customers would have a material adverse impact on our financial condition and
operating results.





Costs
and Expenses




Cost of product revenue. Cost
of product revenue decreased by $454,000, or 22%, to $1.6 million for the nine
months ended September 30, 2008, from $2.1 million for the nine months ended
September 30, 2007. The decrease was primarily attributable to lower product
sales and a decrease in personnel and personnel related expenses for the
assembly and testing of such products, including a decrease of $62,000 in stock
based compensation expense.




Cost of services, maintenance and
support revenue. Cost of services, maintenance and support revenue was
$1.7 million for the nine months ended September 30, 2008 and 2007.




Income from settlement and patent
licensing.Income from settlement
and patent licensing decreased by $12.0 million, or 79%, to $3.2 million for the
nine months ended September 30, 2008, from $15.2 million for the nine month
period ended September 30, 2007. The decrease was due to the Settlement and
Patent License Agreement entered into with Tandberg ASA and its subsidiaries in
February 2007, which resulted in a cash payment to us of $12.0 million. The nine
months ended September 30, 2008 and 2007 each also reflect $3.2 million of
amortization of the net proceeds from the November 2004 Polycom settlement and
cross-license agreement, recognized over a five year period beginning in
November 2004 and ending in November 2009.




Research and
development.Research and development
expenses decreased by $1.6 million, or 29%, to $3.9 million for the nine months
ended September 30, 2008 from $5.5 million for the nine months ended September
30, 2007. The decrease was primarily attributable to a decrease in personnel and
personnel related expenses, including a decrease of $319,000 in stock based
compensation expense.




Sales and marketing. Sales
and marketing expenses decreased by $1.9 million, or 40%, to $2.8 million for
the nine months ended September 30, 2008 from $4.6 million for the nine months
ended September 30, 2007. The decrease was primarily attributable to a decrease
in personnel and personnel related expenses, including a decrease of $493,000 in
stock based compensation expense.




General and administrative.
General and administrative expenses decreased by $5.9 million, or 56% to $4.7
million for the nine months ended September 30, 2008 from $10.6 million for the
nine months ended September 30, 2007. The decrease was due primarily to $4.7
million in legal fees associated with our litigation against Tandberg for patent
infringement that occurred during the nine months ended September 30, 2007, with
no comparable expense in the same period during
2008.   Additionally, to a lesser extent, there was a decrease in
personnel and personnel related expenses including a decrease of $155,000 in
stock based compensation expense, partially offset by increased employee
severance expense, incurred primarily during the first quarter of
2008.




Other
income




Interest
income decreased by $225,000, or 73%, to $82,000 for the nine months ended
September 30, 2008, from $307,000 for the nine months ended September 30, 2007.
The decrease was due to lower interest income due to both a decrease in interest
rates and a decrease in the average outstanding balance of investments that
earned interest in the nine months ended September 30, 2008, as compared to the
same period in 2007.




Other
expense, net, increased by $173,000, or 107%, to $335,000 for the nine months
ended September 30, 2008, from $162,000 for the nine months ended September 30,
2007. The increase was due to higher interest expense due to a higher
outstanding balance of debt outstanding during the nine months ended September
30, 2008, as compared to the same period in 2007.




Page
19


Liquidity
and Capital Resources




We had
cash and cash equivalents of $4.4 million as of September 30, 2008, and cash,
cash equivalents and short-term investments of $4.9 million as of December 31,
2007. For the nine months ended September 30, 2008, we had a net increase in
cash and cash equivalents of $367,000. The net cash used by operations of $9.3
million for the nine months ended September 30, 2008 resulted primarily from the
net loss of $6.2 million, a decrease in deferred income from settlement and
patent licensing of $4.2 million, an increase in accounts receivable of $2.7
million, a decrease in account payable of $395,000, all offset by an increase in
deferred services revenue and customer deposits of $1.5 million, non-cash
expenses of $1.3 million,  and a decrease in deferred settlement and
patent licensing costs of $1.0 million.  The net cash provided by investing
activities of $720,000 for the nine months ended September 30, 2008 was
primarily due to the maturities of short-term investments of $799,000.  The
net cash provided by financing activities of $9.0 million for the nine
months ended September 30, 2008 related primarily to $7.0 million in proceeds
from the issuance of convertible debt in January 2008, and $7.0 million of
borrowings on our line of credit, offset by payments made on our line of credit
of $5.1 million.




Our
accounts receivable increased by $2.7 million, or 194%, to $4.1 million on
September 30, 2008 from $1.4 million on December 31, 2007.  This
increase was due to a $3.0 million receivable from IBM, related to the Licensed
Works Agreement and Patent License Agreement entered into on September 8, 2008
and on September 9, 2008.   The $3.0 million payment was received
by Avistar on November 7, 2008.




At
September 30, 2008, we had open purchase orders and other contractual
obligations of approximately $431,000 primarily related to inventory purchase
commitments. We also have commitments that consist of obligations under our
operating leases. These purchase order commitments and contractual obligations
are reflected in our financial statements once goods or services have been
received or payments related to the obligations become due. A table summarizing our minimum purchase commitments to
our contract manufacturers and our minimum commitments under non-cancelable
operating leases as of December 31, 2007 is included in our Annual Report on
Form 10-K for the year ended December 31, 2007, filed with the Securities and
Exchange Commission on March 31, 2008.In 2008, we subleased some of our
office facilities in San Mateo, California and New York, New York, and assigned
our primary facility lease in London, United Kingdom.




As a
result of these subleases and assignment, our future minimum lease commitments
under all facility leases as of September 30, 2008, net of projected
sublease proceeds, are as follows (in thousands):




Three
      Months Ending  December 31,
                    
                    Amount2008
                    
                    $
                    146Year
      Ending December 31,2009
                    
                    
                    5812010
                    
                    
                    5962011
                    
                    
                    7052012
                    
                    
                    221thereafter
                    
                    
                    173Total
      future minimum lease payments
                    
                    $
                    2,422




As of September 30, 2008, we had no material off-balance
sheet arrangements,other than the operating leases described in the
contractual obligations table 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 September 30, 2008, we
have not incurred material costs to defend lawsuits or settle claims related to
these indemnifications agreements and therefore, we have no liabilities recorded
for these agreements as of September 30, 2008.




Due to
the implementation of aggressive cost control measures structured to effectively
align operations to predictable revenues, as discussed in Item 1A. Risk Factors in this Form
10Q, we currently believe that our existing cash and cash equivalents balance
and line of credit will provide us with sufficient funds to finance our
operations for the next 12 months. We intend to continue to invest in the
development of new products and enhancements to our existing products. Our
future liquidity and capital requirements will depend upon numerous factors,
including without limitation, general economic conditions and conditions in the
financial services industry in particular, the level and timing of product,
services and patent licensing revenues and income, the costs and timing of our
product development efforts and the success of these development efforts, the
costs and timing of our sales, 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.




Recent
      Accounting Pronouncements




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




Page
20


In
December 2007, the FASB Emerging Issues Task Force reached a consensus and
published Issue No. 07-01, Accounting for Collaborative
Arrangements (EITF 07-01). EITF 07-01 defines a collaborative arrangement
as a contractual arrangement in which the parties are active participants to the
arrangements and exposed to significant risks and rewards that depend on the
commercial success of the endeavor. EITF 07-01 requires that costs incurred and
revenues generated from transactions with third parties should be reported by
the collaborators on the appropriate line item in their respective income
statements. EITF 07-01 also states that the income statement characterization of
payments between the participants to a collaborative arrangement should be based
on other authoritative literature if the payments are within the scope of such
literature. EITF 07-01 requires collaborators to disclose, in the footnotes to
financial statements in the initial period of adoption and annually thereafter,
the income statement classification and amounts attributable to transactions
arising from collaborative arrangements between participants for each period for
which an income statement is presented and information regarding the nature and
purpose of the collaborative arrangement, the collaborators' rights and
obligations under the arrangement, and any accounting policies for the
collaborative arrangement. EITF 07-01 is effective for fiscal years beginning
after December 15, 2008. We are currently evaluating the impact of adopting the
provisions EITF 07-01.




Item 4T. Controls and
Procedures




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




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




PART II - OTHER INFORMATION




Item 1. Legal Proceedings




None.




Item
1A.
Risk Factors




Factors Affecting Future Operating
      Results




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




We recorded a net loss of $6.2 million for the nine
months ended September 30, 2008, a net loss of $2.9 million for fiscal year
2007, and a net loss of $8.1 million for fiscal year 2006. As of September 30,
2008, our accumulated deficit was $112 million. Our revenue and income from
settlement and patent licensing may not increase, or even remain at its current
level. In addition, our operating expenses, which have been reduced recently,
may increase as we continue to develop our business and pursue licensing
opportunities. As a result, to become profitable, we will need to increase our
revenue and income from settlement and patent licensing by increasing sales to
existing customers and by attracting additional new customers, distribution
partners and licensees. If our revenue does not increase adequately, we may not
become profitable. Due to the volatility of our product and licensing revenue
and our income from settlement and patent licensing activities, we may not be
able to achieve, sustain or increase profitability on a quarterly or annual
basis. If we fail to achieve or to maintain profitability or to sustain or grow
our profits within the time frame expected by investors, the market price of our
common stock may be adversely impacted.




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




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




Page 21


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




In July 2007, Simon Moss was appointed as President of
the products division of our company.  In September 2007, William
Campbell resigned from the position of Chief Operating Officer, and in November
2007, we announced that Gerald Burnett was resigning from his position as our
Chief Executive Officer effective January 1, 2008 and that he would be replaced
in that position by Simon Moss.  In addition, during the second half
of 2007 and the nine months ended September 30, 2008, we implemented a number of
other management changes.   In September 2007 and March 2008, we
announced an intensive set of corporate initiatives aimed at increasing our
product sales, expanding our customer deployments and support, improving our
corporate efficiency and increasing our development capacity.  The
components of this initiative included:




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




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




·
            A reduction in our employees from an average of
      88 in 2007 to approximately 49 at September 30, 2008;
    and




·
            Pursuing multiple distribution, services and
      technology licensing partners.




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




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




On November 16, 2007, we
received a deficiency letter from The NASDAQ Stock Market indicating that we did
not comply with Marketplace Rule 4310(c)(3), which requires that we have a
minimum of $2,500,000 in stockholders’ equity or $35,000,000 in market value of
listed securities or $500,000 of net income from continuing operations for the
most recently completed fiscal year or two of the three most recently completed
fiscal years.  The NASDAQ staff noted that the market value of our
listed securities had been below the minimum $35,000,000 for the previous 10
consecutive trading days.




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




On August 19, 2008, we received a notice from The
NASDAQ Stock Market’s Listing Qualifications Director, and on August 25, 2008 we
received a subsequent letter from the NASDAQ Hearings Panel that Avistar has
re-gained full compliance with the continued listing standards of the NASDAQ
Capital Market.




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




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




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




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




·
            quarterly variations in our results of
      operations;




·
            announcements regarding our product
      developments;




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




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




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




·
            announcements of competitive product
      introductions by our
competitors;




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




·
            limited trading volume of shares;
      and,




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




Page 22


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




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




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




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




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




Our executive officers, directors and entities
affiliated with them, in the aggregate, beneficially owned approximately 59% of
our common stock as of September 30, 2008. If they were to act together, these
stockholders would be able to exercise control over most matters requiring
approval by our stockholders, including the election of directors and approval
of significant corporate transactions. These actions may be taken even if they
are opposed by other investors. This concentration of ownership may also have
the effect of delaying or preventing a change in control of Avistar, which could
cause the market price of our common stock to decline.




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




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




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




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




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




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




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




Page 23


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




To date, a significant portion of our revenue and
income from settlement and patent licensing has resulted from sales or licenses
to a limited number of customers, particularly Deutsche Bank AG, UBS AG,
Polycom, Inc., Radvision Ltd., and Sony and SCEI and their affiliates. 
Collectively, Deutsche Bank AG, UBS AG, Polycom, Inc., Sony Corporation, and
their affiliates accounted for approximately 88% of combined revenues and income
from settlement and patent licensing for the nine months ended September 30,
2008. As of September 30, 2008, approximately 88% of our gross accounts
receivable was concentrated with two customers, each of whom represented more
than 10% of our gross accounts receivable. As of December 31, 2007,
approximately 78% of our gross accounts receivable was concentrated with three
customers, each of whom represented more than 10% of our gross accounts
receivable.




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




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




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




·
            rapid technological
  change;




·
            the emergence of new
      competitors;




·
            significant development
    costs;




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




·
            integration of joint solutions in collaboration
      platforms;




·
            evolving industry
  standards;




·
            transition from hardware appliances and
      infrastructure to software; and




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




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




Page 24


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




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




Competition could reduce our market share and decrease
our revenue.




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




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




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




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




The U.S. and global economy may enter a severe
recession or even a depression, and our customers and potential customers,
partners and distributor may delay or forego ordering our products, and we could
fall short of our revenue expectations for 2008 and beyond. Slower growth among
our customers, tightening of customers’ operating budgets, retrenchment in the
capital markets and other general economic factors all have had, and could in
the future have, a materially adverse effect on our revenue, capital resources,
financial condition and results of operations.




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




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




Page 25


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




On February 25, 2008 we announced that Microsoft
Corporation had filed requests for re-examination of 24 of our 29 U.S. patents.
Subsequently, Microsoft also filed requests for re-examination of our remaining
five U.S. patents.  On June 10, 2008 we announced that the USPTO had
completed its review of Microsoft’s requests for re-examination and had rejected
19 of the re-examination applications in their entirety, and the majority of the
arguments for one additional application. The USPTO agreed to re-examine, either
in part or fully, 10 of our existing patents.  Subsequently, Microsoft
submitted five petitions for reconsideration of USPTO’s rejection of Microsoft’s
re-examination applications.  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 our licensing negotiations in process, and may require us to
spend substantial time and resources defending our patents, including the fees
and expenses of our legal advisors.  The potential impact to our
results of operations may require us to seek additional financing to fund our
operations and the defense of our patents.




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




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




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




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




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




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




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




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




Page 26


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




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




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




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




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




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




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




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




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




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




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




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




Page 27


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




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




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




International revenue, which consists of sales to
customers with operations principally in Western Europe and Asia, comprised 50%
and 62% of total revenues for the three months ended September 30, 2008 and
2007, respectively, and 51% and 75% of total revenues for the nine months ended
September 30, 2008 and 2007, respectively. Some of the risks we may encounter in
conducting international business activities include the
following:




·
            tariffs and other trade
      barriers;




·
            unexpected changes in foreign regulatory
      requirements and laws;




·
            economic and political
      instability;




·
            increased risk of infringement
      claims;




·
            protection of our intellectual
      property;




·
            restrictions on the repatriation of
      funds;




·
            potentially adverse tax
      consequences;




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




·
            fluctuations in foreign currencies;
      and




·
            limitations in communications infrastructures in
      some foreign countries.




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




Page 28


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




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




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




Not applicable.




Item 3. Defaults Upon Senior
Securities




Not applicable.




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




Not applicable.




Item 5. Other
Information




Not applicable.




Page
29





Item 6.Exhibits





Exhibit No.
            
            Description10.21+
            
            Licensed
      Works Agreement between Avistar Communications Corporation and
      International Business Machines Corporation dated September 8,
      2008.10.22+
            
            Licensed
      Works Agreement Statement of Work between Avistar Communications
      Corporation and International Business Machines Corporation dated
      September 8, 2008.10.23+
            
            Patent
      License Agreement between Avistar Communications Corporation and
      International Business Machines Corporation dated September 9,
      200831.1
            
            Rule 13a-14(a)/15d-14(a)
      Certification by the Chief Executive Officer.31.2
            
            Rule 13a-14(a)/15d-14(a)
      Certification by the Chief Financial Officer.32.1
            
            Certification
      of Chief Executive Officer and Chief Financial Officer Pursuant to 18
      U.S.C. Section 1350, as adopted pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002.




_______________________________________





+Portions
of this exhibit have been omitted pursuant to a request for confidential
treatment and the omitted portions have been separately filed with the U.S.
Securities and Exchange Commission





Page
30





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 14th day of November 2008.





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




Page
31









EXHIBIT
INDEX





Exhibit No.
            
            Description10.21+
            
            Licensed
      Works Agreement between Avistar Communications Corporation and
      International Business Machines Corporation dated September 8,
      2008.10.22+
            
            Licensed
      Works Agreement Statement of Work between Avistar Communications
      Corporation and International Business Machines Corporation dated
      September 8, 2008.10.23+
            
            Patent
      License Agreement between Avistar Communications Corporation and
      International Business Machines Corporation dated September 9,
      200831.1
            
            Rule 13a-14(a)/15d-14(a)
      Certification by the Chief Executive Officer.31.2
            
            Rule 13a-14(a)/15d-14(a)
      Certification by the Chief Financial Officer.32.1
            
            Certification
      of Chief Executive Officer and Chief Financial Officer Pursuant to 18
      U.S.C. Section 1350, as adopted pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002.




_______________________________________





+Portions
of this exhibit have been omitted pursuant to a request for confidential
treatment and the omitted portions have been separately filed with the U.S.
Securities and Exchange Commission


Page
32