Edgar Filing: AVISTAR COMMUNICATIONS CORP

form10k.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2008

TRANSITION REPORT PURSUANT TO SECTION 13 OF 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to .

Commission File Number: 000-31121

AVISTAR COMMUNICATIONS CORPORATION

(Exact name of registrant as specified in its charter)

Delaware		88-0463156
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)
1875 South Grant Street, 10th Floor, San Mateo California		94402
(Address of Principal Executive Offices)		(Zip Code)

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

Securities registered pursuant to Section 12(b) of the Act:

	Title of each class		Name of each exchange on which registered
Common Stock, $0.001 par value		The NASDAQ Stock Market LLC
		(NASDAQ Capital Market)

Securities registered pursuant to Section 12(g) of the Act:

None

Indicate by check mark if the registrant is a well known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x

Indicate by check mark if the registrant is not required to file the reports pursuant to Section 13 or 15(d) of the Act. Yes o No x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

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

Large accelerated filer o Accelerated filer o

Non-accelerated filer o (Do not check if a smaller reporting company) 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 o No x

Aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold on June 30, 2008 was $11,617,788. Shares of Common Stock held by each executive officer and director and by each person who owns 10% or more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

As of March 3, 2009, the registrant had outstanding 34,756,861 shares of Common Stock.

DOCUMENTS INCORPORATED BY REFERENCE

The Registrant incorporates by reference into Part III of this Annual Report on Form 10-K specific portions of its Proxy Statement for its 2009 Annual Meeting of Stockholders.

Table of Contents

AVISTAR COMMUNICATIONS CORPORATION

ANNUAL REPORT ON FORM 10-K

YEAR ENDED DECEMBER 31, 2008

TABLE OF CONTENTS	Page
PART I
Item 1. Business		3
Item 1a. Risk Factors		16
Item 1b. Unresolved Staff Comments		23
Item 2. Properties		23
Item 3. Legal Proceedings		24
Item 4. Submission of Matters to a Vote of Security Holders		24
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities		24
Item 6. Omitted		24
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations		24
Item 7a. Omitted		35
Item 8. Financial Statements and Supplementary Data		35
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure		35
Item 9a. Controls and Procedures		36
Item 9b. Other Information		36
PART III
Item 10. Directors, Executive Officers and Corporate Governance		36
Item 11. Executive Compensation		37
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters		37
Item 13. Certain Relationships and Related Transactions and Director Independence		37
Item 14. Principal Accountant Fees and Services		37
PART IV
Item 15. Exhibits, Financial Statement Schedules		38
Signatures		41
Index to Financial Statements		F-1

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Forward Looking Statements

This Annual Report on Form 10-K, the exhibits hereto and the information incorporated by reference herein contain “forward looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and such forward looking statements involve risks and uncertainties. When used in this Annual Report, the words “expects,” “anticipates,” “believes,” “plans,” “intends” and “estimates” and similar expressions are intended to identify forward looking statements. These forward looking statements include predictions, among others, regarding our future revenues and profits, income from settlement and patent licensing, customer concentration, customer buying patterns, research and development expenses, sales and marketing expenses, general and administrative expenses, litigation and legal fees, income tax provision and effective tax rate, realization of deferred tax assets, liquidity and sufficiency of existing cash, cash equivalents, and investments for near-term requirements, sufficiency of leased facilities, purchase commitments, product development and transitions, expansion and licensing of our patent portfolio, competition and competing technologies, and financial condition and results of operations as a result of recent accounting pronouncements. Such statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected. These risks and uncertainties include those discussed below and those discussed in “Item 1a. Risk Factors” as well as others incorporated by reference herein. Avistar Communications Corporation (the “Company,” “we,” or “us”) undertakes no obligation to publicly release any revisions to these forward looking statements to reflect events or circumstances after the date this Annual Report is filed with the Securities and Exchange Commission or to reflect the occurrence of unanticipated events.

PART I

Item 1. 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). 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 one remaining wholly-owned subsidiary, Avistar Systems U.K. Limited (ASUK).

Our principal executive offices are located at 1875 South Grant Street, 10th Floor, San Mateo, California, 94402. Our telephone number is (650) 525-3300. Our trademarks include Avistar and the Avistar logo, AvistarVOS, Shareboard, vBrief and The Enterprise Video Company. This Annual Report on Form 10-K 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, 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 100 F Street, NE, Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC at http://www.sec.gov. The contents of these websites are not incorporated into this filing.

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.

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

Since inception, we have recognized the innovative value of our research and development efforts, and have invested in securing protection for these innovations through domestic and foreign patent applications and issuance. As of December 31, 2008, we held 96 U.S. and foreign patents, which we look to license to others in the collaboration technology marketplace.

In late 2007 and 2008, we implemented corporate initiatives aimed at increasing our product sales, expanding our customer deployments and support, improving our corporate efficiency and increasing our development capacity. The components of these initiatives 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 50 on December 31, 2008; and

Pursuing multiple distribution, services and technology partners.

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

Industry Background

Globalization, supported by the near ubiquity of communications networks such as the Internet, has allowed companies to lower costs, reach new markets, change business processes (e.g., eBusiness) and distribute and outsource operations. It also has meant increased competition, a faster business pace and less differentiation. These factors, coupled with the difficulty and cost of travel, increased risks due to socio-political uncertainties and pandemic concerns and the desire to reduce carbon emissions and environmental impact, are causing businesses to look for new tools that will help them increase productivity, reduce budgetary expenses, take advantage of revenue opportunities, and minimize business continuity risks. Enterprises of all sizes stand to benefit from new and advanced communication and collaboration tools that enable their employees, partners, suppliers and customers to collaborate more effectively and form tighter relationships within and across buildings and over disparate geographies and time zones. Communications tools that speed decision-making, build trust-based relationships, especially across cultures, and are software-presence-aware are becoming even more critical in today’s increasingly complex business environment.

The emergence of the Internet has accelerated the adoption of network-based collaboration applications including email, instant messaging, and web conferencing. The increasing availability and affordability of bandwidth on communication networks is further driving businesses to utilize new communication tools, such as voice and video over IP, and are enabling users to connect from more places, including home offices and WiFi hot spots such as airports, and hotels. This is enabling more distributed, mobile and global operations while maintaining communications.

Limitations of Current Means of Communication and Collaboration

As technology advances become more affordable and modes of communication expand, enterprises are seeking widely deployable and cost effective technology to replicate, at the desktop, the impact of visual communication and collaboration that occurs in a face-to-face meeting. Individuals generally prefer face-to-face encounters to less personal forms of communication because they can see one another and benefit from the non-verbal cues that speed communication and deepen understanding. This is particularly true for more complex interactions such as negotiations, sales, product development, project and crises management and decision making across geography/functions/cultures. However, in today’s globalized, fast-paced business environment, face-to-face interactions are often forgone due to the difficulty and time required for travel, and the need to act quickly. These time and distance challenges become increasingly difficult to deal with as the number of potential participants increase. Beyond traditional teleconferencing, attempts to conduct virtual meetings as an alternative to face-to-face meetings have generally been limited to conference room-based video conferencing and web-based data teleconferences.

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To address the growing need for collaboration across distance and time, organizations have resorted to using a patchwork of discrete technologies, including video conferencing and teleconferencing, fax, email, instant messaging, Internet audio and video delivery and data sharing applications. Many of these technologies have been widely adopted, and collectively indicate the need for collaboration tools including visual unified communications solutions. However, these discrete technologies are not good substitutes by themselves for face-to-face meetings and presentations because they do not provide an integrated communications solution that fosters team interaction and delivers critical, time-sensitive information quickly and reliably. By providing face-to-face collaboration in an integrated communications solution, video can speed problem resolution and motivate action, trust and understanding. Additionally, users want to leverage knowledge and expertise by being able to create and publish video content from their desktop, either spontaneously, as with email or voicemail, or in a more formal manner for broader distribution through the Internet or corporate data network.

Although IP communications technologies are already in use at many enterprises, businesses and other organizations require increasingly comprehensive, integrated and scalable visual unified communication capabilities. For example, video conferencing is often limited to scheduled point-to-point communication from designated rooms or through the use of “roll-about” products, where call set-up procedures, lack of networking, bandwidth requirements and room availability greatly constrain functionality, spontaneity, usability, reliability and efficiency. Most individuals do not have immediate access to these video technologies, and the reservation and set-up time make them unlikely to be used on a spontaneous basis. Few of these video solutions are deployed widely to individuals to support them where and how they normally work—at their desks, integrated into the business applications they use. Usage and adoption of these systems is thus often limited.

Elements of a Complete Communications and Collaboration Solution

To become a critical tool in the enterprise, a communications solution must first and foremost provide application functionality that boosts worker productivity. It also has to be “self service” and provide high quality at scale, high reliability, low total cost of ownership, and be available to people where and when they do most of their work, which typically means at their desks, but increasingly means from home or while traveling. It must also effectively utilize existing and evolving network infrastructure. We believe a complete communications and collaboration solution must provide the following:

Applications and Functionality

support or integrate into the applications people use, in the way they use them, to deliver real-time and non-real-time self service personal for collaboration and visual communication;

do so in an intuitive, “easy” manner in order to foster expanding usage;

Quality

approximate the video and audio quality of television for natural and easy interaction;

make interactions as realistic as possible by minimizing visual artifacts when transmitting and receiving video calls such as latency, jitter, freeze-frame, stutter and small frame size;

seamlessly integrate all forms of audio, video and data communications;

Scalability

like the Internet and public telephone networks, the communications solution must be designed for size independence and should scale cost-effectively to support a very large numbers of users;

Reliability

operate dependably and reliably to avoid user frustration, while minimizing support costs;

provide visual unified communications with the ease of use, speed, quality, functionality, flexibility and global access of the telephone, while easily supporting more complex applications and situations;

Adaptability

offer an upgradeable architecture that can evolve as bandwidth availability, protocols, standards and compression technologies change;

include powerful software to manage an integrated suite of collaborative applications, relying on networked infrastructure;

leverage current and future business investments in local and wide area networks, Internet protocol and standards-based infrastructures;

reduce reliance on hardware components through a shift to software-based integrated communications functionality;

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Affordability

operate and scale cost effectively;

utilize standard, low cost and widely available hardware components, such as “web-cams”;

be cost-effective compared to other pervasive forms of enterprise communication, such as email; and

deliver cost savings through innovations in support, network and resource management.

We believe high quality visual unified communications allow businesses to improve collaboration and thereby offer them the opportunity to increase productivity, enhance customer service and revenue generation, and facilitate business-to-business interactions that reduce costs, all on an accelerated basis. We also believe that, just as every organization now relies on a telephone network, and most businesses increasingly rely on the Internet, a market is emerging in which businesses and other organizations will choose to rely on fully integrated video, audio and data collaboration, regardless of networks, to make their business applications more effective.

The Avistar Solution

Avistar delivers a suite of video, audio and collaboration solutions which are designed to support users in the office, via the conference room or on-the-go. It is through an intelligent coupling of various forms of communication and collaboration into daily work processes that we believe the benefits described above can be realized. To fulfill this, we deliver a communication and collaboration platform known as Avistar C3. C3 provides a comprehensive and integrated suite of video, audio and collaboration applications that include on-demand access to interactive video calling and conferencing, content creation and publishing, broadcast origination and video distribution, and video-on-demand, as well as data sharing, presence-based directory services and network management. Our C3 architecture is open and flexible in order to embrace continued technological innovation and standardization. It is designed to use existing and emerging communication and video standards such as session initiation protocol, or SIP. It also provides customers choice and flexibility in designing and implementing network topologies to best deliver high-quality video, audio and collaboration applications to desktops, conference rooms and individuals on-the-go.

We have built a complete collaboration solution that is delivering business-quality video, audio and collaboration solutions to thousands of desktops across hundreds of locations. Each of our applications can be used, integrated and managed in conjunction with one another. Our platform also joins users in a high-quality video network to improve their ability to solve complex problems, connect to co-workers, customers and suppliers, manage large projects and quickly act together on opportunities. Our system does this cost effectively and reliably, and is designed to be able to serve the wide range of businesses from a single office operation to global corporations with branch offices and/or geographically dispersed operations.

Interactive video calling. Our system allows users to participate in spontaneous interactive video collaborations from their desktops. Users can simultaneously see multiple participants in windows on their workstations or an external monitor. Additionally, our system provides full duplex audio, which allows multiple users to speak and hear each other clearly at the same time. The desktop window can be divided into four quadrants, to permit up to three other video sources. These sources can include other participants in real-time, broadcast content or recorded video. The participants can include individual users or conference-room groups located at multiple sites and/or various enterprises, all without requiring advance reservations or conferencing services. Each participant has the full ability to utilize all the call functions of the system, such as adding or removing participants, focusing the view on one participant, putting anyone or the entire call on hold, and transferring the call. Advanced telephony features such as Caller ID, Do Not Disturb, leave Message and multiline calling are also provided. The system supports the communications needs of users by allowing them to add a third or fourth participant into a call spontaneously for a quick conference, and then revert back to a two or three party call. This ability helps speed decision-making and leverages the knowledge of experts. As an example, a sales trader can be on a video call with a client portfolio manager and spontaneously add a research analyst to the call for added insight on a particular security, then drop the analyst and add a trader to review execution strategy, instantaneously with a series of mouse clicks.

Interactive broadcasts and presentations. Interactive broadcasts allow moderated presentations to an audience of viewers, who have the ability to send questions to the presenters. Moderators can dynamically control who’s presenting, bring audience members into the broadcast, select what views are broadcast, and monitor questions. Sales meetings, training seminars, analyst reports, management presentations and live news broadcasts can be delivered real-time to every user’s workstation and streamed to browser-based users. For example, a customer employed its Avistar video network to maximize the reach and impact of an educational seminar. The customer broadcasted the seminar to an estimated 300 desktops and meeting rooms, with more than 2,000 employees and clients watching in the United States and Europe. As another example, one customer has shifted its international sales meetings to broadcasts and recorded presentations on its Avistar system, thereby saving travel time and costs, while expanding the broadcast to a wider audience. Additionally, video feeds from broadcast TV channels or other video sources can be distributed to users through the Avistar system.

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Video-on-demand. Users anywhere on the Avistar network can easily retrieve stored videos. For example, a corporation has used our system to record its sales training seminars. Salespeople who are unable to attend these face-to-face presentations are now able to watch the seminars by retrieving and playing the stored videos on their desktops when it is convenient for them. Another customer uses our system to record and broadcast their daily morning meetings so colleagues in other time zones around the world can be updated on the issues of the day when they report to work. The ability to both archive and retrieve stored content can facilitate the establishment of a visual “institutional memory” and support training efforts.

Integrated collaboration & data sharing. In addition to viewing the four quadrants of our video window, multiple users can simultaneously create and annotate a shared document using text or drawing tools color-coded specifically for each user. All participants can access the contents of any shared window and save the marked changes for later reference. Our system can also be utilized in conjunction with other application-sharing programs that utilize data networks or the Internet, including popular web-based data collaboration solutions. As one example, while participating in an interactive video call, users can access Microsoft NetMeeting’s application sharing capabilities through a button on our tool bar, and jointly view and edit a document. Multiple design engineers, for example, can share a technical drawing in order to resolve an issue with a defective part.

Our system has the following key features necessary to make integrated video collaboration effective:

Easy to use interface. Our applications combine the rich interaction of a face-to-face meeting with a self-service interface that’s intuitive and easy to use.

Click-to-connect simplicity. To initiate calls or add another user to a call already underway, a user simply clicks on either a “direct connect” button or a name in the directory. Standard telephone-like features such as hold, hang-up, forward, “leave message” or “begin another call” are all completed with the click of a mouse, or keyboard shortcuts. Additionally, anyone on an Avistar network can initiate a video call to the desktop of colleagues, customers, suppliers and others on other Avistar networks. If the person being called is logged-in but unavailable, users can leave a personalized call back message that allows the person to automatically return the video call without having to look up the address. A portion of this functionality is protected under certain patents held by Avistar.

“Find Me, Follow Me.” Avistar video calling is built on directories and presence-based features referred to as “Find Me, Follow Me.” Using this feature, our system is able to determine the presence and location of any user on an Avistar network at any time. To call any user in the Avistar network, it is not necessary to know their number or current location. As long as the Avistar user is logged into his or her Avistar application, the Find Me, Follow Me application automatically registers where that user is logged in, regardless of site or geography, and routes all calls to the user’s location. Using this Find Me, Follow Me technology, Avistar’s system makes video calling a one-click process and enables what we call “Video Instant Messaging.” A portion of this functionality is protected under certain patents held by Avistar.

Comprehensive directory. The presence-based Avistar network directory is a comprehensive list of Avistar numbers that can be called with a click. All users currently logged into an enterprise’s Avistar network will be shown, providing immediate ‘presence’ information as to availability. The global directory can be tailored to include only a subset of a more specific business’ community of users. In addition, a private directory feature allows users to create their own directory and reach frequently called parties with a one-click “direct connect” tool. Both global and private directories can also include other non-Avistar sites that use standards-based video conferencing systems. Through the Avistar Community Exchange and Avistar C3 Proxy products, presence information can be shared across participating enterprises. The result is one-click, presence-based, cross-enterprise calling network which helps form a community of users. A portion of this functionality is protected under certain patents held by Avistar.

Consistency across locations. The Avistar user interface is consistent across desktops and conference rooms. Thus, a user who is familiar with the functionality at the desktop requires no additional training or set-up to utilize an Avistar system in a conference room setting. This allows conference room systems to be “self-service,” thereby avoiding the support logistics and expense of traditional room-based systems.

Seamless integration of system applications. All of our applications are seamlessly integrated with one user interface. As a user adds an additional video source during an on going video call—such as an additional live participant, a one-way broadcast or a stored video clip—there is virtually no delay in launching another application or downloading data. In addition, each application is synchronized with the others so that all participants in a video call see and hear the same content simultaneously. Thus, recorded or broadcast video can be added to a live session and shown to all participants. The entire session can also be recorded. Our system enables common network and application management, so the same directory can be used for two-way calls, one-way broadcasts and data sharing in the same session. Usage can be determined with our integrated call-reporting tool that provides summary data for analysis and cost management. A portion of this functionality is protected under certain patents held by Avistar.

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Network Bandwidth Management. Our network architecture provides system administrators with the ability to flexibly and proactively manage each of the various components of the network. Within our system, the most costly and complex equipment and software applications are shared as networked resources. This arrangement allows for redundancy and dynamic allocation of these resources to users who need them, and ensures that users experience the best video quality possible at the highest reliability and lowest cost of use. Servers and switches can be maintained, installed and repaired centrally, and many network support functions can be performed remotely over the data network, assisted by System Central, thereby limiting the disruption of service to an individual user. Similarly, additional desktops and meeting rooms can be easily and inexpensively added to the Avistar network, with those new users concurrently added to the Avistar directory. Additionally, our software makes call routing decisions to minimize communications costs and control bandwidth utilization. A portion of this functionality is protected under certain patents held by Avistar.

We believe our solution includes the following benefits to our customers:

Speed business processes. We provide a fully integrated Internet protocol-based video collaboration solution that seamlessly allows individuals to make video calls, view broadcasts and create, store and access video content or other forms of data from the desktop making visual communications widely and easily available which can speed business processes by enhancing collaboration and communication.

Increased availability of knowledge within the enterprise. At many businesses, individuals who possess valuable knowledge often cannot effectively distribute their knowledge to the rest of the organization. Our system enables these businesses to access these individuals and disseminate their knowledge more efficiently and effectively by offering them the ability to call, broadcast or record from their desktops, and offering other users the ability to receive this information real-time, or access video recordings at a convenient time and location. The ability to spontaneously add additional participants to a call encourages personal communications between individuals who otherwise might not enjoy this access. In addition, our system gives every desktop the ability to create and publish valuable visual content, which can be distributed inside and outside the organization to support employee and customer needs worldwide.

Improved productivity and revenue generation. Our system helps companies increase the productivity of their employees and accelerate time critical decision-making. By creating a network of Avistar users, our customers can have face-to-face meetings within the enterprise and with customers and partners, without the costs and time delays of travel. Negotiations, crises management, sales, advisory services, decision-making and other persuasive communications are more effective when done face-to-face. Our solution allows interactions to happen in real-time, speeding up the manner in which business is done, freeing up time for employees, enhancing business-to-business communications, and potentially increasing revenue generation.

Enhanced customer and partner relationships. Our system helps companies to be more responsive to and develop stronger business relationships with their customers, partners and suppliers. An Avistar call is generally as easy and reliable as a telephone call or “instant message”, while being more personal. One of our customers has provided Avistar networks to their clients and business partners, including offshore outsource partners, in order to facilitate interactions and improve relationships.

Opportunity to leverage existing and future communication infrastructures. We provide an open architecture that uses existing standards and is designed to take advantage of emerging standards. Our system integrates into our customers’ existing network communications infrastructure, and supports the protocols a company may choose to use for video broadcasts, data sharing and the transport of information. However, video quality varies depending on the protocol selected. Our system utilizes existing data networks for transporting video, and is designed to support real time digital networking and video transmission. We have designed our system to continue to work with Internet protocol-based technologies as standards evolve and quality of service improves. We expect this flexibility, together with simplified software and hardware at the desktop, to allow companies to make effective use of their existing local area and wide area networks, as well as their next generation networks.

Better communication to face new business challenges such as globalization, business continuity planning, and distributed locations. Within global corporations, professionals collaborate daily with customers, partners and associates who are often located in different offices and/or different time zones. This has increasingly become the case as firms, due to economic and security concerns, have restricted travel, begun decentralizing their personnel across a more distributed set of locations, taking advantage of lower costs of real estate and increased business resiliency through distributed operations, and shifted more operations to outsourcing providers. In this context, critical information must be delivered on a timely basis and without confusion, as smoothly as if colleagues were working together in person. Avistar’s video product suite enables companies that are reducing travel and/or distributing their operations to easily and quickly connect small, remote offices as well as at-home workers to the central organization and still benefit from face-to-face interaction. Based on our experience in helping existing customers choose their optimal configurations, we are able to advise new customers on setups and configurations that will be most effective for a large central office, a small branch office, an outsourcing provider, or other remote locations.

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System Architecture and Technology

Our visual unified communications solutions are based on our 10th major release of our open architecture, which enables users to communicate using various networking protocols and transport media, including IP networks and the Internet. We developed our architecture to address the necessary elements of a complete video-enabled collaboration solution.

We believe that the following technical factors will transform and consolidate the existing video collaboration applications marketplace, creating a strong need for a software platform that will support this consolidation and evolution:

improved compression technologies;

widespread proliferation of broadband infrastructure and virtual private networks, or VPNs (with enhanced tools to optimize bandwidth for video transmission (QOS; quality of service));

developing availability of converged audio, video and data networks;

improved computer processing speeds; and

adoption of critical digital video and multimedia standards.

Our C3 platform supports this consolidation and evolution by integrating industry standards for audio, video and data transport, but separating them from application functionality and system management. This allows our software application platform to manage the interoperation and transcoding of various standards to seamlessly integrate video, audio and data into complex applications, and not be limited by the functionality built into one particular, application-specific standard. It also allows the system to accommodate new and evolving standards with minimal disruption. Current industry and widely accepted proprietary standards supported include H.263, H.264, H.320, H.323, SIP, NTSC, PAL, MPEG, Microsoft Windows Media Video and Real Networks RealMedia. Our system uses TCP/IP, the standard Internet protocol, for providing video and audio calls, scheduling and starting broadcast presentations, and managing the creation of materials. In addition, we use TCP/IP for overall systems and network management throughout our C3 software platform. This approach allows us to deliver connectivity throughout an enterprise and allows us to leverage existing Internet infrastructure. For delivery of high-quality video streams in the local area network, including wireless, we primarily utilize video over IP technology but offer a choice of IP or traditional circuit switched technologies, including the ability to mix and match network types. Thus, Avistar customers can successfully deploy desktop video across the enterprise, even if portions of their network, in older buildings for example, aren’t capable of supporting real-time video on their data networks. We use our gateways to translate between the various network technologies used in our system. These gateways are managed and controlled by our systems software with TCP/IP-based protocols.

Each Avistar endpoint functions as a node on the network, like personal computers, printers or file servers on a local area network. Just as color printers and file servers are often shared network resources on the local area network, the more costly equipment in an Avistar system, such as servers, media servers, switches, and gateways, are centralized and made available to multiple users. Network nodes and resources, like those of a data network, are managed through centralized, Internet protocol-based applications and administration tools, such as web-based reports of video call activity.

We believe our video software platform positions us to lead the transformation described above. Further, we provide a suite of collaboration applications that seamlessly operate with the AvistarVOS system allowing users to access this functionality in an easy and intuitive manner. We expect to make this platform more accessible to developers and to allow integration with other applications and network hardware.

Because of the intelligent integration of various video network components, all Avistar products are controlled by the Avistar C3 platform, our architecture has the following key features:

Network management: Avistar C3 utilizes open protocols for call set-up, call control and directory services. It also complies with standards and interfaces and connects with video networks through shared Avistar gateways, which are further connected via private or public telephony or TCP/IP networks. Servers communicate through our signaling system for video protocol, SSV, which is based on TCP/IP, the standard Internet protocol. Through this signaling system, servers exchange configuration information and allocate call resources during call set-up, and exchange network status information. The signaling system selects the optimal route for all video calls, helping to minimize call costs and performance demands on wide area network resources. Most videoconferencing equipment using industry standard compression technologies also can communicate with an Avistar network.

Transport standard independence: Our system selects the appropriate transport standards for transmitting information over networks to help deliver the highest quality video possible and full duplex audio in the most efficient manner. For example, the Avistar C3 software automatically exchanges information among servers and switches to determine the best network route for video calls. For the transport of video over a local area network, our system uses either data networks with our IP endpoints, or existing spare Ethernet wires for our legacy product to deliver standards-compliant high quality signals. This allows customers to choose the transport type to best fit their network capabilities in the local area. In a wide area network, we use industry video compression standards across a customer’s private IP network, or VPN’s, or the Internet, or the public telephony network. Recent product releases have enhanced our ability to support mobile and home workers who may have lower bandwidth connections. For the transmission of recorded content on corporate data networks or via the Internet, our system uses standard digital storage formats and transport technologies.

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Expandable to thousands of users: Because shared resources, such as servers, are attached to the Avistar switch and are managed through the data network, new users and new capabilities can be added without replacing existing infrastructure, but rather, by simply adding video software and a web-camera at each desktop. Just as local area network switches and public telephony networks can be linked together without the use of routers, Avistar switches can be similarly linked without the use of video network gateways. As a result, customers can easily add capacity as their needs grow.

System Products and Applications

Our system-level products and applications consist of shared resources and a network of desktop, laptop and conference room endpoints which connect to each other and to shared resources.

Infrastructure, Server and Software Products

Avistar C3 Server. All systems require Avistar C3 Server software. It enables the seamless integration of video applications, audio support, collaboration services, comprehensive network and bandwidth management and administration. The Avistar C3 software supports a highly-distributed topology, and multiple instances may be deployed.

Avistar Directory Software. Our directories allow a user to place a video call by simply clicking on a name in the presence-based Avistar network directory. Our system will route the call to the correct location over the local area network or the wide area as appropriate. The user doesn’t need to know phone numbers or IP addresses. The user can also look up addresses in private and global address books, utilize browser style type-in boxes, and access speed-dial ‘direct connect buttons’. This server-based directory integrates with LDAP directories, simplifies administration, and allows users to get started quickly, without having to manually enter many video phone numbers into their desktop directory.

Shareboard Software. Our Shareboard application allows users to collaborate on graphics, data or text during a video call. By clicking on the “share” button, users are linked to the Shareboard data sharing application. Users can share any application window or image with all conference participants, see all users’ color-keyed pointers and text and paintbrush annotations, and save or print shared images from any desktop or conference room.

Avistar Call Reporting System. With our web-based call reporting system, our customers can track all calls logged by our servers. Reports show call details, device usage and calls by user, all viewable from any Web browser. Reports can be customized and stored for future or specialized analysis.

Desktop and Conference Room Endpoint Products

Client personal computers run the Avistar C3 Client software applications, including Avistar Conference, the primary user interface to server-based video applications. Endpoints access video services managed by the Avistar C3 Server software through the Avistar C3 Client software and Client Access Licenses. Software-only endpoints have higher processing power requirements on the client PC than endpoints with hardware assist. The Avistar C3 software detects what, if any, additional hardware is attached and can work in any of three modes. Thus, in the office, a user may have an IP hardware accelerator to minimize processor loading, while on the road or at home, they may use the software-only mode to simplify the equipment required.

Desktop Endpoints. The standard Avistar two-way desktop system consists of the following components:

Avistar C3 client software, which includes video and audio codecs;

Web camera—required for software-only operation; or,

A high quality camera with built-in directional microphone for hardware assisted endpoints.

Avistar Room Systems. We deliver complete video systems for a range of room sizes and layouts. We believe that one key advantage of our system is that the interface used in a conference room system is consistent with the interface used on individual desktops, allowing for all forms of video-enabled communications: interactive video calling, content creation and publishing, broadcasting and video-on-demand. Therefore, desktop users are familiar with the controls used in Avistar room systems and do not need additional training to operate the room system, nor do they need a technician to set-up and connect conference room calls (as is common with traditional room systems). In addition, since rooms are simply additional nodes on the network, they can be less expensive than self-contained, traditional room systems.

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Patent Licensing

We derive a significant portion of our annual revenues by licensing 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. This broad suite of patents enables much of the functionality of our Avistar C3 platform. Licenses to third parties may cover part of or all of our patent portfolio. End-to-end rich media collaborative application companies which have taken licenses to our patents include firms such as Polycom, Inc., Tandberg ASA, Sony Corporation and Sony Computer Entertainment Inc. (SCEI), Emblaze-VCON Ltd., Radvision, LifeSize Communications, Inc. and International Business Machines Corp. (IBM). Examples of the many patented innovations in our portfolio include: the handling of decentralized video call endpoints, unshielded twisted pair video conferencing, with data conferencing and desktop workstation echo cancellation. We maintain and support an active program to protect and grow our intellectual property, primarily through the filing of patent applications and the defense of issued patents against infringement. As of December 31, 2008, we had 96 U.S. and foreign patents covering various aspects of our technology, with expiration dates ranging from 2013 to 2018, and have over 28 pending patent applications. In addition, we attempt to protect our trade secrets and other proprietary information through agreements with licensees, proprietary information agreements with employees and consultants, and other security measures. We also rely on trademarks and trade secret laws to protect our intellectual property.

Segment Information

We operate through two segments:

Our products division engages in the design, development, manufacture, sale and marketing of networked video communications products.

Our intellectual property division engages in the development, prosecution, maintenance, support and licensing of the intellectual property and technology used in our video communications system.

Financial information regarding these segments is provided in Note 11 to our consolidated financial statements included in this Annual Report on Form 10-K. Financial information relating to revenues and other operating income, net loss, operating expenses and total assets for the three years ended December 31, 2008, can be found in our Consolidated Financial Statements attached hereto.

Customers

Video Communications Products

As of December 31, 2008, we have licensed and recognized revenue with respect to over 22,000 end-users at over 400 customer sites in approximately 151 cities in over 40 countries. Because many of our customers operate on a decentralized basis, decisions to purchase our systems are often made independently by individual business units. As such, a single company may represent several separate accounts, and multiple customer sites may relate to the same company.

For the year ended December 31, 2008, Deutsche Bank AG and its affiliates, UBS Warburg LLC and its affiliates, IBM and Sony Corporation accounted for 40%, 19%, 18% and 11% of our total revenues, respectively. For the year ended December 31, 2007, Radvision Ltd., Deutsche Bank AG and its affiliates, and UBS Warburg LLC and its affiliates accounted for 33%, 24% and 18% of our total revenues, respectively. For the year ended December 31, 2006, Sony Corporation, Deutsche Bank AG and its affiliates, and UBS Warburg LLC and its affiliates accounted for 38%, 25% and 20% of our total revenues, respectively. The level of sales to any customer may vary from quarter to quarter, and while we continue to expand our indirect sales channel, we expect that significant customer concentration will continue for the foreseeable future. The loss of, or a decrease in the level of sales to, or a change in the ordering pattern of, any one of these customers could have a material adverse impact on our financial condition or results of operations.

International revenue, which consists of sales to customers with operations principally in Western Europe and Asia comprised 51%, 72% and 75% of total revenue for 2008, 2007and 2006, respectively. For 2008, 2007and 2006, revenues to customers in the United Kingdom accounted for 22%, 12% and 12% of total revenue, respectively.

Licensing Activities

We derived 11% or $954,000, 42%, or $5.0 million and 39%, or $5.2 million, of our annual revenues in 2008, 2007 and 2006, respectively, by licensing our broad portfolio of patents to third parties covering video and rich media collaboration technologies, networked real-time text and non-text communications and desktop workstation echo cancellation. Our license revenue in 2008 was primarily generated by licenses granted to Sony Corporation and its subsidiaries. License revenue in 2007 was primarily generated by licenses granted to Radvision Ltd. and Sony Corporation and its subsidiaries, including SCEI. Radvision agreed to make an up-front license payment of $4.0 million in the three months ended June 30, 2007. License revenue in 2006 was primarily due to a license to Sony Corporation and its subsidiaries. Sony Corporation agreed to make an up-front license payment of $5.0 million and future royalty payments, which was recognized by us as licensing revenue in the three months ended September 30, 2006.

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Sales and Marketing

Direct Sales. We have a direct sales force in the United States and Europe consisting of sales managers located in New York and London. Sales managers have direct responsibility for selling and account management of our technology at customer sites.

Indirect Sales. Through our partnership organization, we have established a set of relationships with strategic partners and value added resellers, in order to establish and expand an indirect channel of sales for our products.

Marketing. Our marketing efforts are directed towards Global 5000 companies with targeted solutions for the SMB and Enterprise markets, focused on the specific collaboration needs of each. We also work with our existing customers to demonstrate how our solutions can further satisfy their needs, thereby growing our footprint within our installed base. We emphasize initiatives to develop market awareness of our solutions and services, as well as increase usage of our installed systems.

We also use marketing programs to build recognition of our corporate brand, foster partnerships, and promote our technology in regards to licensing opportunities.

Installation, Maintenance, Training and Support Services

We provide a wide variety of services for installation, design and adoption of our video communications products. This may include the analysis of workflows in order to identify patterns of collaboration between workgroups, so that the best configuration of networked resources can be designed and implemented for the enterprise. We generally install our systems for new customers. In an increasing number of cases, our customers’ information technology group or services partner install follow-on orders. In the future, we expect our customers or their services partners will increasingly perform the installation process.

The installation that we offer to our customers as a separately-priced service relates to the physical set up and configuration of desktop and infrastructure components of our solution. To accomplish this activity, our staff frequently interfaces with the customer’s internal information technology, or IT, staff and external suppliers, in order to provide for connectivity to the customer’s local and wide area networks, and for the physical placement (arranging for rack space and appropriate environmental conditions) and connections between the various components purchased. The effective operation of software and hardware is checked by our staff during this installation process. Although the “work time” of this activity at a single location may be only one or two days, the coordination necessary for accommodating the equipment and establishing connectivity frequently creates cycle times of between two and six weeks from product shipment to installation at the customer’s site.

Our maintenance services ensure that customers benefit from the latest networked video technology through software upgrades and expedited repair and replacement services. Our customer support center provides voice and video call assistance to Avistar users and administrators throughout the world. On-site support is also available from each of our major regional offices for a separate fee. In addition, training for users is available on-site or at an Avistar facility, and for system administrators at an Avistar facility, on a for-fee basis.

Backlog

We had a backlog of $326,000 in product orders at December 31, 2008. Backlog is not necessarily indicative of past or future operating results.

Research and Development

We believe that strong system development capabilities are essential to our strategy. Our research and development efforts focus on enhancing our core technology, developing additional applications, addressing emerging technologies, standards and protocols, and engaging in patent generation activities. Our system development team consists of engineers and software developers with experience in video and data networking, voice communications, video and data compression, email, collaboration and Internet technologies. We believe that our diverse technical expertise contributes to the highly integrated functionality of our system. We devote a significant amount of our resources to research and development as this is core to our business strategy and ongoing success. Our research and development expense for the years ended December 31, 2008, 2007 and 2006 was $5.2 million, $7.7 million and $5.8 million, respectively.

Manufacturing

We use contract manufacturers to produce and/or purchase components, and to perform some material assembly. Our operations staff develops manufacturing strategies and qualifies and audits manufacturing processes and suppliers. We work with our contract manufacturers to reduce manufacturing costs and to resolve quality control issues, as we perform the final assembly and testing of our products. We believe our manufacturing strategy enables us to utilize the capabilities of our contract manufacturers, while allowing us to focus on rapid system development and deployment, software architecture and development of video communication applications. We use third party, commercially available camera components, microphones, speakers and monitors for desktop and room systems, as well as third party compression and decompression components for our gateways.

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Intellectual Property and Proprietary Rights

Our ability to compete, and to continue to provide technological innovation depends substantially upon internally developed technology. We rely on a combination of patent, copyright, trademark and trade secret laws, as well as licensing, non-disclosure and other agreements with our consultants, suppliers, customers and employees, to protect our technology. We believe that other factors such as the technological and creative skills of our personnel, new system developments, frequent system and feature enhancements and reliable system support and maintenance are also essential to maintaining our leadership position in technology.

We have pursued registration of our key trademarks and service marks in the United States, the United Kingdom and certain other European countries, and intend to pursue additional registrations in additional countries where we plan to establish a significant business presence. We own several United States, Canadian and United Kingdom trademarks, including Avistar and the Avistar logo, AvistarVOS, Shareboard, vBrief and The Enterprise Video Company.

We held 37 United States patents and 59 foreign patents as of December 31, 2008. The patents that have been issued expire at varying dates between 2013 and 2018. In addition, numerous patent applications are pending in the United States and several other jurisdictions. Specifically, these patent applications, some of which relate to and claim priority from an application originally filed in 1993, include both method and apparatus claims. These patents and pending patent applications disclose and/or claim aspects of our analog or digital desktop video conferencing technology, video and multimedia storage technology for messaging and publishing, directory services, and public wide area networking access, switching and architecture. A portion of these technologies is currently utilized in our system. To date, we have focused on expanding our patent portfolio, expediting patent issuance and licensing of our patents to reinforce the adoption of our technology.

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.

Our intellectual property division seeks to license its 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. The broad suite of patents enables much of the functionality of our Avistar C3 application platform. Licenses to third parties may cover part or all of our patent portfolio. Examples of the many patented innovations in our portfolio include: the handling of decentralized video call endpoints, unshielded twisted pair video conferencing with data conferencing and desktop workstation echo cancellation.

We generally enter into confidentiality, license and nondisclosure agreements with our employees, consultants, prospective customers, licensees, and partners that seek to limit the use and distribution of our proprietary materials and prohibit reverse-engineering of our proprietary technologies. In addition, we control access to and distribution of our software, documentation and other proprietary information. Several of our license agreements with our customers require us to place our software source code into escrow. In these cases, these agreements provide that these customers may be entitled to retain copies of the software, and have a limited non-exclusive right to use and/or reproduce, maintain, update, enhance and produce derivative works of the software source code under the terms of the agreements if we fail to cure a contractual breach by us on a timely basis, or if we become the subject of a bankruptcy or similar proceeding.

We maintain a strong working relationship with vendors whom we identify as key suppliers, and assign preferred provider status to these vendors under agreements that secure ordering and extended warranty rights for us.

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Competition

The market for video collaboration products and solutions is highly competitive. As a result of advances in technology, increases in communications capability and reductions in communications costs in the past several years, the market is now characterized by many competitors, rapidly changing technology, evolving user needs, developing industry standards and protocols and the frequent introduction of new products and services. Within the market for video collaboration products and solutions, we compete primarily with Polycom, Inc., Tandberg ASA, Radvision, Ltd., and Emblaze-VCON Ltd.

With increasing interest in the power of video collaboration, unified communications and the establishment of communities of users, we face increasing competition from alternative communications solutions that employ new technologies or new combinations of technologies from companies such as Cisco Systems, Inc., Avaya, Inc., Nortel Networks Corporation, Microsoft Corporation, and IBM Corporation that enable web-based or network-based video and unified communications with low-cost digital camera systems.

We believe that the principal factors affecting competition in our markets include:

product features, functionality and scalability;

product quality and performance;

product reliability and ease of use;

use of open standards;

quality of service and support;

company reputation, size and financial stability;

price and overall cost of ownership;

integration with other desktop collaboration products; and

document sharing, including internet-based collaboration.

Currently, our principal competitors are companies that provide products and services in specific areas where we offer our integrated system, such as:

room-based point-to-point and multi-point video communications products;

desktop video communications products;

broadcast video products;

video retrieval and viewing products;

desktop content creation products; and

web-based data collaboration products.

While a number of companies have marketed applications that enable users to use individual features similar to our solutions, we do not believe that any single competitor currently offers as comprehensive a set of functionality as our solution provides. We believe these companies in many cases can also represent complementary opportunities to extend the reach of our solutions by potentially expanding the market for video and unified communications and collaboration.

We expect competition to increase significantly in the future from existing providers of specialized video and unified communications products, VOIP solution providers and other companies as they enter our existing or future markets, possibly including major telephone companies or communications equipment providers. These companies may develop similar or substitute solutions, which may be less costly or provide better performance or functionality than our systems. A number of our existing and potential competitors have longer operating histories, significantly greater financial, marketing, service, support, technical and other resources, significantly greater name recognition and a larger installed base of customers than we do. In addition, many of our current or potential competitors have well-established relationships with our current and potential customers, and have extensive knowledge of our industry. It is possible that new competitors or alliances among competitors may emerge and acquire significant market share. To be successful, we must continue to respond promptly and effectively to the challenges of developing customer requirements, technological change and competitors’ innovations. Accordingly, we cannot predict what our relative competitive position will be as the market evolves for video collaboration and unified communications products and services.

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Employees

As of December 31, 2008, we had 50 employees, including personnel dedicated to research and development, customer service, including installation and support services, sales and marketing, and finance and administration. Our future performance depends in significant part upon the continued service of our key technical, sales and marketing, and senior management personnel, most of them are not obligated to remain with us by an employment agreement. The loss of the services of one or more of our key employees could harm our business.

Executive Officers of the Registrant

Our officers and their ages as of December 31, 2008 were as follows:

Name		Age	Position
Simon B. Moss	43		Chief Executive Officer
Elias MurrayMetzger	38		Acting Chief Financial Officer
J. Chris Lauwers	48		Chief Technology and Product Officer
Darren Innes	43		General Manager – Global Sales
Anton F. Rodde	66		President, Intellectual Property Division
Stephen Epstein	49		Chief Marketing Officer
Michael Horn	35		Vice President, Operations and Customer Support

Simon B. Moss joined Avistar in July 2007 as President of our Products Division and became Chief Executive Officer on January 1, 2008. He previously served as Chief Executive Officer of Mantas, Inc. a behavior detection software company, from April 2002 to 2006, where he led its successful acquisition by Oracle/I-flex. He was a Partner at PricewaterhouseCoopers LLC from 2000 to 2002, President of FNX from 1999 to 2000, Director of Financial Markets at IBM Corporation and co-founder of IBM's risk management practice in London, from 1994 to 1999 and held various positions at Chase Manhattan Bank prior to 1994.

Elias MurrayMetzger has served as Acting Chief Financial Officer of Avistar since January 2009. From January 2006 to January 2009, Mr. MurrayMetzger served as Avistar's worldwide Corporate Controller, playing a key role in the Company’s financial reporting and compliance functions. From April 2004 to January 2006, Mr. MurrayMetzger served as Assistant Controller of Centra Software, Inc., a provider of software solutions for online business communication, collaboration and learning. During his tenure at Centra, Mr. MurrayMetzger successfully navigated Centra’s Sarbanes-Oxley compliance effort and SEC reporting functions. Mr. MurrayMetzger worked in the technology audit practice of PricewaterhouseCoopers from February 2000 to March 20004. He is a Certified Public Accountant and has a Bachelors of Science in Agribusiness with a concentration in finance from California Polytechnic State University, San Luis Obispo.

J. Chris Lauwers has been our Chief Technology and Product Officer since August 2005. He served as Chief Technology Officer from March 2001 to August 2005. He was our Vice President of Engineering from 1996 to 2001 and Director of Engineering from 1994 to 1996. He previously served as Principal Software Architect at Vicor Inc., a private e-business product solutions and engineering consulting company, from 1990 to 1994, and as a research associate at Olivetti Research Center from 1987 to 1990. Dr. Lauwers holds a B.S. in electrical engineering from the Katholieke Universiteit Leuven of Belgium. Dr. Lauwers also holds an M.S. and a Ph.D. in electrical engineering and computer science from Stanford University.

Anton F. Rodde has been the President of the Intellectual Properties Division, Inc., since December 2003. Prior to joining Avistar, he served as President and CEO of Western Data Systems, an ERP software company, from 1991 to 2002, as Group Vice President at Manugistics from 2002 to 2003, the company which acquired Western Data Systems, as President and General Manager of several subsidiaries of Teknekron Corporation, a technology incubator, from 1984 to 1991, as founder and President of Control Automation, a robotics company, from 1980 to 1984, and held a variety of technical and management positions at AT&T from 1970 to 1980. Dr. Rodde holds a B.S. in physics from Benedictine University and an M.S. and Ph.D. in physics from the Illinois Institute of Technology.

Darren Innes joined Avistar in November 2007 as General Manager and Global Head of Sales. Prior to joining Avistar, Mr. Innes served as Global Head of Sales and General Manager EMEA at Mantas Inc. from April 2002 to November 2007 and as Financial Services Practice Manager at Izodia, a business to business e-commerce software company prior to 2002.

Stephen Epstein joined Avistar in January 2008. Prior to Avistar he was Vice President, Head of Product Management at Mantas, Inc. from July 2003 to January 2008, where he was responsible for global product strategy, managing product requirements, defining go to market plans and marketing strategy, while evaluating the financial services market. Previously to joining Mantas, Epstein was Head of Product & Business Development at Bang Networks from May 2002 to July 2003 where he spearheaded product and business development efforts, focusing on delivering real-time information distribution products. Mr. Epstein held senior-level management and product development positions including Head of Global Foreign Exchange Sales Technology and Group CTO at Deutsche Bank from March 1995 to May 2002.

Michael Horn has served as Avistar's Vice President, Operations and Customer Support since August 2007. He joined Avistar in April 2007 as Director of Managed Services. From January 2005 to April 2007, Mr. Horn worked as an independent technology and strategy consultant at Caddis Consulting, a company he founded to work with companies ranging from small venture-backed startups to Fortune 500 companies. From May 2004 to January 2005, Mr. Horn was the Director, Product Management at Level 3 Communications. From May 2000 to May 2004, he served as Director, Engineering and Architecture at Virtela Communications. Mr. Horn has a Bachelor of Science in Electrical Engineering from George Mason University and a MBA from University of Denver.

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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 incurred net losses of $6.4 million for 2008, $2.9 million for 2007 and $8.1 million for 2006. As of December 31, 2008, our accumulated deficit was $112.1 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. We have a revolving credit facility under which $7.0 million was outstanding on December 31, 2008, which matures on December 21, 2009, and $7.0 million in outstanding convertible promissory notes that become due and payable on January 4, 2010 if not earlier converted. If we are unable to obtain additional funding when needed on acceptable terms, we may not be able to develop or enhance our products, take advantage of opportunities, respond to competitive pressures or unanticipated requirements, or finance our efforts to protect and enforce our intellectual property rights, which could seriously harm our business, financial condition, results of operations and ability to continue operations. We have in the past, and may in the future, reduce our expenditures by reducing our employee headcount in order to better align our expenditures with our available resources. Any such reductions may adversely affect our ability to maintain or grow our business.

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

In July 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 on January 1, 2008 Gerald Burnett resigned from his position as our Chief Executive Officer and was replaced in that position by Simon Moss. In January 2009, Bob Habig resigned from the position of Chief Financial Officer and he was replaced in that position by Elias MurrayMetzger, the Company’s Corporate Controller. In addition, during the second half of 2007 and in 2008, we implemented a number of other management changes. In 2007 and 2008, we implemented an intensive set of corporate initiatives aimed at increasing our product sales, expanding our customer deployments and support, improving our corporate efficiency and increasing our development capacity. The components of this initiative included:

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

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

·	A reduction in our employees from an average of 88 in 2007 to approximately 50 at December 31, 2008; and

·	Pursuing multiple distribution, services and technology licensing partners.

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

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

On November 21, 2008, 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. We were granted a 30 day grace period, or until December 22, 2008 to regain compliance with the $35,000,000 provision of the Rule by recording a minimum closing bid price of $1.02 for a minimum of ten consecutive business days.

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

We appealed the Nasdaq Staff’s determination to the Listing Qualifications Panel which automatically resulted in the stay of the Staff’s de-listing of our common stock. The appeal took place on January 29, 2009 and the Listing Qualifications Panel has the authority to grant Avistar a further extension of time in which to regain compliance with the Marketplace Rules, though there can be no assurance that the Panel will grant a further extension of time. In the event that the Panel rejects our appeal, our securities will be subject to immediate delisting from The Nasdaq Capital Market.

There can be no assurance that our securities will continue to be listed 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.

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.

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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 62% of our common stock as of December 31, 2008. If they were to act together, these stockholders would be able to exercise control over most matters requiring approval by our stockholders, including the election of directors and approval of significant corporate transactions. These actions may be taken even if they are opposed by other investors. This concentration of ownership may also have the effect of delaying or preventing a change in control of Avistar, which could cause the market price of our common stock to decline.

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 limits the visibility we have on the progress and timing of large initial or follow-on orders. A lost or delayed order could result in lower than expected revenue in a particular quarter or year. There is also a tendency in the technology industry to close business deals at the end of a quarter, thereby increasing the likelihood that a possible material deal would not be concluded in a current quarter, but slip into a subsequent reporting period. This kind of delay may result in a given quarter’s performance being below shareholder expectations.

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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., IBM, and Sony and their affiliates. Collectively, Deutsche Bank AG, UBS AG, Polycom, Inc., IBM, Sony Corporation, and their affiliates accounted for approximately 92% of combined revenues and income from settlement and patent licensing for the year 2008. As of December 31, 2008, approximately 98% of our gross accounts receivable was concentrated with four customers, each of whom represented more than 10% of our gross accounts receivable. 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, as was the $4.0 payment for a patent license from Radvision Ltd in the second quarter of 2007. Additionally, we expect to complete the amortization of the Polycom, Inc. proceeds in 2009. If we are unable to license our patent portfolio to additional parties on terms equal to or better than our agreements with Polycom, Inc. and Tandberg, our licensing revenue and our income from settlement and licensing will decline, which could cause our losses to increase. We currently depend on a limited number of customers with lengthy budgeting cycles and unpredictable buying patterns, and as a result, our revenue from quarter-to-quarter or year-to-year may be volatile. Adverse changes in our revenue or operating results as a result of these budgeting cycles or any other reduction in capital expenditures by our large customers could substantially reduce the trading price of our common stock.

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

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

·	rapid technological change;

·	the emergence of new competitors;

·	significant development costs;

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

·	integration of joint solutions in collaboration platforms;

·	evolving industry standards;

·	transition from hardware appliances and infrastructure to software; and

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

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

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

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

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Competition could reduce our market share and decrease our revenue.

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

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

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

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

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

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

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

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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.

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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.

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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 51% of total revenue for 2008, 72% for 2007 and 75% for 2006. Some of the risks we may encounter in conducting international business activities include the following:

·	tariffs and other trade barriers;

·	unexpected changes in foreign regulatory requirements and laws;

·	economic and political instability;

·	increased risk of infringement claims;

·	protection of our intellectual property;

·	restrictions on the repatriation of funds;

·	potentially adverse tax consequences;

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

·	fluctuations in foreign currencies; and

·	limitations in communications infrastructures in some foreign countries.

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

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

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

Item 1b. Unresolved Staff Comments

None.

Item 2. Properties

We lease approximately 29,000 square feet of office space in San Mateo, California as our corporate headquarters and technology licensing activities, of which we occupy 19,000 square feet and sublease 10,000 square feet. In addition, we lease approximately 7,000 square feet of office space in New York for sales and marketing functions, of which we sublease substantially all of the office space to third parties. The above leases expire in March 2012 and 2017 respectively. We believe that our existing facilities are adequate to meet our current requirements, and foresee no difficulties in meeting any future space requirements.

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Item 3. Legal Proceedings

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

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

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

None.

PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Our common stock has traded on the NASDAQ National Market from August 17, 2000 until October 29, 2002 and has traded on the NASDAQ Capital Market since October 30, 2002 under the symbol “AVSR.” Prior to August 17, 2000, there was no public market for our common stock. The following table sets forth for the period indicated the high and low sale prices for our common stock, as reported by the NASDAQ Capital Market.

	Year Ended December 31, 2008				Year Ended December 31, 2007
	High		Low		High		Low
First Quarter	$	1.30	$	0.33	$	1.91	$	1.32
Second Quarter	$	1.53	$	0.81	$	1.75	$	1.28
Third Quarter	$	1.70	$	0.65	$	1.44	$	1.10
Fourth Quarter	$	1.45	$	0.52	$	1.27	$	0.31

On December 31, 2008, the last reported sale price of our common stock on the NASDAQ Capital Market was $0.88 per share. According to the records of our transfer agent, as of December 31, 2008, there were 69 holders of record of our common stock and we believe there are a substantially greater number of beneficial holders.

Dividend Policy

We have never paid cash dividends on our common stock, and we do not anticipate paying cash dividends in the foreseeable future.

Equity Compensation Plan Information

The information required by this Item is included under Item 12 of Part III of this Annual Report on Form 10-K.

Item 6. Omitted

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with the Consolidated Financial Statements and Notes thereto included elsewhere in this Annual Report on Form 10-K. 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 Annual Report on Form 10-K. In some cases, you can identify forward looking statements by terminology such as “may”, “will”, “should”, “expects”, “intends”, “plans”, “anticipates”, “believes”, “estimates”, “predicts”, “potential”, “continue” or the negative of these terms, or other comparable terminology. These statements are only predictions. Actual events or results may differ materially. In evaluating these statements, you should specifically consider various factors, including the risks outlined under “Risk Factors.” These factors may cause our actual results to differ materially from any forward-looking statement.

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

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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, or 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 the enterprise and between enterprises, and to enhance 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 SMB and 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 operate on a 52-week fiscal year ending December 31. We operate in two segments. Our products division engages in the design, development, manufacture, sale and marketing of networked video communications products and associated support services. Our intellectual property division engages in the prosecution, maintenance, support and licensing of the intellectual property and technology that we have developed, some of which is used in our products.

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

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

A reduction in our employees from an average of 88 in 2007 to approximately 50 on December 31, 2008; and

Pursuing multiple distribution, services and technology partners.

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

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

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Critical Accounting Policies

The preparation of our 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 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 45%, 29% and 34% for 2008, 2007 and 2006, 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), or Emerging Issues Task Force (EITF) Issue No. 00-21, Revenue Arrangements with Multiple Deliverables. 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 we have 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.

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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.

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, in accordance with the “Input 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. The amount of revenue recognized is based on the total project fee under the agreement and the percentage of completion achieved. The percentage of completion is measured by monitoring progress using records of actual time incurred to date in the project compared to the total estimated project requirements, which corresponds to the costs related to the earned revenues. 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 December 31, 2008, these criteria for recognizing license revenue following the commencement of litigation have not been met, and proceeds received after commencement of litigation have therefore been recorded in “income from settlement and patent licensing” in our statement of operations.

In July 2006, we entered into a Patent License Agreement with Sony Corporation (Sony) and Sony Computer Entertainment, Inc. (SCEI). Under the license agreement, we granted Sony and its subsidiaries, including SCEI a license to all of our patents with a filing date on or before January 1, 2006 for a specific field of use relating to video conferencing. The license covers Sony’s video conferencing apparatus as well as other products, including video-enabled personal computer products and certain SCEI PlayStation products. Future royalties under this license are being recognized as 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.

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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 that exceeds a contractual base amount, 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 in accordance with the “Input 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, therefore no additional provision for this element has been made. For the year ended December 31, 2008, we recognized $1.3 million in product revenue and $255,000 in service revenue from our agreements with IBM. The remaining $3.8 million is expected to be recognized in product revenue under the percentage of completion method over the projected development time of 12 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 Deutsche Bank AG, UBS AG and their affiliates. In 2008, these customers, IBM, Sony and its subsidiaries including SCEI collectively accounted for $7.7 million, or 88% of our total revenue. In 2007, these customers and Radvision Ltd., collectively accounted for $9.0 million, or 75% of our total revenue. In 2006, these customers and Sony Corporation and its subsidiaries, including SCEI accounted for $10.9 million, or 83% of our total revenue. No other customers individually contributed greater than 10% of our total revenue for 2008, 2007 or 2006. We anticipate that our revenue, and therefore, our operating results for any given period, will continue to depend to a significant extent on a limited number of customers. As a result, the loss of or a reduction in sales to any one of these customers would have a significant adverse impact on our operations and financial performance.

International revenue, which consists of sales to customers with operations principally in Western Europe and Asia, comprised 51% of total revenue for 2008, 72% for 2007 and 75% for 2006.

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.

On November 12, 2004, we 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, we 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 we paid $6.4 million in contingent legal fees to our 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. We are 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 our 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.

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

Stock Based Compensation

We account for stock based compensation to employees according to the SFAS No. 123 (R), Share-Based Payment (SFAS No. 123R), which is a very complex accounting standard, the application of which requires significant judgment and the use of estimates, particularly surrounding Black-Scholes-Merton assumptions such as stock price volatility and expected option terms, as well as expected option forfeiture rates. There is little experience or guidance with respect to developing these assumptions and models. SFAS No. 123R requires the recognition of the fair value of stock compensation in net income (loss). Refer to Note 2 “Stock-Based Compensation” and Note 7 “Stock Option Plans and Employee Stock Purchase Plan” to our Consolidated Financial Statements included elsewhere in this Annual Report of Form 10-K 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 December 31, 2008, approximately 98% of our gross accounts receivable was concentrated with four customers, each of whom represented more than 10% of our gross receivables. 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.

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.

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Results of Operations

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

	Percentage of Total Revenue
	Year Ended December 31,
	2008			2007			2006

Revenue:
Product		45	%		29	%		34	%
Licensing		11			42			39
Services, maintenance and support		44			29			27
Total revenue		100			100			100
Costs and expenses:
Cost of product revenues		25			22			24
Cost of services, maintenance and support revenues		27			19			14
Income from settlement and patent licensing		(48	)		(136	)		(32	)
Research and development		59			64			44
Sales and marketing		40			52			41
General and administrative		66			104			73
Total costs and expenses		169			125			164
Loss from operations		(69	)		(25	)		(64	)
Other income (expense):
Interest income		1			3			2
Other (expense) income, net		(5	)		(2	)		—
Total other (expense) income, net		(4	)		1			2
Loss before provision for (recovery from) income taxes		(73	)		(24	)		(62	)
Provision for (recovery from) income taxes		—			—			—
Net loss		(73	)%		(24	)%		(62	)%

COMPARISON OF 2008 AND 2007

Revenue

Total revenue decreased by $3.2 million or 27%, to $8.8 million for 2008, from $12.0 million for 2007, primarily due to decreases in licensing revenue.

·	Product revenue increased by $0.5 million or 14%, to $4.0 million for 2008 from $3.5 million for 2007. The increase was primarily due to revenue of $1.3 million from IBM, offset by decreased sales to existing customers in 2008 compared to 2007.

Licensing revenue, relating to the licensing of our patent portfolio, decreased by $4.1 million, or 81%, to $954,000 for 2008, from $5.0 million for 2007. The decrease was primarily attributable to the lack of new licensing agreements in 2008 compared to the Radvision licensing agreement, which resulted in $4.0 million in licensing revenue in 2007.

Services, maintenance and support revenue, which includes our installation services, funded software development and maintenance and support, increased by $367,000, or 11%, to $3.8 million for 2008, from $3.5 million for 2007, due primarily to an increase in revenue from professional on-site services provided to an existing customer.

In 2008, revenue from four customers accounted for 88% of total revenue compared to three customers and 75% in 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. While we continue to expand our indirect sales channel, 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.

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Costs and expenses

Cost of product revenue. Cost of product revenue decreased by $489,000, or 18%, to $2.2 million in 2008 from $2.7 million for 2007. The decrease was primarily attributable to a decrease in personnel and personnel related expenses for the assembly and testing of products, including a decrease of $47,000 in stock based compensation expense. We expect the cost of product revenue to vary with the mix of products sold in 2009.

Cost of services, maintenance and support revenue. Cost of services, maintenance and support revenue increased by $109,000, or 5%, to $2.4 million in 2008 from $2.2 million in 2007, primarily due to a net increase in allocated overhead cost. We expect the cost to vary with the mix of services, maintenance and support provided to our customers in 2009.

Income from settlement and patent licensing. Income from settlement and patent licensing decreased by $12 million, or 74%, to $4.2 million in 2008 from $16.2 million for 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, that was fully recognized in 2007. The years ended December 31, 2008 and 2007 each also reflect $4.2 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 $2.5 million, or 32%, to $5.2 million in 2008 from $7.7 million in 2007. The decrease was primarily attributable to a decrease in personnel and personnel related expenses, including a decrease of $368,000 in stock based compensation expense. Research and development expenses in 2009 are expected to decrease as part of the aggressive ongoing cost control measures.

Sales and marketing. Sales and marketing expenses decreased by $2.7 million, or 43% to $3.5 million in 2008 from $6.2 million in 2007. The decrease was primarily attributable to a decrease in personnel and personnel related expenses, including a decrease of $576,000 in stock based compensation expense. Sales and marketing expenses are expected to remain relatively flat in 2009.

General and administrative. General and administrative expenses decreased by $6.8 million, or 54% to $5.7 million in 2008 from $12.5 million in 2007. The decrease was due primarily to $4.3 million in legal fees associated with our litigation against Tandberg for patent infringement that occurred during 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 $191,000 in stock based compensation expense, partially offset by increased employee severance expense, incurred primarily during the first quarter of 2008. General and administrative expenses in 2009 are expected to decrease as part of the aggressive ongoing cost control measures.

Other income (expense)

Interest income. Interest income decreased by $252,000, or 73%, to $94,000 in 2008 from $346,000 in 2007. The decrease was due to both a decrease in interest rates and a decrease in the average outstanding balance of investments that earned interest in 2008, as compared to 2007.

Other expense, net. Other expense, net increased by $251,000, or 134%, to $439,000 in 2008 from $188,000 in 2007. The increase was due to higher interest expense due to a higher outstanding balance of debt outstanding during 2008, as compared to 2007.

Provision for (recovery from) income taxes

There was no significant change in the provision for income taxes in 2008 as compared to 2007. Both provisions for income taxes of $23,000 in 2008 and 2007 were related to foreign tax expense.

COMPARISON OF 2007 AND 2006

Revenue

Total revenue decreased by 10% in 2007 to $12.0 million from $13.2 million for 2006. The decrease in total revenue in 2007 relative to 2006 was primarily due to decreased product sales.

·	Product revenue decreased by $1.1 million, or 24%, to $3.5 million in 2007 from $4.5 million in 2006, due primarily to reduced sales to our existing customer base.

·	Licensing revenues decreased by $139,000, or 3% to $5.0 million from $5.2 million in 2006.

·	Services, maintenance and support revenue remained relatively flat at $3.5 million in 2007 and 2006.

In 2007, three customers accounted for 75% of our revenue as compared to 2006 when three customers accounted for 83% of our revenue.

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Costs and expenses

Cost of product revenue. Total cost of revenue decreased by $501,000, or 16%, in 2007 to $2.7 million from $3.2 million for 2006. The decrease in total cost of revenue in 2007 relative to 2006 was primarily due to declines in product sales, offset by an increase in personnel salary and benefits.

Cost of services, maintenance and support revenue. Cost of services, maintenance and support revenues increased by $423,000 or 23% to $2.2 million for 2007, from $1.8 million for 2006. This increase was attributable to an increase in funded software development project costs in 2007.

Income from settlement and patent licensing. Income from settlement and patent licensing increased by 284% in 2007 to $16.2 million from $4.2 million for 2006, reflecting a $12.0 million settlement and patent licensing agreement with Tandberg in the three months ended March 31, 2007 and the $4.2 million recognition of the full year amortization of income in 2007 and 2006 associated with the Polycom, Inc. settlement and patent cross-license agreement.

Research and development. Research and development expenses increased by 33% in 2007 to $7.7 million from $5.8 million in 2006. The increase in research and development expenses in 2007 relative to 2006 was due to the hiring of new employees focused on new product development projects in 2007, the use of external labor to augment our internal development capabilities, and an increase in stock-based compensation of $261,000. Research and development projects associated with customer funded development are expensed to cost of sales in the period in which they are incurred.

Sales and marketing. Sales and marketing expenses increased by 13% in 2007 to $6.2 million from $5.5 million in 2006. The increase in sales and marketing expenses in 2007 relative to 2006 was due to the hiring of additional sales and marketing personnel and an increase in stock-based compensation of $117,000.

General and administrative. General and administrative expenses increased by 29% in 2007 to $12.5 million from $9.7 million in 2006. The increase in general and administrative expenses in 2007 relative to 2006 was due primarily to the contingent legal fees associated with the litigation with Tandberg of $4.3 million. The litigation concluded in a patent license agreement on February 15, 2007, resulting in a decrease in 2007 of $3.5 million in ongoing litigation expenses due to the cessation of the litigation against Tandberg. This decrease was offset by an increase in 2007 of $1.1 million of patent prosecution fees due to increased activity related to patent applications on file with the USPTO. There was also an increase in 2007 of $0.3 million in salaries and recruiting fees associated with the hiring of Simon Moss, President Products Division, and an increase of $244,000 in stock-based compensation.

Other income (expense)

Interest income. Interest income increased by $47,000, or 16%, in 2007 to $346,000 from $299,000 in 2006. The increase in interest income in 2007 relative to 2006 was due primarily to the effect of increased interest income from higher average cash and cash equivalents and short-term investment balances in 2007, offset by lower interest rates earned on those balances in 2007 compared to 2006.

Other expense, net. Other expense, net increased by $186,000 in 2007 to an expense of $188,000 from an expense of $2,000 in 2006. The increase in other expense, net in 2007 relative to 2006 was due to interest expense on higher average outstanding balances on our line of credit during 2007, as compared to 2006.

Provision for (recovery from) income taxes

Provision for (recovery from) income taxes increased to a $23,000 expense in 2007 due to foreign tax expense, from a recovery of $31,000 in 2006, which was partially due to the recovery of $53,000 in 2006 of tax overpayments made in 2004.

Liquidity and Capital Resources

We have funded our operations since inception primarily from product, services and licensing revenue, the net proceeds of $31.3 million from our August 2000 initial public offering of common stock, lines of credit with related parties and financial institutions, the proceeds of approximately $5.7 million and $3.6 million from the private sale of our common stock in October 2003 and March 2004, respectively, the gross proceeds of $39.5 million from the settlement and patent cross-license agreements signed with Polycom, Inc. in 2004 and Tandberg ASA, Tandberg AS and Tandberg, Inc. in February 2007, and the proceeds of $7.0 million from issuance of Convertible Subordinated Secured Notes in January 2008.

We had cash and cash equivalents of $4.9 million as of December 31, 2008, and cash, cash equivalents and short-term investments of $4.9 million as of December 31, 2007. For the year ended December 31, 2008, we had a net increase in cash and cash equivalents of $821,000. The net cash used by operations of $8.9 million for the year ended December 31, 2008 resulted primarily from the net loss of $6.4 million, a decrease in deferred income from settlement and patent licensing of $5.6 million, an increase in accounts receivable of $1.3 million, a decrease in account payable of $708,000, all offset by an increase in deferred services revenue and customer deposits of $1.5 million, non-cash expenses of $2.0 million, and a decrease in deferred settlement and patent licensing costs of $1.3 million. The net cash provided by investing activities of $718,000 for the year ended December 31, 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 year ended December 31, 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 at December 31, 2008 increased 95% over the December 31, 2007 balance from $1.4 million to $2.7 million mainly due to a $1.0 million advance billing of services to a customer in December 2008 which was subsequently collected in January 2009.

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We had cash and cash equivalents of $4.1 million as of December 31, 2007 and $7.9 million as of December 31, 2006. For 2007, we had a net cash outflow of $3.8 million resulting primarily from net cash outflows from operations of $4.5 million, net cash outflows from investing activities of $1.8 million and net cash inflows from financing activities of $2.5 million. The net cash outflows from operations were primarily due to a net loss of $2.9 million, a decrease in deferred income from settlement and patent licensing and other of $5.5 million, and a decrease in accrued liabilities and other of $812,000, partially offset by non-cash expenses of $3.2 million of stock-based compensation and depreciation, and a decrease in deferred settlement and patenting licensing costs of $1.3 million. The net cash outflows from investing were due to the purchase of $1.0 million of property and equipment and the purchase of $799,000 in short-term investments. The net cash inflows from financing activities were due to $2.1 million drawn on our line of credit, and $372,000 from the net issuance of common stock through our employee stock purchase plan and stock option plans.

For 2006, we had a net cash outflow of $362,000 resulting primarily from net cash outflows from operations of $7.3 million, net cash inflows from investing activities of $3.7 million and net cash inflows from financing activities of $3.3 million. The net cash outflows from operations were primarily due to a net loss of $8.1 million, a decrease in deferred income from settlement and patent licensing and other of $5.5 million, partially offset by non-cash expenses of $2.4 million associated with the expensing of stock-based compensation and depreciation, a decrease in deferred settlement and patenting licensing costs of $1.3 million, an increase in deferred services revenue and customer deposits of $1.3 million, and an increase in account payable, accrued liabilities and other of $1.3 million. The net cash inflows from investing were due to $4.0 million in short and long-term investments that matured in 2006, offset by the purchase of $290,000 of property and equipment. The net cash inflows from financing activities were due to $3.0 million drawn on our line of credit, and $312,000 from the issuance of common stock through our employee stock purchase plan and stock option plans.

Expenditures for property and equipment in 2008 were approximately $89,000. At December 31, 2008, we did not have any material commitments for future capital expenditures. We anticipate spending approximately $105,000 in capital expenditures during the next 12 months.

The following table summarizes our known contractual obligations and commitments as of December 31, 2008 (in thousands) for the periods presented.

	Payments due by period
	Total		Less than 1 Year		1 – 3 Years		3 – 5 Years		More than 5 Years
Contractual obligations
Long-term debt obligations	$	7,000	$	—	$	7,000	$	—	$	—
Operating lease obligations, net of projected sublease proceeds		2,998		715		1,814		344		125
Purchase obligations		47		47		—		—		—
Total	$	10,045	$	762	$	8,814	$	344	$	125

On November 12, 2004, we entered into a settlement and patent cross-license agreement with Polycom, Inc. Under this agreement, we agreed to dismiss, with prejudice, our infringement suit against Polycom, Inc. and both companies agreed to cross-license each other’s patent portfolios. The agreement resulted in a payment, net of legal fees, to us from Polycom, Inc. in the amount of $21.1 million. In July 2006, we entered into a Patent License Agreement with Sony Corporation and SCEI. Under the license agreement, we granted Sony Corporation 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. As consideration for the licenses granted under the agreement, Sony Corporation and SCEI agreed to make an upfront license payment of $5.0 million and agreed to make future royalty payments relating to the sale, in certain countries, of certain SCEI products.

In February 2007, we entered into a patent license agreement with Tandberg ASA, Tandberg AS and Tandberg, Inc. Under this agreement we agreed to dismiss, with prejudice, our infringement suit against Tandberg and both companies agreed to cross-license each other’s patent portfolios. The agreement resulted in a payment to us from Tandberg in the amount of $12.0 million, $4.3 million of which was used by us to pay contingent legal fees associated with the Tandberg litigation.

In June 2007, we entered into a Patent License Agreement with Radvision Ltd. Under the license agreement, we granted a license to all of our patents and certain patent applications for a specific field of use relating to video conferencing. As consideration for the licenses granted under the agreement, Radvision Ltd. agreed to make an upfront license payment to us of $4.0 million.

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On December 23, 2006, we entered into a Revolving Credit and Promissory Note and a Security Agreement with a financial institution to borrow up to $10.0 million under a revolving line of credit. The agreement includes a first priority security interest in all of our assets. Gerald Burnett, our Chairman, provided a collateralized guarantee to the financial institution, assuring payment of our obligations under the agreement and as a consequence, there are no restrictive covenants, allowing us greater access to the full amount of the facility. In addition to the guarantee provided to the financial institution, on March 29, 2009, Dr. Burnett provided a personal guarantee to us assuring us a line of credit of $10.0 million with the same terms and mechanisms as the existing revolving line of credit in the event the existing revolving line of credit from the financial institution was unavailable for any reason during the period from its termination on December 21, 2009 to March 31, 2010. The line of credit requires monthly interest-only payments based on Adjusted LIBOR plus 1.25%, or 4.5% at December 31, 2008 or Prime Rate plus 1.25%, or 4.5% at December 31, 2008. The Company borrowed $7.0 million and $2.1 million under the revolving line of credit for the years ended December 31, 2008 and 2007, respectively, with an ending balance of $7.0 million as of December 31, 2008. Balance of $5.1 million as of December 31, 2007 was fully repaid during 2008. The Revolving Credit and Promissory Note was renewed on December 22, 2008 and matures on December 21, 2009, and is subject to annual renewal with the consent of the Company and the lender.

On January 4, 2008, we issued $7,000,000 of 4.5% Convertible Subordinated Secured Notes, which are due in 2010 (Notes). The Notes were sold pursuant to a Convertible Note Purchase Agreement to Baldwin Enterprises, Inc., a subsidiary of Leucadia National Corporation, directors Gerald Burnett, R. Stephen Heinrichs, William Campbell, and Craig Heimark, officers Simon Moss and Darren Innes, and WS Investment Company. Our obligations under the Notes are secured by the grant of a security interest in substantially all our tangible and intangible assets pursuant to a Security Agreement among the us and the purchasers. The Notes have a two year term, will be due on January 4, 2010 and are convertible prior to maturity. Interest on the Notes accrues at the rate of 4.5% per annum and is payable semi-annually in arrears on June 4 and December 4 of each year, commencing on 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.

As of December 31, 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 December 31, 2008, we have not incurred material costs to defend lawsuits or settle claims related to these indemnifications agreements and therefore, we have no liabilities recorded for these agreements as of December 31, 2008.

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

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

Recent Accounting Pronouncements

In February 2007, the FASB issued Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115 (SFAS No. 159). The standard permits entities to choose, at specified election dates, to measure eligible financial assets, financial liabilities and firm commitments at fair value, on an instrument-by-instrument basis, that are otherwise not permitted to be accounted for at fair value under other generally accepted accounting principles. The fair value measurement election is irrevocable and subsequent changes in fair value must be recorded in earnings. SFAS No. 159 became effective for us on January 1, 2008. We did not elect to measure any eligible items at fair value in accordance with this new standard either at the date we adopted this new standard or subsequently during 2008; therefore the adoption of this standard did not have an impact on our financial position and results of operations.

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In December 2007, the FASB issued SFAS No. 141(Revised), Business Combinations, or SFAS No. 141(R), which replaces SFAS No. 141, Business Combinations, and requires an acquirer to recognize the assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date, measured at their fair values as of that date, with limited exceptions. This statement also requires the acquirer in a business combination achieved in stages to recognize the identifiable assets and liabilities, as well as the noncontrolling interest in the acquiree, at the full amounts of their fair values. SFAS No. 141(R) makes various other amendments to authoritative literature intended to provide additional guidance or to confirm the guidance in that literature to that provided in this statement. This statement applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. We adopted this statement on January 1, 2009. SFAS No. 141(R)’s impact on accounting for business combinations is dependent upon acquisition activity on or after its effective date.

In December 2007, FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements, which amends Accounting Research Bulletin No. 51, Consolidated Financial Statements, to improve the relevance, comparability, and transparency of the financial information that a reporting entity provides in its consolidated financial statements. SFAS No. 160 establishes accounting and reporting standards that require the ownership interests in subsidiaries not held by the parent to be clearly identified, labeled and presented in the consolidated statement of financial position within equity, but separate from the parent’s equity. This statement also requires the amount of consolidated net income attributable to the parent and to the noncontrolling interest to be clearly identified and presented on the face of the consolidated statement of income. Changes in a parent’s ownership interest while the parent retains its controlling financial interest must be accounted for consistently, and when a subsidiary is de-consolidated, any retained non-controlling equity investment in the former subsidiary must be initially measured at fair value. The gain or loss on the de-consolidation of the subsidiary is measured using the fair value of any non-controlling equity investment. The statement also requires entities to provide sufficient disclosures that clearly identify and distinguish between the interests of the parent and the interests of the non-controlling owners. This statement applies prospectively to all entities that prepare consolidated financial statements and applies prospectively for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. We adopted this statement on January 1, 2009. The adoption of SFAS 160 did not have an impact on our financial condition and results of operations.

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 adopted this statement on January 1, 2009. The adoption of EITF 07-01 did not have material impact on our financial condition and results of operations.

In February 2008, the FASB issued FASB Staff Position No. FAS 157-2, Effective Date of FASB Statement No. 157 (FSP 157-2), to partially defer SFAS 157, Fair Value Measurements. 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 adopted this statement on January 1, 2009. The adoption of FSP 157-2 did not have material impact on our financial condition and results of operations.

Item 7a. Omitted

Item 8. Financial Statements and Supplementary Data

Our consolidated financial statements and Report of Independent Registered Public Accounting Firm appears on pages F-1 through F-25 of this Report.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

None

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Item 9a. Controls and Procedures

Evaluation of disclosure controls and procedures

Our management evaluated, with the participation of our Chief Executive Officer and Acting Chief Financial Officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Annual Report on Form 10-K (the Evaluation Date). Based on this evaluation, our Chief Executive Officer and Acting Chief Financial Officer have concluded as of the Evaluation Date that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the Exchange Act)) were effective such that information required to be disclosed by us in reports that we file or submit under the Exchange Act (i) is accumulated and communicated to our management, including our Chief Executive Officer and Acting 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.

Management’s Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our management, including our Chief Executive Officer and Acting Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2008 based on the criteria set forth in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the criteria set forth in Internal Control — Integrated Framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2008.

Changes in Internal Control Over Financial Reporting

There was no change in our internal control over financial reporting that occurred during the quarter ended December 31, 2008 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Inherent Limitations on Effectiveness of Controls

In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, 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.

Attestation Report of Registered Public Accounting Firm Not Required

This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management's report was not subject to attestation by our registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit us to provide only management's report in this annual report.

Item 9b. Other Information

None

PART III

Item 10. Directors, Executive Officers and Corporate Governance

The information required by this item is incorporated by reference to the sections captioned “Election of Directors” and “Section 16(a) Beneficial Ownership Reporting Compliance” contained in our Proxy Statement related to the 2009 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission within 120 days of December 31, 2008, pursuant to General Instruction G(3) of Form 10-K (the “Proxy Statement”). Certain information required by this item concerning executive officers is set forth in Part I of this Report in “Business—Executive Officers,” and certain other information required by this item is incorporated by reference from the sections captioned “Principal Stockholders” contained in our Proxy Statement.

We have adopted a code of ethics that applies to our principal executive officers and all members of our finance department, including the principal financial officer and principal accounting officer. This code of ethics, which also applies to employees generally, is posted on our Internet website. The Internet address for our website is http://www.avistar.com, and the code of ethics may be found as follows:

From our main Web page, first click on “Company.”

Next, click on “Investor Relations.”

Next, click on “Avistar’s Business Conduct and Ethics Policy.”

We intend to satisfy the disclosure requirement under Item 5.05 of Form 8-K regarding an amendment to, or waiver from, a provision of this code of ethics by posting such information on our website, at the address and location specified above.

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Item 11. Executive Compensation

The information required by this item is incorporated by reference to the section captioned “Executive Compensation and Other Matters” contained in our Proxy Statement.

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

The information required by this item is incorporated by reference to the sections captioned “Principal Stockholders”, “Executive Compensation and Other Matters” and “Certain Transactions” contained in our Proxy Statement.

Equity Compensation Plan Information

The following table provides information as of December 31, 2008 with respect to the shares of our Common Stock that may be issued under our existing equity compensation plans.

	A			B		C
Plan Category	Number of securities to be issued upon exercise of outstanding options			Weighted-average exercise price of outstanding options		Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in Column A)
Equity compensation plans approved by security holders		11,629,599	(1)	$	1.97		2,797,294	(2)
Equity compensation plans not approved by security holders		—			—		—
Total		11,629,599		$	1.97		2,797,294

(1)

This number reflects the number of shares to be issued upon exercise of outstanding options under our 2000 Director Option Plan (“Director Plan”), the 1997 Stock Option Plan (the “1997 Plan”) and the 2000 Stock Option Plan (the “2000 Option Plan”). This number excludes purchase rights accruing under the Employee Stock Purchase Plan (“Purchase Plan”). The Purchase Plan authorizes the granting of stock purchase rights to eligible employees during six month offering periods. Shares are purchased through employee payroll deductions at purchase prices equal to 85% of the lesser of the fair market value of our Common Stock at either the first day of each offering period or the date of purchase.

(2)

Includes 1,220,219 shares available for issuance under the 2000 Option Plan, 341,480 shares available for issuance under the Director Plan and 1,235,595 shares available for issuance under the Purchase Plan. No securities are available for future issuance under the 1997 Plan. The 2000 Option Plan provides for an annual increase in the number of shares of Common Stock reserved for issuance thereunder on the first day of our fiscal year in an amount equal to the lesser of (x) 1,200,000 shares, (y) 4% of the outstanding shares of the Company’s common Stock as of the last day of the prior fiscal year or (z) such lesser amount as determined by the Board. The Director Plan currently provides for an annual increase to the number of shares reserved thereunder on the first day of the Company’s fiscal year equal to the lesser of (x) 175,000 shares, (y) 1% of the outstanding shares of our Common Stock on such date or (z) such amount as determined by the Board. The Purchase Plan provides for an annual increase in the number of shares of Common Stock reserved thereunder on the first day of our fiscal year in an amount equal to the lesser of (x) 900,000 shares, (y) 3% of our outstanding shares on the last day of the prior fiscal year or (z) such amount as determined by the Board. Under the terms of the Plans, on January 1, 2008, 1,200,000 and 175,000 shares were added to the 2000 Option Plan and the Director Plan, respectively. No shares were added to the Purchase Plan on January 1, 2008.

Item 13. Certain Relationships and Related Transactions and Director Independence

The information required by this item is incorporated by reference to the sections captioned “Proposal One—Election of Directors,” “Compensation Committee Interlocks and Insider Participation” and “Certain Transactions” contained in our Proxy Statement.

Item 14. Principal Accountant Fees and Services

The information required by this section is incorporated by reference from the information in the section entitled “Ratification of Appointment of Independent Accountants” in our Proxy Statement.

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PART IV

Item 15. Exhibits, Financial Statement Schedules

(a)(1) Financial Statements

The following financial statements are incorporated by reference in Item 8 of this Annual Report:

	Page
Report of Independent Registered Public Accounting Firm		F-2
Consolidated Balance Sheets as of December 31, 2008 and 2007		F-3
Consolidated Statements of Operations for the years ended December 31, 2008, 2007 and 2006		F-4
Consolidated Statements of Stockholders’ Equity (Deficit) for the years ended December 31, 2008, 2007 and 2006		F-5
Consolidated Statements of Cash Flows for the years ended December 31, 2008, 2007 and 2006		F-6
Notes to the Consolidated Financial Statements		F-7

(a)(2) Financial Statement Schedules

Schedule II—Valuation and Qualifying Accounts (see page S-1)

Schedules not listed above have been omitted because the information required to be set forth therein is not applicable or is shown in the financial statements or notes thereto.

(a)(3) Exhibits

3.2		Restated Certificate of Incorporation (Filed as an exhibit to the Company’s Registration Statement on Form S-1 (File No. 333-39008) as declared effective by the Securities and Exchange Commission on August 16, 2000.)
3.3		Bylaws of Avistar Communications Corporation (Filed as an exhibit to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2004 filed with the Securities and Exchange Commission on March 28, 2005.)
4.1		Specimen Certificate evidencing shares of Common Stock (Filed as an exhibit to the Company’s Registration Statement on Form S-1 (File No. 333-39008) as declared effective by the Securities and Exchange Commission on August 16, 2000.)
10.1		1997 Stock Option Plan, as amended* (Filed as an exhibit to the Company’s Registration Statement on Form S-1 (File No. 333-39008) as declared effective by the Securities and Exchange Commission on August 16, 2000.)
10.1.1		1997 Stock Option Plan Form of Stock Option Agreement* (Filed as an exhibit to the Company’s Registration Statement on Form S-1 (File No. 333-39008) as declared effective by the Securities and Exchange Commission on August 16, 2000.)
10.2		2000 Stock Option Plan, as amended* (Filed as an exhibit to the Company’s Registration Statement on Form S-1 (File No. 333-39008) as declared effective by the Securities and Exchange Commission on August 16, 2000.)
10.3		2000 Director Option Plan, as amended* (Filed as an exhibit to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2005 filed with the Securities and Exchange Commission on April 28, 2006.)
10.4		Form of Director Option Agreement* (Filed as an exhibit to the Company’s Registration Statement on Form S-1 (File No. 333-39008) as declared effective by the Securities and Exchange Commission on August 16, 2000.)
10.5		2000 Employee Stock Purchase Program, as amended* (Filed as an exhibit to the Registrant’s Quarterly Report on Form 10-Q for the three months ended September 30, 2006 filed with the Securities and Exchange Commission on November 14, 2006.)
10.6		Form of Indemnification Agreement* (Filed as an exhibit to the Company’s Registration Statement on Form S-1 (File No. 333-39008) as declared effective by the Securities and Exchange Commission on August 16, 2000.)
10.7		Settlement Agreement and Release between the Registrant and R. Stephen Heinrichs dated April 26, 2001* (Filed as an exhibit to the Registrant’s Current Report on Form 8-K filed with the Securities and Exchange Commission on May 8, 2001.)

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10.8		Lease Agreement among the Registrant and Crossroads Associates and Clocktower Associates dated December 1, 2006 (Filed as an exhibit to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2006 filed with the Securities and Exchange Commission on March 22, 2007.)
10.9		Common Stock Purchase Agreement by and among the Registrant and The Gerald J. Burnett and Marjorie J. Burnett Revocable Trust, Grady Burnett and Wendolyn Hearn dated October 15, 2003 (Filed as an exhibit to the Registrant’s Quarterly Report on Form 10-Q for the three months ended September 30, 2003 filed with the Securities and Exchange Commission on October 23, 2003.)
10.10		Stock Purchase Agreement among the Registrant, Fuller & Thaler Behavioral Finance Fund, Ltd. and Fuller & Thaler Avalanche Fund, L.P. dated March 23, 2004 (Filed as an exhibit to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2004 filed with the Securities and Exchange Commission on May 11, 2004.)
10.11		Settlement Agreement among the Registrant, Collaboration Properties, Inc. and Polycom, Inc. dated November 12, 2004 (Filed as an exhibit to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2004 filed with the Securities and Exchange Commission on March 28, 2005.)
10.12†		Patent Cross-License Agreement Among the Company, Collaboration Properties, Inc. and Polycom, Inc. dated November 12, 2004 (Filed as an exhibit to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2005 filed with the Securities and Exchange Commission on April 28, 2006.)
10.13†		Patent License Agreement dated May 15, 2006 among the Registrant, Collaboration Properties, Inc., Sony Corporation and Sony Computer Entertainment, Inc. (Filed as an exhibit to the Registrant’s Quarterly Report on Form 10-Q for the three months ended September 30, 2006 filed with the Securities and Exchange Commission on November 14, 2006.)
10.14†		Patent License Agreement dated February 15, 2007 by and among the Registrant, Collaboration Properties, Inc., Tandberg ASA, Tandberg Telecom AS, and Tandberg, Inc. (Filed on May 14, 2007 as an exhibit to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2007)
10.15†		Patent License Agreement dated May 15, 2007 by and among the Registrant, Avistar Systems (UK) Limited, and Radvision LTD. (Filed on August 3, 2007 as an exhibit to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2007)
10.16		Employment Agreement between the Registrant and Simon B. Moss effective July 16, 2007. * (Filed on November 13, 2007 as an exhibit to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2007)
10.17		Amended and restated Security Agreement dated December 17, 2007 between the Registrant and JPMorganChase Bank, N.A. originally dated December 23, 2006. (Filed as an exhibit to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2007 filed with the Securities and Exchange Commission on March 31, 2008)
10.18		Amendment dated December 17, 2007 to the Revolving Credit Promissory Note issued by the Registrant in favor of JPMorgan originally dated December 23, 2006. (Filed as an exhibit to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2007 filed with the Securities and Exchange Commission on March 31, 2008)
10.19		Second amendment dated December 17, 2007 to the Revolving Credit Promissory Note issued by the Registrant in favor of JPMorgan originally dated December 23, 2006. (Filed as an exhibit to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2007 filed with the Securities and Exchange Commission on March 31, 2008)
10.20		Amendment dated December 17, 2007 to the Guaranty issued by Gerald J. Burnett and The Gerald J. Burnett and Marjorie J. Burnett Revocable Trust in favor of JPMorgan originally dated December 23, 2006. (Filed as an exhibit to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2007 filed with the Securities and Exchange Commission on March 31, 2008)
10.21		Convertible Note Purchase Agreement among the Company and the Purchasers named therein dated January 4, 2008 (Filed on January 9, 2008 as an exhibit to the Registrant’s Current Report on Form 8-K)

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10.22		Security Agreement among the Company, Baldwin Enterprises, Inc., as Collateral Agent, and the Purchasers named therein dated January 4, 2008 (Filed on January 9, 2008 as an exhibit to the Registrant’s Current Report on Form 8-K)
10.23		Form of 4.5% Convertible Subordinated Secured Note Due 2010 (Filed on January 9, 2008 as an exhibit to the Registrant’s Current Report on Form 8-K)
10.24		Inter-creditor Agreement among the Purchasers of the 4.5% Convertible Subordinated Secured Notes Due 2010 dated January 4, 2008 (Filed on January 9, 2008 as an exhibit to the Registrant’s Current Report on Form 8-K)
10.25†		Licensed Works Agreement between Avistar Communications Corporation and International Business Machines Corporation dated September 8, 2008. (Filed as an exhibit to the Registrant’s Quarterly Report on Form 10-Q for the three months ended September 30, 2008 filed with the Securities and Exchange Commission on November 14, 2008.)
10.26†		Licensed Works Agreement Statement of Work between Avistar Communications Corporation and International Business Machines Corporation dated September 8, 2008. (Filed as an exhibit to the Registrant’s Quarterly Report on Form 10-Q for the three months ended September 30, 2008 filed with the Securities and Exchange Commission on November 14, 2008.)
10.27†		Patent License Agreement between Avistar Communications Corporation and International Business Machines Corporation dated September 9, 2008. (Filed as an exhibit to the Registrant’s Quarterly Report on Form 10-Q for the three months ended September 30, 2008 filed with the Securities and Exchange Commission on November 14, 2008.)
10.28		Amended and Restated Revolving Credit Promissory Note issued by the Registrant to JPMorgan Chase Bank, N.A. dated December 22, 2008
10.29		Facility Agreement between the Registrant and JPMorgan Chase Bank, N.A. dated December 22, 2008
10.30		Amended and Restated Collateral Agreement dated December 22, 2008 between the Registrant and JPMorgan Chase Bank, N.A. dated December 22, 2008
10.31		Second Amended and Restated Security Agreement between the Registrant and JPMorgan Chase Bank, N.A.
10.32		Amended and Restated Guaranty issued by Gerald J. Burnett and The Gerald J. Burnett and Marjorie J. Burnett Revocable Trust in favor of JPMorgan Chase Bank, N.A. dated December 22, 2008
10.33		Amended and Restated Form of Note Sale Agreement among Gerald J. Burnett, The Gerald J. Burnett and Marjorie J. Burnett Revocable Trust and JPMorgan Chase Bank, N.A.
10.34		Personal guarantee issued by Gerald J. Burnett in favor of Avistar Communications Corporation dated March 29, 2009
21.1		Subsidiaries of the Company
23.1		Consent of Independent Registered Public Accounting Firm: Burr, Pilger & Mayer LLP
24.1		Power of Attorney (see page 41)
31.1		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		Certification by the 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

*	Indicates management contract or compensatory plan or arrangement required to be filed an exhibit pursuant to Item 14(c) of Form 10-K.

†	Portions of the exhibit have been omitted pursuant to a request for confidential treatment and the omitted portions have been separately filed with the Commission.

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this annual report to be signed on its behalf by the undersigned, thereunto duly authorized.

	AVISTAR COMMUNICATIONS CORPORATION
	By:	/s/ Simon B. Moss
		Simon B. Moss
		Chief Executive
		Officer and Director
Date: March 31, 2009

POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Simon B. Moss and Elias A. MurrayMetzger, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, to sign any and all amendments (including post- effective amendments) to this Annual Report on Form 10-K and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or his substitute or substitutes, or any of them, shall do or cause to be done by virtue hereof.

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated:

	Signature		Title		Date
/s/ Gerald J. Burnett		Chairman		March 31, 2009
Gerald J. Burnett
/s/ Simon B. Moss		Chief Executive Officer and Director		March 31, 2009
Simon B. Moss
/s/ Elias A. MurrayMetzger		Acting Chief Financial Officer (Principal		March 31, 2009
Elias A. MurrayMetzger		Financial and Accounting Officer)
/s/ William L. Campbell		Director		March 31, 2009
William L. Campbell
/s/ Craig F. Heimark		Director		March 31, 2009
Craig F. Heimark
/s/ R. Stephen Heinrichs		Director		March 31, 2009
R. Stephen Heinrichs
/s/ Robert M. Metcalfe		Director		March 31, 2009
Robert M. Metcalfe
/s/ James W. Zeigon		Director		March 31, 2009
James W. Zeigon

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INDEX TO FINANCIAL STATEMENTS

		Page
Report of Independent Registered Public Accounting Firm		F-2
Consolidated Balance Sheets as of December 31, 2008 and 2007		F-3
Consolidated Statements of Operations for the years ended December 31, 2008, 2007 and 2006		F-4
Consolidated Statements of Stockholders’ Equity (Deficit) for the years ended December 31, 2008, 2007 and 2006		F-5
Consolidated Statements of Cash Flows for the years ended December 31, 2008, 2007 and 2006		F-6
Notes to the Consolidated Financial Statements		F-7

F-1

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Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders of

Avistar Communications Corporation

We have audited the accompanying consolidated balance sheets of Avistar Communications Corporation and its subsidiary as of December 31, 2008 and 2007, and the related consolidated statements of operations, stockholders’ equity (deficit), and cash flows for each of the three years in the period ended December 31, 2008. Our audits also included the related financial statement schedule listed in Item 15(a)(2). These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor have we been engaged to perform, an audit of the Company’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Avistar Communications Corporation and its subsidiary as of December 31, 2008 and 2007, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2008, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related financial statement schedule, when considered in relation to the consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

/s/ BURR, PILGER & MAYER LLP
San Jose, California
March 30, 2009

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AVISTAR COMMUNICATIONS CORPORATION AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

as of December 31, 2008 and 2007

(in thousands, except share and per share data)

	December 31, 2008			December 31, 2007
Assets:
Current assets:
Cash and cash equivalents	$	4,898		$	4,077
Short-term investments		-			799
Total cash, cash equivalents and short-term investments		4,898			4,876
Accounts receivable, net of allowance for doubtful accounts of $20 and $24 at December 31, 2008 and 2007, respectively		2,701			1,385
Inventories		307			428
Deferred settlement and patent licensing costs		1,100			1,256
Prepaid expenses and other current assets		320			462
Total current assets		9,326			8,407
Property and equipment, net		310			767
Long-term deferred settlement and patent licensing costs		-			1,117
Other assets		157			286
Total assets	$	9,793		$	10,577

Liabilities and Stockholders’ Equity (Deficit):
Current liabilities:
Line of credit	$	7,000		$	5,100
Accounts payable		579			1,287
Deferred income from settlement and patent licensing		4,751			5,520
Deferred services revenue and customer deposits		3,687			2,231
Accrued liabilities and other		1,382			1,451
Total current liabilities		17,399			15,589
Long-term liabilities:
Long term convertible debt		7,000			-
Long-term deferred income from settlement and patent licensing and other		23			4,814
Total liabilities		24,422			20,403
Commitments and contingencies (Notes 4 and 8)
Stockholders’ equity (deficit):
Common stock, $0.001 par value; 250,000,000 shares authorized at December 31, 2008 and 2007; 35,750,680 and 35,678,807 shares issued at December 31, 2008 and 2007, respectively		36			36
Less: treasury common stock, 1,182,875 shares at December 31, 2008 and 2007, at cost		(53	)		(53	)
Additional paid-in-capital		97,506			95,925
Accumulated deficit		(112,118	)		(105,734	)
Total stockholders’ equity (deficit)		(14,629	)		(9,826	)
Total liabilities and stockholders’ equity (deficit)	$	9,793		$	10,577

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

F-3

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AVISTAR COMMUNICATIONS CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF OPERATIONS

for the years ended December 31, 2008, 2007 and 2006

(in thousands, except per share data)

	Year Ended December 31,
	2008			2007			2006

Revenue:
Product	$	3,957		$	3,462		$	4,528
Licensing		954			5,016			5,155
Services, maintenance and support		3,844			3,477			3,542
Total revenue		8,755			11,955			13,225
Costs and expenses:
Cost of product revenues*		2,195			2,684			3,185
Cost of services, maintenance and support revenues*		2,352			2,243			1,820
Income from settlement and patent licensing		(4,226	)		(16,226	)		(4,226	)
Research and development*		5,200			7,670			5,753
Sales and marketing*		3,521			6,192			5,488
General and administrative*		5,729			12,465			9,682
Total costs and expenses		14,771			15,028			21,702
Loss from operations		(6,016	)		(3,073	)		(8,477	)
Other (expense) income:
Interest income		94			346			299
Other (expense) income, net		(439	)		(188	)		(2	)
Total other (expense) income, net		(345	)		158			297
Loss before provision for (recovery from) income taxes		(6,361	)		(2,915	)		(8,180	)
Provision for (recovery from) income taxes		23			23			(31	)
Net loss	$	(6,384	)	$	(2,938	)	$	(8,149	)
Net loss per share – basic and diluted	$	(0.18	)	$	(0.09	)	$	(0.24	)
Weighted average shares used in calculating basic and diluted net loss per share		34,551			34,290			33,928

*Including stock-based compensation of:
Cost of product, services, maintenance and support revenue	$	141	$	188	$	155
Research and development		511		879		618
Sales and marketing		38		614		497
General and administrative		817		1,008		764

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

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AVISTAR COMMUNICATIONS CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)

for the years ended December 31, 2008, 2007 and 2006

(in thousands, except share amounts)

										Additional			Other						Total
	Common Stock				Treasury Stock					Paid-In			Comprehensive			Accumulated			Stockholders’
	shares		amount		shares		amount			Capital			Income (Loss)			Deficit			Equity (Deficit)
Balance at December 31, 2005		34,939,124	$	35		1,182,875	$	(53	)	$	90,519		$	(12	)	$	(94,647	)	$	(4,158	)
Issuance of common stock to employees pursuant to employee stock purchase plan		225,657		—		—		—			266			—			—			266
Issuance of common stock to employees pursuant to exercise of options		54,987		—		—		—			46			—			—			46
Non-employee stock-based compensation		—		—		—		—			93			—			—			93
Employee stock-based compensation		—		—		—		—			1,941			—			—			1,941
Unrealized gain on short and long-term investments		—		—		—		—			—			12			—			12
Net loss		—		—		—		—			—			—			(8,149	)		(8,149	)
Balance at December 31, 2006		35,219,768		35		1,182,875		(53	)		92,865			—			(102,796	)		(9,949	)
Issuance of common stock to employees pursuant to employee stock purchase plan		176,072		1		—		—			219			—			—			220
Issuance of common stock to employees pursuant to exercise of options		282,967		—		—		—			210			—			—			210
Repurchase of stock options from employees		—		—		—		—			(58	)		—			—			(58	)
Non-employee stock-based compensation		—		—		—		—			66			—			—			66
Employee stock-based compensation		—		—		—		—			2,623			—			—			2,623
Net loss		—		—		—		—			—			—			(2,938	)		(2,938	)
Balance at December 31, 2007		35,678,807		36		1,182,875		(53	)		95,925			—			(105,734	)		(9,826	)
Issuance of common stock to employees pursuant to employee stock purchase plan		66,373		—		—		—			67			—			—			67
Issuance of common stock to employees pursuant to exercise of options		5,500		—		—		—			7			—			—			7
Non-employee stock-based compensation		—		—		—		—			18			—			—			18
Employee stock-based compensation		—		—		—		—			1,489			—			—			1,489
Net loss		—		—		—		—			—			—			(6,384	)		(6,384	)
Balance at December 31, 2008		35,750,680	$	36		1,182,875	$	(53	)	$	97,506		$	—		$	(112,118	)	$	(14,629	)

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

F-5

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AVISTAR COMMUNICATIONS CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

for the years ended December 31, 2008, 2007 and 2006

(in thousands)

	Year Ended December 31,
	2008			2007			2006

Cash Flows from Operating Activities:
Net loss	$	(6,384	)	$	(2,938	)	$	(8,149	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation		538			468			345
Compensation on options issued to consultants and employees		1,507			2,689			2,034
Provision for doubtful accounts		(4	)		(27	)		(70	)
Changes in assets and liabilities:
Accounts receivable		(1,312	)		51			89
Inventories		121			284			(37	)
Prepaid expenses and other current assets		142			72			(71	)
Deferred settlement and patent licensing costs		1,273			1,274			1,294
Other assets		129			1			84
Accounts payable		(708	)		(291	)		574
Deferred income from settlement and patent licensing and other		(5,560	)		(5,494	)		(5,481	)
Deferred services revenue and customer deposits		1,456			252			1,267
Accrued liabilities and other		(69	)		(812	)		772
Net cash used in operating activities		(8,871	)		(4,471	)		(7,349	)
Cash Flows from Investing Activities:
Purchase of short and long-term investments		—			(799	)		—
Maturities of short and long-term investments		799			—			3,965
Sale of property and equipment		8			—			—
Purchase of property and equipment		(89	)		(979	)		(290	)
Net cash (used in) provided by investing activities		718			(1,778	)		3,675
Cash Flows from Financing Activities:
Line of credit payments		(5,100	)		—			—
Proceeds from line of credit		7,000			2,100			3,000
Proceeds from convertible debt issuance		7,000			—			—
Net proceeds from issuance of common stock		74			372			312
Net cash provided by financing activities		8,974			2,472			3,312
Net increase (decrease) in cash and cash equivalents		821			(3,777	)		(362	)
Cash and cash equivalents, beginning of year		4,077			7,854			8,216
Cash and cash equivalents, end of year	$	4,898		$	4,077		$	7,854
Supplemental Cash Flow Information:
Cash paid for income taxes	$	—		$	—		$	—
Cash paid for interest	$	412		$	138		$	2

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

F-6

Table of Contents

AVISTAR COMMUNICATIONS CORPORATION AND SUBSIDIARY

NOTES TO FINANCIAL STATEMENTS

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

Business

Avistar Communications Corporation (Avistar or the Company) 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. The Company’s 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 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, customers can use Avistar’s solutions to help reduce costs and improve productivity and communications within their enterprise and between enterprises, 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. The Company currently sells the Avistar system directly and indirectly to small and medium size businesses, or SMBs, and large globally distributed organizations, or Enterprise, markets comprising the Global 5000. The Company’s objective is to establish its technology as the standard for networked visual unified communications and collaboration through limited direct sales, indirect channel sales/partnerships and the licensing of the Company’s technology to others. Avistar also seeks to license its 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.

Organization

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

Basis of Presentation

The accompanying financial statements present the consolidated financial position, results of operations, and cash flows of Avistar and ASUK after elimination of all intercompany accounts and transactions. The consolidated results are referred to, collectively, as those of Avistar or the Company in these notes. The Company has prepared the accompanying consolidated financial statements in conformity with accounting principles generally accepted in the United States of America.

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

The Company’s fiscal year end is December 31.

Risks and Uncertainties

The markets for the Company’s products and services are in the early stages of development. Some of the Company’s products utilize changing and emerging technologies. As is typical in industries of this nature, demand and market acceptance are subject to a high level of uncertainty, particularly when there are adverse conditions in the economy. Acceptance of the Company’s products, over time, is critical to the Company’s success. The Company’s prospects must be evaluated in light of difficulties encountered by it and its competitors in further developing this evolving marketplace. The Company has generated losses since inception and had an accumulated deficit of $112.1 million as of December 31, 2008. The Company’s operating results may fluctuate significantly in the future as a result of a variety of factors, including, but not limited to, the economic environment, the adoption of different distribution channels, and the timing of new product announcements by the Company or its competitors.

The Company’s future liquidity and capital requirements will depend upon numerous factors, including, but not limited to, the ability to become profitable or generate positive cash flow from operations, current discussions with the holders of the convertible debt (Notes) to convert the Notes into shares of common stock at or prior to maturity in January 2010 or extend the term of the Notes, the Company’s cost reduction efforts, Dr. Burnett’s personal guarantee to Avistar to support an extension of the revolving line of credit through March 31, 2010, the Company’s ability to obtain a renewal of its existing line of credit or a new line of credit with another bank, the costs and timing of its expansion of product development efforts and the success of these development efforts, the costs and timing of its expansion of sales and marketing activities, the extent to which its existing and new products gain market acceptance, competing technological and market developments, the costs involved in maintaining, enforcing and defending patent claims and other intellectual property rights, the level and timing of revenue, and other factors. If adequate funds are not available on acceptable terms or at all, the Company’s ability to achieve or sustain positive cash flows, maintain current operations, fund any potential expansion, take advantage of unanticipated opportunities, develop or enhance products or services, or otherwise respond to competitive pressures would be significantly limited.

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2.	Summary of Significant Accounting Policies and Balance Sheet Details

Use of Estimates

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

Cash and Cash Equivalents and Short and Long-term Investments

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

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

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

	December 31,
	2008		2007
Cash and cash equivalents:
Cash and money market funds	$	4,898	$	740
Commercial paper cash equivalents		—		3,337
Total cash and cash equivalents		4,898		4,077
Short-term investments (average 27 remaining days to maturity in 2007)		—		799
Total cash, cash equivalents and short- term investments	$	4,898	$	4,876

Fair Value Measurements

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.

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

	Fair Value		Level 1		Level 2		Level 3
Cash Equivalents:
Money market funds	$	4,704	$	4,704	$	—	$	—
Total cash equivalents	$	4,704	$	4,704	$	—	$	—

Significant Concentrations

A relatively small number of customers have accounted for a significant percentage of the Company’s revenue for the years ended December 31, 2008, 2007 and 2006. Revenues from these customers as a percentage of total revenues for each fiscal year are as follows:

	2008			2007			2006
Customer A		40	%		24	%		25	%
Customer B		19	%		18	%		20	%
Customer C		18	%		*	%		*	%
Customer D		11	%		*	%		38	%
Customer E		*	%		33	%		*	%

*	Less than 10%

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

Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of temporary cash investments and trade receivables. The Company has cash and investment policies that limit the amount of credit exposure to any one financial institution, or restrict placement of these investments to financial institutions evaluated as highly credit worthy. As of December 31, 2008, the Company had cash and cash equivalents on deposit with a major financial institution that were in excess of FDIC insured limits. Historically, the Company has not experienced any loss of its cash and cash equivalents due to such concentration of credit risk. Concentrations of credit risk with respect to trade receivables relate to those trade receivables from both United States and foreign entities, primarily in the financial services industry. As of December 31, 2008, approximately 98% of our gross accounts receivable was concentrated with four customers, each of whom represented more than 10% of our gross accounts receivable. 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. No other customer individually accounted for greater than 10% of total accounts receivable as of December 31, 2008 and 2007.

Allowance for Doubtful Accounts

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

Fair Value of Financial Instruments

The carrying amounts of the Company’s financial assets and liabilities, including cash and cash equivalents, short-term investments, accounts receivable, line of credit, and accounts payable at December 31, 2008 and 2007, approximate fair value because of the short maturity of these instruments.

The long-term convertible debt was stated at cost at December 31, 2008 since there were no unamortized discounts and the Company did not elect to measure the instrument at fair value in accordance with SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115. The carrying amount of the long-term convertible debt is $7.0 million and the estimated fair value is $11.2 million at December 31, 2008. The fair value is estimated as the sum of the present value of future interest and principal payments of the debt based on rates available to the Company for debt with similar terms and remaining maturities, and the fair value of the conversion feature calculated based on the Black-Scholes method. See Note 3 for further details on the terms of the convertible debt.

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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):

	December 31,_
	2008		2007
Raw materials and sub-assemblies	$	10	$	25
Finished goods		297		403
	$	307	$	428

Property and Equipment

Property and equipment are stated at cost and are depreciated using the double declining balance method over the estimated useful lives (three or five years) of the assets. Repairs and maintenance are expensed as incurred. The Company has net property and equipment of $303,000 in the United States and $7,000 in United Kingdom. Property and equipment consisted of the following (in thousands):

	December 31,
	2008			2007
Computer equipment	$	1,512		$	1,408
Computer software		377			339
Furniture, fixtures and equipment		228			304
Leasehold improvements		201			268
		2,318			2,319
Less: Accumulated depreciation		(2,008	)		(1,552	)
	$	310		$	767

Accrued Liabilities and Other

Accrued liabilities and other consisted of the following (in thousands):

	December 31,
	2008		2007
Accrued consulting and professional fees	$	410	$	478
Accrued payroll and related benefits		424		630
Accrued commissions and bonuses		186		57
Deferred rent payable		171		69
Accrued loss on subleases		63		-
Other		128		217
	$	1,382	$	1,451

Patent Costs

Due to uncertainties about the estimated future economic benefits and lives of the Company’s patents and patent applications, all related outside patent costs have been expensed as incurred. Outside patent costs were approximately $1.0 million, $1.8 million and $0.7 million for 2008, 2007 and 2006, respectively, and are reflected in general and administrative expenses in the accompanying statements of operations.

Revenue Recognition and Deferred Revenue

The Company recognizes product and services revenue in accordance with Statement of Position (SOP) 97-2, Software Revenue Recognition (SOP 97-2), as amended by SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions (SOP 98-9), or Emerging Issues Task Force (EITF) Issue No. 00-21, Revenue Arrangements with Multiple Deliverables. The Company derives product revenue from the sale and licensing of a set of desktop (endpoint) products (hardware and software) and infrastructure products (hardware and software) that combine to form an Avistar video-enabled collaboration solution. Services revenue includes revenue from 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.

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

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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 December 31, 2008, these criteria for recognizing license revenue following the commencement of litigation had not been met.

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

On September 8, 2008 and on September 9, 2008, Avistar entered into a Licensed Works Agreement, Licensed Works Agreement Statement of Work and a Patent License Agreement with International Business Machines Corporation, or IBM, under which Avistar agreed to integrate its bandwidth management technology and related intellectual property into future Lotus Unified Communications offerings by IBM, and to provide maintenance support services. An initial cash payment of $3.0 million was made by IBM to Avistar on November 7, 2008. Avistar expects IBM to make two additional non-refundable payments of $1.5 million, each associated with scheduled phases of delivery. IBM has agreed to make future royalty payments to Avistar equal to two percent of the world-wide net revenue derived by IBM from Lotus Unified Communications products sold that exceeds a contractual base amount, and maintenance payments received from existing customers, which incorporate Avistar’s technology. The agreements have a five year term and are non-cancelable except for material default by either party. The agreements 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, in accordance with the “Input Method”, and the maintenance revenue will be recognized over the future maintenance service period. As the Company believes there are no future deliverables associated with the intellectual property patent licenses, no additional provision for this element has been made. For fiscal year ended December 31, 2008, the Company has recognized $1.3 million in product revenue and $255,000 in service revenue. The remaining $3.8 million is expected to be recognized in product revenue under the percentage of completion method over the projected development time of 12 months. The estimate of current period percentage of completion requires significant management judgment and is subject to updates in future periods until the project is complete.

Income from Settlement and Patent Licensing

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

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

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On February 15, 2007, the Company entered into a Patent License Agreement with Tandberg ASA, Tandberg Telecom AS and Tandberg, Inc. Under this agreement, Avistar dismissed its infringement suit against Tandberg, Tandberg dismissed its infringement suit against Avistar, and the companies cross-licensed each other’s patent portfolios. The agreement resulted in a payment of $12.0 million to Avistar 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.

Taxes Collected from Customers and Remitted to Governmental Authorities

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

Warranty

The Company accrues the estimated costs of fulfilling the warranty provisions of its contracts over the warranty period, which is typically 90 days. There was no warranty accrual as of December 31, 2008 and 2007.

Research and Development

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

Stock-Based Compensation

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

Stock-based compensation expense for fiscal 2008, 2007 and 2006 included compensation expense for all stock-based compensation awards granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provision of SFAS No. 123, Accounting for Stock-Based Compensation (SFAS No. 123). Stock-based compensation expense for all stock-based compensation awards granted after January 1, 2006 is based on the grant-date fair value estimated in accordance with the provisions of SFAS No. 123R. The Company recognizes compensation expense on a straight-line basis over the requisite service period of the award.

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The effect of recording stock-based compensation for the years ended December 31, 2008, 2007 and 2006 was as follows (in thousands):

	Year Ended December 31,
	2008		2007		2006
Stock-based compensation expense by type of award:
Employee stock options	$	1,482	$	2,513	$	1,815
Non-employee stock options		18		66		93
Employee stock purchase plan		7		110		126
Total stock-based compensation		1,507		2,689		2,034
Tax effect of stock-based compensation		—		—		—
Net effect of stock-based compensation on net loss	$	1,507	$	2,689	$	2,034

Other Comprehensive Income

SFAS No. 130 (SFAS 130), Reporting Comprehensive Income, establishes standards for the reporting and the display of comprehensive income (loss) and its components. This standard defines comprehensive income (loss) as the changes in equity of an enterprise, except those resulting from stockholder transactions. Accordingly, comprehensive income (loss) includes certain changes in equity that are excluded from the net income or loss. The comprehensive loss was $6.4 million, $2.9 million and $8.1 million for the years ended December 31, 2008, 2007 and 2006, respectively.

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

	Year Ended December 31,
	2008			2007			2006
Net loss	$	(6,384	)	$	(2,938	)	$	(8,149	)
Other comprehensive income (loss):
Change in net unrealized gains and losses on investments		—			—			12
Total comprehensive loss	$	(6,384	)	$	(2,938	)	$	(8,137	)

Recent Accounting Pronouncements

In February 2007, the FASB issued Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115 (SFAS No. 159). The standard permits entities to choose, at specified election dates, to measure eligible financial assets, financial liabilities and firm commitments at fair value, on an instrument-by-instrument basis, that are otherwise not permitted to be accounted for at fair value under other generally accepted accounting principles. The fair value measurement election is irrevocable and subsequent changes in fair value must be recorded in earnings. SFAS No. 159 became effective for the Company on January 1, 2008. The Company did not elect to measure any eligible items at fair value in accordance with this new standard either at the date it adopted this new standard or subsequently during 2008; therefore the adoption of this standard did not have an impact on the Company’s financial position and results of operations.

In December 2007, the FASB issued SFAS No. 141(Revised), Business Combinations (SFAS No. 141(R)), which replaces SFAS No. 141, Business Combinations, and requires an acquirer to recognize the assets acquired, the liabilities assumed, and any non-controlling interest in the acquiree at the acquisition date, measured at their fair values as of that date, with limited exceptions. This statement also requires the acquirer in a business combination achieved in stages to recognize the identifiable assets and liabilities, as well as the non-controlling interest in the acquiree, at the full amounts of their fair values. SFAS No. 141(R) makes various other amendments to authoritative literature intended to provide additional guidance or to confirm the guidance in that literature to that provided in this statement. This statement applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. The Company adopted this statement on January 1, 2009. SFAS No. 141(R)’s impact on accounting for business combinations is dependent upon acquisition activity on or after its effective date.

In December 2007, FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements, which amends Accounting Research Bulletin No. 51, Consolidated Financial Statements, to improve the relevance, comparability, and transparency of the financial information that a reporting entity provides in its consolidated financial statements. SFAS No. 160 establishes accounting and reporting standards that require the ownership interests in subsidiaries not held by the parent to be clearly identified, labeled and presented in the consolidated statement of financial position within equity, but separate from the parent’s equity. This statement also requires the amount of consolidated net income attributable to the parent and to the non-controlling interest to be clearly identified and presented on the face of the consolidated statement of income. Changes in a parent’s ownership interest while the parent retains its controlling financial interest must be accounted for consistently, and when a subsidiary is deconsolidated, any retained non-controlling equity investment in the former subsidiary must be initially measured at fair value. The gain or loss on the deconsolidation of the subsidiary is measured using the fair value of any non-controlling equity investment. The statement also requires entities to provide sufficient disclosures that clearly identify and distinguish between the interests of the parent and the interests of the non-controlling owners. This statement applies prospectively to all entities that prepare consolidated financial statements and applies prospectively for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. The Company adopted this statement on January 1, 2009. The adoption of SFAS 160 did not have an impact on the Company’s financial condition and results of operations.

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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 adopted this statement on January 1, 2009. The adoption of EITF 07-01 did not have material impact on the Company’s financial condition and results of operations.

In February 2008, the FASB issued FASB Staff Position No. FAS 157-2, Effective Date of FASB Statement No. 157 (FSP 157-2), to partially defer SFAS 157, Fair Value Measurements. 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 adopted this statement on January 1, 2009. The adoption of FSP 157-2 did not have material impact on the Company’s financial condition and results of operations.

3.	Borrowings

Line of Credit

On December 23, 2006, the Company entered into a Revolving Credit and Promissory Note and a Security Agreement with a financial institution to borrow up to $10.0 million under a revolving line of credit. The agreement includes a first priority security interest in all of the Company’s assets. Gerald Burnett, Chairman of the Company, provided a collateralized guarantee to the financial institution, assuring payment of the Company’s obligations under the agreement and as a consequence, there are no restrictive covenants, allowing the Company greater access to the full amount of the facility. In addition to the guarantee provided to the financial institution, on March 29, 2009, Dr. Burnett provided a personal guarantee to Avistar, assuring the Company a line of credit of $10.0 million with the same terms and mechanisms as the existing revolving line of credit in the event the existing revolving line of credit from the financial institution was unavailable for any reason during the period from its termination on December 21, 2009 to March 31, 2010. The line of credit required monthly interest-only payments based on Adjusted LIBOR plus 1.25% or Prime Rate plus 1.25% at December 31, 2008, and Adjusted LIBOR plus 0.75% or Prime Rate minus 2.0% at December 31, 2007, respectively. The Company elected Prime Rate plus 1.25% or 4.5% at December 31, 2008, and Prime Rate minus 2.0% or 5.3% at December 31, 2007, respectively. The Company borrowed $7.0 million and $2.1 million under the revolving line of credit for the years ended December 31, 2008 and 2007, respectively, and has a balance of $7.0 million outstanding as of December 31, 2008. The balance of $5.1 million as of December 31, 2007 was fully repaid during 2008. The Revolving Credit and Promissory Note was renewed on December 22, 2008 and matures on December 21, 2009, and is subject to annual renewal with the consent of the Company and the lender.

Convertible Debt

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

4.	Commitments and Contingencies

At December 31, 2008, the Company had open purchase orders and other contractual obligations of approximately $47,000, primarily related to inventory purchases. These purchase order commitments and contractual obligations will be reflected in the Company’s financial statements once goods or services have been received, or payments related to the obligations become due.

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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 December 31, 2008, net of sublease proceeds, are as follows (in thousands):

	Minimum lease payments		Estimated sublease proceeds			Net
Year Ending December 31,
2009	$	1,251	$	(536	)	$	715
2010		1,280		(476	)		804
2011		1,333		(323	)		1,010
2012		567		(270	)		297
2013		310		(263	)		47
thereafter		1,008		(883	)		125
Total future minimum lease payments	$	5,749	$	(2,751	)	$	2,998

Gross rent expense for 2008, 2007 and 2006 was approximately $1.4 million, $1.2 million, and $0.8 million, respectively. Sublease rental income under non-cancelable subleases was $219,000 for 2008. There was no sublease rental income for 2007 and 2006.

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 unlimited. 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 December 31, 2008.

Microsoft

During 2008, Microsoft Corporation had filed requests for re-examination of 29 U.S. patents held by Avistar. In June 2008, 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 the Company’s existing U.S. patents. Subsequently, Microsoft submitted five petitions for reconsideration of the USPTO’s rejection of Microsoft’s re-examination applications. The USPTO’s review of the five petitions for reconsideration is currently in process, with an indeterminate time period established for their decision on Microsoft’s request.

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

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

5.	Related Party Transactions

Certain directors with controlling interests in the Company are also the majority owners of one entity that conducted business with the Company, Vicor Inc. (Vicor). Revenue from Vicor represented less than 10% of total revenue for 2007 and 2006. There was no revenue from Vicor in 2008. Management believes the transactions with Vicor are at terms comparable to those provided to unrelated third parties. As of December 31, 2008 and 2007, the Company did not have any accounts receivable outstanding from Vicor.

Revenue from a Related Party

UBS Warburg LLC, which is an affiliate of UBS AG, is a stockholder of the Company and is also a customer of the Company. As of December 31, 2008, 2007 and 2006, UBS Warburg LLC held less than 5% of the Company’s stock. Revenue from UBS Warburg LLC and its affiliates represented 19%, 18% and 20% of total revenue for 2008, 2007 and 2006, respectively. Management believes the transactions with UBS Warburg LLC and its affiliates are at terms comparable to those provided to unrelated third parties. As of December 31, 2008 and 2007, the Company had accounts receivable outstanding from UBS Warburg LLC and its affiliates of approximately $350,000 and $143,000, respectively.

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Fees to Related Parties

Robert P. Latta, a member of the law firm Wilson Sonsini Goodrich & Rosati, a Professional Corporation (WSGR), served as a director of the Company from February 2001 until June 2007. Mr. Latta and WSGR have represented the Company and its predecessors as corporate counsel since 1997. During 2007 and 2006, payments of $203,000 and $118,000, respectively, were made to WSGR for legal services provided to the Company. The Company had outstanding payables of $50,000 to WSGR as of December 31, 2007.

Borrowings from Related Parties

On January 4, 2008, Avistar issued $7,000,000 of 4.5% Convertible Subordinated Secured Notes (the Notes), which are due in 2010. The Notes were sold pursuant to a Convertible Note Purchase Agreement to Baldwin Enterprises, Inc., a subsidiary of Leucadia National Corporation, directors Gerald Burnett, R. Stephen Heinrichs, William Campbell, and Craig Heimark, officers Simon Moss and Darren Innes, and WS Investment Company, a fund associated with WSGR. See Note 3 for further details.

6.	Stockholders’ Equity

Stock Repurchase Plan

On March 22, 2001, the Company announced that its Board of Directors authorized the repurchase of up to $2.0 million of its common stock in the open market. No shares of common stock were repurchased by the Company during 2008, 2007 or 2006.

Preferred Stock

In April 2000, the stockholders of the Company authorized 10,000,000 shares of convertible preferred stock, effective upon completion of its initial public offering in August 2000. As of December 31, 2008, the Company had 10,000,000 shares of convertible preferred stock authorized, at $0.001 per share par value. No shares of convertible preferred stock were issued or outstanding as of December 31, 2008.

7.	Stock Option Plans and Employee Stock Purchase Plan

1997 Stock Option Plan

In December 1997, the Board established the 1997 Stock Option Plan (the 1997 Plan) and authorized the issuance of 1,828,602 shares of common stock thereunder. In December 1999 and May 2000, respectively, the Board authorized an additional 1,065,625 shares and 100,000 shares to be issued under the Plan. In connection with the initial public offering in August 2000, the Board terminated the 1997 Plan as to future grants, effective August 17, 2000. Under the 1997 Plan, incentive stock options to purchase shares of common stock were granted only to employees at not-less-than 100% of the fair market value at the grant date as determined by the Board. Additionally, nonqualified stock options to purchase shares of common stock were granted to employees and consultants at not-less-than 85% of the fair market value at the grant date. Options granted generally have had a contractual life of ten years.

Options granted under the plan vest over a four-year period, with 25% vesting after one year and the remaining balance vesting 6.25% per quarter. At December 31, 2008, options to purchase a total of 403,400 shares were outstanding under the 1997 Plan, and no options were available for grant.

2000 Stock Option Plan

In April 2000, the Board established the 2000 Stock Option Plan (the 2000 Plan). Initially, a total of 3,000,000 shares of common stock were approved by the Board for issuance under the 2000 Plan, together with annual increases in the number of shares of common stock reserved under the plan beginning on the first day of the Company’s fiscal year, commencing January 1, 2001. In January 2001, the Board approved an increase of 1,004,936 shares. In January 2002, the Board approved an increase of 1,007,858 shares. In January 2003, the Board approved an increase of 1,011,957 shares. In January of each year from 2004 to 2008 the Board approved an increase of 1,200,000 shares. As of December 31, 2008, a total of 12,024,751 shares had been reserved for issuance under the 2000 Plan. The contractual term of the options granted under this plan may not exceed 10 years and in the case of the grantees who own more than 10% of the Company’s outstanding stock at the time of grant, the contractual term of the option may not exceed five years. Options granted under the 2000 Plan vest and become exercisable as set forth in each option agreement; generally one quarter vest after one year and one-twelfth vest quarterly thereafter. In the event of a merger or sale of substantially all assets, these options must be assumed by the successor and if not assumed, will fully vest. The 2000 Plan will terminate in 2010. As a result of past and future increases, a maximum of 15,000,000 shares of common stock could be issued under the 2000 Plan. The Company granted options to purchase approximately 2.3 million, 4.4 million and 1.4 million shares under the plan in 2008, 2007 and 2006, respectively. At December 31, 2008 options to purchase a total of 10,289,929 shares were outstanding under the 2000 Plan and 1,220,219 options were available for future grant.

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2000 Director Option Plan

In April 2000, the Company adopted the 2000 Director Option Plan (the “Director Plan”). Initially, a total of 90,000 shares of common stock were approved by the Board for issuance under the plan, together with an annual increase in the number of shares of common stock reserved thereunder as provided in the plan beginning on the first day of the Company’s fiscal year, commencing January 1, 2001. In January 2001, the Board approved an annual increase of 12,000 shares. In May 2001, the Board approved an additional 198,000 shares under this plan. In January 2002, the Board approved the annual increase of 30,000 shares. In January 2003, the Board approved the annual increase of 30,000 shares. In April 2003, the Board approved an additional 104,000 shares under this plan. In January of each year from 2004 through 2008, the Board approved annual increases of 175,000 shares. As of December 31, 2008, the Company has authorized a total of 1,339,000 shares for issuance under this plan. As a result of past and future annual increases, a maximum of 1,689,000 share of common stock could be issued over the 10-year life of the plan. The Company granted options to purchase 170,000, 145,000 and 145,000 shares under this plan in 2008, 2007 and 2006 respectively. At December 31, 2008 options to purchase a total of 936,270 shares were outstanding under the Director Plan and 341,480 options were available for future grant.

In April 2005, the Board authorized further amendments to the Director Plan, subject to stockholder approval, to: (i) provide that annual grants under the plan shall take place on January 1 of each year starting in 2006, (ii) provide that, after the first year, options granted under the plan vest at a rate of 1/48 per month rather than 1/4 per year, (iii) provide that options granted under the plan shall continue to vest and be exercisable for so long as the option holder remains a director or consultant to the Company, subject to the term of the option; (iv) extend the time period for optionees to exercise options following the date on which they are no longer a director or consultant to the Company, and (v) to provide the Board with the authority to make amendments to the Director Plan applicable to all options granted under the Director Plan, including options granted prior to the effective date of the amendment. The proposed amendments were approved by stockholders in June 2005 but did not affect options already granted under the Director Plan prior to the effective date of the amendments.

A summary of the 1997 Plan, the 2000 Plan, and the Director Plan activity and related information for the years ended December 31, 2008, 2007 and 2006 is as follows:

				Options Outstanding
	Shares Available for Option Grant			Shares		Weighted Average Exercise Price
Balance, December 31, 2005		1,678,455		7,979,647		$3.06
Authorized		1,375,000		—		—
Granted		(1,511,000	)	1,511,000		1.39
Exercised		—		(54,987	)	0.87
Expired		150,000		(150,000	)	1.52
Canceled		396,938		(396,938	)	1.72
Balance, December 31, 2006		2,089,393		8,888,722		$2.87
Authorized		1,375,000		—		—
Granted		(4,550,000	)	4,550,000		1.21
Exercised		—		(282,967	)	0.74
Canceled		2,419,063		(2,590,663	)	2.59
Balance, December 31, 2007		1,333,456		10,565,092		$2.28
Authorized		1,375,000		—		—
Granted		(2,459,318	)	2,459,318		0.85
Exercised		—		(5,500	)	0.99
Canceled		1,312,561		(1,389,311	)	2.40
Balance, December 31, 2008		1,561,699		11,629,599		$1.97

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The pretax intrinsic value of outstanding options is the difference between the closing price of Avistar shares as quoted on the NASDAQ Capital Market for December 31, 2008 and the exercise price, multiplied by the number of in-the-money options. The aggregate intrinsic value of the options outstanding at December 31, 2008 for all options outstanding was $436,000 and $109,000 for only vested options outstanding. Vested and exercisable options outstanding at December 31, 2008 had a weighted average remaining contractual life of 4.24 years. The intrinsic value of options changes based on the fair market value of Avistar stock. The Company had 10,981,943 options vested and exercisable and expected to be vested and exercisable at December 31, 2008 with a weighted average exercise price of $2.02, a weighted average remaining contractual term of 5.11 years, and an aggregate intrinsic value of $377,000. Total intrinsic value of options exercised for the years ended December 31, 2008, 2007 and 2006 were $1,500, $138,000 and $47,000, respectively. The following table summarizes significant ranges of outstanding and exercisable options as of December 31, 2008.

Options Outstanding							Options Exercisable
Range of Exercise Prices	Number Outstanding at December 31, 2008		Weighted-Average Remaining Contractual Life		Weighted-Average Exercise Price		Number Exercisable at December 31, 2008		Weighted-Average Exercise Price
$0.36 - $0.83		1,832,687		7.98		$0.66		581,312		$0.72
$0.86		1,759,506		2.22		0.86		754,045		0.86
$0.90 - $1.16		1,831,510		4.75		1.00		1,519,510		1.01
$1.21 - $1.41		2,305,313		7.31		1.33		1,123,750		1.29
$1.42 - $2.21		1,965,333		4.62		1.74		1,412,447		1.80
$2.25 - $8.50		1,604,650		4.72		3.82		1,469,649		3.92
$17.25		330,600		1.25		17.25		330,600		17.25
		11,629,599		5.26		$1.97		7,191,313		$2.51

As of December 31, 2008, the Company had an unrecognized stock-based compensation balance related to stock options of approximately $3.5 million before estimated forfeitures and after actual cancellations. SFAS No. 123R requires forfeitures to be estimated at the time of grant and revised if necessary in subsequent periods if actual forfeitures differ from those estimates. Based on the Company’s historical experience of option pre-vesting cancellations, the Company has assumed an annualized forfeiture rate of 9% for its executive options and 38% for non-executive options. Accordingly, as of December 31, 2008, the Company estimated that the stock-based compensation for the awards not expected to vest was approximately $1.2 million and therefore, the unrecognized deferred stock-based compensation balance related to stock options was adjusted to approximately $2.3 million after estimated forfeitures and after actual cancellations. This amount will be recognized over an estimated weighted average period of 2.2 years. For the years ended December 31, 2008, 2007 and 2006, the Company granted 2,459,318, 4,550,000 and 1,486,000 stock options to employees, with an estimated total grant-date fair value of $1.3 million, $5.0 million and $1.9 million, or $0.54, $1.10 and $1.29 per share, respectively. For the years ended December 31, 2008, 2007 and 2006, 2.5 million , 1.6 million and 1.4 million options vested with a total fair value of $2.6 million, $2.6 million and $2.5 million, respectively.

2000 Employee Stock Purchase Plan

In April 2000, the Company adopted the 2000 Employee Stock Purchase Plan (“Employee Stock Purchase Plan”). Initially, a total of 1,500,000 shares of common stock were approved by the Board for issuance under the plan, together with an annual increase in the number of shares of common stock reserved thereunder as provided in the plan beginning on the first day of the Company’s fiscal year, commencing January 1, 2001. In January 2001, the Board approved an increase of 753,702 shares. As of December 31, 2008, the Company has authorized a total of 2,253,702 shares for issuance under this plan. As a result of past and future annual increases, a maximum of 10,500,000 shares could be sold over the 10-year life of the plan. The Employee Stock Purchase Plan permits employees to purchase common stock through payroll deductions, which may not exceed 15% of an employee’s compensation, at 85% of the lower of the fair market value of the Company’s common stock on the first or the last day of each offering period. A total of 66,373, 176,072 and 225,657 shares were sold under this plan during 2008, 2007 and 2006, respectively.

On July 19, 2006, the Compensation Committee of the Board of Directors of the Company approved amendments to the 2000 Employee Stock Purchase Plan to (i) change the offering periods under the plan from approximately 24 months to approximately six months, commencing on the first trading day on or after February 1 and August 1 of each year, and (ii) eliminate the section of the plan that provided for automatic withdrawal and re-enrollment in the event that the fair market value of the common stock on any exercise date was lower than the fair market value of the common stock on the enrollment date of the same offering period.

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Valuation Assumptions

The Company estimated the fair value of stock options granted during 2008, 2007 and 2006, using a Black-Scholes-Merton valuation model, consistent with the provisions of SFAS No. 123R, and SEC Staff Accounting Bulletin (SAB) No. 107. The fair value of each option grant is estimated on the date of grant using the Black-Scholes-Merton option valuation model and the straight-line attribution approach with the following weighted-average assumptions for the years ended December 31, 2008, 2007 and 2006:

	Year Ended December 31,
	2008			2007			2006
Employee Stock Option Plan
Expected dividend		0	%		0	%		0	%
Average risk-free interest rate		2.2	%		4.4	%		4.9	%
Expected volatility		115	%		132	%		143	%
Expected term (years)		2.9			6.1			6.1

	Year Ended December 31,
	2008			2007			2006
Employee Stock Purchase Plan
Expected dividend		0	%		0	%		0	%
Average risk-free interest rate		2.0	%		5.1	%		4.0	%
Expected volatility		144	%		155	%		89	%
Expected term (months)		6.0			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 equal to 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.

For the year ended December 31, 2008, stock-based compensation expense associated with employee stock options and ESPP shares amounted to $1.5 million and $6,500, respectively.

Common Stock Reserved for Future Issuance

As of December 31, 2008, the Company had reserved the following shares of common stock for issuance in connection with:

Stock options under stock option plans			13,191,298
Employee stock purchase plan			1,235,595
Total			14,426,893

8.	Legal Proceedings

Avistar is not currently party to any legal proceedings and is not aware of any threatened legal proceedings against us.

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

9.	Income Taxes

The Company accounts for income taxes in accordance with SFAS No. 109, Accounting for Income Taxes (SFAS 109). SFAS 109 provides for an asset and liability approach to account for income taxes under which deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities, and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some or all of the deferred tax assets will not be realized. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period of enactment.

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In July 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements in accordance with SFAS 109 and prescribes a recognition threshold and measurement attributes for financial statement disclosure of tax positions taken or expected to be taken on a tax return. Under FIN 48, the impact of an uncertain income tax position on the income tax return must be recognized at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained. Additionally, FIN 48 provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. Avistar adopted FIN 48 effective January 1, 2007 and as a result of the adoption, the Company recognized no adjustment to retained earnings and a reduction of $676,000 in the deferred tax asset for unrecognized tax benefits due to an estimate of the sustainability of income tax positions taken. At December 31, 2008 and 2007, respectively, the total amount of unrecognized tax benefits was $915,000 and $817,000. A reconciliation of unrecognized tax benefits follows:

Balance at January 1, 2007	$	676
Additions for 2007 tax positions		141
Balance at December 31, 2007		817
Additions for 2008 tax positions		98
Balance at December 31, 2008	$	915

Avistar files income tax returns in the U.S. federal jurisdiction and in various states, and the tax returns filed for the years 2001 through 2007 have not been examined and the applicable statues of limitation have not expired with respect to those returns. Because of net operating loss and research credit carryovers, substantially all of the Company’s tax years remain open to examination.

The Company’s policy is to recognize interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense.

The (recovery from) provision for income taxes relates to Federal, State and Foreign tax. The Company provided for income taxes for its subsidiary in the United Kingdom (ASUK) of approximately $23,000, $23,000 and $22,000 in 2008, 2007 and 2006, respectively. Federal and State overpayments of 2004 income taxes of $33,000 and $20,000, respectively, were refunded in 2006.

The (recovery from) provision for income taxes consisted of the following (in thousands):

	Year Ended December 31,
	2008		2007		2006
Current:
Federal	$	—	$	—	$	(33	)
State		—		—		(20	)
Foreign		23		23		22
	$	23	$	23	$	(31	)

For financial reporting purposes, loss before provision for income taxes included the following components (in thousands):

	Year Ended December 31,
	2008			2007			2006
Domestic	$	(6,444	)	$	(3,021	)	$	(9,611	)
Foreign		83			106			1,431
Loss before provision for income taxes	$	(6,361	)	$	(2,915	)	$	(8,180	)

The Company’s effective income tax provision differed from the federal statutory rate of 34% due to the following (in thousands):

	Year Ended December 31,
	2008			2007			2006
Expected tax benefit at federal statutory rate	$	(2,163	)	$	(991	)	$	(2,771	)
Foreign and state taxes, net		23			23			2
Recovery of federal tax payments		—			—			(33	)
Non-deductible stock compensation and other		397			629			463
Current year operating losses and temporary differences for which no tax benefit is recognized		1,766			362			2,308
Provision for income taxes	$	23		$	23		$	(31	)

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The net deferred income tax asset consisted of the following as of December 31, 2008 and 2007 (in thousands):

	December 31,
	2008			2007
Deferred income tax assets:
Federal net operating loss carry-forwards	$	19,700		$	16,664
State net operating loss carry-forwards		1,868			1,604
Tax credit carry-forwards		2,524			2,325
Deferred settlement and patent licensing, net		1,416			3,058
Reserves and other		1,095			873
Property and Equipment		212			253
		26,815			24,777
Valuation allowance		(26,815	)		(24,777	)
Net deferred income tax asset	$	—		$	—

Net operating loss carry-forwards at December 31, 2008 were approximately $57.9 million and $39.1 million, for Federal and state income tax purposes, respectively. The Federal net operating loss carry-forwards expire on various dates through the year 2028. The valuation allowance increased by $2.0 million in 2008, $161,000 in 2007 and $3.1 million in 2006.

As of December 31, 2008, unused research and development tax credits of approximately $1.3 million and $1.4 million are available to reduce future Federal and California income taxes, respectively. Federal credit carry-forwards expire beginning in year 2014. California credits will carry forward indefinitely.

The Internal Revenue Code of 1986, as amended, contains provisions that may limit the net operating loss carry-forwards to be used in any given year upon the occurrence of certain events, including a significant change in ownership interest. The Company believes significant uncertainty exists regarding the realizability of the net operating loss and tax credit carry-forwards and other timing differences. Accordingly, a valuation allowance has been provided for the entire net deferred tax asset.

10.	Net Loss Per Share

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

In accordance with SFAS 128, basic net loss per share has been computed using the weighted average number of shares of common stock outstanding during the period, less shares subject to repurchase. Diluted net loss per share is computed on the basis of the weighted average number of shares and potential common shares outstanding during the period. Potential common shares result from the assumed exercise of outstanding stock options that have a dilutive effect when applying the treasury stock method. The Company has excluded all outstanding stock options and shares subject to repurchase from the calculation of diluted net loss per share for 2008, 2007 and 2006, because all such securities are antidilutive (owing to the fact that the Company is in a loss position). Accordingly, diluted net loss per share is equal to basic net loss per share for all years presented.

The total number of potential dilutive common shares excluded from the calculations of diluted net loss per share was 206,756, 590,788 and 846,929 for 2008, 2007 and 2006, respectively.

The following table presents the calculation of basic and diluted net loss per share (in thousands, except per share data):

	Year Ended December 31,
	2008			2007			2006
Numerator – basic and diluted:
Net loss	$	(6,384	)	$	(2,938	)	$	(8,149	)

Denominator – basic and diluted:
Weighted average shares of common stock used in computing net loss per share		34,551			34,290			33,928

Net loss per share - basic and diluted	$	(0.18	)	$	(0.09	)	$	(0.24	)

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11.	Segment Reporting

Disclosure of segments is presented in accordance with SFAS No. 131 (SFAS 131), Disclosures About Segments of an Enterprise and Related Information. SFAS 131 establishes standards for disclosures regarding operating segments, products and services, geographic areas and major customers. The Company is organized and operates as two operating segments: (1) the design, development, manufacturing, sale and marketing of networked video communications products (products division) and (2) the prosecution, maintenance, support and licensing of the intellectual property and technology, some of which is used in the Company’s products (intellectual property division). Service revenue relates mainly to the maintenance, support, training, software development and installation of products, and is included in the products division for purposes of reporting and decision-making. The products division also engages in corporate functions, and provides financing and services to its intellectual property division. The Company’s chief operating decision-maker, its Chief Executive Officer (CEO), monitors the Company’s operations based upon the information reflected in the following table (in thousands). The table includes a reconciliation of the revenue and expense classification used by the Company’s CEO with the classification of revenue, other income and expenses as set forth in the Company’s audited 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			Total
Year Ended December 31, 2008
Revenue	$	5,180		$	7,801		$	(4,226	)	$	8,755
Depreciation expense		—			(538	)		—			(538	)
Stock-based compensation		(248	)		(1,259	)		—			(1,507	)
Total costs and expenses		(2,030	)		(16,967	)		4,226			(14,771	)
Interest income		—			94			—			94
Interest expense		—			(439	)		—			(439	)
Net income (loss)		3,150			(9,534	)		—			(6,384	)
Assets		1,610			8,183			—			9,793
Year Ended December 31, 2007
Revenue	$	21,162		$	7,019		$	(16,226	)	$	11,955
Depreciation expense		—			(468	)		—			(468	)
Stock-based compensation		(240	)		(2,449	)		—			(2,689	)
Total costs and expenses		(7,513	)		(23,741	)		16,226			(15,028	)
Interest income		—			346			—			346
Interest expense		—			(187	)		—			(187	)
Net income (loss)		13,649			(16,587	)		—			(2,938	)
Assets		2,808			7,769			—			10,577
Year Ended December 31, 2006
Revenue	$	9,381		$	8,070		$	(4,226	)	$	13,225
Depreciation expense		—			(345	)		—			(345	)
Stock-based compensation		(440	)		(1,594	)		—			(2,034	)
Total costs and expenses		(5,701	)		(20,227	)		4,226			(21,702	)
Interest income		—			299			—			299
Interest expense		—			(1	)		—			(1	)
Net income (loss)		3,680			(11,829	)		—			(8,149	)
Assets		3,752			10,947			—			14,699

International revenue, which consists of sales to customers with operations principally in Western Europe and Asia, comprised 51%, 72% and 75% of total revenue for 2008, 2007 and 2006, respectively. Revenue is allocated to individual countries and geographical region by customer, based on where the product is shipped to, location of services performed or the location of equipment that is under an annual maintenance agreement. In the case of patent licensing, revenue is allocated to geographical region based on the location of the customer. For 2008, 2007 and 2006, respectively, international revenues from customers in the United Kingdom accounted for 22%, 12% and 12% respectively, of total revenue. The Company had no significant long-lived assets in any country other than the United States for any period presented.

12.	Subsequent Events

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

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

Avistar appealed the Nasdaq Staff’s determination to the Listing Qualifications Panel which automatically resulted in the stay of the Staff’s de-listing of Avistar’s common stock. The appeal took place on January 29, 2009 and the Listing Qualifications Panel has the authority to grant Avistar a further extension of time in which to regain compliance with the Marketplace Rules, though there can be no assurance that the Panel will grant a further extension of time.

In January 2009, Bob Habig resigned from the position of Chief Financial Officer and he was replaced in that position by Elias MurrayMetzger, the Company’s Corporate Controller.

On February 5, 2009, the Company repaid $3.9 million of the $7.0 million revolving line of credit outstanding as of December 31, 2008.

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13.	Selected Quarterly Results of Operations (unaudited)

The following tables set forth, for the periods indicated, the Company’s unaudited financial information for the last eight quarters. The Company believes that the financial statements used to prepare this information include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of this information when read in conjunction with the Company’s financial statements and notes to financial statements. The operating results for any quarter do not necessarily indicate the results expected for any future period.

On February 15, 2007, the Company entered into a Patent License Agreement with Tandberg ASA, Tandberg Telecom AS and Tandberg, Inc. Under this agreement, the Company agreed to dismiss its infringement suit against Tandberg, Tandberg agreed to dismiss its infringement suit against Avistar, and the companies agreed to cross-license each other’s patent portfolios. The agreement resulted in a payment to Avistar from Tandberg in the amount of $12.0 million, which was recognized as income from settlement and patent licensing in the three months ended March 31, 2007.

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

As described in the Summary of Significant Accounting Policies, Income from Settlement and Patent Licensing, we expect to recognize the payment received from Polycom and the associated deferred contingent legal costs paid in settlement and patent licensing in equal installments over a five-year period starting November 12, 2004. The payment from Polycom and its recognition in income from settlement and patent licensing may affect the comparability of the Company’s financial statements for periods before and after the recognition periods.

	Quarter Ended
	December 31, 2008			September 30, 2008				June 30, 2008		March 31, 2008
	(In thousands except per share data)
Total revenue	$	3,109		$	2,705		$	1,790		$	1,151
Cost of product revenue		551			720			565			359
Cost of services, maintenance and support revenue		646			584			603			519
Net loss	$	(231	)	$	(774	)	$	(1,612	)	$	(3,767	)
Net loss per share—Basic/Diluted	$	(0.01	)	$	(0.02	)	$	(0.05	)	$	(0.11	)
Weighted average shares—Basic/Diluted		34,568			34,561			34,547			34,532

	Quarter Ended
	December 31, 2007			September 30, 2007				June 30, 2007			March 31, 2007
	(In thousands except per share data)
Total revenue	$	1,914		$	1,751		$	5,898		$	2,392
Cost of product revenue		586			658			711			729
Cost of services, maintenance and support revenue		503			493			571			676
Net (loss) income	$	(3,693	)	$	(4,126	)	$	388		$	4,493
Net (loss) income per share—Basic/Diluted	$	(0.11	)	$	(0.12	)	$	0.01		$	0.13
Weighted average shares—Basic		34,448			34,379			34,230			34,101
Weighted average shares—Diluted		34,448			34,379			35,008			35,146

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Item 15(a)

AVISTAR COMMUNICATIONS CORPORATION AND SUBSIDIARY

SCHEDULE II—VALUATION AND QUALIFYING ACCOUNTS

	Balance at Beginning of Year		Additions Charged to Operations			Write-Offs			Balance at End of Year
	(In thousands)
Allowance for Doubtful Accounts
Year Ended:
December 31, 2008	$	24	$	4		$	(8	)	$	20
December 31, 2007		51		17			(44	)		24
December 31, 2006	$	121	$	(61	)	$	(9	)	$	51

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INDEX TO EXHIBITS

3.2		Restated Certificate of Incorporation (Filed as an exhibit to the Company’s Registration Statement on Form S-1 (File No. 333-39008) as declared effective by the Securities and Exchange Commission on August 16, 2000.)
3.3		Bylaws of Avistar Communications Corporation (Filed as an exhibit to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2004 filed with the Securities and Exchange Commission on March 28, 2005.)
4.1		Specimen Certificate evidencing shares of Common Stock (Filed as an exhibit to the Company’s Registration Statement on Form S-1 (File No. 333-39008) as declared effective by the Securities and Exchange Commission on August 16, 2000.)
10.1		1997 Stock Option Plan, as amended* (Filed as an exhibit to the Company’s Registration Statement on Form S-1 (File No. 333-39008) as declared effective by the Securities and Exchange Commission on August 16, 2000.)
10.1.1		1997 Stock Option Plan Form of Stock Option Agreement* (Filed as an exhibit to the Company’s Registration Statement on Form S-1 (File No. 333-39008) as declared effective by the Securities and Exchange Commission on August 16, 2000.)
10.2		2000 Stock Option Plan, as amended* (Filed as an exhibit to the Company’s Registration Statement on Form S-1 (File No. 333-39008) as declared effective by the Securities and Exchange Commission on August 16, 2000.)
10.3		2000 Director Option Plan, as amended* (Filed as an exhibit to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2005 filed with the Securities and Exchange Commission on April 28, 2006.)
10.4		Form of Director Option Agreement* (Filed as an exhibit to the Company’s Registration Statement on Form S-1 (File No. 333-39008) as declared effective by the Securities and Exchange Commission on August 16, 2000.)
10.5		2000 Employee Stock Purchase Program, as amended* (Filed as an exhibit to the Registrant’s Quarterly Report on Form 10-Q for the three months ended September 30, 2006 filed with the Securities and Exchange Commission on November 14, 2006.)
10.6		Form of Indemnification Agreement* (Filed as an exhibit to the Company’s Registration Statement on Form S-1 (File No. 333-39008) as declared effective by the Securities and Exchange Commission on August 16, 2000.)
10.7		Settlement Agreement and Release between the Registrant and R. Stephen Heinrichs dated April 26, 2001* (Filed as an exhibit to the Registrant’s Current Report on Form 8-K filed with the Securities and Exchange Commission on May 8, 2001.)
10.8		Lease Agreement among the Registrant and Crossroads Associates and Clocktower Associates dated December 1, 2006 (Filed as an exhibit to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2006 filed with the Securities and Exchange Commission on March 22, 2007.)
10.9		Common Stock Purchase Agreement by and among the Registrant and The Gerald J. Burnett and Marjorie J. Burnett Revocable Trust, Grady Burnett and Wendolyn Hearn dated October 15, 2003 (Filed as an exhibit to the Registrant’s Quarterly Report on Form 10-Q for the three months ended September 30, 2003 filed with the Securities and Exchange Commission on October 23, 2003.)
10.10		Stock Purchase Agreement among the Registrant, Fuller & Thaler Behavioral Finance Fund, Ltd. and Fuller & Thaler Avalanche Fund, L.P. dated March 23, 2004 (Filed as an exhibit to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2004 filed with the Securities and Exchange Commission on May 11, 2004.)
10.11		Settlement Agreement among the Registrant, Collaboration Properties, Inc. and Polycom, Inc. dated November 12, 2004 (Filed as an exhibit to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2004 filed with the Securities and Exchange Commission on March 28, 2005.)
10.12†		Patent Cross-License Agreement Among the Company, Collaboration Properties, Inc. and Polycom, Inc. dated November 12, 2004 (Filed as an exhibit to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2005 filed with the Securities and Exchange Commission on April 28, 2006.)
10.13†		Patent License Agreement dated May 15, 2006 among the Registrant, Collaboration Properties, Inc., Sony Corporation and Sony Computer Entertainment, Inc. (Filed as an exhibit to the Registrant’s Quarterly Report on Form 10-Q for the three months ended September 30, 2006 filed with the Securities and Exchange Commission on November 14, 2006.)
10.14†		Patent License Agreement dated February 15, 2007 by and among the Registrant, Collaboration Properties, Inc., Tandberg ASA, Tandberg Telecom AS, and Tandberg, Inc. (Filed on May 14, 2007 as an exhibit to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2007)

Table of Contents

10.15†		Patent License Agreement dated May 15, 2007 by and among the Registrant, Avistar Systems (UK) Limited, and Radvision LTD. (Filed on August 3, 2007 as an exhibit to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2007)
10.16		Employment Agreement between the Registrant and Simon B. Moss effective July 16, 2007. * (Filed on November 13, 2007 as an exhibit to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2007)
10.17		Amended and restated Security Agreement dated December 17, 2007 between the Registrant and JPMorganChase Bank, N.A. originally dated December 23, 2006. (Filed as an exhibit to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2007 filed with the Securities and Exchange Commission on March 31, 2008)
10.18		Amendment dated December 17, 2007 to the Revolving Credit Promissory Note issued by the Registrant in favor of JPMorgan originally dated December 23, 2006. (Filed as an exhibit to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2007 filed with the Securities and Exchange Commission on March 31, 2008)
10.19		Second amendment dated December 17, 2007 to the Revolving Credit Promissory Note issued by the Registrant in favor of JPMorgan originally dated December 23, 2006. (Filed as an exhibit to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2007 filed with the Securities and Exchange Commission on March 31, 2008)
10.20		Amendment dated December 17, 2007 to the Guaranty issued by Gerald J. Burnett and The Gerald J. Burnett and Marjorie J. Burnett Revocable Trust in favor of JPMorgan originally dated December 23, 2006. (Filed as an exhibit to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2007 filed with the Securities and Exchange Commission on March 31, 2008)
10.21		Convertible Note Purchase Agreement among the Company and the Purchasers named therein dated January 4, 2008 (Filed on January 9, 2008 as an exhibit to the Registrant’s Current Report on Form 8-K)
10.22		Security Agreement among the Company, Baldwin Enterprises, Inc., as Collateral Agent, and the Purchasers named therein dated January 4, 2008 (Filed on January 9, 2008 as an exhibit to the Registrant’s Current Report on Form 8-K)
10.23		Form of 4.5% Convertible Subordinated Secured Note Due 2010 (Filed on January 9, 2008 as an exhibit to the Registrant’s Current Report on Form 8-K)
10.24		Inter-creditor Agreement among the Purchasers of the 4.5% Convertible Subordinated Secured Notes Due 2010 dated January 4, 2008 (Filed on January 9, 2008 as an exhibit to the Registrant’s Current Report on Form 8-K)
10.25†		Licensed Works Agreement between Avistar Communications Corporation and International Business Machines Corporation dated September 8, 2008. (Filed as an exhibit to the Registrant’s Quarterly Report on Form 10-Q for the three months ended September 30, 2008 filed with the Securities and Exchange Commission on November 14, 2008.)
10.26†		Licensed Works Agreement Statement of Work between Avistar Communications Corporation and International Business Machines Corporation dated September 8, 2008. (Filed as an exhibit to the Registrant’s Quarterly Report on Form 10-Q for the three months ended September 30, 2008 filed with the Securities and Exchange Commission on November 14, 2008.)
10.27†		Patent License Agreement between Avistar Communications Corporation and International Business Machines Corporation dated September 9, 2008. (Filed as an exhibit to the Registrant’s Quarterly Report on Form 10-Q for the three months ended September 30, 2008 filed with the Securities and Exchange Commission on November 14, 2008.)
10.28		Amended and Restated Revolving Credit Promissory Note issued by the Registrant to JPMorgan Chase Bank, N.A. dated December 22, 2008
10.29		Facility Agreement between the Registrant and JPMorgan Chase Bank, N.A. dated December 22, 2008
10.30		Amended and Restated Collateral Agreement dated December 22, 2008 between the Registrant and JPMorgan Chase Bank, N.A. dated December 22, 2008
10.31		Second Amended and Restated Security Agreement between the Registrant and JPMorgan Chase Bank, N.A.
10.32		Amended and Restated Guaranty issued by Gerald J. Burnett and The Gerald J. Burnett and Marjorie J. Burnett Revocable Trust in favor of JPMorgan Chase Bank, N.A. dated December 22, 2008
10.33		Amended and Restated Form of Note Sale Agreement among Gerald J. Burnett, The Gerald J. Burnett and Marjorie J. Burnett Revocable Trust and JPMorgan Chase Bank, N.A.
10.34		Personal guarantee issued by Gerald J. Burnett in favor of Avistar Communications Corporation dated March 29, 2009
21.1		Subsidiaries of the Company
23.1		Consent of Independent Registered Public Accounting Firm: Burr, Pilger & Mayer LLP
24.1		Power of Attorney (see page 41)
31.1		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		Certification by the 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

*	Indicates management contract or compensatory plan or arrangement required to be filed an exhibit pursuant to Item 14(c) of Form 10-K.

†	Portions of the exhibit have been omitted pursuant to a request for confidential treatment and the omitted portions have been separately filed with the Commission.