AVISTAR COMMUNICATIONS CORPORATION AND SUBSIDIARY

 

CONDENSED CONSOLIDATED BALANCE SHEETS

 

as of September 30, 2008 and December 31, 2007

 

(in thousands, except share and per share data)

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

 

 

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

 

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for the nine months ended September 30, 2008 and 2007

 

(in thousands)

 

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

 

 

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

 

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(UNAUDITED)

 

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

 

Business

 

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

 

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

 

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

 

Basis of Presentation

 

The unaudited condensed consolidated balance sheet as of September 30, 2008, the unaudited condensed consolidated results of operations for the three and nine months ended September 30, 2008 and 2007 and the unaudited condensed consolidated cash flows for the nine months ended September 30, 2008 and 2007 present the consolidated financial position of Avistar and ASUK after the elimination of all intercompany accounts and transactions. The unaudited condensed consolidated balance sheet of Avistar as of December 31, 2007 was derived from audited financial statements, but does not contain all disclosures required by accounting principles generally accepted in the United States of America, and certain information and footnote disclosures normally included have been condensed or omitted pursuant to the rules and regulations of the SEC.  The consolidated results are referred to, collectively, as those of Avistar or the Company in these notes.

 

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

 

The Company’s fiscal year end is December 31.

 

Risks and Uncertainties

 

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

 

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

 

2. Summary of Significant Accounting Policies

 

Unaudited Interim Financial Information

 

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

 

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

 

Use of Estimates

 

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

 

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Cash and Cash Equivalents and Short and Long-term Investments

 

The Company considers all investment instruments purchased with an original maturity of three months or less to be cash equivalents. Investment securities with original or remaining maturities of more than three months but less than one year are considered short-term investments. Auction rate securities with original or remaining maturities of more than three months are considered short-term investments even if they are subject to re-pricing within three months. The Company was not invested in any auction rate securities as of September 30, 2008. Investment securities held with the intent to reinvest or hold for longer than a year, or with remaining maturities of one year or more, are considered long-term investments. The Company’s cash equivalents at September 30, 2008 and December 31, 2007 consisted of money market funds and short-term commercial paper with original maturities of three months or less, and are therefore classified as cash and cash equivalents in the accompanying balance sheets.

 

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

 

See Note 3 for further information on fair value.

 

 

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

 

Inventories

 

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

 

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

 

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Revenue Recognition and Deferred Revenue

 

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

 

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

 

·

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

 

·

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

 

·

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

 

·

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

 

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

 

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

 

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

 

The Company recognizes service revenue from software development contracts in accordance with SOP 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts. Product and implementation revenue related to contracts for software development is recognized using the percentage of completion method, when all of the following conditions are met: a contract exists with the customer at a fixed price, the Company expects to fulfill all of its material contractual obligations to the customer for each deliverable of the contract, a reasonable estimate of the costs to complete the contract can be made, and collection of the receivable is probable. The amounts billed to customers in excess of revenues recognized to date are deferred and recorded as deferred revenue and customer deposits in the accompanying balance sheets. Assumptions used for recording revenue and earnings are adjusted in the period of change to reflect revisions in contract value and estimated costs to complete the contract. Any anticipated losses on contracts in progress are charged to earnings when identified.

 

The Company recognizes revenue from the licensing of its intellectual property portfolio according to SOP 97-2, based on the terms of the royalty, partnership and cross-licensing agreements involved. In the event that a license to the Company’s intellectual property is granted after the commencement of litigation proceedings between the Company and the licensee, the proceeds of such transaction are recognized as licensing revenue only if sufficient historical evidence exists for the determination of fair value of the licensed patents to support the segregation of the proceeds between a gain on litigation settlement and patent license revenues consistent with Financial Accounting Standards Board (FASB) Concepts Statement No. 6, Elements of Financial Statements (CON 6). As of September 30, 2008, these criteria for recognizing license revenue following the commencement of litigation had not been met.

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

 

On September 8, 2008 and on September 9, 2008, Avistar entered into a Licensed Works Agreement, Licensed Works Agreement Statement of Work and a Patent License Agreement with International Business Machines Corporation, or IBM, under which Avistar agreed to integrate our bandwidth management technology and related intellectual property into future Lotus Unified Communications offerings by IBM, and to provide maintenance support services. An initial cash payment of $3.0 million was made by IBM to Avistar on November 7, 2008.  Avistar expects IBM to make two additional non-refundable payments of $1.5 million, each associated with scheduled phases of delivery.  IBM has agreed to make future royalty payments to Avistar equal to two percent of the world-wide net revenue derived by IBM from Lotus Unified Communications products sold, and maintenance payments received from existing customers, which incorporate Avistar’s technology.  The agreements have a five year term and are non-cancelable except for material default by either party.  The agreements also convey to IBM a non-exclusive world-wide license to Avistar’s patent portfolio existing at the time of the agreements and for all subsequent patents issued with an effective filing date of up to five years from the date of the agreements.  The agreements also provide for a release of each party for any and all claims of past infringement.

 

The Company has determined the value of maintenance based on VSOE, and allocated the residual portion of the initial $6.0 million to the integration project.  The residual portion is being recognized under the percentage of completion method and the maintenance revenue will be recognized over the future maintenance service period.  As the Company believes there are no future deliverables associated with the intellectual property patent licenses, no additional provision for this element has been made.  For the quarter ended September 30, 2008, the Company has recognized $376,000 in product revenue and $113,000 in is service revenue. The remaining $4.8 million is expected to be recognized in product revenue under the percentage of completion method over the projected development time of 15 months.

 

 

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

 

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

 

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

 

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

 

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Stock-Based Compensation

 

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

 

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

 

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

 

Valuation Assumptions

 

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

 

Employee Stock Option Plan

 

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

 

 

Employee Stock Purchase Plan

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

 

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

 

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3. Fair Value Measurement

 

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

 

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

 

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

 

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

 

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

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

4. Related Party Transactions

 

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

 

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

 

5. Net (Loss) Income Per Share

 

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

 

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

 

 

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

 

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

 

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6. Income Taxes

 

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

 

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

 

The Company accounts for uncertain tax positions according to the provisions of FASB Financial Accounting Standards Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48).   FIN 48 contains a two-step approach for recognizing and measuring uncertain tax positions accounted for in accordance with SFAS 109. Tax positions are evaluated for recognition by determining if the weight of available evidence indicates that it’s probable that the position will be sustained on audit, including resolution of related appeals or litigation. Tax benefits are then measured as the largest amount which is more than 50% likely of being realized upon ultimate settlement. The Company considers many factors when evaluating and estimating tax positions and tax benefits, which may require periodic adjustments and which may not accurately anticipate actual outcomes.  No material changes have occurred in the Company’s tax positions taken as of December 31, 2007 during the nine months ended September 30, 2008.

 

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

 

7. Segment Reporting

 

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

 

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

 

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

 

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8.  Notes Payable

 

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

 

9. Commitments and Contingencies

 

 

Facilities leases

 

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

 

Three Months Ending  December 31,		Amount
2008		$	146
Year Ending December 31,
2009			581
2010			596
2011			705
2012			221
thereafter			173
Total future minimum lease payments		$	2,422

 

Software Indemnifications

 

Avistar enters into standard indemnification agreements in the ordinary course of business. Pursuant to these agreements, Avistar indemnifies, holds harmless, and agrees to reimburse the indemnified party for losses suffered or incurred by the indemnified party, generally Avistar’s business partners or customers, in connection with any patent, copyright or other intellectual property infringement claim by any third party with respect to its products. The term of these indemnification agreements is generally perpetual. The maximum potential amount of future payments Avistar could be required to make under these indemnification agreements is generally limited to the cost of products purchased per customer, but may be material when customer purchases since inception are considered in aggregate. Avistar has never incurred costs to defend lawsuits or settle claims related to these indemnification agreements. Accordingly, Avistar has no liabilities recorded for these agreements as of September 30, 2008.

 

10. Recent Accounting Pronouncements

 

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

 

 

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

 

11. Other Matters

 

 

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

 

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

 

Overview

 

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

 

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

 

Since inception, we have recognized the innovative value of our research and development efforts, and have invested in securing protection for these innovations through domestic and foreign patent applications and issuance. As of September 30, 2008, we held 80 U.S. and foreign patents, which we look to license to others in the collaboration technology marketplace.

 

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

 

·

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

 

·

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

 

·

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

 

·

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

 

·

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

 

·

Pursuing multiple distribution, services and technology partners.

 

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

 

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

 

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

 

 

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Critical Accounting Policies

 

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

 

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

 

·

Revenue recognition;

 

·

Income from settlement and patent licensing;

 

·

Stock-based compensation;

 

·

Valuation of accounts receivable; and

 

·

Valuation of inventories.

 

Revenue Recognition

 

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

 

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

 

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

 

·

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

 

·

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

 

·

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

 

·

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

 

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

 

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

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

 

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

 

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

 

On September 8, 2008 and on September 9, 2008, we entered into a Licensed Works Agreement, Licensed Works Agreement Statement of Work and a Patent License Agreement with International Business Machines Corporation, or IBM, under which we agreed to integrate our bandwidth management technology and related intellectual property into future Lotus Unified Communications offerings by IBM, and to provide maintenance support services. An initial cash payment of $3.0 million was made by IBM to us on November 7, 2008.  We expect IBM to make two additional non-refundable payments of $1.5 million, each associated with scheduled phases of delivery.  IBM has agreed to make future royalty payments to us equal to two percent of the world-wide net revenue derived by IBM from Lotus Unified Communications products sold, and maintenance payments received from existing customers, which incorporate our technology.  The agreements have a five year term and are non-cancelable except for material default by either party.  The agreements also convey to IBM a non-exclusive world-wide license to our patent portfolio existing at the time of the agreements and for all subsequent patents issued with an effective filing date of up to five years from the date of the agreements.  The agreements also provide for a release of each party for any and all claims of past infringement.

 

We have determined the value of maintenance based on VSOE, and allocated the residual portion of the initial $6.0 million to the integration project.  The residual portion is being recognized under the percentage of completion method and the maintenance revenue will be recognized over the future maintenance service period.  We believe there are no future deliverables associated with the intellectual property patent licenses, no additional provision for this element has been made.  For the quarter ended September 30, 2008, we recognized $376,000 in product revenue and $113,000 is in service revenue. The remaining $4.8 million is expected to be recognized in product revenue under the percentage of completion method over the projected development time of 15 months. The estimate of current period percentage of completion requires significant management judgment and is subject to updates in future periods until the project is complete.

 

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

 

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

 

 

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.

 

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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 valuation assumptions such as stock price, volatility and expected option terms, as well as expected option forfeiture rates. There is little experience or guidance with respect to developing these assumptions and models. SFAS No. 123R requires the recognition of the fair value of stock compensation in net income (loss). Refer to Note 2 — Stock-Based Compensation in the Notes to our Condensed Consolidated Financial Statements included elsewhere in this Quarterly Report on Form 10-Q for more information.

 

Valuation of Accounts Receivable

 

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

 

Valuation of Inventories

 

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

 

Results of Operations

 

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

 

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

 

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

 

Revenue

 

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

 

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

 

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

 

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

 

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

 

Costs and Expenses

 

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

 

Cost of services, maintenance and support revenue. Cost of services, maintenance and support revenue increased by $91,000, or 18%, to $584,000 for the three months ended September 30, 2008, from $493,000 for the three months ended September 30, 2007. This increase in cost of services revenue was due to the associated freight on higher product sales for the three months ended September 30, 2008.

 

Income from settlement and patent licensing. Income from settlement and patent licensing was $1.1 million for the three month periods ended September 30, 2008 and September 30, 2007, reflecting the amortization of the net proceeds from the November 2004 Polycom settlement and cross-license agreement over a five year period, beginning in November 2004 and ending in November 2009.

 

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

 

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

 

General and administrative. General and administrative expenses decreased by $848,000, or 38% to $1.4 million for the three months ended September 30, 2008, from $2.2 million for the three months ended September 30, 2007. The decrease was due primarily to a reduction in legal expense associated with patent prosecution and filing expenses, and a decrease in personnel and personnel related expenses.

 

Other Income

 

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

 

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

 

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

Revenue

 

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

 

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

 

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

 

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

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

Costs and Expenses

 

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

 

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

 

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

 

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

 

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

 

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

 

Other income

 

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

 

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

 

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Liquidity and Capital Resources

 

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

 

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

 

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

 

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

 

Three Months Ending  December 31,		Amount
2008		$	146
Year Ending December 31,
2009			581
2010			596
2011			705
2012			221
thereafter			173
Total future minimum lease payments		$	2,422

 

 As of September 30, 2008, we had no material off-balance sheet arrangements, other than the operating leases described in the contractual obligations table above.   We enter into indemnification provisions under agreements with other companies in our ordinary course of business, typically with our contractors, customers, landlords and our investors. Under these provisions, we generally indemnify and hold harmless the indemnified party for losses suffered or incurred by the indemnified party as a result of our activities or, in some cases, as a result of the indemnified party's activities under the agreement. These indemnification provisions generally survive termination of the underlying agreement. The maximum potential amount of future payments we could be required to make under these indemnification provisions is generally unlimited. As of September 30, 2008, we have not incurred material costs to defend lawsuits or settle claims related to these indemnifications agreements and therefore, we have no liabilities recorded for these agreements as of September 30, 2008.

 

Due to the implementation of aggressive cost control measures structured to effectively align operations to predictable revenues, as discussed in Item 1A. Risk Factors in this Form 10Q, we currently believe that our existing cash and cash equivalents balance and line of credit will provide us with sufficient funds to finance our operations for the next 12 months. We intend to continue to invest in the development of new products and enhancements to our existing products. Our future liquidity and capital requirements will depend upon numerous factors, including without limitation, general economic conditions and conditions in the financial services industry in particular, the level and timing of product, services and patent licensing revenues and income, the costs and timing of our product development efforts and the success of these development efforts, the costs and timing of our sales, partnering and marketing activities, the extent to which our existing and new products gain market acceptance, competing technological and market developments, and the costs involved in maintaining, defending and enforcing patent claims and other intellectual property rights, all of which may impact our ability to achieve and maintain profitability or generate positive cash flows.

 

Recent Accounting Pronouncements

 

 

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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. We are currently evaluating the impact of adopting the provisions EITF 07-01.

 

 

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

 

 

 

Exhibit No.		Description
10.21+		Licensed Works Agreement between Avistar Communications Corporation and International Business Machines Corporation dated September 8, 2008.
10.22+		Licensed Works Agreement Statement of Work between Avistar Communications Corporation and International Business Machines Corporation dated September 8, 2008.
10.23+		Patent License Agreement between Avistar Communications Corporation and International Business Machines Corporation dated September 9, 2008
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.
32.1		Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

_______________________________________

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

 

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Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized, on the 14th day of November 2008.

	AVISTAR COMMUNICATIONS CORPORATION
	By:	/s/ SIMON B. MOSS
		Simon B. Moss
		Chief Executive Officer
		(Principal Executive Officer)
	By:	/s/ ROBERT J. HABIG
		Robert J. Habig
		Chief Financial Officer
		(Principal Financial and Accounting Officer)

 

 

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Exhibit No.		Description
10.21+		Licensed Works Agreement between Avistar Communications Corporation and International Business Machines Corporation dated September 8, 2008.
10.22+		Licensed Works Agreement Statement of Work between Avistar Communications Corporation and International Business Machines Corporation dated September 8, 2008.
10.23+		Patent License Agreement between Avistar Communications Corporation and International Business Machines Corporation dated September 9, 2008
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.
32.1		Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

_______________________________________