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

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

Overview

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

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

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

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

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

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

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

· Implementing aggressive cost control measures structured to effectively align operations and to address Microsoft's requests for reexamination 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 47 on September 30, 2009; and

· Pursuing multiple distribution, services and technology partners.

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

On February 25, 2008 we announced that Microsoft Corporation had filed requests for reexamination of 24 of our 29 U.S. patents. Subsequently, Microsoft also filed requests for reexamination 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 reexamination and had rejected 19 of the requests in their entirety, and the majority of the arguments for one additional patent under reexamination. The USPTO thus agreed to reexamine, either in part or fully, 10 of our existing U.S. patents.

During 2008, Microsoft submitted five petitions for reconsideration of the USPTO's rejection of Microsoft's requests for reexamination. As of October 31, 2009 two of the Microsoft petitions have been denied. These denials cannot be appealed. Three other petitions by Microsoft are still pending.

As of October 31, 2009, three of the 10 patents being reexamined have been issued with certificates of reexamination. We have filed appeals with the USPTO Board of Patent Appeals and Interferences in six of the 10 patents under reexamination and a response to the latest rejection of the tenth patent under reexamination.

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

Critical Accounting Policies

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

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

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,
                                           2009                     2008              2009                    2008
Revenue:
Product                                            20 %                   48 %               47 %                    37 %
Licensing                                          25                     14                  8                      12
Services, maintenance and support                  55                     38                 45                      51
Total revenue                                     100                    100                100                     100
Costs and Expenses:
Cost of product revenue                            18                     27                 13                      29
Cost of services, maintenance and
support revenue                                    52                     22                 35                      30
Income from settlement and patent
licensing                                         (74 )                  (39 )              (46 )                   (56 )
Research and development                           62                     41                 40                      70
Sales and marketing                                44                     23                 29                      49
General and administrative                        120                     51                 60                      83
Total costs and expenses                          222                    125                131                     205
Loss from operations                             (122 )                  (25 )              (31 )                  (105 )
Other income (expense):
Interest income                                     -                      1                  -                       2
Other expense, net                                (10 )                   (5 )               (4 )                    (6 )
Total other expense, net                          (10 )                   (4 )               (4 )                    (4 )
Net loss                                         (132 )%                 (29 )%             (35 )%                 (109 )%

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

Total revenue decreased by $1.3 million or 47%, to $1.4 million for the three month period ended September 30, 2009, from $2.7 million for the three months ended September 30, 2008, primarily due to decrease in hardware sales revenue.

· Product revenue decreased by $1.0 million or 78%, to $289,000 for the three month period ended September 30, 2009 from $1.3 million for the three months ended September 30, 2008. This was primarily due to decline in hardware sales revenue in the quarter ended September 30, 2009 as the Company shifted to more software-only based products and solutions.

· Licensing revenue, relating to the licensing of our patent portfolio, remained relatively flat at $350,000 for the three months ended September 30, 2009 compared to $367,000 for the three months ended September 30, 2008.

· Services, maintenance and support revenue, which includes funded software development and maintenance and support, decreased by $235,000, or 23%, to $790,000 for the three months ended September 30, 2009, from $1.0 million for the three months ended September 30, 2008, due primarily to a decrease in revenue from maintenance contracts with existing customers in the quarter ended September 30, 2009.

For the three months ended September 30, 2009, revenue from three customers accounted for 86% of total revenue compared to four customers and 89% for the three months ended September 30, 2008. No other customer accounted for greater than 10% of total revenue in either period. The level of sales to any customer may vary from quarter to quarter. We expect that there will be significant customer concentration in future quarters. The loss of any one of those customers would have a materially adverse impact on our financial condition and operating results.

Costs and expenses

Cost of product revenue. Cost of product revenue decreased by $457,000 or 63%, to $263,000 for the three months ended September 30, 2009 from $720,000 for the three months ended September 30, 2008. The decrease was mainly attributable to lower hardware product sales in the quarter ended September 30, 2009 which carried a higher cost than software sales.

Cost of services, maintenance and support revenue. Cost of services, maintenance and support revenue increased by $153,000, or 26%, to $737,000 for the three months ended September 30, 2009, from $584,000 for the three months ended September 30, 2008, primarily due to an increase in software implementation and enhancement services for customers in the quarter ended September 30, 2009 compared to the same period in 2008.

Income from settlement and patent licensing. Income from settlement and patent licensing was $1.1 million for the three months ended September 30, 2009 and 2008, 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 $231,000, or 21%, to $891,000 for the three months ended September 30, 2009 from $1.1 million for the three months ended September 30, 2008. This decrease was primarily due to greater allocation of engineering employee and external labor expenses to cost of services, maintenance and support revenue associated with an increased number of software implementation and enhancement service deliveries and reduction in overhead expenses in the quarter ended September 30, 2009.

Sales and marketing. Sales and marketing expenses remained relatively flat at $629,000 for the three months ended September 30, 2009 compared to $634,000 for the same period in 2008.

General and administrative. General and administrative expenses increased by $340,000, or 25% to $1.7 million for the three months ended September 30, 2009, from $1.4 million for the three months ended September 30, 2008. The increase was due primarily to the severance pay of $473,000 for Simon Moss, former Chief Executive Officer, and other former executives, and legal expense of $311,000 associated with patent and licensing related activities, offset by a decrease in personnel and personnel related expenses and cost optimization efforts.

Other income (expense)

Interest income. Interest income was nominal for the three months ended September 30, 2009, compared to $15,000 for the same period in 2008, primarily due to lower average outstanding balance of cash and cash equivalents that earned interest in the three months ended September 30, 2009 compared to the same period in 2008.

Other expense, net. Other expense, net, increased by $20,000, or 16%, to $142,000 for the three months ended September 30, 2009, from $122,000 for the three months ended September 30, 2008, primarily due to foreign corporate tax expense associated with our wholly-owned subsidiary, Avistar Systems U.K. Limited, or ASUK.

COMPARISON OF THE NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008

Total revenue increased by $1.3 million or 23%, to $6.9 million for the nine month period ended September 30, 2009, from $5.6 million for the nine months ended September 30, 2008, primarily due to increase in software product revenue.

· Product revenue increased by $1.1 million or 53%, to $3.2 million for the nine month period ended September 30, 2009 from $2.1 million for the nine months ended September 30, 2008. The increase was due primarily to an increase in software product revenue from IBM and Deutsche Bank, partially offset by decrease in hardware sales revenue, in the nine months ended September 30, 2009.

· Licensing revenue, relating to the licensing of our patent portfolio, decreased by $102,000 or 15%, to $572,000 for the nine months ended September 30, 2009 from $674,000 for the nine months ended September 30, 2008, mainly due to a decline in the ongoing royalty revenue from Sony.

· Services, maintenance and support revenue, which includes funded software development and maintenance and support, increased by $273,000, or 10%, to $3.1 million for the nine months ended September 30, 2009, from $2.9 million for the nine months ended September 30, 2008, due primarily to increase in revenue from software implementation and enhancement services and professional on-site services provided to existing customers, offset by a decrease in revenue from maintenance contracts with existing customers in the nine months ended September 30, 2009.

For the nine months ended September 30, 2009, revenue from three customers accounted for 71% of total revenue compared to three customers and 81% for the nine months ended September 30, 2008. No other customer accounted for greater than 10% of total revenue. The level of sales to any customer may vary from quarter to quarter. We expect that there will be significant customer concentration in future quarters. The loss of any one of those customers would have a materially adverse impact on our financial condition and operating results.

Costs and expenses

Cost of product revenue. Cost of product revenue decreased by $718,000 or 44%, to $926,000 for the nine months ended September 30, 2009 from $1.6 million for the nine months ended September 30, 2008. The decrease was mainly attributable to lower hardware product sales which carried a higher cost than software sales, offset by an increase of $95,000 in stock based compensation expense in the nine months ended September 30, 2009.

Cost of services, maintenance and support revenue. Cost of services, maintenance and support revenue increased by $694,000, or 41%, to $2.4 million for the nine months ended September 30, 2009, from $1.7 million for the nine months ended September 30, 2008, primarily due to an increase in software implementation and enhancement services for customers in the nine months ended September 30, 2009 compared to the same period in 2008.

Income from settlement and patent licensing. Income from settlement and patent licensing was $3.2 million for the nine months ended September 30, 2009 and 2008, 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 $1.2 million, or 29%, to $2.8 million for the nine months ended September 30, 2009 from $3.9 million for the nine months ended September 30, 2008. This decrease was primarily due to a reduction in personnel and personnel related expenses, a greater allocation of engineering employee and external labor expenses to cost of services, maintenance and support revenue associated with an increase in software implementation and enhancement service deliveries in the nine months ended September 30, 2009, partially offset by an increase of $124,000 in stock based compensation expense.

Sales and marketing. Sales and marketing expenses decreased by $760,000, or 28%, to $2.0 million for the nine months ended September 30, 2009, from $2.8 million for the nine months ended September 30, 2008. The decrease was due primarily to a reduction in personnel and personnel related expenses and cost optimization efforts, partially offset by an increase of $179,000 in stock based compensation expense.

General and administrative. General and administrative expenses decreased by $540,000, or 12% to $4.1 million for the nine months ended September 30, 2009, from $4.7 million for the nine months ended September 30, 2008. The decrease was due primarily to an overall decrease in personnel and personnel related expenses and the ongoing cost optimization efforts, partially offset by severance expenses and an increase of $75,000 in stock based compensation expense, in the nine months ended September 30, 2009.

Other income (expense)

Interest income. Interest income decreased by $74,000, or 90%, to $8,000 for the nine months ended September 30, 2009, from $82,000 for the nine months ended September 30, 2008, primarily due to both a decrease in interest rates and a decrease in the average outstanding balance of cash and cash equivalents that earned interest in the nine months ended September 30, 2009 compared to the same period in 2008.

Other expense, net. Other expense, net, decreased by $6,000, or 2%, to $329,000 for the nine months ended September 30, 2009, from $335,000 for the nine months ended September 30, 2008, primarily due to a decrease in the interest expense resulting from lower average convertible debt and line of credit balances outstanding during the nine months ended September 30, 2009.

Liquidity and Capital Resources

We had cash and cash equivalents of $382,000 and $4.9 million as of September 30, 2009 and December 31, 2008, respectively. For the nine months ended September 30, 2009, we had a net decrease in cash and cash equivalents of $4.5 million. The net cash used by operations of $4.3 million for the nine months ended September 30, 2009 resulted primarily from the net loss of $2.5 million, a decrease in deferred income from settlement and patent licensing of $4.1 million, a decrease in deferred services revenue and customer deposits of $2.5 million, offset by a decrease in accounts receivable of $1.5 million, a decrease in inventory of $171,000, a decrease in deferred settlement and patent licensing costs of $955,000 and non-cash expenses of $1.6 million. The net cash used in investing activities of $47,000 for the nine months ended September 30, 2009 was related to purchases of equipment. The net cash used in financing activities of $176,000 for the nine months ended September 30, 2009 related primarily to payments made on our line of credit of $5.0 million, offset by $4.7 million of borrowings on our line of credit and $173,000 in proceeds from the issuance of common stock under employee stock option and stock purchase plans.

At September 30, 2009, we had approximately $2.3 million in minimum commitments under non-cancelable operating leases net of sublease proceeds.

On December 22, 2008, we renewed our Revolving Credit and Promissory Note and a Security Agreement with a financial institution to borrow up to $10.0 million under a revolving line of credit. The agreement includes a first priority security interest in all of our assets. Gerald Burnett, our Chairman, provided a collateralized guarantee to the financial institution, assuring payment of our obligations under the agreement and as a consequence, there are no restrictive covenants, allowing us greater access to the full amount of the facility. In addition to the guarantee provided to the financial institution, on March 29, 2009, Dr. Burnett provided a personal guarantee to us assuring us a line of credit of $10.0 million with the same terms and mechanisms as the existing revolving line of credit in the event the existing revolving line of credit from the financial institution was unavailable for any reason during the period from its termination on December 21, 2009 to March 31, 2010. The line of credit requires monthly interest-only payments based on Adjusted LIBOR plus 1.25% or Prime Rate plus 1.25%. We elected Prime Rate plus 1.25% or 4.5% at September 30, 2009 and December 31, 2008. We repaid $5.0 million and borrowed $4.7 million under the revolving line of credit for the nine months ended September 30, 2009 and have a balance of $6.7 million outstanding as of September 30, 2009. The Revolving Credit and Promissory Note matures on December 21, 2009, and is subject to annual renewal with the consent of the Company and the lender.

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

As of September 30, 2009, we had no material off-balance sheet arrangements, other than the operating leases described above. We enter into indemnification . . .